Use these links to rapidly review the documentTABLE OF CONTENTSMAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
o TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 1-6639
MAGELLAN HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)
Delaware |
| |
(State or other jurisdiction of | (I.R.S. Employer | |
16 Munson Road, Farmington, Connecticut | 06032 | |
(Address of principal executive offices) | (Zip Code) |
Registrant'sRegistrant’s telephone number, including area code:(860) 507-1900
Securities registered pursuant to Section 12(b) of the Act:None.
Securities registered pursuant to Section 12(g) of the Act: Ordinary Common Stock($par value ($0.01 per share par value)share).
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 twelve 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 ýx No o
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'sregistrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ox No ýo
The aggregate market value of the pre-petition common stock held by non-affiliates of the registrant as of June 30, 20032004 (the last business day of the registrant'sregistrant’s most recently completed second fiscal quarter) was approximately $1.4$899 million.
The number of shares of reorganized Magellan Health Services, Inc.'s’s Ordinary Common Stock and Multi-Vote Common Stock outstanding as of March 4, 2004February 28, 2005 was 26,900,26826,865,166 and 8,469,846,8,505,600, respectively.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ýx No o
DOCUMENTS INCORPORATED BY REFERENCE
None.Portions of the definitive proxy statement for the 2005 Annual Meeting of Shareholders are incorporated by reference.
MAGELLAN HEALTH SERVICES, INC.
REPORT ON FORM 10-K
For the Fiscal Year Ended December 31, 20032004
Table of Contents
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Management’s Discussion and Analysis of Financial Condition and | 40 | ||||
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Changes in and Disagreements with Accountants on Accounting and | 68 | ||||
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Item 10. | Directors and Executive Officers of the Registrant | ||||
Item 11. | Executive Compensation | ||||
Item 12. | Security Ownership of Certain Beneficial Owners and Management and | ||||
Item 13. | Certain Relationships and Related Transactions | ||||
Item 14. | Principal Accountant Fees and Services | ||||
Exhibits, Financial Statement Schedule and | 71 | ||||
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This Form 10-K includes "forward-looking statements"“forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"“Exchange Act”). Although the Company believes that its plans, intentions and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such plans, intentions or expectations will be achieved. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements are set forth under the heading "Cautionary Statements"“Cautionary Statements” in Item 1 and elsewhere in this Form 10-K. When used in this Form 10-K, the words "estimate", "anticipate", "expect", "believe", "should"“estimate,” “anticipate,” “expect,” “believe,” “should” and similar expressions are intended to be forward-looking statements.
Magellan Health Services, Inc. ("Magellan"(“Magellan”) was incorporated in 1969 under the laws of the State of Delaware. The Company'sCompany’s executive offices are located at 16 Munson Road, Farmington, Connecticut 06032, and its telephone number at that location is (860) 507-1900.
Magellan, directly and through its subsidiaries (collectively, the "Company"“Company”) coordinates and manages the delivery of behavioral healthcare treatment services that are provided through its contracted network of third-party treatment providers, which includes psychiatrists, psychologists, other behavioral health professionals, psychiatric hospitals, residential treatment centers and other treatment facilities. See "Business—“Business—Provider Network"Network” for further discussion of the Company'sCompany’s managed behavioral healthcare network. The treatment services provided through the Company'sCompany’s provider network include outpatient programs (such as counseling or therapy), intermediate care programs (such as intensive outpatient programs and partial hospitalization services), inpatient treatment and crisis intervention services. The Company, however, generally does not directly provide, or own any provider of, treatment services. The Company provides its management services primarily through: (i) risk-based products, where the Company assumes all or a portion of the responsibility for the cost of providing treatment services in exchange for a fixed per member per month fee, (ii) administrative services only ("ASO"(“ASO”) products, where the Company provides services such as utilization review, claims administration and/or provider network management but does not assume responsibility for the cost of the treatment services, (iii) employee assistance programs ("EAPs"(“EAPs”) and (iv) products whichthat combine features of some or all of the Company'sCompany’s risk-based, ASO or EAP products. At December 31, 2003,2004, the Company managed the behavioral healthcare benefits of approximately 58.657.1 million individuals.
In May 2003, the Company'sCompany’s board of directors approved a change in the Company'sCompany’s fiscal year. Instead of a fiscal year ending on September 30, the Company has adopted a fiscal year that coincides with the calendar year, effective December 31, 2002. On August 12, 2003, the Company filed with the Securities and Exchange Commission ("SEC"(“SEC”) a Transition Report on Form 10-K for the three-month period ended December 31, 2002. Throughout this Report on Form 10-K, references to the Company'sCompany’s historical financial information prior to December 31, 2002 will refer to the Company'sCompany’s former fiscal year end of September 30. For example, fiscal years 2001 andyear 2002 correspondcorresponds to the twelve-month periodsperiod ended September 30, 20012002, and 2002, respectively. Referencesreferences to fiscal 2003 and 2004 relate to the Company'sCompany’s fiscal yearyears ended December 31, 2003.2003 and 2004, respectively.
On January 5, 2004 (the "Effective Date"“Effective Date”), Magellan and 88 of its subsidiaries consummated their Third Joint Amended Plan of Reorganization, as modified and confirmed (the "Plan"“Plan”), under
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chapter 11
of title 11 of the United States Bankruptcy Code (the "Bankruptcy Code"“Bankruptcy Code”), which had been confirmed by order of the United States Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"“Bankruptcy Court”) on October 8, 2003, and accordingly the Plan became fully effective and the companies emerged from the protection of their chapter 11 proceedings. The cash and other distributions to which the Company’s former creditors and stockholders became entitled under the Plan were made on the Effective Date or shortly thereafter, except that distributions in respect of certain disputed claims were reserved as of the Effective Date, to be made upon resolution of the disputed claims. As discussed below, all but an immaterial portion of such disputed claims were resolved and the required distributions were completed during 2004. Magellan and these subsidiaries had filed voluntary petitions for relief under the Bankruptcy Code in the Bankruptcy Court on March 11, 2003.
The following is a summary of the transactions which became effective on the Effective Date pursuant to or in connection with the consummation of the Plan. The distributions to which the Company'sCompany’s former creditors and shareholders became entitled under the Plan were made by the Company on the Effective Date or were disbursed in accordance with the Plan soon thereafter, except for certain immaterial distributions that were subsequently made or will be made in the future as provided for by the Plan upon certain conditions being satisfied. This summary only highlights certain of the substantive provisions of the Plan and the documents implementing the Plan and is qualified in its entirety by reference to (i) the full text of the Plan, a copy of which was filed as Exhibit 2(a) to Magellan'sMagellan’s Quarterly Report on Form 10-Q filed with the SEC on August 19, 2003, as first supplemented by the modification filed as Exhibit 99.2 to Magellan'sMagellan’s Current Report on Form 8-K filed with the SEC on September 30, 2003 and further supplemented by the modification filed as Exhibit 2.3 to Magellan'sMagellan’s Current Report on Form 8-K filed with the SEC on October 9, 2003 and as to be implemented pursuant to the confirmation order, a copy of which was filed as Exhibit 2.4 to Magellan'sMagellan’s Current Report on Form 8-K filed with the SEC on October 9, 2003, and (ii) the implementing documents, which are referred to below in this summary, filed as Exhibits 2.2 –- 2.15 to Magellan'sMagellan’s Current Report on Form 8-K filed with the SEC on January 6, 2004, and as amended in certain instances by Magellan'sMagellan’s Current Reports on Form 8-K and Form 8-K/A filed with the SEC on January 7, 2004.
Giving effect to the Plan, Magellan and its subsidiaries continued, in their previous organizational form, to conduct their business as previously conducted, with the same assets in all material respects (except for cash to be distributed under the Plan to former creditors of the Company), but the Company was recapitalized. Specifically, the Company'sCompany’s secured bank loans, as existing before the Effective Date, were paid in full, and other then existingthen-existing indebtedness (i.e., two classes of notes and general unsecured creditor claims) and the then existingthen-existing equity interests in Magellan were cancelled as of the Effective Date in exchange for the distributions provided for by the Plan, as further described below, all as of the Effective Date.
On the Effective Date, the Company entered into a credit agreement with Deutsche Bank, as lender and administrative agent, and other lenders providing for a $100.0 million term loan, an $80.0 million letter of credit facility and a $50.0 million revolving credit facility (collectively, the "Credit Agreement").facility. The interest rate on term loan and revolving credit borrowings will fluctuatefluctuates, and will beoriginally was at a rate that was equal to the higher of (i) the prime rate established by Deutsche Bank or (ii) one-half of one percent in excess of the overnight "federal funds"“federal funds” rate, as from time to time in effect, plus in either case two and one-half percent per year, subject to the Company'sCompany’s election to have interest calculated based on the "Eurodollar rate"“Eurodollar rate” offered by Deutsche Bank plus three and one-half percent per year.year (see discussion of credit agreement amendment below). The interest rate on letter of credit-related borrowings will bewas fixed at 3.5 percent. However, in each case the interest rate could be reduced upon achievement of certain conditions. Borrowings under the Credit Agreementcredit agreement will mature on August 15, 2008 and certain quarterly principal payments on the term loan are also required. The Credit Agreement isMagellan’s obligations under the credit agreement are guaranteed by substantially all of the subsidiaries of Magellan and isare secured by substantially all of the assets of Magellan and the subsidiary
guarantors. TheOn the Effective Date, in accordance with the Plan, the proceeds of the term loan, together with other existing funds, were used on the Effective Date to repay in full in accordance with the Plan the Company'sCompany’s senior secured bank indebtedness under its previous credit agreement (the "Old“Old Credit Agreement"Agreement”) of approximately $161 million, to make other cash payments contemplated by the Plan, to pay fees and expenses related to the chapter 11 cases, and
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for general working capital purposes. In addition, the letter of credit facility has been utilized to back letters of credit outstanding on the Effective Date and to provide additional letters of credit when needed for the Company'sCompany’s business. In September 2004, the Company reduced the letter of credit facility from $80.0 million to $50.0 million. Also, in October 2004 the credit agreement was amended to reduce the annual interest rate on borrowings under the term loan facility and the letter of credit facility, each by 1.25 percent. This credit agreement as initially entered into and as amended is referred to hereafter as the “Credit Agreement.” For a further discussion of the Credit Agreement, see Note 7—"“Long-Term Debt and Capital Lease Obligations"Obligations” to the audited consolidated financial statements set forth elsewhere herein.
As of the Effective Date, in satisfaction of the $250$250.0 million of principal owed on the 9.375% senior notes due 2007 (the "Old“Old Senior Notes"Notes”) and all accrued and unpaid interest thereon, the Company issued to the holders of such notes approximately $233.5 million in original principal amount of Series A notes of a new issue of senior notes due November 15, 2008 (the "Series“Series A Notes",Notes,” together with the Series B Notes (see below), the "Senior Notes"“Senior Notes”) and made a cash payment of approximately $46.1 million. The terms of the Senior Notes are substantially similar to those of the Old Senior Notes, except that they mature on November 15, 2008. For a further discussion of the Senior Notes, see Note 7—"“Long-Term Debt and Capital Lease Obligations"Obligations” to the audited consolidated financial statements set forth elsewhere herein.
Under the Plan, holders of the Company's previousCompany’s previously outstanding 9% Senior Subordinated Notes due 2008 in the principal amount of $625.0 million (the "Old“Old Subordinated Notes"Notes”) and holders of general unsecured creditor claims, (otherother than claims on the Old Senior Notes and Old Subordinated Notes) ("Notes (“Other GUCs"GUCs”), were to receive in the aggregate approximately 97 percent of the Ordinary Common Stock par value $0.01 per share (“Ordinary Common Stock”) (or approximately 22.3 million shares) of the reorganized Company (before giving effect to the Cash-Out Elections discussed below). The actual number of shares allocated between these two classes of creditors, as well as the number of shares allocated to each individual creditor in such creditor classes, is dependentwas made, in accordance with the Plan, based upon the final,estimated, total aggregate claims value of claims for the two creditor classes, as discussed further below.
As of the Effective Date, the Company estimated that the holders of the Old Subordinated Notes would receive in satisfaction of their claims (including all accrued and unpaid interest), approximately 20.5 million shares of Ordinary Common Stock of Magellan (before giving effect to the Cash-Out Elections discussed below). Accordingly, the Company distributed, as of the Effective Date, approximately 32.83 shares per $1,000 of principal amount of such notes (although no fractional shares or cash in lieu thereof were issued or paid). The Ordinary Common Stock share distribution amount has been adjusted during 2004 and is subject to adjustmentsfurther adjustment as set forth below.
As ofIn accordance with the Effective Date, the Company estimated that total claims ofPlan, Other GUCs would be approximately $78 million (including unresolved disputed claims). Under the Plan, and based upon this total estimated claim value, such creditor class was estimated to receivereceived in satisfaction of their claims (including any unpaid interest accrued thereon) the following consideration for each $1,000 of claim value: (i) $50.34 in cash, (ii) $254.99 of Series B of the Senior Notes ("(“Series B Notes"Notes”), and (iii) 22.41 shares of Ordinary Common Stock (although no fractional shares or cash in lieu thereof were or will be issued or paid), for an aggregate of 1.8 million shares (before giving effect to the Cash-Out Elections discussed below). AsReflected on the Company’s balance sheet as of March 4,December 31, 2003 and 2004 the Company has issuedwere approximately $5.1 million and $5.3 million, respectively, of Series B Notes for the settled claims of Other GUCs. Also, the Company issued $1.8 million of Series B Notes as partial consideration for services performed by one of the financial advisers involved with the reorganization efforts. The Series B Notes portionsconsideration for claims of certain other claims of Other GUCs werewas settled for cash, based upon claim settlement terms between the Company and such individual general unsecured creditors.claimants. The Ordinary Common Stock share distribution amount has been adjusted during 2004 and is subject to further adjustment as set forth below.
The Company currently estimates thatAs of February 22, 2005, the total claim valueamount of outstanding, disputed claims for Other GUCs is $6.3 million (“Disputed Claims”). The Company does not believe that it is probable that liability for the Disputed Claims will ultimately be resolved for approximately $55.0 million, of which $50.5 millionincurred, and thus no liability has been settledrecorded for the Disputed Claims as of March 4,December 31, 2004. IfNonetheless, the claims of Other GUCs are ultimately resolved for the Company's current estimate of $55.0 million, the Other GUCs would receive additional consideration of approximately 0.53Company has reserved, but treated as outstanding, 144,437 shares of Ordinary Common Stock per $1,000 of claim value (although no fractional shares or cash in lieu thereofwhich will be issued or paid) anddistributed in accordance with the terms of the Plan to holders of claims on the Old Subordinated Notes would receive an additional
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0.77 sharesor Other GUCs (including holders of Ordinary Common Stock per $1,000Disputed Claims to the extent their claims are allowed) upon the final resolution of principalthe Disputed Claims, subject, however, to adjustment on account of Cash-Out Elections as described below. If the Disputed Claims were to be resolved for their full amount of such notes (although no fractional shares or$6.3 million, then the Company would also be required to issue to the individual claimants that filed the Disputed Claims additional consideration of $0.3 million in cash in lieu thereof will be issued or paid).and Series B Notes of $1.6 million.
Also on the Effective Date, the previously outstanding shares of Common Stock and Preferred Stock of Magellan were cancelled, three new classes of capital stock were authorized and Magellan'sMagellan’s certificate of incorporation and bylaws were amended and restated. Specifically, 100 million shares of Ordinary Common Stock, $0.01 par value per share ("Ordinary Common Stock"), and 40 million shares of Multiple and Variable Vote Restricted Convertible Common Stock, $0.01 par value per share ("(“Multi-Vote Common Stock"Stock”) were authorized, as were 10 million shares of Preferred Stock, $0.01 par value per share (the “Preferred Stock”), that are issuable at the discretion of the Board of Directors in the manner provided by law in one or more series with such powers, privileges and rights as may be determined by the Board (except that no non-voting shares shall be issued). No shares of Preferred Stock were issued or are to be issued under the Plan. Shares of the Multi-Vote Common Stock may only be issued to, and held by, Onex Corporation, a Canadian corporation, or an affiliate thereof (collectively, "Onex"“Onex”). As described below, Onex, in connection with the Plan, invested in the equity of Magellan in the form of shares of Multi-Vote Common Stock. Upon transfer of any shares of Multi-Vote Common Stock to any party other than Onex, the shares of Multi-Vote Common Stock will automatically convert on a share-for-share basis into shares of Ordinary Common Stock. In addition, any shares of Ordinary Common Stock that Onex may come to own at any time when the Multi-Vote Common Stock is outstanding will automatically convert into shares of Multi-Vote Common Stock.
In general, the Multi-Vote Common Stock and Ordinary Common Stock have the same powers, privileges and rights, and each share represents an equivalent interest in Magellan'sMagellan’s equity, except that the shares of Multi-Vote Common Stock will have the number of votes per share from time to time sufficient so that all the outstanding shares of Multi-Vote Common Stock will have an equal number of votes as all the outstanding shares of Ordinary Common Stock (i.e., the Multi-Vote Common Stock will be entitled to exercise 50 percent of the voting power of all the classes of common stock of Magellan). The Multi-Vote Common Stock and Ordinary Common Stock also differ in that each class has different voting rights in the election of directors and certain other voting rights and other special rights and privileges. The Multi-Vote Common Stock will cease to have any special voting rights or any other special rights or powers in the event the outstanding shares of Multi-Vote Common Stock cease to represent at least 15.33 percent of the total number of shares of common stock (both Ordinary Common Stock and Multi-Vote Common Stock) issued on the Effective Date (approximately 35.1 million shares) or at least 10 percent of the total number of shares of common stock outstanding at any time (the "Minimum“Minimum Hold Condition"Condition”). For furtherAdditional information regarding the voting rights of the Ordinary Common Stock and the Multi-Vote Common Stock, seewhich would otherwise be reflected in Item 10—"“Directors and Executive Officers of the Registrant—Director ElectionRegistrant,” is incorporated by reference from the Company’s Proxy Statement related to its 2005 Annual Meeting of Stockholders, which Proxy Statement will be filed with the U.S. Securities and TermsExchange Commission no later than April 30, 2005. Shares of Office".the Ordinary Common Stock and Multi-Vote Common Stock are referred to below collectively as “Shares of Common Stock.”
As part of the Plan, Magellan offered to holders of its Old Subordinated Notes, its general unsecured creditorsthe Other GUCs and one holder of an administrative claim the opportunity to purchase, on the effective date of the Plan, shares of common stock equivalentup to
6,052,632 shares of Ordinary Common Stock for a total purchase price of $75 million ($12.39 per share). The Company also received as part of the Plan a commitment from Onex to purchase on the same terms anya number of shares of Multi-Vote Common Stock equal to the amount of shares of Ordinary Common Stock not purchased in the Equity Offering by the creditors to whom such shares were offered. Pursuant to the equity offering included in the Plan, creditors purchased 5,111,019 shares of Ordinary Common Stock and Onex purchased 941,613 shares.shares of Multi-Vote Common Stock.
Onex also purchased, pursuant to an additional commitment under the Plan, 6,052,632 shares of common stockMulti-Vote Common Stock for a total purchase price of $75 million (the "Onex Investment"“Onex Investment”), or $12.39 per share. In addition, Onex committed, under the Plan, to fund an offer made by Magellan pursuant to the Plan to holders of its Old Subordinated Notes and to the Company'sCompany’s other general unsecured creditors permitting them to elect to receive $9.78 in cash per share in lieu of the shares of Ordinary Common Stock they would otherwise receive under the Plan (the "Cash-Out Election"“Cash-Out Election”). Onex committed to fund the Cash-Out Election by purchasing that amount of shares of Multi-Vote Common Stock at $9.78 per
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share equal to the amount of shares of Ordinary Common Stock cashed out pursuant to the Cash-Out Election. As of the Effective Date,December 31, 2003, Onex had purchased 1,421,335 shares pursuant to this commitment. Also pursuant to this commitment, Onexand committed to purchase subsequent to the Effective Date, up to an additional 137,1208,552,700 shares as a result of the settlement of claims that had elected the Cash-Out Election but were disputed and unresolved at the Effective Date. Onex has purchased and will purchase 8,552,700Multi-Vote Common Stock shares in the aggregate (in(941,613 shares in the Equity Offering, 6,052,632 shares pursuant to the Onex Investment and 1,558,455 shares to fund the Cash-Out Election), all. In January 2004, Onex sold 82,854 shares of which areMulti-Vote Common Stock to Morgan Noble LLC, resulting in the conversion of such shares to Ordinary Common Stock upon the transfer of the shares. Also during fiscal 2004, Onex purchased another 17,904 shares of Multi-Vote Common Stock as a result of its commitment under the Cash-Out Election. Therefore, as of December 31, 2004, Onex owned 8,487,750 shares of Multi-Vote Common Stock. These shares represented approximately 24.224.0 percent of the shares of common stock outstanding on the Effective Dateas of December 31, 2004, and 21.223.3 percent of the common stock on a fully diluted basis as of December 31, 2004. As part of Onex’s commitment under the Effective Date. As stated above, the allocationCash-Out Election, as of stock among creditors will changeFebruary 22, 2005, Onex is required to purchase an additional 17,850 shares of Multi-Vote Common Stock based on the valueresolution of alldisputed claims as ultimately resolved. If all claims are ultimately resolved for the amount of the Company's current estimate, 36,592 additional shares would be allocatedOther GUCs through such date. Also in relation to claims that had electedOnex’s commitment under the Cash-Out Election, which would result insubsequent to February 22, 2005, Onex acquiring anmay be required to purchase additional 36,592Multi-Vote Common Stock shares, at $9.78 per share (fortotaling up to a totalmaximum of 8,589,292 shares).11,269shares, based upon the ultimate resolution of the remaining Disputed Claims.
The previously outstanding Series A Redeemable Preferred Stock of Magellan was cancelled on the Effective Date and the holders thereof were issued 456,660 shares of Ordinary Common Stock, representing approximately 1.3 percent of the common stock of Magellan as of the Effective Date on a fully diluted basis (giving effect to all shares outstanding or subject to options or warrants outstanding as of the Effective Date), as well as warrants to purchase until January 5, 2011 for $30.46 per share, 456,660 shares of Ordinary Common Stock. The previously outstanding common stock of Magellan also was cancelled on the Effective Date and the holders thereof received 114,165 shares of Ordinary Common Stock, representing approximately 0.3 percent of the common stock of Magellan on the Effective Date on a fully diluted basis (calculated on the same basis as described above), as well as warrants to purchase at any time until January 5, 2011 for $30.46 per share, 114,165 shares of Ordinary Common Stock, which equals approximately one share of Ordinary Common Stock and a warrant to purchase one share of Ordinary Common Stock for every 310 shares of the previously outstanding common stock.Stock. For further information regarding the warrants issued under the Plan, see Note 8—"Stockholders' Equity"“Stockholders’ Equity” to the audited consolidated financial statements set forth elsewhere herein. Pursuant to the Plan, on the Effective Date all previously outstanding options and warrants to purchase common stock of Magellan were cancelled.
As part of the consummation of the Plan, an agreement became effective between Aetna, Inc. ("Aetna"(“Aetna”) and the Company to renew their behavioral health services contract. Undercontract, relating to the renewed agreement, the Company will continue to manageCompany’s management of the behavioral health care of members of Aetna'sAetna’s healthcare programs through December 31, 2005. On December 8, 2004, the Company was informed that Aetna planned to not renew such contract as of December 31, 2005, with anand that Aetna planned to exercise its option for Aetna at that time to either extend the agreement or to purchase, on December 31, 2005, certain assets of the Company used solely in the management of the behavioral healthcare of Aetnahealth care services for Aetna’s members (the "Aetna-Dedicated Assets"“Aetna Assets”). Pursuant to the Plan, on February 23, 2005, the Company and Aetna executed an asset purchase agreement related to Aetna’s purchase of the Aetna Assets. The purchase price for the Aetna Assets is based on certain variable factors and the Company estimates that the price will be $50 million to $55 million. Pursuant to the Plan, on the Effective Date, the
Company paid $15.0 million to Aetna, out of a debt obligation allowed under the Plan of $60.0 million plus accrued interest, and issued to Aetna an interest-bearing note (the "Aetna Note"“Aetna Note”) for the balance of $48.9 million, which will mature on December 31, 2005. The Aetna Note is guaranteed by substantially all of the subsidiaries of Magellan and is secured by a second lien on substantially all of the assets of Magellan and the subsidiary guarantors. Additionally, if the behavioral health services contract is extended by Aetna at its option through at least December 31, 2006, one-halfUpon Aetna’s purchase of the Aetna Note would be payable on December 31, 2005, and the remainder would be payable on December 31, 2006. If Aetna opts to purchase the Aetna-Dedicated Assets, the purchase price (or a portion thereof) could be offset against any amounts owing under the Aetna Note. In addition,Also pursuant to the Plan, the Company issued to Aetna a warrant to purchase 230,000 shares of Ordinary Common Stock from January 1, 2006 to January 5, 2009 at a purchase price of $10.48 per share. For further information regarding the Company'sCompany’s agreement with Aetna, the Aetna Note and the warrant issued to Aetna under the Plan, see Note 7—"“Long-Term Debt and Capital Lease Obligations"Obligations” and Note 8—"Stockholders' Equity"“Stockholders’ Equity” to the audited consolidated financial statements set forth elsewhere herein.
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On the Effective Date, Magellan'sMagellan’s Board of Directors was reconstituted to consist of nine members, as specified in accordance with the Plan. Information on the members of the Magellan Board of Directors isas required to be disclosed in Part III herein.of this report is incorporated by reference from the Company’s Proxy Statement related to its 2005 Annual Meeting of Stockholders, which Proxy Statement will be filed with the U.S. Securities and Exchange Commission no later than April 30, 2005.
The Company'sCompany’s senior executive officers before the Effective Date (Steven J. Shulman, Dr. ReneRené Lerer, M.D. and Mark S. Demilio) entered into employment agreements with Magellan as of the Effective Date in a form provided by the Plan and providing for them to continuecontinued in their current positions. In general, the Company'sCompany’s other senior officers continued in Magellan's employMagellan’s employment in substantially the same positions after the Effective Date and entered into employment agreements with Magellan in a form provided by the Plan. AThe 2003 Management Incentive Plan became effective on the Effective Date in accordance with the Plan, under which restricted stock awards, stock options and other equity incentives may be issued to members of the Company'sCompany’s management and other employees. The Company'sCompany’s employment agreements with its senior executive officers provided for the purchase by Mr. Shulman of certain shares of Ordinary Common Stock and for the grant to each such officer pursuant to the 2003 Management Incentive Plan of certain restricted shares of Ordinary Common Stock, all as of the Effective Date, and for certain cash payments to such officers related to the income taxes incurred by them in connection with such transactions. Options for a total of 4.34.4 million shares of Ordinary Common Stock were issued under the 2003 Management Incentive Plan in January and February ofduring fiscal 2004. Information on the Company'sCompany’s executive officers',officers, their compensation and the 2003 Management Incentive Plan, as required to be disclosed in Part III of Form 10-K, is incorporated by reference from the Company’s Proxy Statement related to its 2005 Annual Meeting of Stockholders, which Proxy Statement will be reported in an amendment to this Annual Report on Form 10-K, filed with the U.S. Securities and Exchange Commission no later than April 29, 2004.30, 2005. See Note 8—"Stockholders' Equity"“Stockholders’ Equity” to the audited consolidated financial statements set forth elsewhere herein for a discussion of charges to be recorded by the Company related to stock grants, stock options and cash payments pursuant to the employment agreements and stock options under the 2003 Management Incentive Plan. Such charges will be recorded in the first quarter of fiscal 2004 and in future periods corresponding to the vesting or life of the options.
Before the Effective Date, the common stock of the Company was registered pursuant to Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"“Exchange Act”). On the Effective Date, the Ordinary Common Stock of Magellan, as issued in accordance with the Plan, was deemed registered under Section 12(g) of the Exchange Act as a successor issue, and Magellan as reorganized was deemed a successor issuer, in relation to the previously registered common stock in accordance with SEC Rule 12g-3(a). In addition, the warrants issued to former common and preferred stockholders as referred to above became registered under Section 12(g) of the Exchange Act pursuant to a registration statement on Form 8-A. The Ordinary Common Stock of the Company, including shares that may be issued upon conversion of shares of Multi-Vote Common Stock and upon exercise of the warrants and options referred to above, became listed on the Nasdaq Stock Market under the ticker symbol "MGLN"“MGLN” on January 6, 2004. On the Effective Date, in accordance with the Plan, Magellan also entered into a Registration Rights
Agreement with Onex and Aetna, providing them rights with respect to the registration of their shares for public sale under the Securities Act of 1933, as amended, in certain circumstances.
On November 24, 2004, the Company and its pertinent subsidiaries filed an application with the Bankruptcy Court for a final decree to close their chapter 11 case. The application was entered by the Bankruptcy Court on January 19, 2005 thereby closing the chapter 11 case.
Accounting for Consummation of the Plan
In connection with the consummation of the Plan, the Company adopted the "fresh“fresh start reporting"reporting” provisions of AICPA Statement of Position 90-7, "Financial“Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" ("Code” (“SOP 90-7"90-7”), with respect to its financial reports, which requiresrequired the Company to restate its assets and liabilities to their fair values based upon the provisions of the Plan and certain valuations which the Company will makemade in connection with the implementation of the Plan. Under the provisions of SOP 90-7, fresh start reporting shouldis not be applied until all material conditions of the reorganization plan are satisfied. All material conditions to the Company were satisfied as of December 29, 2003 (the "Material“Material Conditions Date"Date”). Due to the proximity of the
8
Material Conditions Date to year end and the immateriality of the results of operations for the intervening two-day period, the Company applied fresh start reporting as if the material conditions were satisfied as of December 31, 2003. All adjustments and reorganization expenses as a result of the application of fresh start reporting are reflected in the audited consolidated financial statements as of and for the year ended December 31, 2003 included elsewhere herein. See "Critical“Critical Accounting Policies and Estimates"Estimates” in Item 7 and Note 2—"“Fresh Start Reporting"Reporting” to the audited consolidated financial statements elsewhere herein for further discussion of fresh start reporting and adjustments recorded pursuant to the application of SOP 90-7 by the Company.
As a result of the application of the fresh start reporting provision of SOP 90-7, the consolidated balance sheets of the Company prior to December 31, 2003 are not comparable with the consolidated balance sheet as of, and subsequent to, December 31, 2003. Therefore, allAll balance sheet data as of, and subsequent to December 31, 2003 have been disclosed herein asrepresents balances of the Reorganized“Reorganized Company,” and all balance sheet data prior to December 31, 2003 have been disclosed asrepresents balances of the Predecessor“Predecessor Company.” Statement of operations and statement of cash flows data for all periods presented hereinprior to January 1, 2004 represents the results of the Predecessor Company. Accordingly, all references to the Company with respect to disclosures of amounts recorded (i) through or prior to December 31, 2003 in relation to income statement of operations or cash flow items; and (ii) prior to December 31, 2003 in relation to balance sheet items, relate to the Predecessor Company. All references to the Company with respect to disclosures of amounts recorded or to be recorded (i) after December 31, 2003 in relation to income statement of operations or cash flow items; and (ii) on or after December 31, 2003 in relation to balance sheet items, relate to the Reorganized Company.
Prior to June 1997, the Company'sCompany’s primary business was the operation of psychiatric hospitals. In addition, the Company operated, through its human services segment, specialty home-based healthcare services.
In Junelate 1997 and early 1998, the Company sold substantially allcompleted its acquisition of its domestic psychiatric hospitals and residential treatment facilities (collectively, the "Psychiatric Hospital Facilities") to Crescent Real Estate ("Crescent"), and, with Crescent Operating, Inc. ("COI"), an affiliate of Crescent, formed Charter Behavioral Health Systems, LLC ("CBHS") to conduct the operations of the Psychiatric Hospital Facilities through a franchising arrangement with the Company. The Company maintained a 50.0 percent ownership of CBHS; the other 50.0 percent of the ownership interest of CBHS was owned by COI.
In December 1995, the Company acquired a 61.0 percent ownership interest in Green Spring Health Services, Inc. ("(“Green Spring"Spring”), a managed behavioral healthcare company specializing in mental health and substance abuse/dependence services, and in January 1998, acquired the remaining 39.0 percent. In December 1997, the Company purchased from Aetna, Human Affairs International, Incorporated ("HAI"(“HAI”), which managed behavioral healthcare programs primarily through EAPs and other managed behavioral healthcare plans. In February 1998, the Companyplans, and acquired Merit Behavioral Care Corporation ("Merit"(“Merit”), which managed behavioral healthcare programs across all segments of the healthcare industry, including health maintenance organizations ("HMOs"), Blue Cross/Blue Shield organizations and other insurance companies, corporations and labor unions, federal, state and local governmental agencies and various state Medicaid programs.industry.
In AprilSeptember 1999, the Company sold its European psychiatric provider operations, and in September 1999, completed its exit from the healthcare provider and franchising businesses by transferring certain assets and other interests pursuant tobusinesses. In October 2000, the Company adopted a Letter Agreement with Crescent, COI and CBHS (the "CBHS Transaction"). See Note 5—"Discontinued Operations" to the Company's audited consolidated financial statements set forth elsewhere herein. The CBHS Transaction, together with the formal plan of disposal authorized byto exit from the Company'sbusinesses included in the Company’s specialty managed healthcare. In January 2001, the Board of Directors on September 2, 1999 (the measurement date)approved the sale of
the stock of National Mentor, Inc. (“Mentor”), which represented the disposal ofbusiness and interests that comprised the Company's healthcare provider and healthcareCompany’s human services segment.
9
franchisingThe Company accounted for the exits from these business segments under Accounting Principles Board Opinion No. 30, "Reporting“Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("Transactions” (“APB 30"30”).
On October 4, 2000, the Company adopted a formal plan to exit from the businesses included in the Company's specialty managed healthcare segment through the sale and/or abandonment of these businesses and related assets. The specialty managed healthcare segment included the businesses acquired in conjunction with the purchase of Vivra, Inc. ("Vivra"), which was consummated in February 2000 and Allied Specialty Care Services, Inc. ("Allied"), which was consummated in December 1997. The Company exited the specialty managed healthcare business via sale and/or abandonment of businesses and related assets, certain of which activities had already occurred in the normal course prior to October 4, 2000. See Note 5—"Discontinued Operations" to the Company's audited consolidated financial statements set forth elsewhere herein.
On January 18, 2001, the Board of Directors approved, and the Company entered into a definitive agreement for, the sale of the stock of National Mentor, Inc. ("Mentor"), which represented the business and interests that comprised the Company's human services segment. The human services the Company provided through Mentor included specialty home-based healthcare services provided through "mentor" homes, as well as residential and day treatment services for individuals with acquired brain injuries and for individuals with developmental disabilities. See Note 5—"Discontinued Operations" to the Company's audited consolidated financial statements set forth elsewhere herein.
As a result of these transactions, the Company'sCompany’s sole business is the managed behavioral healthcare business.
Due primarily to the debt-financed acquisitions noted above, and the subsequent disposal activities, the Company had amassed over $1.0 billion in total debt as of September 30, 2002. Although the Company believed it had sufficient cash on hand to meet its then current operating obligations, the Company did not believe it had sufficient cash on hand or capacity to borrow under the Old Credit Agreement to pay scheduled interest and to make contingent purchase price payments. Based on market trends and forecasted level of operations, the Company concluded that it could no longer support the existing capital structure. Therefore, the Company'sCompany’s management determined to restructure its debt to levels that were more in line with its operations. On March 11, 2003, the Company and 88 of its subsidiaries filed voluntary petitions for relief under the Bankruptcy Code in order to accomplish such restructuring.
According to the final report,Achieving “Achieving the Promise: Transforming Mental Health Care in America, from” issued by the President'sPresident’s New Freedom Commission on Mental Health (established on April 29, 2002 by Executive Order 13263) (the "Commission Report"“Commission Report”), approximately 5 percent to 7 percent of adults in a given year have a "serious“serious mental illness",illness,” defined as any diagnosable mental disorder that affects work, home or other areas of social functioning; and approximately 5 percent to 9 percent of children have a "serious“serious emotional disturbance"disturbance” defined as any diagnosable mental disorder (in a child under 18) that severely disrupts social, academic and emotional functioning. In addition, according to the Commission Report, mental illness ranks first among all diseases in terms of causing disability in the United States, Canada and Western Europe. In 1997, the latest year for which comparable data is available, spending in the United States on the treatment of mental illness totaled almost $71 billion. In addition, the Commission Report states that the annual economic, indirect cost of mental illness is estimated to be $79 billion, of which approximately $63 billion represents the loss of productivity as a result of illnesses.
Managed behavioral healthcare companies such as the Company were formed to address the behavioral health needs of society. Managed behavioral healthcare companies focus on matching an
10
appropriate level of specialist and treatment setting with the behavioral health treatment needs of the patient to provide care in a cost-efficient manner while improving early access to care and utilizing the most modern and effective treatments. As the growth of managed behavioral healthcare increased, there was a significant decrease in occupancy rates and average lengths of stay for inpatient psychiatric facilities and an increase in outpatient treatment and alternative care services.
According to an industry trade publication entitled "Open“Open Minds Yearbook of Managed Behavioral Health Market Share in the United States 2002-2003"2002-2003” published by Open Minds, Gettysburg, Pennsylvania (hereinafter referred to as "Open Minds"“Open Minds”), as of January 2002 (the most recently available data), some form of managed behavioral healthcare plan covered approximately 227.1 million beneficiaries.Open Minds divides the managed behavioral healthcare industry as of January 2002 into the following categories of care, based on services provided, extent of care management and level of risk assumption:
| Category of Care | Category of Care | Beneficiaries (In Millions) | Percent of Total |
|
|
| Beneficiaries |
| Percent of |
| |||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
| (In Millions) |
|
|
| |||||||||||
| Risk-Based Network Products | Risk-Based Network Products | 58.6 | 25.8 | % | Risk-Based Network Products |
|
| 58.6 |
|
|
| 25.8 | % |
| |||
| EAPs | EAPs | 62.8 | 27.7 | EAPs |
|
| 62.8 |
|
|
| 27.7 |
|
| ||||
| Integrated Products | Integrated Products | 17.4 | 7.6 | Integrated Products |
|
| 17.4 |
|
|
| 7.6 |
|
| ||||
| Utilization Review/Care Management Products | Utilization Review/Care Management Products | 42.9 | 18.9 | Utilization Review/Care Management Products |
|
| 42.9 |
|
|
| 18.9 |
|
| ||||
| Non-Risk-Based Network Products | Non-Risk-Based Network Products | 45.4 | 20.0 | Non-Risk-Based Network Products |
|
| 45.4 |
|
|
| 20.0 |
|
| ||||
| Total | 227.1 | 100.0 | % | ||||||||||||||
Total | Total |
|
| 227.1 |
|
|
| 100.0 | % |
| |||||||
The following is a summary of each of these categories of care as defined byOpen Minds:Minds:
Risk-Based Network Products.Under risk-based network products, the managed behavioral healthcare company manages the delivery of behavioral healthcare treatment services through a contracted network of behavioral healthcare providers and assumes all or a portion of the responsibility for the cost of providing such services. Most of these programs have payment arrangements in which the managed care company receives a fixed fee per member per month (that varies depending on the profile of the beneficiary population). Under these products, the managed behavioral healthcare company not only reviews and monitors a course of treatment, but also arranges and pays for the provision of patient care, usually through a network of specialized providers and facilities that is contracted and managed by the managed care company. This product generally provides higher revenue for the managed behavioral healthcare company, due to the fact that it bears the financial responsibility for the cost of delivering care. The Company'sCompany’s risk-based products are risk-based network products as(as defined byOpen Minds.Minds).
Employee Assistance Programs.An EAP is a product sold directly to employers that is designed to assist in the early identification and resolution of productivity problems associated with behavioral conditions or other personal concerns of employees and their dependants. Under an EAP, staff or network providers or other affiliated clinicians provide assessment and referral services to employee beneficiaries and their dependants. These services consist of evaluating a beneficiary'sbeneficiary’s needs and, if indicated, providing limited counseling and/or identifying an appropriate provider, treatment facility or other resource for more intensive treatment services. The EAP industry developed largely out of employers'employers’ efforts to combat alcoholism and substance abuse problems afflicting workers. Many businesses have expanded beyond alcoholism and drug abuse treatment programs in the workplace to cover a wider spectrum of personal problems experienced by workers and their families, such as depression and anxiety disorders. As a result, EAP products now typically include consultation services, evaluation and referral services and employee education and outreach services and employers increasingly regard EAPs as an important component in the continuum of behavioral healthcare services. The Company categorizes its products within this segment of the managed behavioral healthcare industry (as defined byOpen Minds)Minds) as risk-based products.
11
Integrated EAP/Managed Behavioral Healthcare Products.Integrated Products combine the preventive and early intervention EAP products with the more comprehensive managed behavioral healthcare programs. Integrated products offer employers comprehensive management and treatment of all aspects of behavioral healthcare. The managed behavioral healthcare program component of the Integrated Product can be risk-based or non-risk-based. The Company categorizes its products within this
segment of the managed behavioral healthcare industry (as defined byOpen Minds)Minds) as risk-based products.
Utilization Review/Care Management Products.Under utilization review/care management products, a managed behavioral healthcare company manages and often arranges for treatment, but does not maintain a network of providers or assume any of the responsibility for the cost of providing treatment services. The Company categorizes its products within this segment of the managed behavioral healthcare industry (as it is defined byOpen Minds) as ASO products.
Non-Risk-Based Network Products.Under non-risk-based network products, the managed behavioral healthcare company manages the delivery of behavioral healthcare treatment services through a contracted network of behavioral healthcare providers but does not assume any of the responsibility for the cost of providing such services. Under these products, the managed care company provides a full array of managed care services, including selecting, credentialing and managing a network of providers, and performs utilization review, claims administration and care management functions. However, the customer remains responsible for the cost of providing the treatment services rendered. The Company categorizes its products within this segment of the managed behavioral healthcare industry (as it is defined byOpen Minds)Minds) as ASO products.
The Company is engaged in the managed behavioral healthcare business. Within this managed behavioral healthcare business, the Company operates in the following four segments, based on the services it provides and/or the customers that it serves: (i) Magellan Health Plan Solutions ("(“Health Plan Solutions"Solutions”); (ii) Magellan Employer Solutions ("(“Employer Solutions"Solutions”); (iii) Magellan Public Sector Solutions ("(“Public Sector Solutions"Solutions”) and (iv) Corporate and Other. See "Business—Segments"“Business—Segments” for a discussion of the Company'sCompany’s segments.
According to enrollment data reported inOpen Minds, theThe Company believes that it is the nation'snation’s largest provider of managed behavioral healthcare services.services, consistent with the enrollment data reported in Open Minds. As of December 31, 2003,2004, the Company had approximately 58.657.1 million covered lives under managed behavioral healthcare contracts and managed behavioral healthcare programs for approximately 1,9001,700 customers. The Company'sCompany’s managed behavioral healthcare network consists of overapproximately 63,000 behavioral healthcare professionals, including facility locations providing various levels of care nationwide.
The Company coordinates and manages the delivery of behavioral healthcare treatment services that are provided through its contracted network of third-party treatment providers, which includes psychiatrists, psychologists, other behavioral health professionals, psychiatric hospitals, residential treatment centers and other treatment facilities. See "Business—“Business—Provider Network"Network” for further discussion of the Company'sCompany’s managed behavioral healthcare network. The treatment services provided through the Company'sCompany’s provider network include outpatient programs (such as counseling or therapy), intermediate care programs (such as intensive outpatient programs and partial hospitalization services), inpatient treatment and crisis intervention services. The Company, however, generally does not directly provide, or own any provider of, treatment services.
Continued Focus on Improving Operating Efficiency and Margins.New Product Development.The Company believes that it can reduce administrative costsis exploring opportunities to expand its business including the enhancement of existing products, the development of new products within current business lines and improve customer service by consolidating service centers, creating
12
more efficiency in corporate overhead, consolidating systems, improving call center technology and instituting other operational andthe possible development of new products outside of its current business efficiencies implementing best practices across the organization and by standardizing and consolidating processesline. The Company is exploring enhancements to its current products such as appropriate.a disease management approach to behavioral health management. In early 2003,addition, the Company formulated performance improvement plans ("PIP")is exploring the development of products to achieveaddress the management of psychotropic and other behavioral drug spending; to manage obesity through behavioral
modification models; to integrate the treatment of mental and medical care in cases of co-morbidity; to use behavioral modification approaches to treat other disease states; and other potential products. While the Company is in the process of development of these cost efficiencies. The Company began implementing these multi-year initiatives in 2003. The Companytypes of products and has incurred approximately $9.8 million to date related to PIP activities, of which approximately $3.3 million has been paiddiscussed their applications and value with cash from operations as of December 31, 2003 and the remainder was accrued as of December 31, 2003. The Company expects to fund future amounts with cash from operations. Therepotential customers, there can be no assurance that the Company will be able to continue to successfully fundsuccessful in developing any such products, or implement these initiativesif developed, operationalizing such products or realize the anticipated savings.in selling such products or having any sales produce profitable results.
Leverage the Company'sCompany’s Market Position to Grow Revenue and Increase Earnings.The Company believes it is positioned to grow membership and revenues over the long term as a result of its economies of scale, solid customer base and proven behavioral health expertise. Furthermore, as the industry leader, the Company believes it is also positioned to benefit from proposed changespotential growth in federal and state parity legislation, which propose to reduce andthe Medicaid market, however there can be no assurance that the Medicaid market will grow or that the Company will be successful in some cases eliminatewinning additional business. Also, the difference in coverage limits for mental health coverage as compared to medical health coverage. The Company'sCompany’s membership has decreased during the last two years. Thereyears, and there can be no assurance that the Company will be able to reverse the membership decreases in future periods.
New Product Development.Continued Focus on Operating Efficiencies.The Company is exploringhas reduced its administrative costs and improved customer service by consolidating service centers, creating more efficiency in corporate overhead, consolidating systems, improving call center technology and instituting other operational and business efficiencies, implementing best practices across the organization and by standardizing and consolidating processes as appropriate. In 2003, the Company formulated and began implementing performance improvement plans to achieve cost efficiencies in its operations. These initiatives have been largely completed and have successfully reduced administrative costs through 2004. The Company will remain focused on maintaining efficient operations and in attempting to develop new initiatives to achieve additional efficiencies and cost reductions. There can be no assurance that the Company will be able to maintain the efficiency of its operations or develop new initiatives to further reduce costs.
Leverage the Company’s Financial Position to Grow Revenue and/or Increase Earnings. The Company continually evaluates opportunities to expandstrategically leverage its business including the enhancement offinancial position in ways that grow revenue and/or increase earnings. Possible strategic initiatives could include acquiring businesses that are complementary to its existing products and the development ofoperations, that could accelerate its entrance into new products, within current business linesor that could leverage its existing customer relationships. In addition, the Company continually seeks to optimize its capital structure and may consider paying down debt, refinancing debt, or executing other financial initiatives that would further enhance its earnings or shareholder value. There can be no assurance that the possible development ofCompany will execute any new products outside of its current business line.initiatives or that implementing new initiatives will produce improved earnings or shareholder value.
13
Managed Behavioral Healthcare Products and Services
General.The following table sets forth the approximate number of covered lives as of September 30, 2001 and 2002 and December 31, 2001, 2002, 2003 and 2003.2004. The table also shows revenue for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, and for the three months ended December 31, 2001 and 2002 and for the fiscal year ended December 31, 2004, for the types of managed behavioral healthcare programs offered by the Company:
| | | Predecessor Company |
|
| Predecessor Company |
| ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Programs | Programs | Covered Lives | Percent | Revenue | Percent |
|
|
| Covered Lives |
| Percent |
| Revenue |
| Percent |
| ||||||||
| | | (in millions, except percentages) |
|
| (in millions, except percentages) |
| ||||||||||||||||||
| Fiscal Year ended September 30, 2001 | ||||||||||||||||||||||||
| Risk-Based products (1) | 36.5 | 56.8% | $ | 1,540.7 | 87.8% | |||||||||||||||||||
Fiscal Year ended September 30, 2002 | Fiscal Year ended September 30, 2002 |
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Risk-Based products(1) | Risk-Based products(1) |
|
| 34.5 |
|
| 55.3 | % | $ | 1,537.9 |
| 87.7 | % | |||||||||||
| ASO products | ASO products | 27.7 | 43.2 | 214.8 | 12.2 | ASO products |
|
| 27.9 |
|
| 44.7 |
| 215.2 |
| 12.3 |
| |||||||
Total | Total |
|
| 62.4 |
|
| 100.0 | % | $ | 1,753.1 |
| 100.0 | % | |||||||||||
Fiscal Year ended December 31, 2003 | Fiscal Year ended December 31, 2003 |
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Risk-Based products(1) | Risk-Based products(1) |
|
| 29.5 |
|
| 50.3 | % | $ | 1,292.5 |
| 85.6 | % | |||||||||||
ASO products | ASO products |
|
| 29.1 |
|
| 49.7 |
| 218.2 |
| 14.4 |
| ||||||||||||
Total | Total |
|
| 58.6 |
|
| 100.0 | % | $ | 1,510.7 |
| 100.0 | % | |||||||||||
Three Months ended December 31, 2001 (unaudited) | Three Months ended December 31, 2001 (unaudited) |
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Risk-Based products(1) | Risk-Based products(1) |
|
| 37.1 |
|
| 57.4 | % | $ | 390.3 |
| 87.7 | % | |||||||||||
ASO products | ASO products |
|
| 27.5 |
|
| 42.6 |
| 54.5 |
| 12.3 |
| ||||||||||||
Total | Total |
|
| 64.6 |
|
| 100.0 | % | $ | 444.8 |
| 100.0 | % | |||||||||||
Three Months ended December 31, 2002 | Three Months ended December 31, 2002 |
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Risk-Based products(1) | Risk-Based products(1) |
|
| 33.6 |
|
| 54.1 | % | $ | 388.7 |
| 87.2 | % | |||||||||||
ASO products | ASO products |
|
| 28.5 |
|
| 45.9 |
| 57.2 |
| 12.8 |
| ||||||||||||
Total | Total |
|
| 62.1 |
|
| 100.0 | % | $ | 445.9 |
| 100.0 | % | |||||||||||
| Total | 64.2 | 100.0% | $ | 1,755.5 | 100.0% | |||||||||||||||||||
Fiscal Year ended September 30, 2002 | ||||||||||||||||||||||||
| Risk-Based products (1) | 34.5 | 55.3% | $ | 1,537.9 | 87.7% | |||||||||||||||||||
| ASO products | 27.9 | 44.7 | 215.2 | 12.3 | ||||||||||||||||||||
| Total | 62.4 | 100.0% | $ | 1,753.1 | 100.0% | |||||||||||||||||||
Fiscal Year ended December 31, 2003 | ||||||||||||||||||||||||
| Risk-Based products (1) | 29.5 | 50.3% | 1,292.5 | 85.6% | ||||||||||||||||||||
| ASO products | 29.1 | 49.7 | 218.2 | 14.4 | ||||||||||||||||||||
| Total | 58.6 | 100.0% | $ | 1,510.7 | 100.0% | |||||||||||||||||||
Three Months ended December 31, 2001 (unaudited) | ||||||||||||||||||||||||
| Risk-Based products (1) | 37.1 | 57.4% | $ | 390.3 | 87.7% | |||||||||||||||||||
| ASO products | 27.5 | 42.6 | 54.5 | 12.3 | ||||||||||||||||||||
| Total | 64.6 | 100.0% | $ | 444.8 | 100.0% | |||||||||||||||||||
Three Months ended December 31, 2002 | ||||||||||||||||||||||||
| Risk-Based products (1) | 33.6 | 54.1% | $ | 388.7 | 87.2% | |||||||||||||||||||
| ASO products | 28.5 | 45.9 | 57.2 | 12.8 | ||||||||||||||||||||
| Total | 62.1 | 100.0% | $ | 445.9 | 100.0% | |||||||||||||||||||
|
| Reorganized Company |
| |||||||||
|
| Covered Lives |
| Percent |
| Revenue |
| Percent |
| |||
|
| (in millions, except percentages) |
| |||||||||
Fiscal Year ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
| |
Risk-Based products(1) |
|
| 27.9 |
|
| 48.9 | % | $ | 1,583.9 |
| 88.2 | % |
ASO products |
|
| 29.2 |
|
| 51.1 |
| 211.5 |
| 11.8 |
| |
Total |
|
| 57.1 |
|
| 100.0 | % | $ | 1,795.4 |
| 100.0 | % |
(1)
The number of covered lives fluctuates based on several factors, including the number of contracts entered into by the Company and changes in the number of employees, subscribers or enrollees of the Company'sCompany’s customers covered by such contracts.
14
General.The following table sets forth the approximate number of covered lives as of September 30, 2001 and 2002 and December 31, 2001, 2002, 2003 and 20032004 and the revenue for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, and for the three months ended December 31, 2001 and 2002, and for the fiscal year ended December 31, 2004, in each of the Company'sCompany’s behavioral customer segments.segments as to each of which, together with its “Corporate and Other” segment, the Company reports segment financial information. The Company'sbusiness activities of the Company’s behavioral customer segments are defineddescribed below. In certain limited cases, customer contracts that would otherwise meet the definition of one segment are managed and reported internally in another segment, in which cases the membership and financial results of such contracts are reflected in the segment in which it is reported internally. In fiscal 2003, the internal reporting of certain of these
|
| Predecessor Company |
| |||||||||
|
| Covered Lives |
| Percent |
| Revenue |
| Percent |
| |||
|
| (in millions, except percentages) |
| |||||||||
Fiscal Year ended September 30, 2002 |
|
|
|
|
|
|
|
|
|
|
| |
Health Plan Solutions |
|
| 42.1 |
|
| 67.5 | % | $ | 1,013.1 |
| 57.8 | % |
Employer Solutions |
|
| 17.1 |
|
| 27.4 |
| 188.7 |
| 10.8 |
| |
Public Sector Solutions |
|
| 3.2 |
|
| 5.1 |
| 551.3 |
| 31.4 |
| |
Total |
|
| 62.4 |
|
| 100.0 | % | $ | 1,753.1 |
| 100.0 | % |
Fiscal Year ended December 31, 2003 |
|
|
|
|
|
|
|
|
|
|
| |
Health Plan Solutions |
|
| 41.2 |
|
| 70.3 | % | $ | 870.5 |
| 57.6 | % |
Employer Solutions |
|
| 14.7 |
|
| 25.1 |
| 159.0 |
| 10.5 |
| |
Public Sector Solutions |
|
| 2.7 |
|
| 4.6 |
| 481.2 |
| 31.9 |
| |
Total |
|
| 58.6 |
|
| 100.0 | % | $ | 1,510.7 |
| 100.0 | % |
Three Months ended December 31, 2001 (unaudited) |
|
|
|
|
|
|
|
|
|
|
| |
Health Plan Solutions |
|
| 44.6 |
|
| 69.0 | % | $ | 270.1 |
| 60.7 | % |
Employer Solutions |
|
| 17.0 |
|
| 26.3 |
| 45.9 |
| 10.3 |
| |
Public Sector Solutions |
|
| 3.0 |
|
| 4.7 |
| 128.8 |
| 29.0 |
| |
Total |
|
| 64.6 |
|
| 100.0 | % | $ | 444.8 |
| 100.0 | % |
Three Months ended December 31, 2002 |
|
|
|
|
|
|
|
|
|
|
| |
Health Plan Solutions |
|
| 41.7 |
|
| 67.2 | % | $ | 245.6 |
| 55.1 | % |
Employer Solutions |
|
| 16.9 |
|
| 27.2 |
| 46.7 |
| 10.5 |
| |
Public Sector Solutions |
|
| 3.5 |
|
| 5.6 |
| 153.6 |
| 34.4 |
| |
Total |
|
| 62.1 |
|
| 100.0 | % | $ | 445.9 |
| 100.0 | % |
|
| Reorganized Company |
| |||||||||
|
| Covered Lives |
| Percent |
| Revenue |
| Percent |
| |||
|
| (in millions, except percentages) |
| |||||||||
Fiscal Year ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
| |
Health Plan Solutions |
|
| 41.7 |
|
| 73.0 | % | $ | 904.9 |
| 50.4 | % |
Employer Solutions |
|
| 13.4 |
|
| 23.5 |
| 135.7 |
| 7.6 |
| |
Public Sector Solutions |
|
| 2.0 |
|
| 3.5 |
| 754.8 |
| 42.0 |
| |
Total |
|
| 57.1 |
|
| 100.0 | % | $ | 1,795.4 |
| 100.0 | % |
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contracts was transferred between segments. Accordingly, the Company has reclassified the membership and financial results of such contracts for all periods into the corresponding segments consistent with its internal reporting. This restatement did not affect consolidated membership or financial results for any period presented. In fiscal 2003, management also changed the name of its "Workplace" segmentSee Note 16—“Business Segment Information” to the "Employer Solutions" segment. All periods presented were adjusted to conform with the fiscal 2003 restatement.
| | Predecessor Company | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| | Covered Lives | Percent | Revenue | Percent | ||||||
| | (in millions, except percentages) | |||||||||
| Fiscal Year ended September 30, 2001 | ||||||||||
| Health Plan Solutions | 39.9 | 62.2% | $ | 1,079.6 | 61.5% | |||||
| Employer Solutions | 21.8 | 33.9 | 189.6 | 10.8 | ||||||
| Public Sector Solutions | 2.5 | 3.9 | 486.3 | 27.7 | ||||||
| Total | 64.2 | 100.0% | $ | 1,755.5 | 100.0% | |||||
Fiscal Year ended September 30, 2002 | ||||||||||
| Health Plan Solutions | 37.0 | 59.3% | $ | 1,013.1 | 57.8% | |||||
| Employer Solutions | 22.2 | 35.6 | 188.7 | 10.8 | ||||||
| Public Sector Solutions | 3.2 | 5.1 | 551.3 | 31.4 | ||||||
| Total | 62.4 | 100.0% | $ | 1,753.1 | 100.0% | |||||
Fiscal Year ended December 31, 2003 | ||||||||||
| Health Plan Solutions | 36.0 | 61.4% | $ | 870.5 | 57.6% | |||||
| Employer Solutions | 19.9 | 34.0 | 159.0 | 10.5 | ||||||
| Public Sector Solutions | 2.7 | 4.6 | 481.2 | 31.9 | ||||||
| Total | 58.6 | 100.0% | $ | 1,510.7 | 100.0% | |||||
Three Months ended December 31, 2001 (unaudited) | ||||||||||
| Health Plan Solutions | 39.3 | 60.9% | $ | 270.1 | 60.7% | |||||
| Employer Solutions | 22.3 | 34.5 | 45.9 | 10.3 | ||||||
| Public Sector Solutions | 3.0 | 4.6 | 128.8 | 29.0 | ||||||
| Total | 64.6 | 100.0% | $ | 444.8 | 100.0% | |||||
Three Months ended December 31, 2002 | ||||||||||
| Health Plan Solutions | 36.5 | 58.7% | $ | 245.6 | 55.1% | |||||
| Employer Solutions | 22.2 | 35.7 | 46.7 | 10.5 | ||||||
| Public Sector Solutions | 3.4 | 5.6 | 153.6 | 34.4 | ||||||
| Total | 62.1 | 100.0% | $ | 445.9 | 100.0% | |||||
See Note 16—"Business Segment Information" to the Company's auditedCompany’s consolidated financial statements set forth elsewhere herein for additional segment financial information, such as segment profit.profit and identifiable assets by segment.
Health Plan Solutions.The Company'sCompany’s Health Plan Solutions segment generally reflects managed behavioral healthcare services provided under contracts with managed care companies, health insurers and other health plans. This segment'ssegment’s contracts encompass both risk-based and ASO contracts. Although certain health plans provide their own managed behavioral healthcare services, many health plans "carve out"“carve
out” behavioral healthcare from their general healthcare services and subcontract such services to managed behavioral healthcare companies such as the Company. In the Health Plan Solutions segment, the Company'sCompany’s members are the beneficiaries of the health plan (the employees and
15
dependents of the customer of the health plan), for which the behavioral healthcare services have been carved out to the Company.
Employer Solutions.The Company'sCompany’s Employer Solutions segment generally reflects the provision of EAP services, managed behavioral healthcare services and integrated products under contracts with employers, including corporations and governmental agencies, and labor unions. This segment'ssegment’s managed behavioral healthcare services are primarily ASO products.
Public Sector Solutions.The Company'sCompany’s Public Sector Solutions segment generally reflects managed behavioral healthcare services provided to Medicaid recipients under contracts with state and local governmental agencies. This segment'ssegment’s contracts encompass both risk-based and ASO contracts. See "Cautionary“Cautionary Statements—Dependence on Government Spending for Managed Healthcare"Healthcare”; "—“—Possible Impact of Healthcare Reform"Reform” and "—Regulation".“—Government Regulation.”
The Company'sCompany’s contracts with customers typically have terms of one to three years, and in certain cases contain renewal provisions (at the customer'scustomer’s option) for successive terms of between one and two years (unless terminated earlier). Substantially all of these contracts may be immediately terminated with cause and many are terminable without cause by the customer or the Company either upon the giving of requisite notice and the passage of a specified period of time (typically between 60 and 180 days) or upon the occurrence of other specified events. In addition, the Company'sCompany’s contracts with federal, state and local governmental agencies generally are conditioned on legislative appropriations. These contracts notwithstanding terms to the contrary, generally can be terminated or modified by the customer if such appropriations are not made. The Company'sCompany’s contracts generally provide for payment of a per member per month fee to the Company. See "Cautionary“Cautionary Statements—Risk-Related Products"Products” and "—“—Reliance on Customer Contracts".Contracts.”
The Company'sCompany’s managed behavioral healthcare and EAP treatment services are provided by a network of third-party providers, including behavioral healthcare professionals and facilities. The number and type of providers in a particular area depend upon customer preference, site, geographic concentration and demographic make-upcomposition of the beneficiary population in that area. Network behavioral healthcare professionals include a variety of specialized behavioral healthcare personnel, such as psychiatrists, psychologists, licensed clinical social workers, substance abuse counselors and other professionals. Network facilities include psychiatric hospitals, residential treatment facilities and other treatment facilities.
The Company'sCompany’s managed behavioral healthcare network consists of overapproximately 63,000 behavioral healthcare professionals, including facility locations, providing various levels of care nationwide. The Company'sCompany’s network providers are almost exclusively independent contractors located throughout the local areas in which the Company's customers'Company’s customers’ beneficiary populations reside. Network providers work out of their own offices, although the Company'sCompany’s personnel are available to assist them with consultation and other needs. Network providers include both individual practitioners, as well as individuals who are members of group practices or other licensed centers or programs. Network providers typically execute standard contracts with the Company under which they are paid on a fee-for-service basis. In some limited cases, network providers are paid on a "case rate"“case rate” basis, whereby the provider is paid a set rate for an entire course of treatment, or on a subcapitationper member per month basis or other risk sharing arrangements.risk-sharing arrangement.
The Company'sCompany’s managed behavioral healthcare network also includes contractual arrangements with third-party treatment facilities, including inpatient psychiatric and substance abuse hospitals, intensive outpatient facilities, partial hospitalization facilities, community health centers and other community-based facilities, rehabilitative and support facilities and other intermediate care and
16
alternative care facilities or programs. This variety of facilities enables the Company to offer patients a full continuum of care and to refer patients to the most appropriate facility or program within that continuum. Typically, the Company contracts with facilities on a per diem or fee-for-service basis and, in some limited cases, on a "case rate"“case rate” or capitated basis. The contracts between the Company and inpatient and other facilities typically are for one-year terms and are terminable by the Company or the facility upon 30 to 120 days'days’ notice.
The Company currently owns a 50.0 percent interest in Premier Behavioral Systems of Tennessee, LLC (“Premier”), which was formed to manage behavioral healthcare benefits for a certain portion of the State of Tennessee’s TennCare program. In addition, the Company contracts with Premier to provide certain services to the joint venture. Through fiscal 2003, the Company accounted for its investment in Premier using the equity method. Effective December 31, 2003, in connection with the implementation of fresh start reporting, the Reorganized Company early adopted the Financial Accounting Standards Board’s (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51” (“FIN 46”), under which the Reorganized Company has consolidated the balance sheet of Premier in its consolidated balance sheet as of December 31, 2003. Beginning in fiscal 2004, the Reorganized Company has consolidated the results of operations of Premier in its consolidated statement of operations. The creditors (or other beneficial interest holders) of Premier have no recourse to the general credit of the Company, as the primary beneficiary of Premier. See further discussion of FIN 46 in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Accounting Pronouncements.” See Note 4—“Acquisitions and Joint Ventures” to the consolidated financial statements set forth elsewhere herein for further information on Premier.
The Company currently owns a 37.5 percent interest in Royal Health Care, LLC (“Royal”). Royal is a managed services organization that receives management fees for the provision of administrative, marketing, management and support services to managed care organizations. Royal does not provide any services to the Company. The Company accounts for its investment in Royal using the equity method. See Note 4—“Acquisitions and Joint Ventures” to the consolidated financial statements set forth elsewhere herein for further information on Royal.
Prior to October 29, 2002, the Company was a 50.0 percent partner with Value Options,ValueOptions, Inc. in the Choice Behavioral Health Partnership ("Choice"(“Choice”), a managed behavioral healthcare company. Choice derived all of its revenues from a subcontract with a health plan under which it provided managed behavioral healthcare services to TRICARE beneficiaries. TRICARE was formerly known as the Civilian Health and Medical Program of the Uniformed Services (CHAMPUS). The Company accounted for its investment in Choice using the equity method of accounting with the Company'sCompany’s share of net income or loss of Choice recognized in the statement of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations", and Note 4—"“Acquisitions and Joint Ventures"Ventures” to the audited consolidated financial statements set forth elsewhere herein for additional discussion of Choice.
The Company currently owns a 50.0 percent interest in Premier Behavioral Systems of Tennessee, LLC ("Premier"), which was formed to manage behavioral healthcare benefits for a certain portion of the State of Tennessee's TennCare program. In addition, the Company contracts with Premier to provide certain services to the joint venture. Through fiscal 2003, the Company accounted for its investment in Premier using the equity method. Effective December 31, 2003, in connection with the implementation of fresh start reporting, the Reorganized Company early adopted the Financial Accounting Standards Board's ("FASB") Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51 ("FIN 46"), under which the Reorganized Company has consolidated the balance sheet of Premier in its consolidated balance sheet as of December 31, 2003. Beginning in fiscal 2004, the Reorganized Company will consolidate the results of operations of Premier in its consolidated statement of operations. See further discussion of FIN 46 in "Management's Discussion and Analysis of Financial Condition and Results of Operations—Recent Accounting Pronouncements". See Note 4—"Acquisitions and Joint Ventures" to the audited consolidated financial statements set forth elsewhere herein for further information on Premier.
The Company currently owns a 36.3 percent interest in Royal Health Care, LLC ("Royal"). Royal is a managed services organization that receives management fees for the provision of administrative, marketing, management and support services to five managed care organizations. Royal does not provide any services to the Company. The Company accounts for its investment in Royal using the equity method. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Off Balance Sheet Arrangements" and Note 4—"Acquisitions and Joint Ventures" to the audited consolidated financial statements set forth elsewhere herein for further information on Royal.
The Company'sCompany’s business is highly competitive. The Company competes with other managed behavioral healthcare organizations as well as with insurance companies, HMOs, PPOs, third-party administrators ("TPAs"(“TPAs”), independent practitioner associations ("IPAs"(“IPAs”), multi-disciplinary medical groups and other managed care companies. Many of the Company'sCompany’s competitors, particularly certain insurance companies and HMOs, are significantly larger and have greater financial, marketing and other resources than the Company, and some of the Company'sCompany’s competitors provide a broader range of services.
The Company may also encounter competition in the future from new market entrants. ManyIn addition, some of the Company'sCompany’s customers that are managed care companies may seek to provide managed behavioral healthcare services directly to their subscribers, rather than by contracting with the Company
17
for such services. Because of these factors, the Company does not expect to be able to rely solely on price increases to achieve revenue growth and expects to continue experiencing pricing pressures. Also, the Company was adversely affected in its ability to successfully compete in certain circumstances during its financial restructuring process.
The Company believes it benefits from the competitive strengths described below:
Industry Leadership.The Company believes that it is the largest provider of managed behavioral healthcare services in the United States, according toconsistent with the enrollment data reported inOpen Minds. TheMinds. In addition, the Company believes, based on data reported inOpen Minds,, that it also has the number one market position in each of the major managed behavioral healthcare product markets in which it competes. The Company believes this leadership position provides it with a base of treatment experience and expertise that is unmatched by any competitor and provides a value proposition that customers are seeking. The Company also believes there are certain economies of scale resulting from its large membership base and the Company continues to strive to achieve operating efficiencies in order to better capitalize on such economies. See "Cautionary“Cautionary Statements—Competition",Competition,” for a discussion of the risks associated with the highly competitive nature of the managed behavioral healthcare industry.
Broad Product Offering and Nationwide Provider Network.The Company offers managed behavioral care products that can be designed to meet specific customer needs, including risk-based and partial risk-based products, integrated EAPs, stand-alone EAPs and ASO products. The Company'sCompany’s managed behavioral healthcare network consists of overapproximately 63,000 behavioral healthcare providers, including professionals at all levels of care, such as psychiatrists, psychologists, licensed clinical social workers, substance abuse counselors and other professionals, and facilities at all points of the spectrum of behavioral heath services such as psychiatric hospitals, residential treatment centers and other treatment facilities. The Company believes the breadth and depth of its provider network is a competitive asset. See "Cautionary“Cautionary Statements—Risk-Related Products",Products,” for a discussion of the risks associated with risk-based products, which are the Company'sCompany’s primary source of revenue.
Broad Base of Customer Relationships.The Company'sCompany’s customers include: (i) Blue Cross/Blue Shield organizations; (ii) national HMOs and other mid-sized insurers; (iii) large corporations; (iv) state and local governmental agencies and (v) certain agencies of the federal government. The Company believes that its broad base of customer relationships provides the Company with opportunities for additional business from these customers. The Company also believes it has a unique array of customers that demonstrates credibility when competing for new business. See "Cautionary“Cautionary Statements—Reliance on Customer Contracts",Contracts,” for a discussion of the risks associated with the Company'sCompany’s reliance on certain contracts with payors of behavioral healthcare benefits.
The Company maintainshas continuously maintained a program of insurance coverage for a broad range of risks in its business. As part of this program of insurance, the Company is self-insured for a portion of its general and current professional liability risks. Prior to July 1999, the Company maintained certain reserves related primarily to the professional liability risks of the Company’s healthcare provider segment arising prior to the sale of its domestic acute-care psychiatric hospitals and residential treatment facilities to Crescent Real Estate Equities in fiscal 1997. On July 2, 1999, the Company transferred its remaining medical malpractice claims portfolio (the “Loss Portfolio Transfer”) to a third-party insurer for approximately $22.3 million. The Loss Portfolio Transfer was funded from assets restricted for settlement of unpaid claims. The insurance limit obtained through the Loss Portfolio Transfer for future medical malpractice claims is $26.3 million. The Company maintained general, professionalcontinually evaluates the adequacy of these insured
limits and managed care liability insurance policies with unaffiliated insurers covering the two-year period from June 17, 2000 to June 16, 2002. The policies were written on a "claims-made" basis, subject to a $0.25 million per claim and $1.0 million annual aggregate self-insured retention for general and professional liability, and also subject to a $0.5 million per claim and $2.5 million annual aggregate self-insured retention for managed care liability. management believes these amounts are sufficient; however, there can be no assurance in that regard.
The Company recently renewed its general, professional and managed care liability insurance policies with unaffiliated insurers for the one-year period from June 17, 2002 to June 16, 2003. These policies were also written on a "claims-made" basis, and were subject to a $1.0 million per claim ($5.0 million per class action claim) un-aggregated self-insured retention for managed care liability and a $0.25 million per claim un-aggregated self-insured retention for general and professional liability. The Company currently maintains general, professional and managed care liability insurance policies with unaffiliated insurers for a one-year period from June 17, 20032004 to June 17, 2004.2005. The general liability policies are
18
written on an “occurrence” basis, subject to a $0.1 million per claim un-aggregated self-insured retention. The professional liability and managed care errors and omissions liability policies are written on a "claims-made"“claims-made” basis, subject to a $1.25 million per claim ($10.0 million per class action claim) un-aggregated self-insured retention for managed care liability, and a $0.25$0.1 million per claim un-aggregated self-insured retention for general and professional liability. The Company also purchases excess liability coverage in an amount deemedthat management believes to be reasonable by management for the size and profile of the organization. The Company is responsible for claims within its self-insured retentions, for those claims, or portions thereof, that exceed the Company's policy limits and for claims reported after the expiration date of the policies if they are not renewed. See "Cautionary“Cautionary Statements—Professional Liability and Other Insurance",Insurance,” for a discussion of the risks associated with the Company'sCompany’s insurance coverage.
General.The managed behavioral healthcare industry is subject to extensive and evolving state and federal regulation. The Company is subject to certain state laws and regulations, including those governing the licensing of insurance companies, HMOs, PPOs, TPAs and companies engaged in utilization review. In addition, the Company is subject to regulations concerning the licensing of healthcare professionals, including restrictions on business corporations from providing, controlling or exercising excessive influence over behavioral healthcare services through the direct employment of psychiatrists or, in a fewcertain states, psychologists and other behavioral healthcare professionals. These laws and regulations vary considerably among states and the Company may be subject to different types of laws and regulations depending on the specific regulatory approach adopted by each state to regulate the managed care business and the provision of behavioral healthcare treatment services. In addition, the Company is subject to certain federal laws as a result of the role it assumes in connection with managing its customers'customers’ employee benefit plans. The regulatory scheme generally applicable to the Company'sCompany’s managed behavioral healthcare operations is described in this section. The subjects of these regulations include Medicare and Medicaid fraud and abuse.
The Company believes its operations are structured to comply in all material respects with applicable laws and regulations in all material respects and that it has received all licenses and approvals that are material to the operation of the business. However, regulation of the managed healthcare industry is constantly evolving, with new legislative enactments and regulatory initiatives at the state and federal levels being implemented on a regular basis. Consequently, it is possible that a court or regulatory agency may take a position under existing or future laws or regulations, or as a result of a change in the interpretation thereof, that such laws or regulations apply to the Company in a different manner than the Company believes such laws or regulations apply. Moreover, any such position may require significant alterations to the Company'sCompany’s business operations in order to comply with such laws or regulations, or interpretations thereof. Expansion of the Company'sCompany’s business to cover additional geographic areas, to serve different types of customers, to provide new services or to commence new operations could also subject the Company to additional license requirements and/or regulation.
Licenses.Certain regulatory agencies having jurisdiction over the Company possess discretionary powers when issuing or renewing licenses or granting approval of proposed actions such as mergers, a change in ownership, transfer or assignment of licenses and certain intra-corporate transactions. One or multiple agencies may require as a condition of such license or approval that the Company cease or modify certain of its operations or modify the way it operates in order to comply with applicable regulatory requirements or policies. In addition, the time necessary to obtain a license or approval varies from state to state, and difficulties in obtaining a necessary license or approval may result in delays in the Company'sCompany’s plans to expand operations in a particular state and, in some cases, lost business opportunities. In recent
years, in response to governmental agency inquiries or discussions with regulators, the Company has determined to seek licensing as a single service HMO, TPA or utilization review agent in one or more jurisdictions. Compliance activities, mandated changes in the Company'sCompany’s operations, delays in the expansion of the Company'sCompany’s business or lost business opportunities as a result of regulatory requirements or policies could have a material adverse effect on the Company.
19
Insurance, HMO and PPO Activities.To the extent that the Company operates or is deemed to operate in one or more states as an insurance company, HMO, preferred provider organization ("PPO")PPO or similar entity, it may be required to comply with certain laws and regulations that, among other things, may require the Company to maintain certain types of assets and minimum levels of deposits, capital, surplus, reserves or net worth. In many states, entities that assume risk under contracts with licensed insurance companies or HMOs have not been considered by state regulators to be conducting an insurance or HMO business. As a result, the Company has not sought licenses as either an insurer or HMO in certain states. The National Association of Insurance Commissioners (the "NAIC"“NAIC”) has undertaken a comprehensive review of the regulatory status of entities arranging for the provision of healthcare services through a network of providers that, like the Company, may assume risk for the cost and quality of healthcare services, but that are not currently licensed as an HMO or similar entity. As a result of this review, the NAIC developed a "health“health organizations risk-based capital"capital” formula, designed specifically for managed care organizations, that establishes a minimum amount of capital necessary for a managed care organization to support its overall operations, allowing consideration for the organization'sorganization’s size and risk profile. The NAIC also adopted a model regulation in the area of health plan standards, which could be adopted by individual states in whole or in part, and could result in the Company being required to meet additional or new standards in connection with its existing operations. Certain states, for example, have adopted regulations based on the NAIC initiative, and as a result, the Company has been subject to certain minimum capital requirements in those states. Certain other states, such as Maryland, Texas, New York and New Jersey, have also adopted their own regulatory initiatives that subject entities such as the Company'sCompany’s subsidiaries to regulation under state insurance laws. This includes, but is not limited to, requiring adherence to specific financial solvency standards. State insurance laws and regulations may limit the Company'sCompany’s ability to pay dividends, make certain investments and repay certain indebtedness. Being licensed as an insurance company, HMO or similar entity could also subject the Company to regulations governing reporting and disclosure, mandated benefits, rate setting and other traditional insurance regulatory requirements. PPO regulations to which the Company may be subject may require the Company to register with a state authority and provide information concerning its operations, particularly relating to provider and payor contracting. The imposition of such requirements could increase the Company'sCompany’s cost of doing business and could delay the Company'sCompany’s conduct or expansion of its business in some areas. The licensing process under state insurance laws can be lengthy and, unless the applicable state regulatory agency allows the Company to continue to operate while the licensing process is ongoing, the Company could experience a material adverse effect on its operating results and financial condition while its license application is pending. In addition, failure to obtain and maintain required licenses typically also constitutes an event of default under the Company'sCompany’s contracts with its customers. The loss of business from one or more of the Company'sCompany’s major customers as a result of such an event of default or otherwise could have a material adverse effect on the Company.
Regulators may impose operational restrictions on entities granted licenses to operate as insurance companies or HMOs. For example, the California Department of CorporationsManaged Health Care imposed certain restrictions on the Company in connection with the issuance of an approval of the Company'sCompany’s acquisitions of HAI and Merit, including restrictions on the ability of the California subsidiaries of HAI and Merit to fund the Company'sCompany’s operations in other states and on the Company'sCompany’s ability to make certain operational changes with respect to the subsidiaries of HAI and Merit in California.
In addition, regulators of certain of the Company'sCompany’s subsidiaries may exercise certain discretionary rights under regulations including increasing its supervision of such entities, requiring additional restricted
cash or other security or seizing or otherwise taking control of the assets and operations of such subsidiaries. In particular, the State of California has taken certain actions to increase its supervision of the Company's regulated subsidiaries in California due primarily to the Company's financial condition prior to the bankruptcy filing.
20
Utilization Review and Third-Party Administrator Activities.Numerous states in which the Company does business have adopted, or are expected to adopt, regulations governing entities engaging in utilization review and TPA activities. Utilization review regulations typically impose requirements with respect to the qualifications of personnel reviewing proposed treatment, timeliness and notice of the review of proposed treatment and other matters. TPA regulations typically impose requirements regarding claims processing and payments and the handling of customer funds. Utilization review and TPA regulations may increase the Company'sCompany’s cost of doing business in the event that compliance requires the Company to retain additional personnel to meet the regulatory requirements and to take other required actions and make necessary filings. Although compliance with utilization review regulations has not had a material adverse effect on the Company, there can be no assurance that specific regulations adopted in the future would not have such a result, particularly since the nature, scope and specific requirements of such provisions vary considerably among states that have adopted regulations of this type.
There is a trend among states to require licensing or certification of entities performing utilization review or TPA activities. However, certain federal courts have held that such licensing requirements are preempted by the Employment Retirement Income Security Act of 1974 ("ERISA"(“ERISA”). ERISA preempts state laws that mandate employee benefit structures or their administration, as well as those that provide alternative enforcement mechanisms. The Company believes that its TPA activities performed for its self-insured employee benefit plan customers are exempt from otherwise applicable state licensing or registration requirements based upon federal preemption under ERISA and have relied on this general principle in determining not to seek licenses for certain of the Company'sCompany’s activities in many states. Existing case law is not uniform on the applicability of ERISA preemption with respect to state regulation of utilization review or TPA activities. There can be no assurance that additional licenses will not be required with respect to utilization review or TPA activities in certain states.
Licensing of Healthcare Professionals.The provision of behavioral healthcare treatment services by psychiatrists, psychologists and other providers is subject to state regulation with respect to the licensing of healthcare professionals. The Company believes that the healthcare professionals who provide behavioral healthcare treatment on behalf of or under contracts with the Company and the case managers and other personnel of the health services business are in compliance with the applicable state licensing requirements and current interpretations thereof. However, there can be no assurance that changes in such state licensing requirements or interpretations thereof will not adversely affect the Company'sCompany’s existing operations or limit expansion. With respect to the Company'sCompany’s crisis intervention program, additional licensing of clinicians who provide telephonic assessment or stabilization services to individuals who are calling from out-of-state may be required if such assessment or stabilization services are deemed by regulatory agencies to be treatment provided in the state of such individual'sindividual’s residence. The Company believes that any such additional licenses could be obtained. However, there can be no assurance that such licensing requirements will not adversely affect the Company'sCompany’s existing operations or limit expansion.
Prohibition on Fee Splitting and Corporate Practice of Professions.The laws of some states limit the ability of a business corporation to directly provide, control or exercise excessive influence over behavioral healthcare services through the direct employment of psychiatrists, psychologists, or other behavioral healthcare professionals, who are providing direct clinical services. In addition, the laws of some states prohibit psychiatrists, psychologists, or other healthcare professionals from splitting fees with other persons or entities. These laws and their interpretations vary from state to state and enforcement by the courts and regulatory authorities may vary from state to state and may change over time. The Company believes that its operations as currently conducted are in material compliance with the applicable laws. However, there can be no assurance that the Company'sCompany’s existing operations and its contractual arrangements with psychiatrists, psychologists and other healthcare professionals will not be successfully
challenged under state laws prohibiting fee splitting or the practice of a profession by an unlicensed entity, or that the enforceability of such contractual arrangements will not be limited. The
21
Company believes that it could, if necessary, restructure its operations to comply with changes in the interpretation or enforcement of such laws and regulations, and that such restructuring would not have a material adverse effect on its operations.
Direct Contracting with Licensed Insurers.Regulators in several states in which the Company does business have adopted policies that require HMOs or, in some instances, insurance companies, to contract directly with licensed healthcare providers, entities or provider groups, such as IPAs, for the provision of treatment services, rather than with unlicensed intermediary companies. In such states, the Company'sCompany’s customary model of contracting directly with its customers may need to be modified so that, for example, the IPAs (rather than the Company) contract directly with the HMO or insurance company, as appropriate, for the provision of treatment services. The Company intends to work with a number of these HMO customers to restructure existing contractual arrangements, upon contract renewal or in renegotiations, so that the entity, which contracts with the HMO directly, is an IPA. The Company does not expect this method of contracting to have a material adverse effect on its operations.
HIPAA.Confidentiality and patient privacy requirements are particularly strict in the field of behavioral healthcare. The Health Insurance Portability and Accountability Act of 1996 ("HIPAA"(“HIPAA”) requires the Secretary of the Department of Health and Human Services ("HHS"(“HHS”) to adopt standards relating to the transmission, privacy and security of health information by healthcare providers and healthcare plans. In connection with HIPAA, calls for HHSthe Company commissioned a dedicated HIPAA project management office to create regulationsachieve compliance within the required timeframes. The Company believes it is currently in several different areascompliance with those provisions of HIPAA currently requiring compliance relating to address the following: electronic transactions and code sets, privacy security, provider IDs,and the use of employer IDs, health plan IDs and individual IDs. At present, all but the health plan IDs and individual IDs have been released in final form. The Company commissioned a dedicated HIPAA Project Management Office ("PMO") to coordinate participation from its customers, providers and business partners in achieving compliance with these regulations. The Company, through the PMO, put together a dedicated HIPAA Project Team to develop, coordinate and implement the compliance plan. The PMO has been phased out as a separate department and these HIPAA compliance activities are now contained in the Company's Corporate Compliance Department. Additionally, the Company has identified business area leads and work group chairpersons to support and lead compliance efforts related to their areas of responsibility and expertise.
The Transactions and Code Sets regulation is final and was effective October 16, 2003 for companies that filed for a one-year deferral that was permitted by law. The Company filed for the extension as permitted by law. This regulation establishes standard data content and formats for the submission of electronic claims and other administrative and health transactions. This regulation only applies to electronic transactions, and healthcare providers will still be able to submit paper documents without being subject to this regulation. In addition, health plans must be prepared to receive these various transactions. The Company has completed the development of a new electronic data interchange ("EDI") strategy, which it believes will significantly enhance its HIPAA compliance efforts. The Company has signed an agreement with an external EDI tool vendor to expand the Company's usage of EDI technology, developed a project plan and an accompanying resource requirements rationale and identified anomalies through mapping of the HIPAA standard transactions to the Company's various clinical, claim and provider systems.
The final regulation on privacy was published on December 28, 2000 and accepted by Congress on February 16, 2001. This regulation, which became effective on April 14, 2001 with a compliance date of April 14, 2003, requires patient authorization to release healthcare information in certain situations, creates rules about how much and when information may be released and creates rights for patients to review and amend their health records, creates a requirement to notify members of privacy practices and also requires that entities contract with their downstream business associates using standards required by the regulation. This regulation applies to both electronic and paper transactions. A new proposed modification to this rule was published on March 27, 2002 in the federal register with a 30-day comment period. This proposal sought to change some of the areas of the privacy regulation
22
that had an unintended adverse effect on the provision of care. The final modification to the privacy regulation was published in the August 14, 2002 Federal Register. The compliance date for the privacy regulation, including these changes was April 14, 2003. The Company has developed and implemented various measures to address areas such as confidential communications, accounting of disclosures, right of access and amendment, identifying and contracting with business associates, creation of HIPAA compliant policies and information technology upgrades. The Company believes that its business and operations are structured to comply with all applicable provisions of the privacy regulations.
The draft version of the regulation on security was published on August 12, 1998. The final version of this rule was published on February 20, 2003 with a compliance date of April 21, 2005. This regulation creates safeguards for physical and electronic storage of, maintenance and transmission of, and access to, individual health information. Although the final security regulation was just released this year, the Company began compliance efforts over two years ago by taking steps to address the requirements of the draft regulation through the implementation of technical, physical and administrative safeguards to enhance physical, personnel and information systems security.identification numbers. The Company has completed its review of the final regulationregulations relating to security and an extensive gap analysis, and is addressing the remaining compliance issues. The Company expects thatbelieves it will be fully compliant with the security regulation by the compliancerequired April 25, 2005 date.
The HIPAA’s regulations regarding provider ID and employer ID regulations are similar in concept. The provider ID regulation was published in draft form on May 7, 1998 and would createidentifiers have a unique number for healthcare providers that will be used by all health plans. The employer ID regulation was published in draft form on June 16, 1998 and calls for using the Employer Identification Number (the taxpayer identifying number for employers that is assigned by the Internal Revenue Service) as the identifying number for employers that will be used by all health plans. The final regulation on employer IDs was published on May 31, 2002 with a compliance date of July 30, 2004. The final regulation on Provider IDs was published on January 23, 2004 with arequired compliance date of May 23, 2005.2005, with which the Company believes it will comply. The health plan ID and individual IDidentification number regulations have not yet been released in draft form.
Management is currently assessing and acting on the wide reaching implications of these regulations to ensure the Company's compliance by the respective implementation dates. Management has identified HIPAA as a major initiative impacting the Company's systems, business processes and business relationships. This issue extends beyond the Company's internal operations and requires active participation and coordination with the Company's customers, providers and business partners. Management has commissioned a dedicated HIPAA project team to develop, coordinate and implement our compliance plan. With respect to the final regulations on security and privacy, thereleased. The Company has hired personnel dedicated to physical and information security issues, appointed an officer who will be responsible for privacy issues, commissioned separate security and privacy workgroups which identified and assessed the potential impact of the regulations and reviewed current policies and drafted new policiesintends to comply with the new requirements.such regulations as required.
Other Significant Privacy Regulation.The privacy regulation under HIPAA generally does not preempt state law except under the following limited circumstances: (i) the privacy rights afforded under state law are contrary to those provided by HIPAA so that compliance with both standards is not possible and (ii) HIPAA'sHIPAA’s privacy protections are more stringent than the state law in question. Because many states have privacy laws that either provide more stringent privacy protections than those imposed by HIPAA or laws that can be followed in addition to HIPAA, the Company must address privacy issues under HIPAA and state law as well. While the Company has always been required to follow state privacy laws, the Company now has had to review these state laws against HIPAA to determine whether it must comply with standards established by both HIPAA and state law. In addition, HIPAA has created an increased awareness of the issues surrounding privacy, which may generate more state regulatory scrutiny in this area.
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Regulation of Customers.Regulations imposed upon the Company'sCompany’s customers include, among other things, benefits mandated by statute, exclusions from coveragescoverage prohibited by statute, procedures governing the payment and processing of claims, record keeping and reporting requirements, requirements for and payment rates applicable to coverage of Medicaid and Medicare beneficiaries, provider contracting and enrollee rights and confidentiality requirements. Although the Company believes that such regulations do not, at present, materially impair its operations, there can be no assurance that such indirect regulation will not have a material adverse effect on the Company in the future.
ERISA.Certain of the Company'sCompany’s services are subject to the provisions of ERISA. ERISA governs certain aspects of the relationship between employer-sponsored healthcare benefit plans and certain
providers of services to such plans through a series of complex laws and regulations that are subject to periodic interpretation by the IRSInternal Revenue Service (“IRS”) and the U.S. Department of Labor. In some circumstances, and under certain customer contracts, the Company may be expressly named as a "fiduciary"“fiduciary” under ERISA, or be deemed to have assumed duties that make it an ERISA fiduciary, and thus be required to carry out its operations in a manner that complies with ERISA requirements in all material respects. Although the Company believes that it is in material compliance with the applicable ERISA requirements and that such compliance does not currently have a material adverse effect on its operations, there can be no assurance that continuing ERISA compliance efforts or any future changes to the applicable ERISA requirements will not have a material adverse effect on the Company.
Other Proposed Legislation.In the last five years, legislation has periodically been introduced at the state and federal levels providing for new healthcare regulatory programs and materially revising existing healthcare regulatory programs. Legislation of this type, if enacted, could materially adversely affect the Company'sCompany’s business, financial condition or results of operations. Such legislation could include both federal and state bills affecting the Medicaid programs which may be pending in, or recently passed by, state legislatures and which are not yet available for review and analysis. Such legislation could also include proposals for national health insurance and other forms of federal regulation of health insurance and healthcare delivery. It is not possible at this time to predict whether any such legislation will be adopted at the federal or state level, or the nature, scope or applicability to the Company'sCompany’s business of any such legislation, or when any particular legislation might be implemented. No assurance can be given that any such federal or state legislation will not have a material adverse effect on the Company.
Other Regulation of Healthcare Providers.The Company'sCompany’s business is affected indirectly by regulations imposed upon healthcare providers. Regulations imposed upon healthcare providers include provisions relating to the conduct of, and ethical considerations involved in, the practice of psychiatry, psychology, social work and related behavioral healthcare professions, accreditation, government healthcare program participation requirements, reimbursements for patient services, Medicare and Medicaid fraud and abuse and, in certain cases, the common law duty to warn others of danger or to prevent patient self-injury.
At December 31, 2004, the Company had approximately 4,300 full-time and part-time employees. The Company believes it has satisfactory relations with its employees.
This Form 10-K includes "forward-looking statements"“forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Although the Company believes that its plans, intentions and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such plans, intentions or expectations will be achieved. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements are set forth below and elsewhere in this Form 10-K. When used in this Form 10-K, the words "estimate", "anticipate", "expect", "believe", "should"“estimate,” “anticipate,” “expect,” “believe,” “should” and similar expressions are intended to be forward-looking statements.
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Fresh Start Reporting. DueReporting—The application of “fresh start” reporting makes it more difficult to compare the Reorganized Company'sCompany’s post-emergence operations and results to those in pre-emergence periods.
In conjunction with the Company’s emergence from bankruptcy, pursuant to the Plan of Reorganization, the Reorganized Company has implemented the "fresh start"“fresh start” reporting provisions of SOP 90-7, effective December 31, 2003. Fresh start reporting requires the Company to restate all assets and liabilities to reflect their respective fair values. As a result, the consolidated balance sheet as of, and subsequent to December 31, 2003 and the statement of operations for periods after the Reorganized Company'sCompany’s emergence from bankruptcy willare not be comparable to the consolidated financial statements for the periods prior to the Company'sCompany’s emergence from bankruptcy, which were prepared on a historical basis. The application
Significant Stockholder—Consequences of "fresh start" reporting may make it more difficultownership by Onex of the Company’s Multi-Vote Common Stock include an inability of the Company’s public stockholders to comparedetermine the Reorganized Company's post-emergence operationsoutcome of most matters presented to them other than elections of certain of the Company’s directors, and resultsa risk that future sales of common stock by Onex could cause the Company’s stock price to those in pre-emergence periods. For further information on fresh start reporting, including the adjustments recorded by the Company as of December 31, 2003, see Note 2—"Fresh Start Reporting" to the audited consolidated financial statements set forth elsewhere herein.fall.
Significant Stockholder.Onex through its affiliate, Magellan Holdings, L.P., beneficially ownscontrols all of the outstanding shares of the Company’s Multi-Vote Common Stock and thereby possessesStock. As a consequence, Onex has the rightability to elect four of the Company’s nine members of the Company's Board of Directors and is entitled to exercise 50 percent of voting power for all other matters that come before Magellan'sthe Company’s stockholders (other than with respect to(including the election of threetwo of the nine members of the Board)Company’s five remaining Directors) until such time as theits ownership of Multi-Vote Common Stock by Onex and affiliated parties decreases below certain pre-determinedspecific levels. This voting power of theexceeds Onex’s approximate 24.0 percent interest in Magellan’s outstanding common stock (viewing both Multi-Vote Common Stock is in excess of its interest in Magellan's outstanding common stock of approximately 24.2 percentand Ordinary Common Stock as a single class) as of the Effective Date. Onex'sDecember 31, 2004. Onex’s interests in the CompanyMagellan may conflict with the interests of the holders of the Ordinary Common Stock. As a result of Onex'sOnex’s substantial equity interest in and voting power, over Magellan, Onex could have significant influence over the management and affairs of the Company,Magellan, and a significant and potentiallyor controlling influence on all matters submitted to the Company's stockholders for approval, including any merger, consolidation or sale of all or substantially all of the Company'sCompany’s assets. WhileIn the case of a potential acquisition of Magellan, this controlling voting power could prevent the Company’s public stockholders from receiving consideration for their stock offered by the potential acquiror in a transaction not supported by Onex is restrictedor result in its ability to sella disposition of their Magellan shares in such a transaction supported by Onex but not broadly supported by the public shareholders.
The market price of the Company’s common stock could also decline as a result of sales by Onex of a significant number of shares of the Company’s Multi-Vote Common Stock, or the perception that such sales might occur. Such sales could also make it owns, itmore difficult for the Company to sell equity securities at a time and price that the Company deems appropriate. Further, Onex is entitled to convert its shares of Multi-Vote Common Stock into shares of Ordinary Common Stock and then sell such shares and,but, in many conditions, inmost cases, doing so will not reduce its voting power. For further information regarding Onex's rights as a stockholder, see "Business—Emergence from Chapter 11". Onex has certain rights to sell publicly the sharespower unless its holdings of OrdinaryMulti-Vote Common Stock fall below the level that it may receive upon conversionwould result in the loss of itsthe stock’s special voting rights. The Multi-Vote Common Stock will cease to have any special voting rights or any other special rights or powers in the event the outstanding shares of Multi-Vote Common Stock. See Item 12—"Security OwnershipStock cease to represent at least 15.33 percent of Certain Beneficial Owners and Management". The market for the total number of shares of common stock (both Ordinary Common Stock may be affected as a resultand Multi-Vote Common Stock) issued on the Effective Date (approximately 35.1 million shares) or at least 10 percent of Onex's substantial position as a stockholderthe total number of Magellan.shares of common stock outstanding at any time (the “Minimum Hold Condition”).
Restrictive Covenants in the Company’s Debt Agreements. OnInstruments—Restrictions imposed by the Effective Date,Company’s debt agreements limit the Company entered into an indenture governing the terms of the Senior Notes (the "Indenture"), as well as a new senior secured credit agreement (the "Credit Agreement"). In general, the Credit AgreementCompany’s operating and the Indenture contain a number of covenants that limit management's discretion in the operations of the Company and its subsidiaries by restricting or limiting the Company's ability to, among other things:
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financial flexibility. These restrictions may adversely affect the Company'sCompany’s ability to finance itsthe Company’s future operations or capital needs or engage in other business activities that may be in itsthe Company’s interest.
The indenture governing the Company’s Senior Notes (the “Indenture”), and the terms of the Credit Agreement each contain covenants. These covenants limit management’s discretion in operating the Company’s business by restricting or limiting the Company’s ability, among other things, to:
· incur or guarantee additional indebtedness or issue preferred or redeemable stock;
· pay dividends and make other distributions;
· repurchase equity interests;
· prepay or amend subordinated debt;
· make certain other payments called “restricted payments”;
· enter into sale and leaseback transactions;
· create liens;
· sell and otherwise dispose of assets;
· acquire or merge or consolidate with another company; and
· enter into some types of transactions with affiliates.
These restrictions could adversely affect the Company’s ability to finance future operations or capital needs or engage in other business activities that may be in the Company’s interest.
The Credit Agreement also requires the Company to comply with specified financial ratios and tests (as defined), including minimum consolidated EBITDA, interest coverage ratios and maximum leverage ratios.tests. Failure to comply with such covenants, without waiver,do so, unless waived by the lenders under the Credit Agreement pursuant to its terms, would result in an event of default under the Credit Agreement and, in the event theif indebtedness under the Credit Agreement wereis accelerated, would give rise to defaults under substantiallymost or all of the Company'sCompany’s other debt agreements. The Credit Agreement is guaranteed by substantially allmost of the Company’s subsidiaries of the Company and is secured by substantially allmost of the Company’s assets ofand the Company’s subsidiaries’ assets.
Risk-Related Products—Because the Company provides services at a fixed fee, if the Company is unable to accurately predict and control behavioral healthcare costs, the subsidiary guarantors.Company’s profitability could decline.
Risk-Related Products.The Company'sCompany’s revenues come primarily from arrangements under which itthe Company assumes all or a portion of the responsibility for the costcosts of providing a full or specified range of behavioral healthcare treatment services (excluding at present the cost of pharmaceuticals or other medication) to a specified beneficiary population in exchange generally, for a fixed per member per month fee. The Company refers to such arrangements as "risk-related contracts"“risk-related contracts” or "risk-related products". Revenues from such arrangements accounted for approximately 87.8 percent, 87.7“risk-related products.” This type of arrangement provided 85.6 percent and 85.688.2 percent of the Company'sCompany’s net revenue in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003 and 2004, respectively. For the three months ended December 31, 2001 and 2002, risk-related products accounted for approximately 87.7 percent and 87.2 percent, respectively,Profitability of the Company's net revenue. In order for suchthese contracts tocould be profitable,reduced if the Company mustis unable to accurately estimate the rate of service utilization by members enrolled under such contracts in order to obtainor the appropriate pricing and control the unit cost of such services when the Company prices its services. If the aggregate cost of behavioral healthcare treatment services provided to members under a contract together with the administrative costs incurred by the Company to operate such contract, exceeds the aggregate of the per member per month fees received by the Company under such contract, the Company will incur a loss with respect to such contract.loss. The Company'sCompany’s assumptions as toof these costs when the utilization ofCompany prices its services by rates and costs may not accurately and adequatelyultimately reflect actual utilization rates and costs, many aspects of which are beyond the control ofCompany’s control.
The Company’s profitability could also be reduced if the Company.
In addition, adjustments may beCompany is required to themake adjustments to estimates made in reporting historical financial results, particularly those regarding cost of care, madereflected in reporting historical financial results. See Note 3—"Summary of Significant Accounting Policies" to the audited consolidatedCompany’s financial statements set forth elsewhere herein.as medical claims payable. Medical claims payable in the Company's financial statements, includes reserves for incurred but not reported, ("IBNR")or “IBNR” claims, which are estimatedclaims for covered services rendered by the Company.Company’s providers which have not yet been submitted to the Company for payment. The Company determines the amount of suchestimates and reserves for IBNR claims based on past claims payment experience, including the average interval between the date services are rendered and the date claims are paid and between the date services are rendered and the date the claims are received, enrollment data, utilization statistics, adjudication decisions, authorized healthcare services and other factors. This data is incorporated into contract specificcontract-specific reserve models. The estimates for submitted claims and IBNR claims are made on an accrual basis and adjusted in future periods as required. However,
Factors that affect the Company’s ability to price its services, control the Company’s costs or accurately make estimates of IBNR claims and other expenses for which the Company creates reserves may include changes in assumptions for medical costs caused by changes in actual experience (such asincluding:
· changes in the delivery system,system;
· changes in utilization patterns,patterns;
· changes in the number of members seeking treatment;
· unforeseen fluctuations in claims backlogsbacklogs;
· increases in the costs of the services;
· the occurrence of catastrophes;
· regulatory changes;
· changes in benefit plan design; and others) may ultimately prove these estimates inaccurate. During fiscal 2001,
· implementation of new products by the Company recorded an adjustment (and corresponding income statement charge) of $15.0 million to its estimate of claims incurred in prior years based on the results of the reduction in claims inventory and other claims processing improvements. During fiscal 2002, the Company experienced net unfavorable prior fiscal year medical claims development of $6.4 million (unfavorable development of $8.6 million for the Health Plan Solutions segment partially offset by favorable development of $2.2 million for the Public Sector Solutions segment). During the three months ended December 31, 2002, the Company experienced net favorable prior fiscal year medical claims development of $3.7 million (composed of Health Plan Solutions segment of $1.3 million, Employer Solutions segment of $0.8 million and Public Sector Solutions segment of $1.6 million). During fiscal 2003, the Company experienced net favorable prior fiscal year medical claims development of
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$11.9 million (composed of Health Plan Solutions segment of $11.4 million and Employer Solutions segment of $0.5 million). As of December 31, 2003, the Company believes that its medical claims payable balance of $177.1 million is adequate in order to satisfy ultimate claim liabilities incurred through December 31, 2003. Any adjustments to such estimates could adversely affect the Company's results of operations in future periods.
If the Company'sCompany’s membership in risk-based business grows, itsthe Company’s exposure to potential losses from risk-related products will also be increased. Furthermore, certain
Required Assurances of theseFinancial Resources—The Company’s liquidity, financial condition, prospects and profitability can be adversely affected by present or future state regulations and contractual requirements that the Company provide financial assurance of the Company’s ability to meet the Company’s obligations.
Some of the Company’s contracts and certain state regulations limit the profits that the Company may earn on risk-related business and may require refunds if the loss experience is more favorable than that originally anticipated. Although experience varies on a contract-by-contract basis, historically, the Company's risk-related contracts have been profitable in the aggregate. However, the degree of profitability varies significantly from contract to contract. For example, the Company's Medicaid contracts with governmental entities generally tend to have direct profit margins that are lower than its other contracts. The most significant factor affecting the profitability of risk-related contracts is the ability to control direct service costs in relation to contract pricing.
Certain of the contracts of the Company and certain state regulations may also require the Company or certain of itsthe Company’s subsidiaries to reserve amaintain specified amountcash reserves or letters of cash credit and/or to maintain a lettercertain minimum tangible net equity in certain of creditthe Company’s subsidiaries as financial assurance that it can meet its obligations under such contracts. As of December 31, 2003, the Reorganized Company had restricted cash and investments of approximately $161.9 million and letters of credit of approximately $56.2 million pursuant to such contracts and regulations. Such amounts are not available to the Company for general corporate purposes. Furthermore,has financial resources to meet the Company’s contractual obligations. Many of these state regulations also restrict the investment activity of certain of the Company’s subsidiaries. Some state regulations also restrict the ability of certain of the Company’s subsidiaries that offer risk-related products to pay dividends to the Company.Magellan. Additional state regulations could be promulgated whichthat would increase the amount of restricted cash or other security the Company would be required to maintain. In addition, the Company'sCompany’s customers may require additional restricted cash or other security with respect to the Company'sCompany’s obligations under itsthe Company’s contracts, including unpaidthe Company’s obligation to pay IBNR claims and other medical claims.claims not yet processed and paid In addition, certain of the Company’s contracts and state regulations limit the profits that may be earned on risk-related business. The Company’s liquidity, financial condition, prospects and profitability could be adversely affected by the effects of such regulations and contractual provisions.
Reliance on Customer Contracts.Contracts—The Company’s inability to renegotiate or extend expiring customer contracts, or the termination of customer contracts, could adversely affect the Company’s liquidity, profitability and financial condition. All
Substantially all of the Company'sCompany’s net revenue is derived from contracts with payors of behavioral healthcare benefits. The Company's managed behavioral healthcare contracts typically have terms of one to three years, and in certain cases contain renewal provisions (at the customer's option) providing for successive terms of between one and two years (unless terminated earlier). Substantially all of these contracts aremay be terminated immediately terminable with cause and many, including some of the Company'sCompany’s most significant contracts, are terminable without cause by the customer upon the provision of requisite notice and the passage of a specified period of time (typically between 60 and 180 days), or upon the occurrence of certain other specified events. The Company'sCompany’s ten largest customers accounted for approximately 59.1 percent, 57.661.6 percent and 61.670.3 percent of the Company'sCompany’s net revenue forin the fiscal years ended September 30, 2001 and 2002 and December 31, 2003 respectively. These customers represented approximately 58.9 percent and 58.2 percent of the Company's net revenue during the three months ended December 31, 2001 and 2002,2004, respectively. Loss of all of these contracts or customers would, and loss of any one of these contracts or customers could, materially reduce the Company’s revenues and have a material adverse effect on the Company.Company’s liquidity, profitability and financial condition. One of these contracts iswas a subcontract
with a health plan under which the Company managesmanaged the mental health and substance abuse services for certain of the beneficiaries of TRICARE, which subcontract expiresexpired on September 30, 2004 and willwas not be renewed. The Company recognized net revenue from this subcontract of $61.5 million, $48.0 million and $47.3 millionAlso, as previously discussed in “Business—Emergence From Chapter 11,” the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively. The Company recognized net revenue from this contract of $12.7 million and $14.0 million during the three months ended December 31, 2001 and 2002, respectively.
The Company's two largest customer contracts are with Aetna and the State of Tennessee's TennCare program. The Company's managed behavioral contract with Aetna, accounted for approximately $315.6 million, $250.3 million and $193.6 millionwhich is one of consolidated net revenue in the fiscal years ended September 30, 2001 and 2002 andCompany’s largest customers, will terminate on December 31, 2003, respectively.2005. The Company
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recognized recorded net revenue from Aetna of $78.8$228.1 million and $54.8 million duringfor the three monthsfiscal year ended December 31, 20012004.
The Company’s largest customer is the State of Tennessee’s TennCare program. The TennCare program provides health and 2002, respectively. The declines in Aetna revenue of approximately $56.7 million in fiscal 2003 compared to fiscal 2002, approximately $65.3 million in fiscal 2002 compared to fiscal 2001, and of approximately $24.0 million for the three months ended December 31, 2002 as comparedother related benefits to the three months ended December 31, 2001, were mainly due to decreased membership as a result of Aetna intentionally reducing its membership levels in an effort to exit less profitable businesses.
As described above in "Business—Emergence from Chapter 11," as part of the consummation of the Plan, Aetna and Magellan have renewed their contract, under which the Company will continue to manage the behavioral health care of Aetna's members through December 31, 2005, with an option for Aetna to either extend the agreement at that time or to purchase the assets usedMedicaid recipients in the operationState of the Aetna contract.
Both theTennessee as well as to certain other uninsured individuals. The Company, through its wholly owned subsidiary, Tennessee BehaviorialBehavioral Health, ("TBH"), and through Premier, a joint venture in which the Company has a 50.050 percent interest, separately contractcontracts with the State of Tennessee (the “State”) to manage the behavioral healthcare benefits for the State's TennCare program. In addition,The creditors (or other beneficial interest holders) of Premier have no recourse to the general credit of the Company, contracts with Premier to provide certain services toas the joint venture. The Company's direct TennCare contract (exclusiveprimary beneficiary of Premier's contract with TennCare) accounted for approximately $248.9 million, $237.5 million and $157.3 million of consolidated net revenue in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and approximately $60.0 million and $63.0 million of consolidated net revenue for the three months ended December 31, 2001 and 2002, respectively. Such revenue amounts include revenue recognized by the Company associated with services performed on behalf of Premier totaling $102.0 million, $134.9 million and $39.8 million for fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and $33.6 million and $34.6 million for the three months ended December 31, 2001 and 2002, respectively.
In September 2003,Premier. Effective July 1, 2004, the State of Tennessee issued a request for proposal ("RFP") relating todivided the TennCare program under which the program will be divided into three regions. The Company, through TBH, submittedTennessee Behavioral Health has a proposal forcontract to serve the East region only and was awarded the contract. The new contractRegion with respect to the East region will become effective July 1, 2004. When contract negotiations between the State and the vendor that had been awarded the contracts for the Middle and West regions were discontinued, the State asked TBH and Premier to continue with their current contracts for those regions through December 31, 2004. The East region contract has an initial term that runs through December 31, 2005 and includes a provision for annual extensions at the State'sState’s option through December 31, 2008. Each of Tennessee Behavioral Health and Premier has a contract with respect to the West and Central regions that runs through December 31, 2005. All three contracts are subject to appropriations funding on July 1, 2005. For the fiscal year ended December 31, 2004, the Company recorded revenues from this customer under these contracts of approximately $431.5 million.
On January 10, 2005, the Governor of Tennessee stated that, because of the increased costs of the TennCare program, the State will cease providing coverage to approximately 323,000 adults who do not qualify for Medicaid and limit benefits to be delivered under the TennCare program. The AetnaGovernor stated that he wishes to begin implementing such membership and benefit changes in March 2005 and complete them by the end of 2005. Certain advocacy groups have filed suits in attempts to prevent the Governor from implementing any membership and benefits reductions. A reduction in membership would, and benefit changes could adversely affect the Company’s revenues and profitability. However, because of the opposition to the Governor’s plan, and because, even if the Governor were to prevail the Company does not yet know which members would be eliminated from the program, the timing of the membership reductions, the benefit changes being proposed or the timing of those changes, it cannot estimate the impact of these potential developments at this time.
In addition, the TennCare contracts maymight not be extended or successfully renegotiated beyond December 31, 2005, or, if renewed or renegotiated, the terms of any new contracts maymight not be comparable to those of existing contracts. If this happens, the Company’s liquidity, financial condition, prospects and profitability may be adversely affected.
The Company derives a significant portion of its revenue from contracts with various counties in the state of Pennsylvania (the "Pennsylvania Counties"). Although these are separate contracts with individual counties, they all pertain to the Pennsylvania Medicaid program. Revenues from the Pennsylvania Counties in the aggregate totaled approximately $121.1 million, $181.9 million and $189.6 million in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and approximately $36.0 million and $56.2 million for the three months ended December 31, 2001 and 2002, respectively. The Company's contract with one of the counties was terminated as December 31, 2003. Revenue related to this particular county totaled approximately $19.6 million, $22.8 million and $24.0 million in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and approximately $5.1 million and $6.4 million for the three months ended December 31, 2001 and 2002, respectively.
Changes in the Medical Managed Care Industry. Substantially all of the Company's revenues in its Health Plan segment are derived from customers in the medical managed care industry including
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managed care companies, health insurers and other health plans. Industry—Certain changes in the business practices of this industry could negatively impact the Company’s resources, profitability and results of operations.
Substantially all of the Company’s Health Plan segment revenues are derived from customers in the medical managed care industry including managed care companies, health insurers and other health plans. Some types of changes in this industry’s business practices could negatively impact the Company. For example, if the Company’s managed care customers seek to provide managed behavioral healthcare services directly to their subscribers, instead of contracting with the Company for such services, the Company could be adversely affected. In this regard, as previously discussed in “Business—Emergence From Chapter 11,” the contract with Aetna, which is one of the Company’s largest customers, will terminate on December 31, 2005. Some of the Company’s customers that are managed care companies that the Company serveshave sought and may seek to provide managed behavioral healthcare services directly to their subscribers, rather than by contracting with the Company for such services, the Company could be adversely affected. See "Reliance on Customer Contracts" for a discussion of the potential impact of lost revenues associated with certain significant health plan customers of the Company
services. In addition, the companyCompany has a significant number of contracts with Blue Cross and Blue Shield health plans and other regional health plans.
Consolidation of thethat industry through acquisitions and mergers could impact this sector of the industry and could potentially result in the loss of contracts for the Company. Any of these changes could reduce the Company’s revenues, and adversely affect the Company’s profitability and financial condition.
Competition.Competition—The Company'scompetitive environment in the Company’s industry, and any failure in the Company’s ability to adequately respond, may limit the Company’s ability to maintain or increase the Company’s rates, which would limit or adversely affect the Company’s profitability.
The Company’s business is highly competitive. The Company competes with other managed behavioral healthcare organizations as well as with insurance companies, HMOs, PPOs, TPAs, IPAs, multi-disciplinary medical groups and other managed care companies. Many of the Company'sCompany’s competitors, particularly certain insurance companies and HMOs, are significantly larger and have greater financial, marketing and other resources than the Company.Company, which can create downward pressure on prices through economies of scale. The entrance or expansion of these larger companies in the managed behavioral healthcare industry (including customers of the Company who have insourced or who may choose to insource behavioral healthcare services) could increase the competitive pressures the Company faces.faces and could limit the Company’s ability to maintain or increase the Company’s rates. If this happens, the Company’s profitability could be adversely affected.
Integration of Operations. The Company is in the process of implementing initiatives aimed at reducing operating costs and improving operating efficiencies (see "Business—Business Strategy" above). These initiatives include consolidating service centers, creating more efficiency in corporate overhead, consolidating systems, improving call center technology and instituting other operational and business efficiencies. The Company believes that it can reduce administrative costs and improve customer service through these measures. The Company expects to fund these costs with internally generated funds. However, there can be no assurance that the Company will be able to successfully implement these initiatives or realize the anticipated savings.
In addition, the Company could experience disruptions in its computer systems or other operations during the implementation of these initiatives, which disruptions could adversely affect the Company's relationships with many of its contracted providers and customers, and its business and results of operations.
Fluctuation in Operating Results.Results—The Company'sCompany experiences fluctuations in quarterly operating results and, as a consequence, the Company may fail to meet or exceed market expectations, which could cause the Company’s stock price to decline.
The Company’s quarterly operating results have varied in the past and may fluctuate significantly in the future due to a combination ofseasonal and other factors, including:
·
·performance-based contractual adjustments to revenue, reflecting utilization results or other performance measures;
·changes in estimates for contractual adjustments under commercial contracts;
·retrospective membership adjustments;
·the timing of implementation of new contracts and enrollment changes; and
·changes in estimates regarding medical costs and incurred but not yet reported medicalIBNR claims.
These factors may affect the Company'sCompany’s quarterly and annual revenues, expenses and results of operationsprofitability in the future. Accordingly, reliance should not be placed on quarter-to-quarter or year-to-year comparisons of the Company's results of operations as an indication of future performance.
Dependence On Government Spending For Managed Healthcare.Healthcare—The Company can be adversely affected by changes in federal, state and local healthcare policies. A significant
All of the Company’s Public Sector Segment revenue and a portion of the Company'sCompany���s revenue isin the Company’s other two segments are derived, directly or indirectly, from federal, state and local governmental agencies, including state Medicaid programs. Contract rates vary from state to state, are subject to periodic negotiation and may limit the Company'sCompany’s ability to maintain or increase rates. The Company is
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unable to predict the impact on itsthe Company’s operations of future regulations or legislation affecting Medicaid programs, or the healthcare industry in general, and future regulations or legislation may have a material adverse effect on the Company. Moreover, any reduction in government spending for such programs could also have a material adverse effect.effect on the Company. In addition, the Company'sCompany’s contracts with federal, state and local governmental agencies, under both direct contract and subcontract arrangements, generally are
conditioned upon financial appropriations by one or more governmental agencies, especially with respect toin the case of state Medicaid programs. These contracts generally can be terminated or modified by the customer if such appropriations are not made. Finally, some of the Company'sCompany’s contracts with federal, state and local governmental agencies, under both direct contract and subcontract arrangements, require the Company to perform additional services if federal, state or local laws or regulations imposed after the contract is signed so require, in exchange for additional compensation to be negotiated by the parties in good faith. Government and other third-party payors are generally seeking to impose lower contract rates and to renegotiate reduced contract rates with service providers in a trend toward cost control. See "Business—Industry" and "—Business Strategy".
Possible Impact of Healthcare Reform.Reform—Healthcare reform can significantly reduce the Company’s revenues or profitability.
The U.S. Congress is considering legislation which,that, among other things, would place limits onlimit healthcare plans and methods of operations, limit employers'employers’ and healthcare plans'plans’ ability to define medical necessity and permit employers and healthcare plans to be sued in state courts for coverage determinations. It is uncertain whether the Company could recoup, through higher revenues or other measures, the increased costs of federally mandated benefits or other increased costs caused by such legislation or similar legislation. In addition, if any federal parity legislation is adopted and the difference in coverage limits for mental health coverage and medical health coverage is reduced or eliminated, any increase in revenue the Company derives following such legislation may not be sufficient to cover the increase in costs that would result from a greater utilization of mental healthcare services. The Company cannot predict the effect of this legislation noror other legislation that may be adopted by the U.S. Congress, and such legislation, mayif implemented, could have an adverse effect on the Company.
Regulation.Government Regulation—The Company is subject to substantial government regulation and scrutiny, which increase the Company’s cost of doing business and could adversely affect the Company’s profitability.
The managed behavioral healthcare industry and the provision of behavioral healthcare services are subject to extensive and evolving federal and state regulation. Such laws and federal regulation. regulations cover, but are not limited to, matters such as licensure, accreditation, government healthcare program participation requirements, information privacy and security, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Government investigations and allegations have become more frequent concerning possible violations of fraud and abuse and false claims statutes and/or regulations by healthcare organizations. Violators may be excluded from participating in government healthcare programs, subject to fines or penalties or required to repay amounts received from the government for previously billed services. A violation of such laws and regulations may have a material adverse effect on the Company.
The Company is subject to certain state laws and regulations and federal laws as a result of the Company’s role the Company assumes in connection with managing its customers'management of customers’ employee benefit plans.
The regulatoryRegulatory issues may also affect the Company’s operations. These include, but are not limited to:
· additional state licenses that may affect operations include:
· limits imposed by state authorities to prevent corporations from controllingupon corporations’ control or excessively influencingexcessive influence over behavioral healthcare services through the direct employment of psychiatrists, psychologists or other professionals, and to prohibit such persons from splitting fees with other persons or entities;
· laws that impose financial terms and requirements upon insurance companies, PPOs, HMOs, TPAs, managed behavioral healthcare organizations and entities that assumeon the Company due to the Company’s assumption of risk under contracts with licensed insurance companies or HMOs;
· laws in certain states that impose upon insurance companies, PPOs, HMOs and other types of third-party payors an obligation to contract with any healthcare provider willing to meet the terms of the payor'sCompany’s contracts with similar providers;
·maintaining confidentiality of patient information; and
30
The imposition of additional license requirementslicensing and other regulatory requirements may, among other things, increase the Company'sCompany’s equity requirements, increase the cost of doing business or force significant changes in the Company'sCompany’s operations significantly to comply with these requirements.
Because an entity indirectly controlled by Onex Corporation, is a non-U.S. company andCanadian corporation, has the right to elect one or more directors of the Company. See "Significant Stockholder" above. Therefore,Company’s directors, (see “Significant Stockholder” above), federal law considers the Company to be under the ownership, control or influence of a foreign entity. As a result, the Company mustmay need to comply with additional requirements in order to obtain a federal facility security clearance issued by the Defense Security Service. Such security clearance is a requirement of one of the Company's contracts with an agency of the federal government and may be a requirement ofService in order to enter into any new contracts with federal agencies. The Company currently has a contract with a federal agency under which the agency has determined that, based on the operational structure of the services the Company attemptsprovides under that contract, that the Company does not need to enter intocomply with agencies ofsuch regulations. However, it is possible that such agency could later determine that such clearance is necessary. If the Company is unable to comply with these additional requirements, the Company could lose its contract with the federal government.agency and be ineligible to bid on other contracts with federal agencies.
The costs associated with compliance with government regulation as discussed above may adversely affect the Company’s financial condition and results of operations.
Risks Related To Realization of Goodwill and Intangible Assets.Assets—The Company'sCompany’s profitability could be adversely affected if the value of intangible assets is not fully realized
The Company’s total assets at December 31, 2003 reflects2004 reflect goodwill of approximately $450.2$392.3 million, representing approximately 34.833.0 percent of total assets. There can be no assurance that such goodwill will be realizable. The application of the fresh start reporting provisions of SOP 90-7 as discussed above (see "Cautionary Statements—Fresh Start Reporting"), requirerequired the Company to value its assets and liabilities at fair market value. In accordance with thethese fresh start reporting provisions of SOP 90-7, implemented as of December 31, 2003, the Company’s reorganization value of the Company was allocated to the Company'sCompany’s tangible and identified intangible assets. Under SOP 90-7, if any portion of the Company’s reorganization value of the Company cannotcould not be attributableallocated to specific assets, such amount should beit was reported as goodwill. As a resultThe Company completed its annual impairment analysis of the application of fresh start reporting, the Predecessor Company's balance of goodwill was written-off at December 31, 2003. See Note 2—"Fresh Start Reporting" to the audited consolidated financial statements set forth elsewhere herein for further discussion of adjustments recorded under fresh start reporting. Pursuant to Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), the Company will test goodwill as of October 1 fornoting that fair value exceeded the associated carrying value; therefore, no impairment based upon fair values.was recorded.
At December 31, 2003,2004, identifiable intangible assets (customer lists, contracts and provider networks) totaled approximately $58.1$44.3 million. Intangible assets are amortized over their estimated remaining useful lives, which range from approximately two to eighteen years. The amortization periods used may differ from those used by other entities. In addition, the Company may be required to shorten the amortization period for intangible assets in future periods based on changes in the Company'sCompany’s business. The Company may not ever realize the value of such assets.
The Company evaluates, on a regular basis, whether events and circumstances have occurred that indicate that all or a portion offor any reason the carrying value of the Company’s intangible assets and other long livedlong-lived assets may no longer be completely recoverable, in which case a charge to earnings for impairment losses could become necessary. When events or changes in circumstances are presentoccur that indicate the carrying amount of long livedlong-lived assets may not be recoverable, the Company assesses the recoverability of long livedlong-lived assets other than goodwill by determining whether the carrying value of such intangible assets will be recovered through the future cash flows expected from the use of the asset and its eventual disposition.
Any event or change in circumstances which leadsleading to a future determination requiring additional write-offs of a significant portion of unamortized intangible assets or goodwill would adversely affect the Company's results of operations.Company’s profitability.
Claims for Professional Liability.Liability—Pending or future actions or claims for professional liability (including any associated judgments, settlements, legal fees and other costs) could require the Company to make significant cash expenditures and consume significant management time and resources, which could have a material adverse effect on the Company’s profitability and financial position. The management
Management and administration of the delivery of managed behavioral healthcare services, and the direct provision of behavioral healthcare treatment services, entail significant risks of liability. In recent years, participants in the managed health care industry have become subject to an increasing number of lawsuits. From time to time, the Company is subject to various actions and claims of professional liability for allegedalleging negligence in performing utilization review activities, as well as for the acts or omissions of the Company'sCompany’s employees, network providers or other parties.others. In the normal course of business, the Company receives reports relating to suicides and other serious incidents
31
involving patients enrolled in the Company'sCompany’s programs. Such incidents occasionally give rise to malpractice, professional negligence and other related actions and claims against the Company or itsthe Company’s network providers. AsIf the number of lives covered by the Company covers grows and the number of providers under contract increases, actions and claims against the Company (and, in turn, possible legal liability) predicated on malpractice, professional negligence or other related legal theories canwould be expected to increase. The Company is also subject to actions and claims for the costs of services for which payment was denied. Many of these actions and claims seek substantial damages and require the Company to incur significant fees and costs related to its defense. Pending or future actions or claims for professional liability (including any judgments, settlements or costs associated therewith) may have a material adverse effect on the Company.
Professional Liability and Other Insurance.Insurance—Claims brought against the Company that exceed the scope of the Company’s liability coverage or denial of coverage could materially and adversely affect the Company’s profitability and financial condition.
The Company maintains a program of insurance coverage foragainst a broad range of risks in itsthe Company’s business. As part of this program of insurance, the Company carries professional liability insurance, subject to certain deductibles and self-insured retentions. SuchThe Company also is sometimes required by customer contracts to post surety bonds with respect to the Company’s potential liability on professional responsibility claims that may be asserted in connection with services provided. As of January 31, 2005, the Company has less than $4 million of such bonds outstanding. The Company’s insurance may not be sufficient to cover any judgments, settlements or costs relating to present or future claims, suits or complaints. Upon expiration of the Company'sCompany’s insurance policies, sufficient insurance may not be available on favorable terms, if at all. To the extent the Company'sCompany’s customers are entitled to indemnification under their contracts with the Company relating to liabilities they incur arising from the operation of the Company'sCompany’s programs, such indemnification may not be covered under the Company'sCompany’s insurance policies. To the extent that certain actions and claims seek punitive and compensatory damages arising from the Company’s alleged intentional misconduct, by the Company, such damages, if awarded, may not be covered, in whole or in part, by the Company'sCompany’s insurance policies. The Company also has certain potential liabilitiesliability relating to the self-insurance program the Company maintained previously with respect to itsthe Company’s provider business prior to the Crescent Transactions.business. If the Company is unable to secure adequate insurance in the future, or if the insurance the Company carries is not sufficient to cover any judgments, settlements or costs relating to any present or future actions or claims, such judgments, settlements or costs may have a material adverse effect on the Company. In addition, the Company obtains surety bonds from insurance companies to meet requirements under the lawsCompany’s profitability and regulations of states in which the Company operates. As of March 17, 2004, the Company has approximately $11.8 million of surety bonds outstanding. The surety bond carriers have collateral in the form of letters of credit in the amount of $13.2 million.financial condition. If the Company is unable to obtain adequateneeded surety bonds in adequate amounts or make alternative arrangements to satisfy the requirements for such bonds, itthe Company may no longer be able to operate in those states, which would have a material adverse effect on the Company.
Class Action Suits and Other Legal Proceedings.Proceedings—The Company could be targeted by class action and other lawsuits that could result in material liabilities to the Company or cause the Company to incur material costs, to change the Company’s operating procedures in ways that increase costs or to comply with additional regulatory requirements. Certain managed
Managed healthcare companies including the Company, have been targeted as defendants in national class action lawsuits regarding their business practices. The Company has been subject to such class actions as defendants and is also subject to certainother lawsuits and legal proceedings in conducting its business. See Item 3—"Legal Proceedings" elsewhere herein. SuchThese lawsuits may take years to resolve and cause the Company to incur substantial litigation expenses and the outcomes could have a material adverse effect on the Company.Company’s profitability and financial condition. In addition to potential damage awards, depending upon the outcomes of such cases, these lawsuits may cause or force changes in practices of the Company’s industry and may also cause additional regulation of the industry through new federal or state laws or new applications of existing laws or regulations. Such changes could increase the Company’s operating costs.
Government Investigations.Investigations—If the Company is unable to cooperate with the investigations of governmental agencies, the Company may be materially and adversely affected.
From time to time, the Company receives notifications from and engages in discussions with various government agencies concerning the Company's respectiveCompany’s managed care businesses and operations. As a result of these contacts with regulators, the Company may, as appropriate, implement changes to its operations, revise its filings with such agencies and/or seek additional licenses to conduct itsthe Company’s business. See Item 3—"Legal Proceedings" elsewhere herein. The Company'sCompany’s inability to cooperate with theseany government investigations and inquiriesinvestigation or inquiry and comply with the various requirements imposed on the Company as a result of these proceedings may have a material adverse effect on the Company'sCompany’s business. In addition, the healthcare industry is subject to numerous laws and regulations. The subjects of such laws and regulations cover, but are not limited to, matters such as licensure, accreditation, government healthcare program participation requirements, information privacy and security, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Over the past several years, government activity has increased with respect to investigations and/or allegations concerning possible violations of fraud and abuse and false claims statutes and/or
32
regulations by healthcare organizations. Entities that are found to have violated these laws and regulations may be excluded from participating in government healthcare programs, subjected to fines or penalties or required to repay amounts received from the government for previously billed services. A violation of such laws and regulations may have a material adverse effect on the Company.
Use of Prior Audit Reports Prepared by Arthur Andersen LLP. Arthur Andersen LLP, the Predecessor Company's accounting firm that audited the Predecessor Company's financial statements for the fiscal year ended September 30, 2001, was found guilty by a jury on June 15, 2002 of federal obstruction of justice charges in connection with the government's investigation of Enron Corp. Arthur Andersen ceased practicing before the Commission effective August 31, 2002. It is possible that events arising out of this conviction or the cessation of Arthur Andersen's practice may adversely affect the ability of Arthur Andersen to satisfy any claims arising from its provision of auditing and other services to clients, including claims that may arise out of Arthur Andersen's audit of the Company's financial statements.
In addition, should the Company seek to access the public capital markets, it would need to satisfy certain requirements of the Commission relating to the Company's audited financial statements for fiscal years which were audited by Arthur Andersen. The Commission's current rules require the inclusion or incorporation by reference of three years of audited financial statements in any prospectus for a public offering of securities of the Company, which would require the Company to present audited financial statements for one or more fiscal years audited by Arthur Andersen until the Company's audited financial statements for the fiscal year ending December 31, 2004 become available in the first quarter of the Company's fiscal year 2005. The Commission has adopted rules exempting certain issuers filing Securities Act registration statements containing financial statements audited by Arthur Andersen from having to comply with the provisions of its rules that would otherwise require issuers to present with such financial statements manually signed reissued accountants' reports and written consents issued by Arthur Andersen. Although the Company believes that it currently meets the requirements for such exemptions, if the Commission ceases accepting financial statements audited by Arthur Andersen pursuant to such exemptions, it is possible that the Company's financial statements for the year ended September 30, 2001 audited by Arthur Andersen might not satisfy the Commission's requirements. If this occurs, the Company would not be able to access the public capital markets unless Ernst & Young LLP, the Company's current independent accounting firm, or another independent accounting firm, is able to audit the financial statements originally audited by Arthur Andersen. Any delay or inability to access the public capital markets caused by circumstances of such nature could have a material adverse effect on the Company.
Employees of the Registrant
At December 31, 2003, the Company had approximately 4,700 full-time and part-time employees. The Company believes it has satisfactory relations with its employees.
The Company makes its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and Section 16 filings available, free of charge, on the Company's InternetCompany’s website at http://www.magellanhealth.com as soon as practicable after the Company has electronically filed such material with, or furnished it to, the SEC. The information on the Company'sCompany’s website is not part of or incorporated by reference in this report on Form 10-K.
33
The Company currently leases approximately 1.11.0 million square feet of office space comprising 6244 offices in 2827 states and Puerto Rico with terms expiring between April 2004January 2005 and January 2013. The Company'sCompany’s principal executive offices are located in Farmington, Connecticut, which lease expires in May 2005. The Company believes that its current facilities are suitable for and adequate to support the level of its present operations.
The management and administration of the delivery of managed behavioral healthcare services entail significant risks of liability. From time to time, the Company is subject to various actions and claims arising from the acts or omissions of its employees, network providers or other parties. In the normal course of business, the Company receives reports relating to suicides and other serious incidents involving patients enrolled in its programs. Such incidents occasionally give rise to malpractice, professional negligence and other related actions and claims against the Company or its network providers. See also "Cautionary“Cautionary Statements—Claims for Professional Liability".Liability.” Many of these actions and claims received by the Company seek substantial damages and therefore require the defendant to incur significant fees and costs related to
their defense. To date, claims and actions against the Company alleging professional negligence have not resulted in material liabilities and the Company does not believe that any such pending action against it will have a material adverse effect on the Company. However, there can be no assurance that pending or future actions or claims for professional liability (including any judgments, settlements or costs associated therewith) will not have a material adverse effect on the Company.
The Company is subject to or party to certain class action suits, litigation and claims relating to its operations and business practices. LitigationExcept as otherwise provided under the Plan, litigation asserting claims against the Company and its subsidiaries that were parties to the chapter 11 proceedings for pre-petition obligations (the "Pre-petition Litigation"“Pre-petition Litigation”) were, was enjoined as of the Effective Date as a consequence of the commencementconfirmation of the Company's chapter 11 proceedings.Plan by the Bankruptcy Court. The Company believes that the Pre-petition Litigation claims constitute pre-petition general unsecured claims and, to the extent allowed by the Bankruptcy Court, would be resolved as Other General Unsecured Claims under the Plan. See "Business—“Business—Emergence from Chapter 11".11.”
In the opinion of management, the Company has recorded reserves that are adequate to cover litigation, claims or assessments that have been or may be asserted against the Company, and for which the outcome is probable and reasonably estimable. Management believes that the resolution of such litigation and claims will not have a material adverse effect on the Company'sCompany’s financial position or results of operations; however, there can be no assurance in this regard.
Item 4. Submission of Matters to a Vote of Security Holders
None.
3433
Item 5. Market for Registrant'sRegistrant’s Common Equity and Related Stockholder Matters
Since January 6, 2004, shares of the Reorganized Company'sCompany’s Ordinary Common Stock, $0.01 par value per share ("(“Ordinary Common Stock"Stock”) have traded on the Nasdaq Stock Market under the symbol "MGLN". From January 6, 2004 through March 4, 2004, the high and low closing bid prices of the Reorganized Company's Ordinary Common Stock, as reported by the Nasdaq National Market, were $29.01 and $26.25, respectively.“MGLN.” For further information regarding the Reorganized Company'sCompany’s Ordinary Common Stock, see Note 8—"Stockholders' Equity"“Stockholders’ Equity” to the audited consolidated financial statements set forth elsewhere herein. Warrants to purchase shares of the Reorganized Company'sCompany’s Ordinary Common Stock have traded on the Over-the-Counter Bulletin Board ("OTCBB"(“OTCBB”) under the ticker symbol MGLNW since February 2, 2004. The following table sets forth the high and low closing bid prices of the Reorganized Company’s Ordinary Common Stock as reported by the Nasdaq National Market from January 6, 2004 through December 31, 2004:
|
| Ordinary |
| ||||
Calendar Year |
|
|
| High |
| Low |
|
2004 |
|
|
|
|
| ||
Period from January 6, 2004 through March 31, 2004 |
| $ 29.01 |
| $ 26.25 |
| ||
Second Quarter |
| 33.99 |
| 27.65 |
| ||
Third Quarter |
| 39.29 |
| 29.22 |
| ||
Fourth Quarter |
| 38.46 |
| 31.39 |
| ||
From October 9, 2002 to January 5, 2004, the Predecessor Company'sCompany’s previously authorized Class A common stock was listed for trading on the OTCBB under the ticker symbol "MGLHQ.OB".“MGLHQ.OB.” As of the Effective Date, trading of the Predecessor Company'sCompany’s pre-petition Class A common stock was halted on the OTCBB and the Company'sCompany’s Class A common stock was cancelled. Prior to October 9, 2002, the Class A Common Stock was traded on the New York Stock Exchange ("NYSE") under the ticker symbol "MGL" until such date, when it was de-listed from that market. The following table sets forth the high and low closing bid prices of the Predecessor Company'sCompany’s previously authorized Class A common stock as reported by the NYSE and the OTCBB from January 1, 20022003 through December 31, 2003:
| | Common Stock Sales Prices |
|
| Common Stock |
| ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Calendar Year |
|
|
| High |
| Low |
| ||||
| High | Low | ||||||||||
| 2002 | |||||||||||
| First Quarter | 6.75 | 5.20 | |||||||||
| Second Quarter | 8.65 | 1.00 | |||||||||
| Third Quarter | 1.75 | 0.26 | |||||||||
| Fourth Quarter | 0.24 | 0.03 | |||||||||
2003 | 2003 |
|
|
|
|
| |||||
| First Quarter | 0.19 | 0.03 | First Quarter |
| $ 0.19 |
| $ 0.03 |
| |||
| Second Quarter | 0.06 | 0.03 | Second Quarter |
| 0.06 |
| 0.03 |
| |||
| Third Quarter | 0.20 | 0.05 | Third Quarter |
| 0.20 |
| 0.05 |
| |||
| Fourth Quarter | 0.11 | 0.06 | Fourth Quarter |
| 0.11 |
| 0.06 |
| |||
On the Effective Date, all interests in the Reorganized Company's pre-petition Common Stock and Preferred Stock were cancelled and three new classes of capital stock were authorized. Specifically, 100 million shares of Ordinary Common Stock and 40 million shares of Multiple and Variable Vote Restricted Convertible Common Stock, $0.01 par value per share ("Multi-Vote Common Stock") were authorized, as were 10 million shares of Preferred Stock, $0.01 par value per share, that are issuable at the discretion of the Board of Directors in the manner provided by law in one or more series with such powers, privileges and rights as may be determined by the Board (except that no non-voting shares shall be issued). No shares of Preferred Stock were issued or are to be issued under the Plan. Shares of the Multi-Vote Common Stock may only be issued to, and held by, Onex Corporation, a Canadian corporation, or (as determined in accordance with Magellan's amended and restated certificate of incorporation) an affiliate thereof (collectively, "Onex"). Onex, in connection with the Plan, invested in the equity of Magellan, which equity is to be in the form of shares of Multi-Vote Common Stock. Upon transfer of any shares of Multi-Vote Common Stock to any party other than Onex, the shares of Multi-Vote Common Stock will automatically convert on a share-for-share basis into shares of the Ordinary Common Stock. In addition, any shares of Ordinary Common Stock that Onex may come to
35
own at any time when the Multi-Vote Common Stock is outstanding will automatically convert into shares of Multi-Vote Common Stock.
As of March 4,December 31, 2004, the approximate number of stockholders of record of the Ordinary Common Stock and the Multi-Vote Common Stock was 263314 and 1, respectively. The stockholders of record data for the Ordinary Common Stock does not reflect stockholders whose stock was held on that date by the Depository Trust Company or other intermediaries. The Company's Multi-Vote Common Stock is held 100.0 percent by Onex, but upon sale of any such shares by Onex to any non-affiliate, such sold shares automatically convert to and become Ordinary Common Stock.
The Company did not declare any cash dividends on its pre-petition Class A common stock during either the fiscal years ended September 30, 2002 or December 31, 2003 nor during the three months ended December 31, 2002. The Company has not declared any cash dividends on the Ordinary Common Stock.or 2004. The Company is prohibited from paying dividends on the Ordinary Common Stock under the terms of the Credit Agreement, except in very limited circumstances. See "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations—Outlook—Liquidity and Capital Resources—Restrictive Covenants in Debt Agreements".Agreements.”
Securities Authorized for Issuance Under Equity Compensation Plans
AsThe following table sets forth certain information as of December 31, 2004 with respect to the 2003 Management Incentive Plan.
Plan category |
|
|
| Number of securities |
| Weighted average |
| Number of securities |
| ||||||
|
| (a) |
| (b) |
| (c) |
| ||||||||
Equity compensation plans approved by security holders |
|
| 4,220,222 | (1) |
|
| $ 13.34 |
|
|
| 1,901,578 | (2) |
| ||
Equity compensation plans not approved by security holders |
|
| — |
|
|
| — |
|
|
| — |
|
| ||
Total |
|
| 4,220,222 | (1) |
|
| $ 13.34 |
|
|
| 1,901,578 | (2) |
| ||
(1) Excludes 251,889 shares issued as of December 31, 2004 as restricted stock grants to, or purchased as restricted stock by, employees under the Company’s 2003 Management Incentive Plan and 13,595 shares issued as of December 31, 2004, subject to certain restrictions, as grants to certain of the Company’s directors under the Company’s 2004 Director Stock Compensation Plan.
(2) Consists of 1,901,578 shares remaining available for issuance as of December 31, 2004 under the Company’s 2003 Management Incentive Plan (under which the Company maintainedmay issue stock optionoptions, restricted stock awards, stock bonuses, stock purchase rights and incentive plansother equity incentives), after giving effect to the shares issuable upon the exercise of outstanding options, warrants and rights and the shares of restricted stock issued as referred to in footnote (1) above and 6,405 shares remaining available for issuance before the Company’s 2005 Annual Meeting of Stockholders under which employeesthe 2004 Director Stock Compensation Plan, although no such additional share issuance under such plan is anticipated.
Unregistered Sales of Securities
Under the Plan and non-employee directors could beimplementing documents (other than executive employment agreements and the Company’s 2003 Management Incentive Plan), the Company as of January 5, 2004 issued (or reserved for issuance upon resolution of Disputed Claims as described above in Item 1) approximately 26,617,532 shares of Ordinary Common Stock, approximately 8,487,750 shares of Multi-Vote Common Stock and warrants to purchase a total of approximately 800,825 shares of Ordinary Common Stock. These shares and warrants were issued without registration under the Securities Act, in exchange for claims in the chapter 11 case of the Company and certain of its subsidiaries in reliance on the exemption provided therefrom by Section 1145 of the Bankruptcy Code or, in the case of the Multi-Vote Common Stock, the exemption for private offerings pursuant to Section 4(2) of the Securities Act. During 2004, 19 of the warrants were exercised. Also in January 2004, 82,854 shares of Ordinary Common Stock were issued without registration under the Securities Act upon conversion of an equal number of shares of Multi-Vote Common Stock in connection with the transfer of such shares. Such issuance was made in reliance upon the exemption from registration provided by Section 4(2) of the Securities Act. During fiscal 2004, the Company granted options to purchase shares of Company common stock or awarded shares of common stock and, in addition, the Company maintained its 2000 Employee Stock Purchase Plan, all of which had previously been approved by the Company's stockholders. No options or shares were granted or issued under any of these plans in the year ended December 31, 2003. All options related to the previously authorized common stock of the Company remaining outstanding under these plans were cancelled on the Effective Date and no consideration was issued in exchange therefor. Any shares of the previously authorized common stock issued under these plans (including shares issued under the 2003 Employee Stock Purchase Plan) that were outstanding on the Effective Date were converted into4.4 million shares of Ordinary Common Stock and Warrants in accordance with the provisions of the Plan. Each of these plans was cancelled as of the Effective Date (except to the extent that provisions of the plans might continue to apply togranted 251,889 restricted shares of Ordinary Common Stock or warrants issued under the Plan in respect of shares of the previously common stock issued under such plans and remaining outstanding immediately before the Effective Date). Accordingly, securities may no longer be issued by the Company under any of these plans.
The Plan provided for the creation of a Management Incentive Plan, under which restricted stock awards, stock options and other equity incentives may be issued to members of the Company's management and other employees. The Plan also provided for employment agreements with certain senior executives of the Company which in turn provide for issuances of shares of the Company's Ordinary Common Stock or options to acquire such shares in certain circumstances. TheCompany’s 2003 Management Incentive Plan, and these agreements became effectivegranted 13,595 shares of Ordinary Common Stock under the Company’s 2004 Director Stock Compensation Plan, in each case without registration under the Securities Act, in reliance on the Effective Date. Information regarding securities
exemptions provided therefrom for private offerings pursuant to Section 4(2) of the Securities Act. No shares have yet been issued and which may be issued under these plans and agreements is contained in Note 1—"General" and in Note 8—"Stockholders' Equity" to the audited consolidated financial statements set forth elsewhere herein.upon exercise of such options.
36
Item 6. Selected Financial Data
In May 2003, the Company'sCompany’s board of directors approved a change in the Company'sCompany’s fiscal year. Instead of a fiscal year ending on September 30, the Company has adopted a fiscal year that coincides with the calendar year, effective December 31, 2002. The following table sets forth selected historical consolidated financial information of the Company as of and for each of the fourthree fiscal years ended September 30, 1999, 2000, 2001 and 2002, as of and for the fiscal year ended December 31, 2003 and as of and for the three-month transition period ended December 31, 2002. The table also presents2002 and unaudited comparable data as of and for the three months ended December 31, 2001. The table also sets forth selected historical consolidated financial information of the Company as of December 31, 2003 and 2004 and for the fiscal year ended December 31, 2004.
As a result of the Company'sCompany’s financial restructuring under chapter 11 of the U.S. Bankruptcy Code commenced in March 2003 and consummated on the Effective Date and the Company'sCompany’s implementation of fresh start reporting effective December 31, 2003, the selected financial data as of and for the yearyears ended December 31, 2003 and 2004 are not comparable to the prior periods presented. Selected financial data as of and for the fiscal year ended December 31, 2003 includes the following significant unusual items:
·Net reorganization benefit related to continuing operations of approximately $438.2 million, incurred in connection with the Company'sCompany’s financial restructuring. The reorganization benefit is primarily comprised of a net fresh start reorganization gain of approximately $479.7 million as a result of the application of fresh start reporting, a net benefit of approximately $7.5 million from lease rejections and court approved claim reductions, and interest income of approximately $1.1 million, which benefits were partially offset by expenses which include the write-off of deferred financing costs of approximately $18.5 million related to the Old Senior Notes and Old Subordinated Notes and approximately $31.6 million of professional fees incurred in conjunction with the financial restructuring activities and chapter 11 proceedings. The Company also recorded a net reorganization benefit related to discontinued operations of $20.3 million, net of a $0.8 million tax benefit. See Note 3—"“Summary of Significant Accounting Policies"Policies” to the Company's auditedCompany’s consolidated financial statements set forth elsewhere herein for a reconciliation of the reorganization expenses recorded in fiscal 2003.
·Pursuant to FIN 46, the Reorganized Company'sCompany’s balance sheetsheets as of December 31, 2003 includesand 2004 include the assets and liabilities of the Premier joint venture, a variable interest entity ("VIE"(“VIE”) for which the Company is the primary beneficiary. The creditors (or other beneficial interest holders) of Premier have no recourse to the general credit of the Company, as the primary beneficiary of Premier. See Note 3—"“Summary of Significant Accounting Policies—Recent Accounting Pronouncements"Pronouncements” to the audited consolidated financial statements set forth elsewhere herein for discussion of FIN 46. The Reorganized Company early adopted FIN 46 on December 31, 2003, as early adoption of new accounting pronouncements is required by companies implementing the fresh start reporting provisions of SOP 90-7. The joint venture was accounted for under the equity method of accounting by the Predecessor Company through December 31, 2003. As such, the assets and liabilities of Premier are not included in the Predecessor Company'sCompany’s balance sheet accounts as of the end of any of the previous periods presented.
See Note 2—"“Fresh Start Reporting"Reporting” to the audited consolidated financial statements elsewhere herein for discussion of fresh start adjustments recorded by the Company.
Net loss for fiscal 2002 includesincluded the effect of the adoption of SFAS 142. Adoption of No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142142”) which resulted in the Company recognizing an impairment loss of $207.8 million before taxes ($191.6 million after taxes), in the first quarter of fiscal 2002, recorded as a
cumulative effect of a change in accounting principle, separate from operating results. Adoption of SFAS 142 also resulted in goodwill impairment charges of $415.9 million and $28.8 million in fiscal 2002 and fiscal 2003, respectively. In accordance with SFAS 142, the Company did not record goodwill amortization, which would have amounted to approximately $31.1 million and $31.8 million in fiscal 2002 and 2003, respectively, and $7.9 million (unaudited) and $7.8 million during the three months ended December 31, 2001 and 2002, respectively,
37
had SFAS 142 not been adopted. See Note 3—"“Summary of Significant Accounting Policies—Goodwill"Predecessor Company Goodwill” to the audited consolidated financial statements set forth elsewhere herein for further discussion of the impact to the Company of the adoption of SFAS 142 in fiscal 2002. In addition, the Company'sCompany’s capital restructuring activities and financial condition resulted in uncertainty as of September 30, 2002 as to the Company'sCompany’s ability to realize its net operating loss carryforwards and other deferred tax assets. Accordingly, as of September 30, 2002, the Company recorded an increase to its valuation allowance of $200.5 million, resulting in a total valuation allowance covering all of its net deferred tax assets. See Note 10—"“Income Taxes"Taxes” to the audited consolidated financial statements set forth elsewhere herein.
The operating results for fiscal 2001 were positively impacted by settlements of certain contract appeals related to subcontracts with respect to TRICARE. For fiscal 2001, net revenue and equity in earnings of unconsolidated subsidiaries included $30.3 million and $22.6 million, respectively, related to such settlements. For fiscal 2001, income from continuing operations and net income each included approximately $31.7 million related to the positive impact of these settlements. Additionally, in the fourth quarter of fiscal 2002, the Company adopted SFAS 145, which led to the reclassification of losses due to early extinguishment of debt in fiscal 2001 from extraordinary losses to losses from operations.
On September 2, 1999, the Company's Board of Directors approved a formal plan to dispose of the Company's businesses and interests included in the Company's healthcare provider and healthcare franchising segments and on September 10, 1999, the Company consummated such disposal. On October 4, 2000, the Company adopted a formal plan to dispose of the business included in the Company's specialty managed healthcare segment. On January 18, 2001, the Company adopted a formal plan to dispose of the business representing the Company's human services segment, and on March 9, 2001, the Company consummated such disposal. Accordingly, the statement of operations data has been restated to reflect the healthcare provider, healthcare franchising, specialty managed healthcare and human services business segments as discontinued operations.
Selected consolidated financial information for the years ended September 30, 2001 and 2002 and December 31, 2003 and 2004 and for the three months ended December 31, 2002, and as of December 31, 20022003 and 20032004 presented below, have been derived from, and should be read in conjunction with, the audited consolidated financial statements and the notes thereto included elsewhere herein. Selected consolidated financial information for the fiscal years ended September 30, 19992000 and 20002001 and as of September 30, 1999, 2000, 2001 and 2002 has been derived from the Company'sCompany’s audited consolidated financial statements not included in this Form 10-K. The selected consolidated financial information as of and for the three months ended December 31, 2001 is unaudited. The selected financial data set forth below also should be read in conjunction with "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations"Operations” appearing elsewhere herein.
38
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
|
| Predecessor Company |
|
| Reorganized |
| ||||||||||||
|
| Fiscal Year |
| Fiscal Year |
| Three Months |
|
| Fiscal Year |
| ||||||||
|
| 2000 |
| 2001 |
| 2002 |
| 2003 |
| 2001(1) |
| 2002 |
|
| 2004 |
| ||
Statement of Operations Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue |
| $1,640,933 |
| $1,755,512 |
| $1,753,058 |
| $1,510,746 |
| $ 444,842 |
| $445,890 |
|
|
| $1,795,402 |
|
|
Salaries, cost of care and other operating expenses |
| 1,442,082 |
| 1,557,042 |
| 1,585,314 |
| 1,324,886 |
| 395,093 |
| 391,433 |
|
|
| 1,567,465 |
|
|
Equity in earnings of unconsolidated subsidiaries |
| (9,792 | ) | (36,566 | ) | (13,006 | ) | (6,202 | ) | (3,177 | ) | (2,138 | ) |
|
| (5,277 | ) |
|
Depreciation and amortization |
| 68,261 |
| 68,294 |
| 47,558 |
| 48,047 |
| 11,190 |
| 14,380 |
|
|
| 42,489 |
|
|
Interest expense (Contractual interest of $106,328 in fiscal 2003) |
| 106,711 |
| 110,423 |
| 97,596 |
| 61,016 |
| 23,719 |
| 25,333 |
|
|
| 37,124 |
|
|
Interest income |
| (9,425 | ) | (10,121 | ) | (5,365 | ) | (2,873 | ) | (1,310 | ) | (1,010 | ) |
|
| (6,127 | ) |
|
Stock compensation expense |
| — |
| — |
| — |
| — |
| — |
| — |
|
|
| 23,152 |
|
|
Reorganization benefit, net |
| — |
| — |
| — |
| (438,217 | ) | — |
| — |
|
|
| — |
|
|
Goodwill impairment charges |
| — |
| — |
| 415,880 |
| 28,780 |
| — |
| — |
|
|
| — |
|
|
Special charges |
| 25,398 |
| 3,340 |
| 15,729 |
| 9,528 |
| 4,485 |
| 3,907 |
|
|
| 5,038 |
|
|
Income (loss) from continuing operations before income taxes and minority interest |
| 17,698 |
| 63,100 |
| (390,648 | ) | 485,781 |
| 14,842 |
| 13,985 |
|
|
| 131,538 |
|
|
Provision for income taxes |
| 8,994 |
| 33,732 |
| 151,609 |
| 33,813 |
| 6,086 |
| 3,129 |
|
|
| 46,584 |
|
|
Income (loss) from continuing operations before minority interest |
| 8,704 |
| 29,368 |
| (542,257 | ) | 451,968 |
| 8,756 |
| 10,856 |
|
|
| 84,954 |
|
|
Minority interest |
| 114 |
| 78 |
| 47 |
| 253 |
| 16 |
| 27 |
|
|
| 333 |
|
|
Income (loss) from continuing operations |
| 8,590 |
| 29,290 |
| (542,304 | ) | 451,715 |
| 8,740 |
| 10,829 |
|
|
| 84,621 |
|
|
Income (loss) from discontinued operations(2) |
| (56,736 | ) | 4,624 |
| 4,894 |
| (25,028 | ) | 158 |
| 803 |
|
|
| 4,781 |
|
|
Income (loss) on disposal of discontinued operations(2) |
| (17,662 | ) | (9,359 | ) | (92 | ) | 4,756 |
| 820 |
| 97 |
|
|
| (1,030 | ) |
|
Reorganization benefit, net(2) (See Note 3) |
| — |
| — |
| — |
| 20,327 |
| — |
| — |
|
|
| — |
|
|
Income (loss) before cumulative effect of change |
| (65,808 | ) | 24,555 |
| (537,502 | ) | 451,770 |
| 9,718 |
| 11,729 |
|
|
| 88,372 |
|
|
Cumulative effect of change in accounting principle(2) |
| — |
| — |
| (191,561 | ) | — |
| (191,561 | ) | — |
|
|
| — |
|
|
Net income (loss) |
| (65,808 | ) | 24,555 |
| (729,063 | ) | 451,770 |
| (181,843 | ) | 11,729 |
|
|
| 88,372 |
|
|
Preferred dividends (Contractual dividends of $4,788 in fiscal 2003) |
| 3,401 |
| 4,527 |
| 4,657 |
| 883 |
| 1,075 |
| 1,243 |
|
|
| — |
|
|
Amortization of redeemable preferred stock issuance costs, and other |
| 401 |
| 522 |
| 540 |
| 172 |
| 143 |
| 136 |
|
|
| — |
|
|
Preferred stock reorganization items, net(2) |
| — |
| — |
| — |
| 2,668 |
| — |
| — |
|
|
|
|
|
|
Income (loss) available to common stockholders |
| $ (69,610 | ) | $ 19,506 |
| $ (734,260 | ) | $ 448,047 |
| $ (183,061 | ) | $ 10,350 |
|
|
| $ 88,372 |
|
|
Income (loss) per common share available to common stockholders—basic: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations |
| $ 0.15 |
| $ 0.72 |
| $ (15.71 | ) | $ 12.69 |
| $ 0.22 |
| $ 0.27 |
|
|
| $ 2.39 |
|
|
Income (loss) from discontinued operations |
| (2.32 | ) | (0.14 | ) | 0.14 |
| — |
| 0.03 |
| 0.02 |
|
|
| 0.11 |
|
|
Cumulative effect of change in accounting |
| — |
| — |
| (5.50 | ) | — |
| (5.53 | ) | — |
|
|
| — |
|
|
Net income (loss) |
| $ (2.17 | ) | $ 0.58 |
| $ (21.07 | ) | $ 12.69 |
| $ (5.28 | ) | $ .029 |
|
|
| $ 2.50 |
|
|
Income (loss) per common share available to common stockholders—diluted: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations |
| $ 0.15 |
| $ 0.69 |
| $ (15.71 | ) | $ 10.86 |
| $ 0.21 |
| $ 0.26 |
|
|
| $ 2.33 |
|
|
Income (loss) from discontinued operations |
| (2.30 | ) | (0.13 | ) | 0.14 |
| — |
| 0.02 |
| 0.02 |
|
|
| 0.10 |
|
|
Cumulative effect of change in accounting |
| — |
| — |
| (5.50 | ) | — |
| (4.55 | ) | — |
|
|
| — |
|
|
Net income (loss) |
| $ (2.15 | ) | $ 0.56 |
| $ (21.07 | ) | $ 10.86 |
| $ (4.32 | ) | $ 0.28 |
|
|
| $ 2.43 |
|
|
| | Predecessor Company | |||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | | Three Months Ended December 31, | ||||||||||||||||
| | Fiscal Year Ended September 30, | | ||||||||||||||||||||
| | Fiscal Year Ended December 31, 2003 | |||||||||||||||||||||
| | 1999 | 2000 | 2001 | 2002 | 2001 (1) | 2002 | ||||||||||||||||
| Statement of Operations Data: | ||||||||||||||||||||||
| Net revenue | $ | 1,465,918 | $ | 1,640,933 | $ | 1,755,512 | $ | 1,753,058 | $ | 1,510,746 | $ | 444,842 | $ | 445,890 | ||||||||
| Salaries, cost of care and other operating expenses | 1,282,064 | 1,442,082 | 1,557,042 | 1,585,314 | 1,324,886 | 395,093 | 391,433 | |||||||||||||||
| Equity in earnings of unconsolidated subsidiaries | (20,442 | ) | (9,792 | ) | (36,566 | ) | (13,006 | ) | (6,202 | ) | (3,177 | ) | (2,138 | ) | ||||||||
| Depreciation and amortization | 62,408 | 68,261 | 68,294 | 47,558 | 48,047 | 11,190 | 14,380 | |||||||||||||||
| Interest expense (Contractual interest of $106,328 in fiscal 2003) | 104,156 | 106,711 | 110,423 | 97,596 | 61,016 | 23,719 | 25,333 | |||||||||||||||
| Interest income | (10,404 | ) | (9,425 | ) | (10,121 | ) | (5,365 | ) | (2,873 | ) | (1,310 | ) | (1,010 | ) | ||||||||
| Reorganization benefit, net | — | — | — | — | (438,217 | ) | — | — | ||||||||||||||
| Goodwill impairment charges | — | — | — | 415,880 | 28,780 | — | — | |||||||||||||||
| Managed care integration costs | 6,238 | — | — | — | — | — | — | |||||||||||||||
| Special charges | 4,441 | 25,398 | 3,340 | 15,729 | 9,528 | 4,485 | 3,907 | |||||||||||||||
| Income (loss) from continuing operations before income taxes and minority interest | 37,457 | 17,698 | 63,100 | (390,648 | ) | 485,781 | 14,842 | 13,985 | ||||||||||||||
| Income tax provision (benefit) | 21,674 | 8,994 | 33,732 | 151,609 | 33,813 | 6,086 | 3,129 | |||||||||||||||
| Income (loss) from continuing operations before minority interest | 15,783 | 8,704 | 29,368 | (542,257 | ) | 451,968 | 8,756 | 10,856 | ||||||||||||||
| Minority interest | 630 | 114 | 78 | 47 | 253 | 16 | 27 | |||||||||||||||
| Income (loss) from continuing operations | 15,153 | 8,590 | 29,290 | (542,304 | ) | 451,715 | 8,740 | 10,829 | ||||||||||||||
| Income (loss) from discontinued operations (2) | 36,958 | (56,736 | ) | 4,624 | 4,894 | (25,028 | ) | 158 | 803 | |||||||||||||
| Income (loss) on disposal of discontinued operations (2) | (47,423 | ) | (17,662 | ) | (9,359 | ) | (92 | ) | 4,756 | 820 | 97 | |||||||||||
| Reorganization benefit, net (2) (See Note 3) | — | — | — | — | 20,327 | — | — | |||||||||||||||
| Income (loss) before cumulative effect of change in accounting principle | 4,688 | (65,808 | ) | 24,555 | (537,502 | ) | 451,770 | 9,718 | 11,729 | |||||||||||||
| Cumulative effect of change in accounting principle (2) | — | — | — | (191,561 | ) | — | (191,561 | ) | — | |||||||||||||
| Net income (loss) | 4,688 | (65,808 | ) | 24,555 | (729,063 | ) | 451,770 | (181,843 | ) | 11,729 | ||||||||||||
| Preferred dividends (Contractual dividends of $4,788 in fiscal 2003) | — | 3,401 | 4,527 | 4,657 | 883 | 1,075 | 1,243 | |||||||||||||||
| Amortization of redeemable preferred stock issuance costs, and other | — | 401 | 522 | 540 | 172 | 143 | 136 | |||||||||||||||
| Preferred stock reorganization items, net (2) | — | — | — | — | 2,668 | — | — | |||||||||||||||
| Income (loss) available to common stockholders | $ | 4,688 | $ | (69,610 | ) | $ | 19,506 | $ | (734,260 | ) | $ | 448,047 | $ | (183,061 | ) | $ | 10,350 | |||||
| Income (loss) per common share available to common stockholders — basic: | ||||||||||||||||||||||
| Income (loss) from continuing operations before extraordinary items | $ | 0.48 | $ | 0.15 | $ | 0.72 | $ | (15.71 | ) | $ | 12.69 | $ | 0.22 | $ | 0.27 | |||||||
| Income (loss) from discontinued operations | (0.33 | ) | (2.32 | ) | (0.14 | ) | 0.14 | — | 0.03 | 0.02 | ||||||||||||
| Cumulative effect of change in accounting principle | — | — | — | (5.50 | ) | — | (5.53 | ) | — | |||||||||||||
| Net income (loss) | $ | 0.15 | $ | (2.17 | ) | $ | 0.58 | $ | (21.07 | ) | $ | 12.69 | $ | (5.28 | ) | $ | .029 | |||||
| Income (loss) per common share available to common stockholders — diluted: | ||||||||||||||||||||||
| Income (loss) from continuing operations before extraordinary items | $ | 0.48 | $ | 0.15 | $ | 0.69 | $ | (15.71 | ) | $ | 10.86 | $ | 0.21 | $ | 0.26 | |||||||
| Income (loss) from discontinued operations | (0.33 | ) | (2.30 | ) | (0.13 | ) | 0.14 | — | 0.02 | 0.02 | ||||||||||||
| Cumulative effect of change in accounting principle | — | — | — | (5.50 | ) | — | (4.55 | ) | — | |||||||||||||
| Net income (loss) | $ | 0.15 | $ | (2.15 | ) | $ | 0.56 | $ | (21.07 | ) | $ | 10.86 | $ | (4.32 | ) | $ | 0.28 | |||||
| | Predecessor Company | Reorganized Company | Predecessor Company | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | September 30, | | December 31, | |||||||||||||||||||
| | December 31, 2003 | |||||||||||||||||||||
| | 1999 | 2000 | 2001 | 2002 | 2001 (1) | 2002 | ||||||||||||||||
| Balance Sheet Data: | ||||||||||||||||||||||
| Current assets | $ | 374,927 | $ | 325,532 | $ | 274,011 | $ | 283,730 | $ | 630,223 | $ | 293,276 | $ | 286,131 | ||||||||
| Current liabilities | 474,268 | 475,758 | 430,285 | 1,494,412 | 523,531 | 425,182 | 1,477,999 | |||||||||||||||
| Property and equipment, net | 120,667 | 112,612 | 94,322 | 86,773 | 122,082 | 90,369 | 85,659 | |||||||||||||||
| Total assets | 1,881,615 | 1,809,666 | 1,666,705 | 1,004,080 | 1,292,017 | 1,667,730 | 998,917 | |||||||||||||||
| Total debt and capital lease obligations | 1,144,308 | 1,098,047 | 1,006,356 | 1,049,354 | 493,699 | 1,005,369 | 1,048,158 | |||||||||||||||
| Stockholders' equity (deficit) | $ | 196,696 | $ | 128,464 | $ | 162,188 | $ | (570,672 | ) | $ | 387,911 | $ | 170,729 | $ | (560,322 | ) | ||||||
|
| Predecessor Company |
| Reorganized |
| ||||||||||
|
| September 30, |
| December 31, |
| December 31, |
| ||||||||
|
| 2000 |
| 2001 |
| 2002 |
| 2001(1) |
| 2002 |
| 2003 |
| 2004 |
|
Balance Sheet Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets |
| $ 325,532 |
| $ 274,011 |
| $ 283,730 |
| $ 293,276 |
| $ 286,131 |
| $ 630,223 |
| $ 540,495 |
|
Current liabilities |
| 475,758 |
| 430,285 |
| 1,494,412 |
| 425,182 |
| 1,477,999 |
| 523,531 |
| 382,308 |
|
Property and equipment, net |
| 112,612 |
| 94,322 |
| 86,773 |
| 90,369 |
| 85,659 |
| 122,082 |
| 120,604 |
|
Total assets |
| 1,809,666 |
| 1,666,705 |
| 1,004,080 |
| 1,667,730 |
| 998,917 |
| 1,292,017 |
| 1,188,338 |
|
Total debt and capital lease obligations |
| 1,098,047 |
| 1,006,356 |
| 1,049,354 |
| 1,005,369 |
| 1,048,158 |
| 493,699 |
| 379,478 |
|
Stockholders’ equity (deficit) |
| $ 128,464 |
| $ 162,188 |
| $ (570,672 | ) | $ 170,729 |
| $ (560,322 | ) | $ 387,911 |
| $ 497,053 |
|
(1)
(2)
39
Item 7. Management's Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Form 10-K includes "forward-looking statements"“forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"“Exchange Act”). Although the Company believes that its plans, intentions and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such plans, intentions or expectations will be achieved. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements are set forth under the heading "Cautionary Statements"“Cautionary Statements” in Item 1 and elsewhere in this Form 10-K. When used in this Form 10-K, the words "estimate", "anticipate", "expect", "believe", "should"“estimate,” “anticipate,” “expect,” “believe,” “should” and similar expressions are intended to be forward-looking statements. Also, capitalized or defined terms included in Item 7 have the meanings set forth in Item 1 of this Form 10-K.
Magellan, directly and through its subsidiaries (collectively, the "Company")The Company coordinates and manages the delivery of behavioral healthcare treatment services that are provided through its contracted network of third-party treatment providers, which includes psychiatrists, psychologists, other behavioral health professionals, psychiatric hospitals, residential treatment centers and other treatment facilities. See "Business—Provider Network" for further discussion of the Company's managed behavioral healthcare network. The treatment services provided through the Company's provider network include outpatient programs (such as counseling or therapy), intermediate care programs (such as intensive outpatient programs and partial hospitalization services), inpatient treatment and crisis intervention services. The Company, however, generally does not directly provide, or own any provider of, treatment services. The Company provides its management services primarily through: (i) risk-based products, where the Company assumes all or a portion of the responsibility for the cost of providing treatment services in exchange for a fixed per member per month fee, (ii) administrative services only ("ASO") products, where the Company provides services such as utilization review, claims administration and/or provider network management but does not assume responsibility for the cost of the treatment services, (iii) employee assistance programs ("EAPs") and (iv) products which combine features of some or all of the Company's risk-based, ASO or EAP products. At December 31, 2003,2004, the Company managed the behavioral healthcare benefits of approximately 58.657.1 million individuals.
Within the managed behavioral healthcare business, the Company operates in the following four segments, based on the services it provides and/or the customers that it serves: (i) Magellan Health Plan Solutions ("(“Health Plan Solutions"Solutions”); (ii) Magellan Employer Solutions ("(“Employer Solutions"Solutions”); (iii) Magellan Public Sector Solutions ("(“Public Sector Solutions"Solutions”) and (iv) Corporate and Other.
Health Plan Solutions.The Company'sCompany’s Health Plan Solutions segment generally reflects managed behavioral healthcare services provided under contracts with managed care companies, health insurers and other health plans. This segment'ssegment’s contracts encompass both risk-based and ASO contracts. Although certain health plans provide their own managed behavioral healthcare services, many health plans "carve out"“carve out” behavioral healthcare from their general healthcare services and subcontract such services to managed behavioral healthcare companies such as the Company. In the Health Plan Solutions segment, the Company'sCompany’s members are the beneficiaries of the health plan (the employees and dependents of the customer of the health plan), for which the behavioral healthcare services have been carved out to the Company. DuringThe Company derived revenue from its contract with Aetna of $250.3 million and $193.6 million, respectively, during the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, the Company derived approximately $315.6 million, $250.3 million and $193.6 million, respectively, of consolidated net revenue from its contracts with Aetna, Inc. ("Aetna"). The Company recognized net revenues from Aetna of $78.8 million and $54.8 million during the three months ended December 31, 2001 and 2002, respectively.respectively, and $228.1 million during the fiscal year ended December 31, 2004. The declines in Aetna revenue of
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approximately $56.7 million in fiscal 2003 compared to fiscal 2002, approximately $65.3 million in fiscal 2002 compared to fiscal 2001, and of approximately $24.0 million for the three months ended December 31, 2002 as compared to the three months ended December 31, 2001, were mainly due to decreased membership as a result of Aetna intentionally reducing its membership levels in an effort to exit less profitable businesses.
As described in "Business—“Business—Emergence from Chapter 11," as part of” the consummation of the Plan, Aetna and Magellan have renewed their contract under which the Company will continue to manage the behavioral health care of Aetna's members throughterminate on December 31, 2005, with an option for Aetna to either extend the agreement at that time or to purchase the assets used in the operation of the Aetna contract.
The Company manages the mental health and substance abuse services for certain of the beneficiaries of TRICARE, formerly the Civilian Health and Medical Program of the Uniformed Services (CHAMPUS), under a subcontract with a health plan that contracts with TRICARE. The Company recognized net revenues from this subcontract of $61.5 million, $48.0 million, and $47.3 million in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and $12.7 million and $14.0 million during the three months ended December 31, 2001 and 2002, respectively. This subcontract expires on September 30, 2004 and will not be renewed. The Company previously had a second subcontract with another health plan that contracted with TRICARE. This second subcontract expired on April 30, 2003. The Company recognized net revenues from the second TRICARE subcontract of $39.3 million, $31.2 million and $9.9 million for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and $8.3 million and $8.9 million during the three months ended December 31, 2001 and 2002, respectively.
The Company receives fixed fees under its TRICARE subcontract, which are subject to certain bid-price adjustments (BPAs). The BPAs are calculated in accordance with contractual provisions and actual healthcare utilization from the data collection period, as defined. The BPAs are recorded when measurable, based upon information available from both the TRICARE program and the Company's information systems.2005.
Employer Solutions.The Company'sCompany’s Employer Solutions segment (formerly "Workplace") generally reflects the provision of EAP services, managed behavioral healthcare services and integrated products under contracts with employers, including corporations and governmental agencies, and labor unions. This segment'ssegment’s managed behavioral healthcare services are primarily ASO products.
Public Sector Solutions.The Company'sCompany’s Public Sector Solutions segment generally reflects managed behavioral healthcare services provided to Medicaid recipients under contracts with state and local governmental agencies. This segment'ssegment’s contracts encompass both risk-based and ASO contracts. The Company provides managed behavioral healthcare services to the State of Tennessee'sTennessee’s TennCare program,
both through a direct contract held by the Company'sCompany’s wholly owned subsidiary Tennessee Behavioral Health, Inc. ("TBH"),TBH, and through a contract held by Premier, Behavioral Systems of Tennessee, LLC ("Premier"), a joint venture in which the Company owns a 50.0 percent interest. In addition, the Company contracts with Premier to provide certain services to the joint venture. Through fiscal 2003, the Predecessor Company accounted for its investment in Premier using the equity method. Effective December 31, 2003, the Reorganized Company early adopted the Financial Accounting Standards Board's ("FASB") Interpretation No.FIN 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51 ("FIN 46"), under which the Reorganized Company has consolidated the balance sheet of Premier in its consolidated balance sheet as of December 31, 2003. Beginning in fiscal 2004, the Reorganized Company will consolidatehas consolidated the results of operations of Premier, including revenue and cost of care of the joint venture, in its consolidated statement of operations. The creditors (or other beneficial interest holders) of Premier have no recourse to the general credit of the Company, as the primary beneficiary of Premier. See further discussion of FIN 46 in "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Accounting Pronouncements".Pronouncements.”
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The Company'sCompany’s direct TennCare contract (exclusive of Premier'sPremier’s contract with TennCare) accounted for approximately $248.9 million, $237.5 million and $157.3 million of consolidated net revenue in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and approximately $60.0 million (unaudited) and $63.0 million of consolidated net revenue for the three months ended December 31, 2001 and 2002, respectively. Such revenue amounts include revenue recognized by the Company associated with services performed on behalf of Premier totaling $102.0 million, $134.9 million and $39.8 million for fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and $33.6 million (unaudited) and $34.6 million for the three months ended December 31, 2001 and 2002, respectively. The Company’s direct TennCare contract (exclusive of Premier’s contract with TennCare) accounted for approximately $178.5 million of consolidated net revenue in the fiscal year ended December 31, 2004. The decline in revenue from fiscal 2002 to fiscal 2003 associated with the TennCare program was primarily the result of the reduction in revenue associated with services no longer performed on behalf of Premier due to a program change, which reduction was partially offset by increases in rates. As previously noted, the Company started consolidating Premier in accordance with FIN 46 as of December 31, 2003. The Company recorded $253.0 million of revenue from Premier’s TennCare contract during the fiscal year ended December 31, 2004.
In September 2003, the State of Tennessee issued a request for proposal ("RFP"(“RFP”) relating to the TennCare program under which the program willwas to be divided into three regions. The Company, through TBH, submitted a proposal for the East region only and was awarded the contract. The new contract, with respect to the East region will become effectivewhich has a term from July 1, 2004.2004 through December 31, 2005, with extensions at the State’s option through December 31, 2008. When contract negotiations between the State and the vendor that had been awarded the contracts for the Middle and West regions were discontinued, the State asked TBH and Premier to continue with their current contracts for those regions through December 31, 2004. The East region contract has an initial term that runsEffective July 1, 2004 agreements with the State were reached, under which TBH and Premier will continue serving the Middle and West regions of TennCare through December 31, 2005. As a result of these agreements, the Company will continue to manage behavioral health care for the entire TennCare program.
On January 10, 2005, the Governor of Tennessee stated that, because of the increased costs of the TennCare program, the State will cease providing coverage to approximately 323,000 adults who do not qualify for Medicaid, and will limit benefits to be delivered under the TennCare program. The Governor stated that he wishes to begin implementing such membership and benefit changes in March 2005 and includes a provision for extensionscomplete them by the end of 2005. Certain advocacy groups have filed suits in attempts to prevent the Governor from implementing any membership and benefits reductions. A reduction in membership would, and benefit changes could adversely affect the Company’s revenues and profitability. However, because of the opposition to the Governor’s plan, and because, even if the Governor were to prevail the Company does not yet know which members would be eliminated from the program, the timing of the membership reductions, the benefit changes being proposed or the timing of those changes, it cannot estimate the impact of these potential developments at the State's option through December 31, 2008.this time.
The Company'sCompany’s Public Sector Solutions segment derives a significant portion of its revenue from contracts with various counties in the state of Pennsylvania (the "Pennsylvania Counties"“Pennsylvania Counties”). Although these are separate contracts with individual counties, they all pertain to the Pennsylvania Medicaid program. Revenues from the Pennsylvania Counties in the aggregate totaled approximately $121.1 million, $181.9 million and $189.6 million in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and approximately $36.0 million and $56.2 million for the three months ended December 31, 2001 and 2002, respectively. The Company'sCompany’s contract with one of the counties was terminated as December 31, 2003. Revenue related to this particular county totaled approximately $19.6 million, $22.8 million and $24.0 million in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and approximately $5.1 million and $6.4 million for the three months ended December 31, 2001 and 2002, respectively. Revenues from the Pennsylvania Counties in the aggregate totaled approximately $187.7 million in the fiscal year ended December 31, 2004.
Risk contracts in the Public Sector Solutions segment generally have higher per member premiums, cost and (to some degree) more volatility than risk contracts in either the Health Plan Solutions and Employer Solutions segments due to the nature of populations, benefits provided and other matters. See "Cautionary“Cautionary Statements—Dependence on Government Spending for Managed Healthcare", "—Healthcare,” “—Possible Impact of Healthcare Reform"Reform” and "—Regulation".“—Government Regulation.”
Corporate and Other.This segment of the Company is comprised primarily of operational support functions such as claims administration, network services, sales and marketing and information technology, as well as corporate support functions such as executive, finance, human resources and legal. Discontinued operations activity is not included in the Corporate and Other segment operating results.
Fiscal Year Change
In May 2003, the Company's board of directors approved a change in the Company's fiscal year. Instead of a fiscal year ending onquarter ended September 30, 2004, the Company has adopted a fiscal year that coincides with the calendar year, effective December 31, 2002. On August 12, 2003, the Company filed with the Securitiesreclassified certain expenses from its Corporate and Exchange Commission ("SEC") a Transition Report on Form 10-K for the three-month period ended December 31, 2002. Throughout this Report on Form 10-K, referencesOther segment to its other segments, as discussed in Note 16—“Business Segment Information” to the Company's
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historical financial information for fiscal years prior to December 31, 2002 will refer to the Company's former fiscal year end of September 30. For example, fiscal years 2001 and 2002 correspond to the twelve-month periods ending September 30, 2001 and 2002, respectively. References to fiscal 2003 relate to the Company's fiscal year ending December 31, 2003.
Emergence from Chapter 11
On January 5, 2004 (the "Effective Date"), Magellan and 88 of its subsidiaries consummated their Third Joint Amended Plan of Reorganization, as modified and confirmed (the "Plan"), under chapter 11 of title 11 of the United States Bankruptcy Code (the "Bankruptcy Code"), which had been confirmed by order of the United States Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court") on October 8, 2003, and accordingly the Plan became fully effective and the companies emerged from the protection of their chapter 11 proceedings. Magellan and these subsidiaries had filed voluntary petitions for relief under the Bankruptcy Code in the Bankruptcy Court on March 11, 2003.
The following is a summary of the transactions which became effective on the Effective Date pursuant to or in connection with the consummation of the Plan. The distributions to which the Company's former creditors and shareholders became entitled under the Plan were made by the Company on the Effective Date or were disbursed in accordance with the Plan soon thereafter, except for certain immaterial distributions that were subsequently made or will be made in the future as provided for by the Plan upon certain conditions being satisfied. This summary only highlights certain of the substantive provisions of the Plan and the documents implementing the Plan and is qualified in its entirety by reference to (i) the full text of the Plan, a copy of which was filed as Exhibit 2(a) to Magellan's Quarterly Report on Form 10-Q filed with the SEC on August 19, 2003, as first supplemented by the modification filed as Exhibit 99.2 to Magellan's Current Report on Form 8-K filed with the SEC on September 30, 2003 and further supplemented by the modification filed as Exhibit 2.3 to Magellan's Current Report on Form 8-K filed with the SEC on October 9, 2003 and as to be implemented pursuant to the confirmation order, a copy of which was filed as Exhibit 2.4 to Magellan's Current Report on Form 8-K filed with the SEC on October 9, 2003, and (ii) the implementing documents, which are referred to below in this summary, filed as Exhibits 2.2 – 2.15 to Magellan's Current Report on Form 8-K filed with the SEC on January 6, 2004, and as amended in certain instances by Magellan's Current Reports on Form 8-K and Form 8-K/A filed with the SEC on January 7, 2004.
Giving effect to the Plan, Magellan and its subsidiaries continued, in their previous organizational form, to conduct their business as previously conducted, with the same assets in all material respects (except for cash to be distributed under the Plan to former creditors of the Company), but the Company was recapitalized. Specifically, the Company's secured bank loans, as existing before the Effective Date, were paid in full, and other then existing indebtedness (i.e., two classes of notes and general unsecured creditor claims) and the then existing equity interests in Magellan were cancelled as of the Effective Date in exchange for the distributions provided for by the Plan, as further described below, all as of the Effective Date.
On the Effective Date, the Company entered into a credit agreement with Deutsche Bank, as lender and administrative agent, and other lenders providing for a $100.0 million term loan, an $80.0 million letter of credit facility and a $50.0 million revolving credit facility (collectively, the "Credit Agreement"). The interest rate on term loan and revolving credit borrowings will fluctuate and will be at a rate equal to the higher of (i) the prime rate established by Deutsche Bank or (ii) one-half of one percent in excess of the overnight "federal funds" rate, as from time to time in effect, plus in either case two and one-half percent per year, subject to the Company's election to have interest calculated based on the "Eurodollar rate" offered by Deutsche Bank plus three and one-half percent per year. The interest rate on letter of credit-related borrowings will be fixed at 3.5 percent. However, in each
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case the interest rate could be reduced upon achievement of certain conditions. Borrowings under the Credit Agreement will mature on August 15, 2008 and certain quarterly principal payments on the term loan are also required. The Credit Agreement is guaranteed by substantially all of the subsidiaries of Magellan and is secured by substantially all of the assets of Magellan and the subsidiary guarantors. The proceeds of the term loan, together with other existing funds, were used on the Effective Date to repay in full in accordance with the Plan the Company's senior secured bank indebtedness under its previous credit agreement (the "Old Credit Agreement") of approximately $161 million, to make other cash payments contemplated by the Plan, to pay fees and expenses related to the chapter 11 cases, and for general working capital purposes. In addition, the letter of credit facility has been utilized to back letters of credit outstanding on the Effective Date and to provide additional letters of credit when needed for the Company's business. For a further discussion of the Credit Agreement, see Note 7—"Long-Term Debt and Capital Lease Obligations" to the audited consolidated financial statements set forth elsewhere herein.
As of the Effective Date, in satisfaction of the $250 million of principal owed on the 9.375% senior notes due 2007 (the "Old Senior Notes") and all accrued and unpaid interest thereon, the Company issued to the holders of such notes approximately $233.5 million in original principal amount of Series A notes of a new issue of senior notes due November 15, 2008 (the "Series A Notes", together with the Series B Notes (see below), the "Senior Notes") and made a cash payment of approximately $46.1 million. The terms of the Senior Notes are substantially similar to those of the Old Senior Notes, except that they mature on November 15, 2008. For a further discussion of the Senior Notes, see Note 7—"Long-Term Debt and Capital Lease Obligations" to the audited consolidated financial statements set forth elsewhere herein.
Under the Plan, holders of the Company's previous 9% Senior Subordinated Notes due 2008 in the principal amount of $625.0 million (the "Old Subordinated Notes") and holders of general unsecured creditor claims (other than claims on the Old Senior Notes and Old Subordinated Notes) ("Other GUCs") were to receive in the aggregate approximately 97 percent of the Ordinary Common Stock (or approximately 22.3 million shares) of the reorganized Company (before giving effect to the Cash-Out Elections discussed below). The actual number of shares allocated between these two classes of creditors, as well as the number of shares allocated to each individual creditor in such creditor classes, is dependent upon the final, total aggregate value of claims for the two creditor classes, as discussed further below.
As of the Effective Date, the Company estimated that the holders of the Old Subordinated Notes would receive in satisfaction of their claims (including all accrued and unpaid interest), approximately 20.5 million shares of Ordinary Common Stock of Magellan (before giving effect to the Cash-Out Elections discussed below). Accordingly, the Company distributed, as of the Effective Date, approximately 32.83 shares per $1,000 of principal amount of such notes (although no fractional shares or cash in lieu thereof were issued or paid). The share distribution amount is subject to adjustments as set forth below.
As of the Effective Date, the Company estimated that total claims of Other GUCs, would be approximately $78 million (including unresolved disputed claims). Under the Plan, and based upon this total estimated claim value, such creditor class was estimated to receive in satisfaction of their claims (including any unpaid interest accrued thereon) the following consideration for each $1,000 of claim value: (i) $50.34 in cash, (ii) $254.99 of Series B of the Senior Notes ("Series B Notes"), and (iii) 22.41 shares of Ordinary Common Stock (although no fractional shares or cash in lieu thereof were or will be issued or paid), for an aggregate of 1.8 million shares (before giving effect to the Cash-Out Elections discussed below). As of March 4, 2004, the Company has issued approximately $5.1 million of Series B Notes for the settled claims of Other GUCs. The Series B Notes portions of certain other claims of Other GUCs were settled for cash, based upon claim settlement terms between
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the Company and such individual general unsecured creditors. The Ordinary Common Stock share distribution amount is subject to adjustment as set forth below.
The Company currently estimates that the total claim value for Other GUCs will ultimately be resolved for approximately $55.0 million, of which $50.5 million has been settled as of March 4, 2004. If the claims of Other GUCs are ultimately resolved for the Company's current estimate of $55.0 million, the Other GUCs would receive additional consideration of approximately 0.53 shares of Ordinary Common Stock per $1,000 of claim value (although no fractional shares or cash in lieu thereof will be issued or paid) and the holders of claims on the Old Subordinated Notes would receive an additional 0.77 shares of Ordinary Common Stock per $1,000 of principal amount of such notes (although no fractional shares or cash in lieu thereof will be issued or paid).
Also on the Effective Date, the previously outstanding shares of Common Stock and Preferred Stock of Magellan were cancelled, three new classes of capital stock were authorized and Magellan's certificate of incorporation and bylaws were amended and restated. Specifically, 100 million shares of Ordinary Common Stock, $0.01 par value per share ("Ordinary Common Stock"), and 40 million shares of Multiple and Variable Vote Restricted Convertible Common Stock, $0.01 par value per share ("Multi-Vote Common Stock") were authorized, as were 10 million shares of Preferred Stock, $0.01 par value per share, that are issuable at the discretion of the Board of Directors in the manner provided by law in one or more series with such powers, privileges and rights as may be determined by the Board (except that no non-voting shares shall be issued). No shares of Preferred Stock were issued or are to be issued under the Plan. Shares of the Multi-Vote Common Stock may only be issued to, and held by, Onex Corporation, a Canadian corporation, or an affiliate thereof (collectively, "Onex"). As described below, Onex, in connection with the Plan, invested in the equity of Magellan in the form of shares of Multi-Vote Common Stock. Upon transfer of any shares of Multi-Vote Common Stock to any party other than Onex, the shares of Multi-Vote Common Stock will automatically convert on a share-for-share basis into shares of Ordinary Common Stock. In addition, any shares of Ordinary Common Stock that Onex may come to own at any time when the Multi-Vote Common Stock is outstanding will automatically convert into shares of Multi-Vote Common Stock.
In general, the Multi-Vote Common Stock and Ordinary Common Stock have the same powers, privileges and rights, and each share represents an equivalent interest in Magellan's equity, except that the shares of Multi-Vote Common Stock will have the number of votes per share from time to time sufficient so that all the outstanding shares of Multi-Vote Common Stock will have an equal number of votes as all the outstanding shares of Ordinary Common Stock (i.e., the Multi-Vote Common Stock will be entitled to exercise 50 percent of the voting power of all the common stock of Magellan). The Multi-Vote Common Stock and Ordinary Common Stock also differ in that each class has different voting rights in the election of directors and certain other voting rights and other special rights and privileges. The Multi-Vote Common Stock will cease to have any special voting rights or any other special rights or powers in the event the outstanding shares of Multi-Vote Common Stock cease to represent at least 15.33 percent of the total number of shares of common stock (both Ordinary Common Stock and Multi-Vote Common Stock) issued on the Effective Date (approximately 35.1 million shares) or at least 10 percent of the total number of shares of common stock outstanding at any time the (the "Minimum Hold Condition"). For further information regarding the voting rights of the Ordinary Common Stock and the Multi-Vote Common Stock, see Item 10—"Directors and Executive Officers of the Registrant—Director Election and Terms of Office".
As part of the Plan, Magellan offered to holders of its Old Subordinated Notes, its general unsecured creditors and one holder of an administrative claim the opportunity to purchase, on the effective date of the Plan, shares of common stock equivalent to 6,052,632 shares of Ordinary Common Stock for a total purchase price of $75 million ($12.39 per share). The Company also received as part of the Plan a commitment from Onex to purchase on the same terms any shares not purchased in the
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Equity Offering by the creditors to whom such shares were offered. Pursuant to the equity offering included in the Plan, creditors purchased 5,111,019 shares and Onex purchased 941,613 shares.
Onex also purchased, pursuant to an additional commitment under the Plan, 6,052,632 shares of common stock for a total purchase price of $75 million (the "Onex Investment"), or $12.39 per share. In addition, Onex committed, under the Plan, to fund an offer made by Magellan pursuant to the Plan to holders of its Old Subordinated Notes and to the Company's other general unsecured creditors permitting them to elect to receive $9.78 in cash per share in lieu of the shares of Ordinary Common Stock they would otherwise receive under the Plan (the "Cash-Out Election"). Onex committed to fund the Cash-Out Election by purchasing that amount of shares of Multi-Vote Common Stock at $9.78 per share equal to the amount of shares of Ordinary Common Stock cashed out pursuant to the Cash-Out Election. As of the Effective Date, Onex purchased 1,421,335 shares pursuant to this commitment. Also pursuant to this commitment, Onex committed to purchase, subsequent to the Effective Date, up to an additional 137,120 shares pursuant to this commitment as a result of the settlement of claims that had elected the Cash-Out Election but were disputed and unresolved at the Effective Date. Onex has purchased and will purchase 8,552,700 shares in the aggregate (in the Equity Offering, pursuant to the Onex Investment and to fund the Cash-Out Election), all of which are shares of Multi-Vote Common Stock. These shares represented approximately 24.2 percent of the shares of common stock outstanding on the Effective Date and 21.2 percent of the common stock on a fully diluted basis as of the Effective Date. As stated above, the allocation of stock among creditors will change based on the value of all claims as ultimately resolved. If all claims are ultimately resolved for the amount of the Company's current estimate, 36,592 additional shares would be allocated to claims that had elected the Cash-Out Election, which would result in Onex acquiring an additional 36,592 shares at $9.78 per share (for a total of 8,589,282 shares).
The previously outstanding Series A Redeemable Preferred Stock of Magellan was cancelled on the Effective Date and the holders thereof were issued 456,660 shares of Ordinary Common Stock, representing approximately 1.3 percent of the common stock of Magellan as of the Effective Date on a fully diluted basis (giving effect to all shares outstanding or subject to options or warrants outstanding as of the Effective Date), as well as warrants to purchase until January 5, 2011 for $30.46 per share, 456,660 shares of Ordinary Common Stock. The previously outstanding common stock of Magellan also was cancelled on the Effective Date and the holders thereof received 114,165 shares of Ordinary Common Stock, representing approximately 0.3 percent of the common stock of Magellan on the Effective Date on a fully diluted basis (calculated on the same basis as described above), as well as warrants to purchase at any time until January 5, 2011 for $30.46 per share, 114,165 shares of Ordinary Common Stock, which equals approximately one share of Ordinary Common Stock and a warrant to purchase one share of Ordinary Common Stock for every 310 shares of the previously outstanding common stock. For further information regarding the warrants issued under the Plan, see Note 8—"Stockholders' Equity" to the audited consolidated financial statements set forth elsewhere herein. Pursuant to the Plan, on the Effective Date all previously outstanding options and warrants to purchase common stock of Magellan were cancelled.
As part of the consummation of the Plan, an agreement became effective between Aetna, Inc. ("Aetna") and the Company to renew their behavioral health services contract. Under the renewed agreement, the Company will continue to manage the behavioral health care of members of Aetna's healthcare programs through December 31, 2005, with an option for Aetna at that time to either extend the agreement or to purchase certain assets of the Company used solely in the management of the behavioral healthcare of Aetna members (the "Aetna-Dedicated Assets"). Pursuant to the Plan, on the Effective Date, the Company paid $15.0 million to Aetna, out of a debt obligation allowed under the Plan of $60.0 million plus accrued interest, and issued to Aetna an interest-bearing note (the "Aetna Note") for the balance of $48.9 million, which will mature on December 31, 2005. The Aetna Note is guaranteed by substantially all of the subsidiaries of Magellan and is secured by a second lien
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on substantially all of the assets of Magellan and the subsidiary guarantors. Additionally, if the behavioral health services contract is extended by Aetna at its option through at least December 31, 2006, one-half of the Aetna Note would be payable on December 31, 2005, and the remainder would be payable on December 31, 2006. If Aetna opts to purchase the Aetna-Dedicated Assets, the purchase price could be offset against any amounts owing under the Aetna Note. In addition, pursuant to the Plan, the Company issued to Aetna a warrant to purchase 230,000 shares of Ordinary Common Stock from January 1, 2006 to January 5, 2009 at a purchase price of $10.48 per share. For further information regarding the Company's agreement with Aetna, the Aetna Note and the warrant issued to Aetna under the Plan, see Note 7—"Long-Term Debt and Capital Lease Obligations" and Note 8—"Stockholders' Equity" to the audited consolidated financial statements set forth elsewhere herein.
On the Effective Date, Magellan's Board of Directors was reconstituted to consist of nine members, as specified in accordance with the Plan. Information on the members of the Magellan Board of Directors is disclosed in Part III herein.
The Company's senior executive officers before the Effective Date (Steven J. Shulman, Dr. Rene Lerer and Mark S. Demilio) entered into employment agreements with Magellan as of the Effective Date in a form provided by the Plan and providing for them to continue in their current positions. In general, the Company's other senior officers continued in Magellan's employ in substantially the same positions after the Effective Date and entered into employment agreements with Magellan in a form provided by the Plan. A Management Incentive Plan became effective on the Effective Date in accordance with the Plan, under which restricted stock awards, stock options and other equity incentives may be issued to members of the Company's management and other employees. The Company's employment agreements with its senior executive officers provided for the purchase by Mr. Shulman of certain shares of Ordinary Common Stock and for the grant to each such officer pursuant to the Management Incentive Plan of certain restricted shares of Ordinary Common Stock, all as of the Effective Date, and for certain cash payments to such officers related to the income taxes incurred by them in connection with such transactions. Options for a total of 4.3 million shares of Ordinary Common Stock were issued under the Management Incentive Plan in January and February 2004. Information on the Company's executive officers, their compensation and the Management Incentive Plan, as well as information regarding such grants under the employment agreements and Management Incentive Plan, is disclosed in Part III herein. See Note 8—"Stockholders' Equity" to the audited consolidated financial statements set forth elsewhere herein for a discussion of charges to be recorded by the Company related to stock grants, stock options and cash payments pursuant to the employment agreements and stock options under the Management Incentive Plan. Such charges, which total $58.4 million, will be recorded in future periods corresponding to the vesting or life of the options.
Before the Effective Date, the common stock of the Company was registered pursuant to Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). On the Effective Date, the Ordinary Common Stock of Magellan, as issued in accordance with the Plan, was deemed registered under Section 12(g) of the Exchange Act as a successor issue, and Magellan as reorganized was deemed a successor issuer, in relation to the previously registered common stock in accordance with SEC Rule 12g-3(a). In addition, the warrants issued to former common and preferred stockholders as referred to above became registered under Section 12(g) of the Exchange Act pursuant to a registration statement on Form 8-A. The Ordinary Common Stock of the Company, including shares that may be issued upon conversion of shares of Multi-Vote Common Stock and upon exercise of the warrants and options referred to above, became listed on the Nasdaq Stock Market under the ticker symbol "MGLN" on January 6, 2004. On the Effective Date, in accordance with the Plan, Magellan also entered into a Registration Rights Agreement with Onex and Aetna, providing them rights with respect to the registration of their shares for public sale under the Securities Act of 1933, as amended, in certain circumstances.
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Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. The Company considers the following to be its critical accounting policies and estimates:
Fresh Start Reporting.In connection with the consummation of the Plan, the Company adopted the "fresh“fresh start reporting"reporting” provisions of AICPA Statement of PositionSOP 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7"), with respect to its financial reports, which requiresrequired the Company to restate its assets and liabilities to their fair values based upon the provisions of the Plan and certain valuations which the Company will makemade in connection with the implementation of the Plan. The Company iswas required to apply the fresh-start provisions of SOP 90-7 to its financial statements, because it hashad concluded that (a) the reorganization value of the assets of the emerging entity immediately before the date of confirmation was less than the total of all post-petition liabilities and allowed claims, and (b) the holders of existing voting shares of the Company immediately before confirmation (i.e., the holders of shares of Magellan'sMagellan’s pre-petition common stock that were issued and outstanding prior to the commencement of the chapter 11 proceedings) received less than 50 percent of the voting shares of the emerging entity. SOP 90-7 sets forth the principles regarding the date at which a company that has emerged from a chapter 11 proceeding should apply fresh start reporting to account for the effects of the plan of reorganization. Under SOP 90-7, application of fresh start reporting is permitted as early as the date on which the plan of reorganization is confirmed by the bankruptcy court, but SOP 90-7 further provides that fresh start reporting shouldis not be applied until all material conditions are satisfied. All material conditions to the Plan were satisfied as of December 29, 2003 (the "Material“Material Conditions Date"Date”). Due to
the proximity of the Material Conditions Date to year end and the immateriality of the results of operations for the intervening two-day period through December 31, 2003, the Company applied fresh start reporting as if the material conditions were satisfied as of December 31, 2003. All adjustments and reorganization expenses as a result of the application of fresh start reporting are reflected in the audited consolidated financial statements as of and for the year ended December 31, 2003 included elsewhere herein. See Note 2—"“Fresh Start Reporting"Reporting” to the audited consolidated financial statements set forth elsewhere herein for adjustments recorded by the Company pursuant to the application of SOP 90-7.
Upon adoption of fresh start reporting as of December 31, 2003, the Company created, in substance, per SOP 90-7, a new reporting entity. The Reorganized Company has adopted the same accounting policies as the Predecessor Company with the exception of the date on which the Reorganized Company intends to performperforms its annual goodwill impairment test under SFAS No. 142. The Reorganized Company will performperformed its annual impairment test on October 1, as opposed to September 1.
As a result of the application of the fresh start reporting provision of SOP 90-7, the consolidated balance sheets of the Company prior to December 31, 2003 are not comparable with the consolidated balance sheet as of, and subsequent to, December 31, 2003. Therefore, allAll balance sheet data as of, and subsequent to December 31, 2003 have been disclosed herein asrepresents balances of the Reorganized Company, and all balance sheet data prior to December 31, 2003 have been disclosed asrepresents balances of the Predecessor Company. Statement of operations and statement of cash flows data for all periods presented hereinprior to January 1, 2004 represents the results of the Predecessor Company. Accordingly, all references to the Company with respect to disclosures of amounts recorded (i) through or prior to December 31, 2003 in relation to income statement of operations or cash flow items; and (ii) prior to December 31, 2003 in relation to balance sheet items, relate to the Predecessor Company. All references to the Company with respect to disclosures of amounts recorded or to be recorded (i) after December 31, 2003 in relation to income statement of operations or cash flow items; and
48
(ii) on or after December 31, 2003 in relation to balance sheet items, relate to the Reorganized Company.
Managed Care Revenue.Managed care revenue is recognized over the applicable coverage period on a per member basis for covered members. Managed care risk revenues earned for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003 approximated $1,540.7 million, $1,537.9 million and $1,292.5 million, respectively. Managedrespectively and managed care risk revenues for the three months ended December 31, 2001 and 2002 were approximately $390.3 million (unaudited) and $388.7 million, respectively. Managed care risk revenues earned for the fiscal year ended December 31, 2004 approximated $1,583.9 million.
The Company has the ability to earn performance-based revenue, primarily under certain risk and non-risk contracts. Performance-based revenue generally is based on either the ability of the Company to manage care for its ASO clients below specified targets.targets, or on other operating metrics. For each such contract, the Company estimates and records performance-basedperformance based revenue after considering the relevant contractual terms and the data available for the performance-basedperformance based revenue calculation. Pro-rata performance-basedperformance based revenue is recognized on an interim basis pursuant to the rights and obligations of each party upon termination of the contracts. The Company recognized performance revenue of approximately $22.7 million, $13.0 million and $7.7 million in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively. Forrespectively and $3.4 million and $1.0 million for the three months ended December 31, 2001 and 2002, therespectively. The Company recognized performance-basedperformance revenue of approximately $3.4$9.7 million (unaudited) and $1.0 million, respectively.
The Company provides mental health and substance abuse services toin the beneficiaries of TRICARE, under a subcontract with a health plan that contracts with TRICARE. See discussion of this subcontract in "Health Plan Solutions" above. The Company receives fixed fees under its TRICARE subcontract, which are subject to certain BPAs. The BPAs are calculated in accordance with contractual provisions and are based on actual healthcare utilization from historical periods as well as changes in certain factors during the contract period. The Company has information to record, on a quarterly basis, for reasonable estimates of the BPAs as part of its managed care risk revenues. These estimates are based upon information available, on a quarterly basis, from both the TRICARE program and the Company's information systems. Under the contract, the Company settles the BPAs at set intervals over the term of the contracts.
The Company recorded estimated receivables of approximately $3.6 million and $2.5 million as offiscal year ended December 31, 2002 and 2003, respectively, based upon the Company's interim calculations of the estimated BPAs. Such amounts were recorded as adjustments to revenues. While management believes that the estimated TRICARE adjustments are adequate, ultimate settlement resulting from adjustments and available appeal processes may vary from the amounts provided.
Prior to fiscal 2001, the Company and its contractors under its TRICARE contracts filed joint appeals regarding incorrect data provided and contractual issues related to the initial bidding process. These contingent claims were settled in fiscal 2001, resulting in the Company recording approximately $30.3 million in additional revenues in fiscal 2001.2004.
Cost of Care and Medical Claims Payable.Cost of care, recorded as a component of operating expenses, is recognized in the period in which members receivereceived behavioral health services. In addition to actual benefits paid, cost of care includes the impact of accruals for estimates of medical claims payable. Medical claims payable in the Company's audited consolidated financial statements representrepresents the liability for healthcare claims reported but not yet paid and claims incurred but not yet reported ("IBNR"(“IBNR”) related to the Company'sCompany’s managed healthcare business. The IBNR portion of medical claims payable is estimated based on past claims payment experience for member
groups, enrollment data, utilization statistics, authorized healthcare services and other factors. This data is incorporated into contract-specific actuarial reserve models. The estimates for submitted claims and IBNR claims are made on an accrual basis and adjusted in future periods as required. However, changes in assumptions for medical costs caused by changes in actual experience (such as changes in the delivery system,
49
changes in utilization patterns, unforeseen fluctuations in claims backlogs, etc.) may ultimately prove these estimates inaccurate. As of December 31, 2003,2004, the Company believes that its medical claims payable balance of $177.1$194.6 million is adequate in order to satisfy ultimate claim liabilities incurred through December 31, 2003.2004. Medical claims payable balances are continually monitored and reviewed. Changes in assumptions for cost of care caused by changes in actual experience could cause the estimates to change in the near term.
The following table presents the components of the change in medical claims payable for the years ended December 31, 2003 and 2004 (in thousands):
|
| 2003 |
| 2004 |
| ||
Medical claims payable, beginning of period |
| $ | 205,331 |
| $ | 177,141 |
|
Cost of care: |
|
|
|
|
| ||
Current year |
| 918,358 |
| 1,197,658 |
| ||
Prior years |
| (11,874 | ) | (7,064 | ) | ||
Total reported cost of care |
| 906,484 |
| 1,190,594 |
| ||
Claim payments: |
|
|
|
|
| ||
Payments for current year |
| 765,872 |
| 1,021,209 |
| ||
Payments for prior years |
| 168,802 |
| 151,888 |
| ||
Total claim payments |
| 934,674 |
| 1,173,097 |
| ||
Medical claims payable, end of period |
| $ | 177,141 |
| $ | 194,638 |
|
The Company believes that the amount of medical claims payable is adequate to cover its ultimate liability for unpaid claims as of December 31, 2004; however, actual claims payments and other items may differ from established estimates.
Long-lived Assets.Long-lived assets, including property and equipment and intangible assets to be held and used, are currently reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount should be addressed pursuant to SFAS No. 144, "Accounting“Accounting for the Impairment or Disposal of Long-Lived Assets" ("Assets” (“SFAS 144"144”) which superseded SFAS No. 121, "Accounting“Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("Of” (“SFAS 121"121”). Pursuant to this guidance, impairment is determined by comparing the carrying value of these long-lived assets to management'smanagement’s best estimate of the future undiscounted cash flows expected to result from the use of the assets and their eventual disposition. The cash flow projections used to make this assessment are consistent with the cash flow projections that management uses internally to assist in making key decisions. In the event an impairment exists, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the asset, which is generally determined by using quoted market prices or the discounted present value of expected future cash flows.
Goodwill.Goodwill is accounted for in accordance with SFAS No. 142, "Goodwill“Goodwill and Other Intangible Assets" ("Assets” (“SFAS 142"142”). Under SFAS 142, goodwill is no longer amortized over its estimated useful life. Instead, goodwilllife, but rather is tested for impairment based upon fair values at least on an annual basis. In accordance with SFAS 142, the book value of goodwill is assigned to the Company'sCompany’s reporting units. See Note 3—"“Summary of Significant Accounting Policies"Policies” to the audited consolidated financial statements set forth elsewhere herein.
Deferred Taxes.The Company files a consolidated federal income tax return for the Company and its wholly owned consolidated subsidiaries. The Company accounts for income taxes in accordance with
SFAS No. 109, "Accounting“Accounting for Income Taxes".Taxes.” The deferredCompany estimates income taxes for each of the jurisdictions in which it operates. This process involves estimating current tax exposures together with assessing temporary differences resulting from differing treatment of items for tax and book purposes. Deferred tax assets and/or liabilities are determined by multiplying the differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. The Company then assesses the likelihood that the deferred tax assets will be recovered from the reversal of temporary timing differences and future taxable income, and to the extent the Company cannot conclude that recovery is more likely than not, it establishes a valuation allowance. The effect of a change in tax rates on deferred taxes is recognized in income in the period that includes the enactment date. Valuation allowances on deferred tax assets are estimated based on the Company's assessment of the realizability of such amounts.
The Company notes that for federal income tax purposes, the cancellation of indebtedness event takes place on the date of the Company'sCompany’s emergence from bankruptcy (January 5, 2004) and the actual attribute reduction calculation as set forth under Internal Revenue Code Section 108 occurs at or immediately after December 31, 2004 (the taxable year of discharge), and generally after determining the income tax liability for 2004. The Company plans to changechanged its income tax reporting year to a calendar year basis in conformity with its financial reporting year effective December 31, 2003. For financial reporting purposes, the emergence from bankruptcy is deemed to occur in 2003; however, since the Company did not emerge from bankruptcy until January 5, 2004, for federal income tax purposes, the emergence from bankruptcy is a 2004 event.
After consideration of the effect of bankruptcy emergence, including the effect of cancellation of indebtedness income and the related attribute reduction effects as provided under Internal Revenue Code Section 108, the Company estimates that it has reportable net operating loss carryforwards (“NOLs”) as of December 31, 2003, the Company has estimated tax net operating loss ("NOL") carryforwards2004 of approximately $507.3$525 million available to reduce future federal taxable income. These estimated NOL carryforwardsNOLs expire in 20062009 through 2019.2020 and are subject to examination and adjustment by the Internal Revenue Service. In accordance with SOP 90-7, subsequent (post-bankruptcy) utilization by the Company of NOLs which existed at January 5, 2004 will be accounted for as reductions to goodwill or additional paid-in capital and therefore, will only benefit cash flows due to reduced tax payments and will not benefit the Company’s tax provision for income taxes.
Valuation allowances on deferred tax assets (including NOLs) are estimated based on the Company'sCompany’s assessment of the realizability of such amounts. As discussed in "Business—“Business—Emergence from Bankruptcy",Bankruptcy,” the
50
Company's Company’s history of recent operating losses (prior to reorganization benefits) and financial restructuring activities and the lack of substantial history of profitable operations subsequent to its emergence from bankruptcy have created uncertainty as to the Company'sCompany’s ability to realize its NOL carryforwardsNOLs and other deferred tax assets. Accordingly, the Company had a total valuation allowance covering all of the Company’s net deferred tax assets as of December 31, 2003 and substantially all of its net deferred tax assets at December 31, 2004. As of December 31, 2004, net deferred tax assets, after reduction for valuation allowance, represent the Company’s estimate of those net deferred tax assets which are more likely than not to be realizable.
In addition, the Company'sCompany’s utilization of NOL carryforwards will beNOLs became subject to limitation under Internal Revenue Code Section 382 upon emergence from bankruptcy, which may affectaffects the timing of the use of or ultimate realization of, NOL carryforwards. Accordingly,NOLs. At this time, the Company does not believe these limitations will cause the Company to be unable to use any NOLs before they expire. Furthermore, as of December 31, 2003, and 2002, the Company hashad tax contingencies which created an uncertainty as to the Company’s ability to realize its NOLs. In addition to recording a totalfull valuation allowance coveringagainst all NOLs, the Company recorded this contingent liability of $23.2 million for taxes payable. During fiscal 2004, the Company received favorable guidance from the Internal Revenue Service which resolved this contingency, resulting in the reversal of the Company's net deferred tax assets.related liability and a reduction to goodwill (in accordance with SOP 90-7).
The Company recognized current tax expense attributable to estimated, current taxable income for the three months ended December 31, 2002 and for the yearyears ended December 31, 2003. This expense was recorded2003 and December 31, 2004 due to the estimated utilization of NOL carryforwards generated prior to a previous bankruptcy filing in 1992 and prioruncertainty as to the occurrence of certain other events that may cause limitationCompany’s ability to realize deferred tax assets based on its NOL carryforwards. The Company's current tax expense in fiscal 2003 also includes changes in estimates regardinghistory of recent operating losses (prior to reorganization benefits) and financial restructuring activities and the Company's utilizationlack of the above-referenced NOL carryforwards duesubstantial history of profitable operations subsequent to amendments of prior year tax returns.its emergence from bankruptcy.
The Company's significant accounting policies are discussed in Note 3—"Summary of Significant Accounting Policies" to the audited consolidated financial statements set forth elsewhere herein.
The Company evaluates performance of its segments based on profit or loss from continuing operations before depreciation, amortization, interest (net), goodwill impairment charges, special charges, income taxes and minority interest ("(“Segment Profit"Profit”). See Note 16—"“Business Segment Information"Information” to the Company's auditedCompany’s consolidated financial statements set forth elsewhere herein. The Company'sCompany’s behavioral customer segments are defined below. In certain limited cases, customer contracts that would otherwise meet the definition of one segment are managed and reported internally in another segment, in which cases the membership and financial results of such contracts are reflected in the segment in which it is managed and reported internally. In fiscal 2003,During the quarter ended September 30, 2004, the Company’s internal reporting of certain of these contracts was transferred betweenoperational and corporate support costs, such as claims administration and network services, changed to allocate such costs from the Corporate and Other segment to the Health Plan Solutions, Employer Solutions and Public Sector Solutions segments. Accordingly, the Company has reclassified the membership and financial results of such contracts for all prior periods to allocate such costs into the corresponding segments consistent with its internal reporting. This restatement did not affect consolidated membership or financial results for any period presented. In fiscal 2003, management also changed the name of its "Workplace" segment to the "Employer Solutions" segment. All periods presented were adjusted to conform with the fiscal 2003 restatement.2004 reclassification. This reclassification does not affect consolidated financial results for any periods presented. For comparative purposes, the Company has presented results of operations below for the twelve-month period ended December 31, 2002, which information is unaudited.
5146
The table below summarizes, for the periods indicated, operating results and other financial information, by business segment (in thousands). Given the Company'sCompany’s change in year-end during fiscal year 2003, the Company believes the period comparisons below present the most useful comparison for readers:
| | Predecessor Company |
| Predecessor Company |
| |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Health Plan Solutions | Employer Solutions | Public Sector Solutions | Corporate and Other | Consolidated | ||||||||||||||||||||||||
| Fiscal Year Ended September 30, 2001 | |||||||||||||||||||||||||||||
| Net revenue | $ | 1,079,549 | $ | 189,625 | $ | 486,338 | $ | — | $ | 1,755,512 | |||||||||||||||||||
| Cost of care | 621,817 | 64,649 | 410,982 | — | 1,097,448 | ||||||||||||||||||||||||
| Direct service costs | 179,836 | 73,363 | 38,225 | — | 291,424 | ||||||||||||||||||||||||
| Other operating expenses | — | — | — | 168,170 | 168,170 | ||||||||||||||||||||||||
| Equity in (earnings) loss of unconsolidated subsidiaries | (39,103 | ) | — | 2,537 | — | (36,566 | ) | ||||||||||||||||||||||
| Segment profit (loss) | $ | 316,999 | $ | 51,613 | $ | 34,594 | $ | (168,170 | ) | $ | 235,036 | ||||||||||||||||||
| Health |
| Employer |
| Public |
| Corporate |
| Consolidated |
| |||||||||||||||||||
Fiscal Year Ended September 30, 2002 |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Net revenue | $ | 1,013,033 | $ | 188,703 | $ | 551,322 | $ | — | $ | 1,753,058 |
| $ 1,013,033 |
| $ 188,703 |
| $ 551,322 |
| $ — |
|
| $ 1,753,058 |
|
| ||||||
| Cost of care | 596,811 | 72,446 | 456,497 | — | 1,125,754 |
| 596,811 |
| 72,446 |
| 456,497 |
| — |
|
| 1,125,754 |
|
| |||||||||||
| Direct service costs | 174,926 | 76,752 | 41,423 | — | 293,101 |
| 226,141 |
| 85,799 |
| 53,256 |
| — |
|
| 365,196 |
|
| |||||||||||
| Other operating expenses | — | — | — | 166,459 | 166,459 |
| — |
| — |
| — |
| 94,364 |
|
| 94,364 |
|
| |||||||||||
| Equity in (earnings) loss of unconsolidated subsidiaries | (15,537 | ) | — | 2,531 | — | (13,006 | ) |
| (15,537 | ) | — |
| 2,531 |
| — |
|
| (13,006 | ) |
| |||||||||
| Segment profit (loss) | $ | 256,833 | $ | 39,505 | $ | 50,871 | $ | (166,459 | ) | $ | 180,750 |
| $ 205,618 |
| $ 30,458 |
| $ 39,038 |
| $ (94,364 | ) |
| $ 180,750 |
|
| |||||
Twelve Months Ended December 31, 2002 (unaudited) (1) | |||||||||||||||||||||||||||||
Twelve Months Ended December 31, 2002 (unaudited)(1) |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Net revenue | $ | 988,465 | $ | 189,533 | $ | 576,108 | $ | — | $ | 1,754,106 |
| $ 988,465 |
| $ 189,533 |
| $ 576,108 |
| $ — |
|
| $ 1,754,106 |
|
| ||||||
| Cost of care | 581,882 | 72,352 | 477,559 | — | 1,131,793 |
| 581,882 |
| 72,352 |
| 477,559 |
| — |
|
| 1,131,793 |
|
| |||||||||||
| Direct service costs | 164,024 | 75,692 | 42,149 | — | 281,865 |
| 212,070 |
| 84,409 |
| 54,664 |
| — |
|
| 351,143 |
|
| |||||||||||
| Other operating expenses | — | — | — | 167,996 | 167,996 |
| — |
| — |
| — |
| 98,718 |
|
| 98,718 |
|
| |||||||||||
| Equity in (earnings) loss of unconsolidated subsidiaries | (13,699 | ) | — | 1,732 | — | (11,967 | ) |
| (13,699 | ) | — |
| 1,732 |
| — |
|
| (11,967 | ) |
| |||||||||
| Segment profit (loss) | $ | 256,258 | $ | 41,489 | $ | 54,668 | $ | (167,996 | ) | $ | 184,419 |
| $ 208,212 |
| $ 32,772 |
| $ 42,153 |
| $ (98,718 | ) |
| $ 184,419 |
|
| |||||
Fiscal Year Ended December 31, 2003 |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Net revenue | $ | 870,540 | $ | 159,034 | $ | 481,172 | $ | — | $ | 1,510,746 |
| $ 870,540 |
| $ 159,034 |
| $ 481,172 |
| $ — |
|
| $ 1,510,746 |
|
| ||||||
| Cost of care | 464,128 | 44,858 | 397,498 | — | 906,484 |
| 464,128 |
| 44,858 |
| 397,498 |
| — |
|
| 906,484 |
|
| |||||||||||
| Direct service costs | 130,731 | 68,135 | 28,759 | — | 227,625 |
| 180,336 |
| 79,071 |
| 40,466 |
| — |
|
| 299,873 |
|
| |||||||||||
| Other operating expenses | — | — | — | 190,777 | 190,777 |
| — |
| — |
| — |
| 118,529 |
|
| 118,529 |
|
| |||||||||||
| Equity in (earnings) loss of unconsolidated subsidiaries | (6,560 | ) | — | 358 | — | (6,202 | ) |
| (6,560 | ) | — |
| 358 |
| — |
|
| (6,202 | ) |
| |||||||||
| Segment profit (loss) | $ | 282,241 | $ | 46,041 | $ | 54,557 | $ | (190,777 | ) | $ | 192,062 |
| $ 232,636 |
| $ 35,105 |
| $ 42,850 |
| $ (118,529 | ) |
| $ 192,062 |
|
| |||||
|
| Reorganized Company |
| ||||||||||
|
| Health |
| Employer |
| Public |
| Corporate |
| Consolidated |
| ||
Fiscal Year Ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue |
| $ 904,872 |
| $ 135,676 |
| $ 754,854 |
| $ — |
|
| $ 1,795,402 |
|
|
Cost of care |
| 484,047 |
| 37,168 |
| 669,379 |
| — |
|
| 1,190,594 |
|
|
Direct service costs |
| 170,131 |
| 66,294 |
| 40,528 |
| — |
|
| 276,953 |
|
|
Other operating expenses |
| — |
| — |
| — |
| 99,918 |
|
| 99,918 |
|
|
Equity in earnings of unconsolidated subsidiaries |
| (5,277 | ) | — |
| — |
| — |
|
| (5,277 | ) |
|
Segment profit (loss) |
| $ 255,971 |
| $ 32,214 |
| $ 44,947 |
| $ (99,918 | ) |
| $ 233,214 |
|
|
(1)The results of operations for the twelve months ended December 31, 2002 represent the amalgamation of the results of operations for the nine-month period ended September 30, 2002 (unaudited) and the three-month period ended December 31, 2002 (audited) previously reported in the Company'sCompany’s Form 10-Q for the quarterly period ended September 30, 2003 filed with the SEC on November 19, 2003 and the Transition Report on Form 10-K for the transition period from October 1, 2002 to December 31, 2002 filed with the SEC on August 12, 2003, respectively.
52
The following table reconciles segment profit as calculated in the table above to consolidated net income (loss):
| | | Predecessor Company |
| Predecessor Company |
|
| Reorganized |
| ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Fiscal Year Ended September 30, | Twelve Months Ended December 31, | Fiscal Year Ended December 31, |
| Fiscal Year |
| Twelve Months |
| Fiscal Year |
|
| Fiscal Year |
| ||||||||||||||||||
| | | 2001 | 2002 | 2002 (1) | 2003 |
| 2002 |
| 2002(1) |
| 2003 |
|
| 2004 |
| |||||||||||||||||
| | | | | (unaudited) | |
| (unaudited) |
|
|
|
| |||||||||||||||||||||
| Segment profit | Segment profit | $ | 235,036 | $ | 180,750 | $ | 184,419 | $ | 192,062 |
|
| $ 180,750 |
|
|
| $ 184,419 |
|
|
| $ 192,062 |
|
|
|
| $ 233,214 |
|
| |||||
| Depreciation and amortization | Depreciation and amortization | (68,294 | ) | (47,558 | ) | (50,748 | ) | (48,047 | ) |
|
| 47,558 |
|
| 50,748 |
|
| 48,047 |
|
|
| 42,489 |
| |||||||||
| Interest expense | Interest expense | (110,423 | ) | (97,596 | ) | (99,210 | ) | (61,016 | ) |
|
| 97,596 |
|
| 99,210 |
|
| 61,016 |
|
|
| 37,124 |
| |||||||||
| Interest income | Interest income | 10,121 | 5,365 | 5,065 | 2,873 |
|
| (5,365 | ) |
|
| (5,065 | ) |
|
| (2,873 | ) |
|
|
| (6,127 | ) |
| |||||||||
| Reorganization benefit | Reorganization benefit | — | — | — | 438,217 |
|
| — |
|
|
| — |
|
|
| (438,217 | ) |
|
|
| — |
|
| |||||||||
Stock compensation expense |
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| 23,152 |
| |||||||||||||||
| Special charges | Special charges | (3,340 | ) | (15,729 | ) | (15,151 | ) | (9,528 | ) |
|
| 15,729 |
|
| 15,151 |
|
| 9,528 |
|
|
| 5,038 |
| |||||||||
| Goodwill impairment charges | Goodwill impairment charges | — | (415,880 | ) | (415,880 | ) | (28,780 | ) |
|
| 415,880 |
|
| 415,880 |
|
| 28,780 |
|
|
| — |
|
| |||||||||
| Income (loss) from continuing operations before provision for income taxes and minority interest | Income (loss) from continuing operations before provision for income taxes and minority interest | 63,100 | (390,648 | ) | (391,505 | ) | 485,781 |
|
| (390,648 | ) |
|
| (391,505 | ) |
|
| 485,781 |
|
|
|
| 131,538 |
|
| |||||||
| Provision for income taxes | Provision for income taxes | 33,732 | 151,609 | 148,652 | 33,813 |
|
| 151,609 |
|
|
| 148,652 |
|
|
| 33,813 |
|
|
|
| 46,584 |
|
| |||||||||
| Income (loss) from continuing operations before minority interest | Income (loss) from continuing operations before minority interest | 29,368 | (542,257 | ) | (540,157 | ) | 451,968 |
|
| (542,257 | ) |
|
| (540,157 | ) |
|
| 451,968 |
|
|
|
| 84,954 |
|
| |||||||
| Minority interest | Minority interest | 78 | 47 | 58 | 253 |
|
| 47 |
|
|
| 58 |
|
|
| 253 |
|
|
|
| 333 |
|
| |||||||||
| Income (loss) from continuing operations | Income (loss) from continuing operations | 29,290 | (542,304 | ) | (540,215 | ) | 451,715 |
|
| (542,304 | ) |
|
| (540,215 | ) |
|
| 451,715 |
|
|
|
| 84,621 |
|
| |||||||
| Discontinued operations: | Discontinued operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
| Income (loss) from discontinued operations (2) | 4,624 | 4,894 | 5,539 | (25,028 | ) | |||||||||||||||||||||||||||
| Income (loss) on disposal of discontinued operations (2) | (9,359 | ) | (92 | ) | (815 | ) | 4,756 | |||||||||||||||||||||||||
| Reorganization benefit (2) | — | — | — | 20,327 | ||||||||||||||||||||||||||||
| (4,735 | ) | 4,802 | 4,724 | 55 | ||||||||||||||||||||||||||||
Income (loss) from discontinued operations(2) |
|
| 4,894 |
|
|
| 5,539 |
|
|
| (25,028 | ) |
|
|
| 4,781 |
|
| ||||||||||||||
Income (loss) on disposal of discontinued operations(2) |
|
| (92 | ) |
|
| (815 | ) |
|
| 4,756 |
|
|
|
| (1,030 | ) |
| ||||||||||||||
Reorganization benefit(2) |
|
| — |
|
|
| — |
|
|
| 20,327 |
|
|
|
| — |
|
| ||||||||||||||
|
| 4,802 |
|
|
| 4,724 |
|
|
| 55 |
|
|
|
| 3,751 |
|
| |||||||||||||||
| Income (loss) before cumulative effect of change in accounting principle | Income (loss) before cumulative effect of change in accounting principle | 24,555 | (537,502 | ) | (535,491 | ) | 451,770 |
|
| (537,502 | ) |
|
| (535,491 | ) |
|
| 451,770 |
|
|
|
| 88,372 |
|
| |||||||
| Cumulative effect of change in accounting principle (2) | — | (191,561 | ) | — | — | |||||||||||||||||||||||||||
Cumulative effect of change in accounting principle(2) |
|
| (191,561 | ) |
|
| — |
|
|
| — |
|
|
|
| — |
|
| ||||||||||||||
| Net income (loss) | Net income (loss) | $ | 24,555 | $ | (729,063 | ) | $ | (535,491 | ) | $ | 451,770 |
|
| $ (729,063 | ) |
|
| $ (535,491 | ) |
|
| $ 451,770 |
|
|
|
| $ 88,372 |
| ||||
(1)
(2)
53
| | Predecessor Company |
| Predecessor Company |
| |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Health Plan Solutions | Employer Solutions | Public Sector Solutions | Corporate and Other | Consolidated |
| Health |
| Employer |
| Public |
| Corporate |
| Consolidated |
| |||||||||||||
| Net Revenue |
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
| Nine months ended September 30, 2002 (unaudited) | $ | 742,884 | $ | 142,833 | $ | 422,499 | $ | — | $ | 1,308,216 |
| $ 742,884 |
| $ 142,833 |
| $ 422,499 |
| $ — |
|
| $ 1,308,216 |
| |||||||
| Three months ended December 31, 2002 | 245,581 | 46,700 | 153,609 | — | 445,890 |
| 245,581 |
| 46,700 |
| 153,609 |
| — |
|
| 445,890 |
| ||||||||||||
| Twelve Months ended December 31, 2002 (unaudited) | $ | 988,465 | $ | 189,533 | $ | 576,108 | $ | — | $ | 1,754,106 |
| $ 988,465 |
| $ 189,533 |
| $ 576,108 |
| $ — |
|
| $ 1,754,106 |
| |||||||
Cost of Care |
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
| Nine months ended September 30, 2002 (unaudited) | $ | 444,381 | $ | 54,984 | $ | 350,718 | $ | — | $ | 850,083 |
| $ 444,381 |
| $ 54,984 |
| $ 350,718 |
| $ — |
|
| $ 850,083 |
| |||||||
| Three months ended December 31, 2002 | 137,501 | 17,368 | 126,841 | — | 281,710 |
| 137,501 |
| 17,368 |
| 126,841 |
| — |
|
| 281,710 |
| ||||||||||||
| Twelve Months ended December 31, 2002 (unaudited) | $ | 581,882 | $ | 72,352 | $ | 477,559 | $ | — | $ | 1,131,793 |
| $ 581,882 |
| $ 72,352 |
| $ 477,559 |
| $ — |
|
| $ 1,131,793 |
| |||||||
Direct Service Costs |
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
| Nine months ended September 30, 2002 (unaudited) | $ | 127,790 | $ | 57,385 | $ | 31,226 | $ | — | $ | 216,401 |
| $ 164,731 |
| $ 63,801 |
| $ 40,287 |
| $ — |
|
| $ 268,819 |
| |||||||
| Three months ended December 31, 2002 | 36,234 | 18,307 | 10,923 | — | 65,464 |
| 47,339 |
| 20,608 |
| 14,377 |
| — |
|
| 82,324 |
| ||||||||||||
| Twelve Months ended December 31, 2002 (unaudited) | $ | 164,024 | $ | 75,692 | $ | 42,149 | $ | — | $ | 281,865 |
| $ 212,070 |
| $ 84,409 |
| $ 54,664 |
| $ — |
|
| $ 351,143 |
| |||||||
Other Operating Expenses |
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
| Nine months ended September 30, 2002 (unaudited) | $ | — | $ | — | $ | — | $ | 123,737 | $ | 123,737 |
| $ — |
| $ — |
| $ — |
| $ 71,319 |
|
| $ 71,319 |
| |||||||
| Three months ended December 31, 2002 | — | — | — | 44,259 | 44,259 |
| — |
| — |
| — |
| 27,399 |
|
| 27,399 |
| ||||||||||||
| Twelve Months ended December 31, 2002 (unaudited) | $ | — | $ | — | $ | — | $ | 167,996 | $ | 167,996 |
| $ — |
| $ — |
| $ — |
| $ 98,718 |
|
| $ 98,718 |
| |||||||
Equity in Unconsolidated Subsidiaries | |||||||||||||||||||||||||||||
Equity in (Earnings) Loss of Unconsolidated Subsidiaries |
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
| Nine months ended September 30, 2002 (unaudited) | $ | (11,706 | ) | $ | — | $ | 1,877 | $ | — | $ | (9,829 | ) |
| $ (11,706 | ) | $ — |
| $ 1,877 |
| $ — |
|
| $ (9,829 | ) |
| ||||
| Three months ended December 31, 2002 | (1,993 | ) | — | (145 | ) | — | (2,138 | ) |
| (1,993 | ) | — |
| (145 | ) | — |
|
| (2,138 | ) |
| ||||||||
| Twelve Months ended December 31, 2002 (unaudited) | $ | (13,699 | ) | $ | — | $ | 1,732 | $ | — | $ | (11,967 | ) |
| $ (13,699 | ) | $ — |
| $ 1,732 |
| $ — |
|
| $ (11,967 | ) |
| ||||
Segment Profit (Loss) |
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
| Nine months ended September 30, 2002 (unaudited) | $ | 182,419 | $ | 30,464 | $ | 38,678 | $ | (123,737 | ) | $ | 127,824 |
| $ 145,478 |
| $ 24,048 |
| $ 29,617 |
| $ (71,319 | ) |
| $ 127,824 |
| ||||||
| Three months ended December 31, 2002 | 73,839 | 11,025 | 15,990 | (44,259 | ) | 56,595 |
| 62,734 |
| 8,724 |
| 12,536 |
| (27,399 | ) |
| 56,595 |
| |||||||||||
| Twelve Months ended December 31, 2002 (unaudited) | $ | 256,258 | $ | 41,489 | $ | 54,668 | $ | (167,996 | ) | $ | 184,419 |
| $ 208,212 |
| $ 32,772 |
| $ 42,153 |
| $ (98,718 | ) |
| $ 184,419 |
| ||||||
54
| | Predecessor Company | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
Nine Months Ended September 30, 2002 | Three Months Ended December 31, 2002 | Twelve Months Ended December 31, 2002 | ||||||||
| | (unaudited) | | (unaudited) | |||||||
| Depreciation and amortization | $ | 36,368 | $ | 14,380 | $ | 50,748 | ||||
| Interest expense | 73,877 | 25,333 | 99,210 | |||||||
| Interest income | (4,055 | ) | (1,010 | ) | (5,065 | ) | ||||
| Special charges | 11,244 | 3,907 | 15,151 | |||||||
| Goodwill impairment charges | 415,880 | — | 415,880 | |||||||
| Provision for income taxes | 145,523 | 3,129 | 148,652 | |||||||
| Minority interest | 31 | 27 | 58 | |||||||
| Income from discontinued operations, net | 4,736 | 803 | 5,539 | |||||||
| Income (loss) on disposal of discontinued operations, net | (912 | ) | 97 | (815 | ) | |||||
|
| Predecessor Company |
| ||||||||||
|
| Nine Months |
| Three Months |
| Twelve Months |
| ||||||
|
| (unaudited) |
|
|
| (unaudited) |
| ||||||
Depreciation and amortization |
|
| $ 36,368 |
|
|
| $ 14,380 |
|
|
| $ 50,748 |
|
|
Interest expense |
|
| 73,877 |
|
|
| 25,333 |
|
|
| 99,210 |
|
|
Interest income |
|
| (4,055 | ) |
|
| (1,010 | ) |
|
| (5,065 | ) |
|
Special charges |
|
| 11,244 |
|
|
| 3,907 |
|
|
| 15,151 |
|
|
Goodwill impairment charges |
|
| 415,880 |
|
|
| — |
|
|
| 415,880 |
|
|
Provision for income taxes |
|
| 145,523 |
|
|
| 3,129 |
|
|
| 148,652 |
|
|
Minority interest |
|
| 31 |
|
|
| 27 |
|
|
| 58 |
|
|
Income from discontinued operations, net |
|
| 4,736 |
|
|
| 803 |
|
|
| 5,539 |
|
|
Income (loss) on disposal of discontinued operations, net |
|
| (912 | ) |
|
| 97 |
|
|
| (815 | ) |
|
FiscalReorganized Company year ended December 31, 2004 (“Current Year”), compared to the Predecessor Company year ended December 31, 2003 ("(“Prior Year”)
Health Plan Solutions
Net Revenue
Net revenue related to the Health Plan Solutions segment increased by 3.9 percent or $34.3 million from the Prior Year to the Current Year"Year. The increase in revenue is mainly due to favorable rate changes of $41.3 million, net increased membership from existing customers of $40.0 million, favorable contractual settlements with customers in the Current Year related to prior periods of $5.5 million, and other net changes totaling $8.5 million, which increases were partially offset by decreases due to terminated contracts of $61.0 million.
Cost of Care
Cost of care increased by 4.3 percent or $19.9 million from the Prior Year to the Current Year. The increase in cost of care is primarily due to net increased membership from existing and new customers of $20.7 million, favorable medical claims development related to prior periods recorded in the Prior Year of $11.4 million, and higher costs due to care trends and other net variances of $28.2 million, which increases were partially offset by terminated contracts of $27.9 million and favorable medical claims development related to prior periods recorded in the Current Year of $7.1 million ($5.4 million of which relates to the Prior Year). Cost of care decreased as a percentage of risk revenue from 68.2 percent in the Prior Year to 66.8 percent in the Current Year, mainly due to increased revenue from favorable rate changes on risk membership and the net impact of medical claims development affecting the Current Year and the Prior Year, partially offset by higher costs due to care trends in the Current Year.
Direct Service Costs
Direct service costs decreased by 5.7 percent or $10.2 million from the Prior Year to the Current Year. The decrease in direct service costs is primarily due to cost reduction efforts undertaken by the Company including the shutdown of several regional service centers. Direct service costs decreased as a percentage of revenue from 20.7 percent in the Prior Year to 18.8 percent in the Current Year. The decrease in the percentage of direct service costs in relationship to revenue is mainly due to the aforementioned cost reduction efforts undertaken by the Company and favorable rate changes and other revenue increases since the Prior Year.
Equity in (Earnings) Loss of Unconsolidated Subsidiaries
Equity in (earnings) loss of unconsolidated subsidiaries decreased 19.6 percent or $1.3 million from the Prior Year to the Current Year. The decrease relates to a decrease in equity in earnings related to the Company’s investment in Royal Health Care, LLC (“Royal”), mainly attributable to a decrease in rates.
Employer Solutions
Net Revenue
Net revenue related to the Employer Solutions segment decreased by 14.7 percent or $23.4 million from the Prior Year to the Current Year. The decrease in revenue is mainly due to terminated contracts of $25.8 million, and net decreased membership from existing customers of $1.1 million, which decreases were partially offset by membership from new customers and other net changes of $3.5 million.
Cost of Care
Cost of care decreased by 17.1 percent or $7.7 million from the Prior Year to the Current Year. The decrease in cost of care is mainly due to terminated contracts of $5.8 million and lower costs due to care trends and other net changes of $1.9 million. The lower costs due to care trends for the Employer Solutions segment are partially due to the closure of several staff offices that had higher per visit costs than that incurred by utilizing the Company’s network of outpatient providers. Cost of care increased as a percentage of risk revenue from 29.6 percent in the Prior Year to 30.9 percent in the Current Year, mainly due to changes in business mix.
Direct Service Costs
Direct service costs decreased by 16.2 percent or $12.8 million from the Prior Year to the Current Year. The decrease in direct service costs is mainly due to lower costs required to support the Company’s decrease in net membership and due to cost reduction efforts undertaken by the Company. Direct service costs decreased as a percentage of revenue from 49.7 percent in the Prior Year to 48.9 percent in the Current Year, mainly due to the aforementioned cost reduction efforts undertaken by the Company.
Public Sector Solutions
Net Revenue
Net revenue related to the Public Sector Solutions segment increased by 56.9 percent or $273.7 million from the Prior Year to the Current Year. The increase in revenue is mainly due to the net impact of including revenue related to Premier of $236.4 million for the Current Year. Effective December 31, 2003, FIN 46 was adopted, as required, pursuant to which the Company began consolidating the results of operations of Premier in its consolidated statement of operations as of January 1, 2004. Excluding the impact of consolidating Premier in the Current Year, net revenue increased by $37.3 million. This increase is primarily due to net increased membership from existing customers of $27.2 million, net rate increases of $26.6 million, increased revenue of $11.9 million associated with cost of care sharing provisions under the TennCare contracts, and other net increases of $1.1 million, which increases were partially offset by terminated contracts of $29.5 million.
Cost of Care
Cost of care increased by 68.4 percent or $271.9 million from the Prior Year to the Current Year. The increase in cost of care is mainly due to the inclusion of approximately $236.4 million of expenses for care of Premier, due to the consolidation of the results of operations of Premier in 2004, as noted above. Excluding the impact of consolidating Premier in the Current Year, cost of care increased by $35.5 million.
This increase is primarily due to net increased membership from existing customers of $23.2 million, and higher costs due to care trends and other net changes of $34.8 million, which increases were partially offset by terminated contracts of $22.5 million. Cost of care increased as a percentage of risk revenue from 86.3 percent in the Prior Year to 90.6 percent in the Current Year, mainly due to the consolidation of the operating results of Premier in the Current Year, which has a higher ratio of care to risk revenue, and higher care trends experienced in the Current Year.
Direct Service Costs
Direct service costs were $40.5 million in each of the Prior Year and the Current Year. As a percentage of revenue, direct service costs decreased from 8.4 percent in the Prior Year to 5.4 percent in the Current Year, primarily due to the aforementioned consolidation of revenue of Premier in the Current Year.
Equity in (Earnings) Loss of Unconsolidated Subsidiaries
The Company recorded equity in loss of unconsolidated subsidiaries of approximately $0.4 million in the Prior Year, which represented its share of net loss realized by Premier. As noted above, the results of operations of Premier have been consolidated beginning in the Current Year in accordance with FIN 46.
Corporate and Other
Other Operating Expense
Other operating expenses related to the Company’s Corporate and Other Segment decreased by 15.7 percent or $18.6 million from the Prior Year to the Current Year. This decrease is mainly due to a decrease in the usage of consultants from the Prior Year of $8.0 million, insurance premiums of $7.5 million incurred in the Prior Year with respect to coverage after the Company’s emergence from bankruptcy for acts occurring prior to emergence and other net decreases of $3.1 million, mainly as a result of the Company’s cost reduction efforts. As a percentage of total net revenue, other operating expenses decreased from 7.9 percent for the Prior Year to 5.6 percent for the Current Year primarily due to the increase in revenue in the Current Year related to the consolidation of Premier (as described above) and the decreases in other operating expenses.
Depreciation and Amortization
Depreciation and amortization decreased by 11.6 percent or $5.6 million from the Prior Year to the Current Year. The decrease is primarily due to changes in the estimated remaining useful lives and basis of certain property and equipment and intangible assets as a result of the application of the fresh start reporting provisions of SOP 90-7 as of December 31, 2003, as well as the inclusion in the Prior Year of higher depreciation expense for certain capitalized software assets that became fully depreciated at March 31, 2003.
Interest Expense
Interest expense decreased by approximately 39.2 percent or $23.9 million from the Prior Year to the Current Year, due to the change in the Company’s debt structure as a result of the consummation of the Plan.
Other Items
A net reorganization benefit from continuing operations of approximately $438.2 million was recorded during the Prior Year. This amount is mainly composed of a $479.7 million net fresh start
52
reorganization gain, partially offset by the write-off of deferred financing costs and professional fees and expenses incurred associated with the financial restructuring process and chapter 11 proceedings. For further discussion, see Note 3—“Summary of Significant Accounting Policies—Financial Reporting Under the Bankruptcy Code” to the consolidated financial statements set forth elsewhere herein.
Special charges of $9.5 million and $5.0 million were recorded in the Prior Year and the Current Year, respectively. The special charges primarily consist of employee severance and termination benefits, lease termination costs and consulting fees related to restructuring plans that have resulted in the elimination of certain positions and the closure of certain offices. The Prior Year special charges include income related to the collection of a previously reserved note receivable. See Note 12—“Special Charges” to the consolidated financial statements set forth elsewhere herein for further discussion.
Goodwill impairment charges of $28.8 million were recorded in the Prior Year. The charge represents impairments to the Employer Solutions and Public Sector Solutions reporting units, based on the comparison between the carrying value and the fair market value of the segments, as estimated by an independent appraisal firm. The Prior Year write-down was attributable to the Company’s financial performance and its business outlook as of September 1, 2003 (the Predecessor Company’s annual measurement date), and resulted in the complete write-down of goodwill related to the Employer Solutions and Public Sector Solutions reporting units.
Stock compensation expense of $23.2 million was recorded in the Current Year mainly related to stock purchased by the CEO, stock granted to the Company’s senior executives, in-the-money stock options granted to management (including senior executives) and stock granted to non-management members of the Board of Directors who are not affiliated with Onex. See discussion of stock compensation expense in “Outlook—Results of Operations” below.
Income Taxes
The Company’s effective income tax rate was 35.4 percent in the Current Year and was 7.0 percent in the Prior Year. For the Current Year and the Prior Year, the Company recorded taxes based on its estimated current taxable income due to the uncertainty as to the Company’s ability to realize deferred tax assets based on its history of recent operating losses (prior to reorganization benefits) and financial restructuring activities and, for the Current Year, the lack of substantial history of profitable operations subsequent to its emergence from bankruptcy. In accordance with SOP 90-7, subsequent (post-bankruptcy) utilization by the Company of NOLs which existed at January 5, 2004 will be accounted for as reductions to goodwill or additional paid-in capital and therefore, will only benefit cash flows due to reduced tax payments and will not benefit the Company’s tax provision for income taxes. The Current Year effective rate differs from the federal statutory rate primarily due to certain transactions which occurred pursuant to the Plan, as consummated on the Effective Date, that reduced taxable income for 2004 but reduced book income in 2003 under SOP 90-7.
The Prior Year effective rate varies from the federal statutory rate primarily due to the Company’s recording, in the Prior Year, of a non-taxable fresh start reporting gain of $479.7 million and changes in estimates regarding the utilization of NOLs that existed prior to the Company’s emergence from bankruptcy in 1992 due to the finalization and amendment of certain previous year income tax returns.
Discontinued Operations
The following table summarizes, for the periods indicated, income (loss) from discontinued operations, net of tax (in thousands):
|
| Predecessor |
| Reorganized |
| ||||
|
| 2003 |
| 2004 |
| ||||
Healthcare provider and franchising segments |
|
| $ (24,482 | ) |
|
| $ 7,508 |
|
|
Specialty managed healthcare segment |
|
| (546 | ) |
|
| 59 |
|
|
Human services segment |
|
| — |
|
|
| (2,786 | ) |
|
|
|
| $ (25,028 | ) |
|
| $ 4,781 |
|
|
The loss from the healthcare provider and franchising segments in the Prior Year is primarily the result of the settlement of a significant claim in the chapter 11 proceeding, which under SOP 90-7 was recorded in 2003. Because the Company records tax expense based on its estimate of current taxable income (as discussed above) and the settlement of such claim reduces 2004 taxable income, the Current Year income from the healthcare provider and franchising segments is primarily attributable to the income tax benefit of $8.0 million with respect to the settlement of such claim.
The loss from the human services segment in the Current Year represents a change in estimated reserves for various accrued liabilities. The loss from the specialty managed healthcare segment in the Prior Year is a result of an increase in estimates of certain reserves for the segment.
The following table summarizes, for the periods indicated, the income (loss) on disposal of discontinued operations, net of tax (in thousands):
|
| Predecessor |
| Reorganized |
| ||||
|
| 2003 |
| 2004 |
| ||||
Healthcare provider and franchising segments |
|
| $ 2,751 |
|
|
| $ (1,030 | ) |
|
Specialty managed healthcare segment |
|
| 1,953 |
|
|
| — |
|
|
Human services segment |
|
| 52 |
|
|
| — |
|
|
|
|
| $ 4,756 |
|
|
| $ (1,030 | ) |
|
The Current Year loss on disposal for the healthcare provider and franchising segments reflects the loss recognized attributable to the sale of a hospital facility formerly used in the operations of such segments, with net proceeds of $2.3 million being received from the sale. The Prior Year income on disposal related to the healthcare provider and franchising segments is attributable to changes in estimates of previously recorded joint venture liabilities related to the disposal of the segment, gains on the sale of a hospital facility of $0.7 million (before taxes) and cash received as a final distribution associated with a discontinued provider joint venture of $0.8 million (before taxes).
The Prior Year income on disposal in the specialty managed healthcare segment is primarily the result of cash received as a partial payment on a note receivable that had been fully reserved in fiscal 2001, resulting in a gain of $1.3 million (before taxes), and a favorable change in estimated lease reserves of $0.5 million (before taxes).
The following table summarizes, for the periods indicated, the net reorganization benefit included in discontinued operations (in thousands):
|
| Predecessor |
| Reorganized |
| ||||
|
| 2003 |
| 2004 |
| ||||
Healthcare provider and franchising segments |
|
| $ 15,268 |
|
|
| $ — |
|
|
Specialty managed healthcare segment |
|
| 5,059 |
|
|
| — |
|
|
|
|
| $ 20,327 |
|
|
| $ — |
|
|
Included in the Prior Year net reorganization benefit is $15.4 million representing the net fresh start reorganization gain. In addition, as part of its financial restructuring plan and chapter 11 proceedings, certain leases for closed offices were rejected and reorganization (expense) benefit was recorded in accordance with SOP 90-7 for the difference between the estimated cost of rejecting such leases and the liability previously recorded.
Predecessor Company fiscal year ended December 31, 2003 (“Calendar 2003”), compared to the Predecessor Company twelve months ended December 31, 2002 (“Calendar 2002”)(unaudited) ("Prior Year")
Health Plan Solutions
Net Revenue.Net revenue related to the Health Plan Solutions segment decreased by 11.9 percent or $118.0$117.9 million from Calendar 2002 to $870.5 million for the Current Year from $988.5 million for the Prior Year.Calendar 2003. The decrease in revenue is mainly due to terminated contracts of $109.2 million, a reduction in revenue under the Company'sCompany’s contract with Aetna (primarily due to decreased membership) of $30.2 million, and contract changes (mainly risk to non-risk) of $23.3 million, and lower performance revenue of $2.7 million (see below), which decreases were partially offset by net increased membership from existing and new customers (excluding Aetna) of $24.6 million (mainly related to non-risk membership), net increases in rates of $17.8 million, and other net increases of $5.0$2.4 million.
Performance-based revenues for the Health Plan Solutions segment were $9.3 million and $6.6 million for the Prior Year and Current Year, respectively. The decrease is primarily due to the Prior Year including performance revenue for a contract that no longer has performance revenue terms.
Cost of Care.Cost of care decreased by 20.2 percent or $117.8 million from Calendar 2002 to $464.1 million for the Current Year from $581.9 million for the Prior Year.Calendar 2003. The decrease in cost of care is primarily due to terminated contracts of $77.9 million, net contract changes (mainly risk to non-risk) of $24.0 million, favorable prior year medical claims development recorded during fiscal 2003 of $11.4 million (which has a year over year impact of $22.8 million), a reduction in care under the Company'sCompany’s contract with Aetna (mainly due to decreased risk membership) of $15.2 million, and net favorable settlements of $6.7 million related to claims paid by clients, which decreases were partially offset by net increased membership from existing and new customers of $8.2 million and estimated higher costs due to care trends and other net changes of $20.6 million. Excluding the impact in the Current YearCalendar 2003 of favorable Prior YearCalendar 2002 care development, cost of care decreased as a percentage of risk revenue decreased from 70.8 percent in the Prior Yearfor Calendar 2002 to 69.9 percent in the Current Year,for Calendar 2003, mainly due to changes in business mix..
Direct Service Costs.Direct service costs decreased by 20.315.0 percent or $33.3$31.7 million from Calendar 2002 to $130.7 million for the Current Year from $164.0 million for the Prior Year.Calendar 2003. The decrease in direct service costs is primarily due to cost reduction efforts undertaken by the Company including the shutdown of several regional service centers, as well as lower costs required to support the decrease in net membership in the Health Plan Solutions segment. Direct service costs decreased as a percentage of revenue decreased from 16.621.5 percent for the Prior YearCalendar 2002 to 15.020.7 percent for the Current Year.Calendar 2003. The decrease in
55
the percentage of direct service costs in relationship to revenue is mainly due to the aforementioned cost reduction efforts undertaken by the Company and rate increases since the Prior Year.Calendar 2002.
Equity in (Earnings) Loss of Unconsolidated Subsidiaries.Equity in (earnings) loss of unconsolidated subsidiaries decreased 51.852.1 percent or $7.1 million from Calendar 2002 to $(6.6) million for the Current Year from $(13.7) million for the Prior Year.Calendar 2003. The decrease primarily relates to the Company'sCompany’s withdrawal from the Choice partnership Behavioral Health Partnership (“Choice”)
as of the end of October 2002, with equity in (earnings) of Choice totaling $(9.0) million for the Prior Year.Calendar 2002. Partially offsetting this reduction is an increase of $1.9 million in equity in (earnings) related to the Royal Health Care, LLC joint venture, (in which the Company has a 36.3 percent ownership interest).mainly due to increased membership.
Employer Solutions
Employer Solutions
Net Revenue.Net revenue related to the Employer Solutions segment decreased by 16.1 percent or $30.5 million from Calendar 2002 to $159.0 million for the Current Year from $189.5 million for the Prior Year.Calendar 2003. The decrease in revenue is mainly due to terminated contracts of $23.6 million, net decreased membership from existing customers of $8.3 million, and contract changes (mainly risk to non-risk) of $3.0 million, which decreases were partially offset by other net changes of $4.4 million.
Cost of Care.Cost of care decreased by 38.0 percent or $27.5 million from Calendar 2002 to $44.9 million for the Current Year from $72.4 million for the Prior Year.Calendar 2003. The decrease in cost of care is mainly due to terminated contracts of $16.4 million, net contract changes (mainly risk to non-risk) of $3.1 million, favorable care trends and other net changes of $6.3 million, and costs associated with net membership reduction from existing customers of $1.7 million. The favorable care trends are partially due to the closure of several staff offices which had higher per cost visits than that incurred by utilizing the Company'sCompany’s contracted network of outpatient providers. Cost of care decreased as a percentage of risk revenue decreased from 40.2 percent in the Prior YearCalendar 2002 to 29.929.6 percent in the Current Year,Calendar 2003, mainly due to favorable care trends experienced in the Current YearCalendar 2003 and changes in business mix.
Direct Service Costs.Direct service costs decreased by 10.06.3 percent or $7.6$5.3 million from Calendar 2002 to $68.1 million for the Current Year from $75.7 million for the Prior Year.Calendar 2003. The decrease in direct service costs is mainly due to lower costs required to support the decrease in net membership in the Employer Solutions segment. As a percentage of revenue, direct service costs increased from 39.944.5 percent for the Prior Yearin Calendar 2002 to 42.849.7 percent for the Current Year.in Calendar 2003. The increase in the percentage of direct service costs in relationship to revenue is mainly due to the reduction in revenue due to terminated contracts and decreased membership from existing customers (as described above), for which the direct service costs are not reduced proportionally, or such reductions are accomplished on a delayed basis.
Public Sector Solutions
Net Revenue.Net revenue related to the Public Sector Solutions segment decreased by 16.5 percent or $94.9 million from Calendar 2002 to $481.2 million for the Current Year from $576.1 million for the Prior Year.Calendar 2003. The decrease in revenue is mainly due to a net reduction in revenue with respect to the TennCare program of $83.3 million, primarily as a result of a program change (as described above), a contract change with respect to the Pennsylvania Counties of $42.9 million and terminated contracts of $4.9 million, which decreases were partially offset by net increased membership from other existing customers of $30.4 million, net rate increases (other than from TennCare) of $4.9 million and other net increases of $0.9 million.
Cost of Care.Cost of care decreased by 16.8 percent or $80.1 million from Calendar 2002 to $397.5 million for the Current Year from $477.6 million for the Prior Year.Calendar 2003. The decrease in cost of care is mainly due to a net reduction in cost of care with respect to the TennCare program of $79.5 million, primarily as a result of a program change (as described above), and a contract change with respect to the Pennsylvania Counties of $31.6 million, which decreases were partially offset by net increased
56
membership from other existing customers of $24.3 million and higher costs due to care trends (other than with respect to TennCare) and other net changes of approximately $6.7 million. Cost of care as a percentage of risk revenue was relatively consistent for both periods at 86.6 percent in the Prior Year and 86.3 percent in the Current Year.periods.
Direct Service Costs.Direct service costs decreased by 31.626.0 percent or $13.3$14.2 million from Calendar 2002 to $28.8 million for the Current Year from $42.1 million for the Prior Year.Calendar 2003. The decrease in direct service costs is primarily due to cost reduction efforts undertaken by the Company and a contract change with respect to the Pennsylvania Counties contracts, partially offset by higher costs required to support the increase in net membership in the Public Sector
Solutions segment. As a percentage of revenue, direct service costs decreased from 7.39.5 percent forin Calendar 2002 to 8.4 percent in Calendar 2003, due to the Prior Year to 6.0 percent for the Current Year.reasons noted above.
Equity in (Earnings) Loss of Unconsolidated Subsidiaries.Equity in loss of unconsolidated subsidiaries decreased $(1.3)$1.3 million to $0.4 million for the Current YearCalendar 2003 from $1.7 million for the Prior Year.Calendar 2002. The investment in unconsolidated subsidiary relates to Premier. The year-to-dateCalendar 2003 improvement is primarily due to increased risk share revenue, favorable runout of prior period IBNR and favorable rate changes, which changes were partially offset by decreased membership.
Corporate and Other
Other Operating Expenses.Other operating costs related to the Corporate and Other Segment increased by 13.620.1 percent or $22.8$19.8 million from Calendar 2002 to $190.8 million for the Current Year from $168.0 million for the Prior Year.Calendar 2003. The increase is mainly due to higher discretionary employee benefit costs of $21.5$11.4 million, (the Prior Year included a change in estimate to reduce certain discretionary employee benefit cost accruals of $2.0 million), insurance premiums of $7.5 million with respect to coverage after the Company'sCompany’s emergence from bankruptcy for acts occurring prior to emergence, and the inclusion in the Prior YearCalendar 2003 of the favorable impact of changes in estimates of the reserves previously recorded for employee health benefits, self-insurance and litigation totaling approximately $3.5 million. Such increases in other operating expenses were partially offset by the Company'sCompany’s cost reduction efforts undertaken in the Current Year.Calendar 2003. As a percentage of total net revenue, other operating expenses increased from 9.65.6 percent for the Prior YearCalendar 2002 to 12.67.9 percent for the Current YearCalendar 2003 due to the lower revenue in the Current YearCalendar 2003 (as described above) and the increase in other operating expenses.
Depreciation and Amortization.Depreciation and amortization decreased by 5.3 percent or $2.7 million from Calendar 2002 to $48.0 million for the Current Year from $50.7 million for the Prior Year.Calendar 2003. The decrease is primarily due to a reduction in depreciation expense mainly related to certain capitalized software assets that became fully depreciated at March 31, 2003, partially offset by an increase in amortization expense related to an adjustment of the remaining useful lives of certain intangible assets as of October 1, 2002.
Interest Expense.Interest expense decreased by 38.5 percent or $38.2 million from Calendar 2002 to $61.0 million for the Current Year from $99.2 million for the Prior Year.Calendar 2003. The decrease is mainly due to the fact that the Company did not accrue interest after March 11, 2003 of approximately $45.3 million for the Old Subordinated Notes as a result of the chapter 11 filing, in accordance with SOP 90-7. Such decrease was partially offset by increased interest expense incurred under the Old Credit Agreement of approximately $2.9 million, mainly related to higher borrowing levels on the Company'sCompany’s Old Revolving Facility and higher overall interest rates charged for all loans under the Old Credit Agreement, $3.9 million related to the Aetna Note and other net increases of $0.3 million.
Other Items.The Company recorded a net reorganization benefit from continuing operations of approximately $438.2 million during the Current Year.in Calendar 2003. This amount is mainly composed of a $479.7 million net fresh start reorganization gain, partially offset by the write-off of deferred financing costs and professional fees and expenses associated with the Company'sCompany’s financial restructuring process and chapter 11 proceedings. For further discussion, see Note 3—"“Summary of Significant Accounting
57
Policies—Financial Reporting Under the Bankruptcy Code"Code” to the audited consolidated financial statements set forth elsewhere herein.
The Company recorded special charges of $9.5 million and $15.2 million in the Current YearCalendar 2003 and the Prior Year,Calendar 2002, respectively. The special charges primarily relate to restructuring plans that have resulted in the elimination of certain positions and the closure of certain offices, partially offset by income recorded to special charges related to the collection of a previously reserved note receivable. The charges related to restructuring plans primarily consist of employee severance and termination benefits, lease termination costs and consulting fees. See Note 12—"“Special Charges"Charges” to the audited consolidated financial statements set forth elsewhere herein for further discussion.
The Company recorded goodwill impairment charges of $28.8 million and $415.9 million in the Current YearCalendar 2003 and the Prior Year,Calendar 2002, respectively. The Current YearCalendar 2003 charge represents impairments to the Employer Solutions and Public Sector Solutions reporting units, based on the comparison between the carrying value and the fair market value of the segments, as estimated by an independent appraisal firm. The Current YearCalendar 2003 write-down was attributable to the Company'sCompany’s financial performance and its business outlook as of September 1, 2003, (the annual measurement date), and resulted in the complete write-down of goodwill related to the Employer Solutions and Public Sector Solutions reporting units. In the Prior Year,Calendar 2002, the Company recorded an impairment charge to write-down the balance of goodwill related to the Health Plan Solutions, Employer Solutions and Public Sector Solutions reporting units to estimated fair value, based on independently appraised values. The Prior YearCalendar 2002 write-down occurred due to changes in the Company'sCompany’s financial performance and its business outlook from the beginning of the year through September 1, 2002, which decreased the estimated fair value of the Company'sCompany’s reporting units.
Income Taxes.The Company'sCompany’s effective income tax rate was 7.0 percent for the Current YearCalendar 2003 as compared to (38.8)(38.0) percent for Calendar 2002. For Calendar 2003 and Calendar 2002 the Prior Year.Company recorded taxes based on estimated current taxable income due to the uncertainty as to the Company’s ability to realize deferred tax assets based on its history of recent operating losses (prior to reorganization benefits) and financial restructuring activities and the lack of substantial history of profitable operations subsequent to its emergence from bankruptcy. In accordance with SOP 90-7, subsequent (post-bankruptcy) utilization by the Company of NOLs which existed at January 5, 2004 will be accounted for as reductions to goodwill or additional paid-in capital and therefore, will only benefit cash flows due to reduced tax payments and will not benefit the Company’s tax provision for income taxes. The Current YearCalendar 2003 effective rate differs from the federal statutory rate primarily due to the Company’s recording, in Calendar 2003, of a non-taxable fresh start reporting gain of $479.7 million and changes in estimates regarding the utilization of NOLs that existed prior to the Company’s emergence from bankruptcy in 1992 due to the finalization and amendment of certain prior year income tax returns.
The Calendar 2002 effective rate varies substantially from the federal statutory rates because the Company's effective rate is based only on current expense due to full valuation allowances against net deferred tax assets and the estimated utilization of net operating loss ("NOL") carryforwards generated prior to a previous bankruptcy filing in 1992 and prior to the occurrence of certain other events which may cause limitations on its NOL carryforwards. In addition, the Company notes that its Current Year taxable income is affected by the non-taxable impact of the fresh start reporting gain and non-deductible goodwill included in the Current Year goodwill impairment charge. Under SOP 90-7, the deferred tax benefit related to the realization of the pre-1992 bankruptcy NOL carryforwards is not reflected in the consolidated statements of operations. The income tax provision in the Current Year also considers certain changes in estimates regarding the Company's anticipated utilization of pre-1992 bankruptcy NOL carryforwards due to amendments of prior year tax returns.
The Prior Year effective rate varies substantially from federal statutory rates primarily due to the impact of non-deductible goodwill included in the prior year goodwill impairment charge and a valuation allowance adjustment to reduce the Company'sCompany’s deferred tax asset balance to zero due to the uncertainty as to the Company'sCompany’s ability to realize its net operating loss carryforwards and other deferred tax assets.
Discontinued Operations.The following table summarizes, for the periods indicated, income (loss) from discontinued operations, net of tax (in thousands):
| | 2002 | 2003 | |||||
|---|---|---|---|---|---|---|---|
| Healthcare provider and franchising segments | $ | 5,341 | $ | (24,482 | ) | ||
| Specialty managed healthcare segment | 198 | (546 | ) | ||||
| $ | 5,539 | $ | (25,028 | ) | |||
58
|
| 2002 |
| 2003 |
|
Healthcare provider and franchising segments |
| $ 5,341 |
| $ (24,482 | ) |
Specialty managed healthcare segment |
| 198 |
| (546 | ) |
|
| $ 5,539 |
| $ (25,028 | ) |
The loss for the Current YearCalendar 2003 in the healthcare provider and franchising segments is primarily the result of the settlement of a significant claim, which resulted in an adjustment to discontinued operations legal expense of $24.0 million, for which there was no tax effect. Income from the healthcare provider and franchising segments for the Prior YearCalendar 2002 includes a reduction of estimates of reserves pertaining to the former psychiatric hospital facilities of $4.3 million (before taxes) and the positive settlement of outstanding Medicare and Medicaid cost reports of $4.3 million (before taxes), partially offset by the cost of collections, legal fees and other costs.
The loss for the Current YearCalendar 2003 in the specialty managed healthcare segment is a result of an increase in estimates of certain reserves for the segment. Income from the specialty managed healthcare segment for the Prior YearCalendar 2002 is a result of a change in estimate of certain lease reserves of $0.3 million (before taxes) related to the settlement of a lease obligation. See Note 5—"Discontinued Operations" to the Company's audited consolidated financial statements set forth elsewhere herein.
The following table summarizes, for the periods indicated, the income (loss) on disposal of discontinued operations, net of tax (in thousands):
| | 2002 | 2003 |
| 2002 |
| 2003 |
| ||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Healthcare provider and franchising segments | $ | 47 | $ | 2,751 |
| $ 47 |
| $ 2,751 |
| ||
| Specialty managed healthcare segment | (1,642 | ) | 1,953 |
| (1,642 | ) | 1,953 |
| |||
| Human services segment | 780 | 52 |
| 780 |
| 52 |
| ||||
| $ (815 | ) | $ 4,756 |
| |||||||
| $ | (815 | ) | $ | 4,756 | |||||||
The Current YearCalendar 2003 income on disposal in the healthcare provider and franchising segments is attributable to changes in estimates of previously recorded joint venture liabilities related to the disposal of the segment. Additionally, the Current YearCalendar 2003 income on disposal includes gains on the sale of a hospital facility of $0.7 million (before taxes) and cash received as a final distribution associated with a discontinued provider joint venture of $0.8 million (before taxes).
The Current YearCalendar 2003 income on disposal in the specialty managed healthcare segment is primarily the result of cash received as a partial payment on a note receivable held by the Company that the Company had been fully reserved in fiscal 2001, resulting in a gain of $1.3 million (before taxes), and a favorable change in estimated lease reserves of $0.5 million (before taxes). Loss on disposal in the specialty managed healthcare segment in the Prior YearCalendar 2002 is primarily the result of an increase in lease reserves of approximately $(2.3)$2.3 million (before taxes) to reflect changes in estimates, which loss is offset by $0.7 million (before taxes) in cash received as partial payment on a note receivable held by the Company that the Company had been fully reserved in fiscal 2001.
The Prior YearCalendar 2002 income on disposal in the human services segment is the result of a change in estimate of self-insurance and other reserves.
The following table summarizes, for the periods indicated, the net reorganization benefit included in discontinued operations (in thousands):
| | 2002 | 2003 |
| 2002 |
| 2003 |
| ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Healthcare provider and franchising segments | $ | — | $ | 15,268 |
|
| $— |
|
| $ 15,268 |
| ||
| Specialty managed healthcare segment | — | 5,059 |
|
| — |
|
| 5,059 |
| ||||
|
| $— |
|
| $ 20,327 |
| |||||||
| $ | — | $ | 20,327 | ||||||||||
Included in the net reorganization benefit for Calendar 2003 is $15.4 million representing the net fresh start reorganization gain. In addition, as part of its financial restructuring plan and chapter 11 proceedings, the Company has rejected certain leases for closed offices.offices were rejected. To the extent that the estimated cost to the
59
Company as a result of rejecting such leases was different than the liability previously recorded, such difference has been recorded as reorganization (expense) benefit in accordance with SOP 90-7.
Fiscal 2002 compared to fiscal 2001
Health Plan Solutions
Net Revenue. Net revenue related to the Health Plan Solutions segment decreased by 6.2 percent or $66.5 million to $1,013.0 million in fiscal 2002 from $1,079.5 million in fiscal 2001. During fiscal 2001, the Company settled certain contract appeals related to two subcontracts with respect to TRICARE that resulted in additional revenues of $30.3 million. The decrease in revenue is mainly due to TRICARE settlements of $30.3 million, the decrease in revenue under the Company's contract with Aetna (mainly due to decreased membership) of $65.2 million, terminated contracts in fiscal 2001 and fiscal 2002 of $38.7 million, contract changes (mainly risk to non-risk) of $16.1 million, decreased performance-based revenue of $7.6 million (see below) and the effect of the fiscal 2001 sale of Group Practice Affiliates, Inc. ("GPA"), a staff model physician practice, of $2.2 million, which decreases were partially offset by net increases in rates of $41.4 million, net increased membership from existing customers (excluding Aetna) of $38.4 million, new business of $11.0 million and other net changes.
The Company earns performance-based fees as part of certain of its health plan contracts. Performance-based revenues are recorded when earned and estimable. Performance-based revenues for the Health Plan Solutions segment were $19.9 million and $12.3 million in fiscal 2001 and 2002, respectively. The decrease is primarily due to the inclusion in fiscal 2001 of positive changes in estimates regarding fiscal 2000 amounts and other positive contractual developments in fiscal 2001 under certain arrangements for which no contract periods had been settled in fiscal 2000.
Cost of Care. Cost of care decreased by 4.0 percent or $25.0 million to $596.8 million in fiscal 2002 from $621.8 million in fiscal 2001. The decrease in cost of care is primarily due to decreased membership from Aetna of $46.6 million, terminated contracts in fiscal 2001 and fiscal 2002 of $24.1 million, net contract changes (mainly risk to non-risk) of $16.1 million and unfavorable prior fiscal year medical claims development during fiscal 2001 of $15.0 million, which decreases were partially offset by higher care trends over the prior year of $31.6 million, net increased membership from existing customers (excluding Aetna) of $22.7 million, unfavorable prior fiscal year medical claims development during fiscal 2002 of $8.6 million (which entirely relates to fiscal 2001), new business of $5.2 million and other net changes. Cost of care increased as a percentage of risk revenue to 71.8 percent in fiscal 2002 from 69.4 percent in fiscal 2001, mainly due to higher care trends experienced in fiscal 2002 and the inclusion of revenue from the TRICARE settlement in fiscal 2001, partially offset by rate and other revenue increases in fiscal 2002.
Direct Service Costs. Direct service costs decreased by 2.7 percent or $4.9 million to $174.9 million in fiscal 2002 from $179.8 million in fiscal 2001. As a percentage of revenue, direct service costs increased to 17.3 percent for fiscal 2002 from 16.7 percent for fiscal 2001. The decrease in direct service costs is primarily due to the sale of GPA and cost reduction efforts undertaken by the Company including the shutdown of several regional service centers. The increase in the percentage of direct service costs in relationship to revenue is mainly due to the inclusion of revenue from the TRICARE settlement in fiscal 2001, partially offset by rate and other revenue increases in fiscal 2002.
Equity in Earnings of Unconsolidated Subsidiaries. Equity in earnings of unconsolidated subsidiaries decreased by 60.3 percent or $23.6 million to $15.5 million in fiscal 2002 from $39.1 million in fiscal 2001. During fiscal 2001, the Company recorded $22.6 million of earnings in connection with the settlement of certain appeals related to the Choice partnership's subcontract with respect to TRICARE. These settlements increased the Company's fiscal 2001 income from continuing operations and net income by approximately $13.5 million. The decrease in equity in earnings is primarily due to the fiscal 2001 TRICARE settlement, lower revenue from Choice due to decreased rates in the current
60
option year and higher care trends for Choice of approximately $1.7 million, partially offset by a favorable $0.7 million retroactive adjustment recorded in fiscal 2002 associated with a change in the operating agreement for Royal.
Employer Solutions
Net Revenue. Net revenue related to the Employer Solutions segment decreased by 0.5 percent or $0.9 million to $188.7 million in fiscal 2002 from $189.6 million in fiscal 2001. The decrease in revenue is mainly due to terminated contracts in fiscal 2001 and fiscal 2002 of $10.4 million, the effect of the fiscal 2001 sale of the Company's Canadian operations, which contributed $3.3 million of revenue in fiscal 2001 and other net decreases of $1.8 million, which decreases were partially offset by net increased membership from existing customers of $10.5 million and new business of $4.1 million.
Cost of Care. Cost of care increased by 12.1 percent or $7.8 million to $72.4 million in fiscal 2002 from $64.6 million in fiscal 2001. The increase in cost of care is mainly due to higher care trends of $8.7 million, net increased membership from existing customers of $3.4 million and new business of $0.3 million, partially offset by terminated contracts of $4.0 million and the sale of the Company's Canadian operations of $0.6 million. As a percentage of risk revenue, cost of care increased to 40.3 percent for fiscal 2002 from 36.7 percent for fiscal 2001, mainly due to higher care trends experienced in fiscal 2002.
Direct Service Costs. Direct service costs increased by 4.6 percent or $3.4 million to $76.8 million in fiscal 2002 from $73.4 million in fiscal 2001. As a percentage of revenue, direct service costs increased to 40.7 percent for fiscal 2002 from 38.7 percent for fiscal 2001. The aforementioned changes are mainly due to a change in the mix of business to include more ASO and cost-plus contracts in fiscal 2002.
Public Sector Solutions
Net Revenue. Net revenue related to the Public Sector Solutions segment increased by 13.4 percent or $65.0 million to $551.3 million in fiscal 2002 from $486.3 million in fiscal 2001. The increase in revenue is mainly due to new business of $44.1 million and net rate increases of $28.5 million, partially offset by net decreased membership from existing customers of $7.6 million and terminated contracts of $1.2 million and other net changes.
Cost of Care. Cost of care increased by 11.1 percent or $45.5 million to $456.5 million in fiscal 2002 from $411.0 million in fiscal 2001. As a percentage of risk revenue, cost of care decreased to 86.6 percent for fiscal 2002 from 87.7 percent for fiscal 2001. The increase in cost of care is mainly due to new business of $35.0 million and higher care trends of $24.6 million, partially offset by net decreased membership from existing customers of $9.4 million, favorable prior fiscal year medical claims development during fiscal 2002 of $2.2 million (which entirely relates to fiscal 2001), terminated contracts of $0.2 million and other net changes.
Direct Service Costs. Direct service costs increased by 8.4 percent or $3.2 million to $41.4 million in fiscal 2002 from $38.2 million in fiscal 2001. The increase in direct service costs is primarily due to costs associated with new business. As a percentage of revenue, direct service costs decreased from 7.9 percent for fiscal 2001 to 7.5 percent for fiscal 2002. This change is primarily due to favorable rate changes, which increased revenue but had no effect on direct service costs.
Equity in Loss of Unconsolidated Subsidiaries. Equity in loss of unconsolidated subsidiaries was $(2.5) million for both fiscal 2002 and 2001. The Public Sector Solutions segment's investment in unconsolidated subsidiary relates to Premier, in which the Company maintains a 50.0 percent interest. Results for fiscal 2002 as compared to fiscal 2001 reflect higher care trends which were entirely offset by rate increases and the inclusion in fiscal 2001 of an expense of $3.1 million for certain legal actions.
61
Corporate and Other
Other Operating Expenses. Other operating costs related to the Corporate and Other Segment decreased by 1.0 percent or $1.7 million to $166.5 million in fiscal 2002 from $168.2 million in fiscal 2001. As a percentage of total revenue, other operating costs decreased to 9.5 percent for fiscal 2002 from 9.6 percent for fiscal 2001. The decrease in other operating expenses is mainly due to lower headcount in various corporate departments of $0.4 million, reduction in discretionary employee benefit costs of $1.3 million, changes in estimates for certain employee benefit related costs recorded in the prior fiscal year of $0.4 million and certain self insurance and legal reserves of approximately $4.0 million, partially offset by fees incurred in conjunction with migration of operating systems of $1.3 million and other net changes.
Depreciation and Amortization. Depreciation and amortization decreased by 30.3 percent or $20.7 million to $47.6 million in fiscal 2002 from $68.3 million in fiscal 2001. The decrease is primarily attributable to the implementation of SFAS 142 in fiscal 2002. Had the Company adopted SFAS 142 effective October 1, 2000, the Company would not have recorded approximately $30.2 million of amortization expense related to continuing operations during fiscal 2001. Partially offsetting this decrease is $5.7 million of increased depreciation expense related to revisions to the estimated useful lives of certain assets and increased depreciation expense associated with fixed asset additions in fiscal 2002. See Note 3—"Summary of Significant Accounting Policies" to the audited consolidated financial statements set forth elsewhere herein for further discussion of the impact of the adoption of SFAS 142.
Interest, Net. Net interest expense decreased by 8.1 percent or $8.1 million to $92.2 million for fiscal 2002 from $100.3 million in fiscal 2001. Fiscal year 2001 interest expense includes approximately $6.6 million to write-off deferred loan costs related to the issuance of the Old Senior Notes. The charge of $6.6 million was previously reported as an extraordinary loss on early extinguishment of debt, net of the tax benefit of $2.6 million. The fiscal 2001 write-off of the deferred loan costs was reclassified to interest expense due to the adoption of SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections" ("SFAS 145") in the fourth quarter of fiscal 2002. Fiscal year 2001 also benefited from $2.1 million of interest income received in conjunction with a retroactive pricing adjustment related to a customer contract. In fiscal 2002, the Company incurred approximately $1.9 million in penalty interest due to non-registration of the Old Senior Notes. Excluding the items above, net interest expense decreased by approximately $5.5 million from fiscal 2001. The decrease is primarily the result of lower average outstanding debt and lower average interest rates in fiscal 2002 versus fiscal 2001. The lower average outstanding debt is due to scheduled payments of principal on the Term Loans under the Old Credit Agreement as well as unscheduled payments under the Old Credit Agreement with the proceeds from the sale of the Company's human services segment in fiscal 2001.
Other Items. The Company recorded special charges of $3.3 million in fiscal 2001 related to the loss on the sale of the Company's Canadian subsidiary. The Company recorded special charges of $15.7 million in fiscal 2002 related to restructuring plans that have resulted in the elimination of certain positions and the closure of certain offices. These charges primarily consist of severance, lease and consulting fees. See Note 12—"Special Charges" to the audited consolidated financial statements set forth elsewhere herein for further discussion. During fiscal 2002, the Company recorded goodwill impairment charges of $415.9 million related to its annual impairment test of goodwill in accordance with SFAS 142. This impairment charge was a result of writing down the balance of goodwill related to the Health Plan Solutions, Employer Solutions and Public Sector Solutions reporting units to estimated fair value, based upon independently appraised values. For further discussion, see Note 3—"Summary of Significant Accounting Policies" to the Company's audited consolidated financial statements set forth elsewhere herein.
Income Taxes. The Company's financial restructuring activities and financial condition result in uncertainty as to the Company's ability to realize its net operating loss carryforwards and other
62
deferred tax assets. Accordingly, as of September 30, 2002, the Company recorded an increase to its valuation allowance of $200.5 million, resulting in a total valuation allowance covering all of the Company's net deferred tax assets. Excluding the impact of this valuation allowance adjustment, the Company's effective income tax rate was approximately (12.5) percent for fiscal 2002 as compared to 53.5 percent for fiscal 2001. The effective rate varies substantially from statutory rates due primarily to the impact of non-deductible goodwill included in the fiscal 2002 goodwill impairment charge, non-deductible goodwill amortization in fiscal 2001 and non-deductible intangible asset amortization resulting primarily from acquisitions.
Discontinued Operations. The following table summarizes, for the periods indicated, income (loss) from discontinued operations, net of tax (in thousands):
| | 2001 | 2002 | ||||
|---|---|---|---|---|---|---|
| Healthcare provider and franchising segments | $ | (287 | ) | $ | 4,696 | |
| Specialty managed healthcare segment | 3,160 | 198 | ||||
| Human services segment | 1,751 | — | ||||
| $ | 4,624 | $ | 4,894 | |||
Income from the healthcare provider and franchising segments in fiscal 2002 includes a reduction of estimates of regulatory reserves pertaining to the former psychiatric hospitals of approximately $5.2 million, before taxes. Additionally, the Company recorded positive settlements of outstanding Medicare and Medicaid cost reports of $7.4 million in fiscal 2002, offset by the cost of collections, legal fees and other costs of exiting the business. Loss from the healthcare provider and franchising segments for fiscal 2001 is a result of the positive settlement of outstanding Medicare and Medicaid cost reports of $6.3 million and collection of certain receivables previously written off of $1.0 million, offset by the cost of collections, lease termination payments and other costs of exiting the business.
Income from the specialty managed healthcare segment for fiscal 2001 represents the settlement of obligations for less than the amount previously estimated. See Note 5—"Discontinued Operations" to the Company's audited consolidated financial statements set forth elsewhere herein.
Income from the human services segment of $1.8 million for fiscal 2001 is primarily the result of operating results prior to the sale of the segment in the second fiscal quarter of 2001. See Note 5—"Discontinued Operations" to the Company's audited consolidated financial statements set forth elsewhere herein. The following table summarizes, for the periods indicated, the income (loss) on disposal of discontinued operations, net of tax (in thousands):
| | 2001 | 2002 | |||||
|---|---|---|---|---|---|---|---|
| Healthcare provider and franchising segments | $ | 2,744 | $ | 867 | |||
| Specialty managed healthcare segment | — | (1,642 | ) | ||||
| Human services segment | (12,103 | ) | 683 | ||||
| $ | (9,359 | ) | $ | (92 | ) | ||
In fiscal 2002, the Company and its joint venture partner sold the operations and assets of the remaining provider joint venture ("Provider JV"), resulting in the Company receiving $3.5 million in cash and recording a pre-tax gain of approximately $1.3 million. In conjunction with the Charter Behavioral Health Systems, LLC ("CBHS") settlement consummated in fiscal 2001, the Company was released from certain liabilities and therefore determined that certain liabilities recorded as a result of certain transactions with CBHS during fiscal 1999 were no longer needed. The reversal of these liabilities, net of tax, was recorded during the third quarter of fiscal 2001, resulting in a change in estimate related to the loss on disposal of the healthcare provider and franchising segments of $2.7 million.
63
The loss on disposal of the specialty managed healthcare segment in fiscal 2002 is primarily attributable to net changes in estimates of certain future lease obligations and other reserves of approximately $2.5 million.
Income from disposal of the human services segment in fiscal 2002 represents changes in estimates regarding previously recorded liabilities related to the disposal of the segment. The Company recorded an estimated loss on disposal of the human service segment of approximately $12.1 million during fiscal 2001. This loss is comprised of an estimated pre-tax loss of $2.8 million and tax provision of $9.3 million. The tax provision is related to the tax gain on the sale which results from a lower tax basis, primarily due to approximately $26.1 million of goodwill that has no tax basis. See Note 5—"Discontinued Operations" to the Company's audited condensed consolidated financial statements set forth elsewhere herein.
Cumulative Effect of Change in Accounting Principle. As of October 1, 2001, the Company early adopted SFAS 142. The initial goodwill impairment charge of $207.8 million, before taxes ($191.6 million after taxes), was recorded as a cumulative effect of a change in accounting principle during such fiscal quarter. This impairment charge was a result of writing down the balance of goodwill related to the Employer Solutions reporting unit to estimated fair value as of October 1, 2001, based upon independently appraised values. For further discussion, see Note 3—"Summary of Significant Accounting Policies" to the Company's audited consolidated financial statements set forth elsewhere herein.
Outlook—Results of Operations
The Company's Segment ProfitCompany’s segment profit and net income are subject to significant fluctuations on a quarterly basis.from period to period. These fluctuations may result from:from a variety of factors such as those set forth under Item 1—“Business—Cautionary Statements as well as a variety of other factors including: (i) changes in utilization levels by enrolled members of the Company'sCompany’s risk-based contracts, including seasonal utilization patterns; (ii) performance-based contractual adjustments to revenue, reflecting utilization results or other performance measures; (iii) contractual adjustments and settlements; (iv)(iii) retrospective membership adjustments; (v)(iv) timing of implementation of new contracts, enrollment changes and contract terminations; (vi)(v) pricing adjustments upon contract renewals (and price competition in general) and (vii)(vi) changes in estimates regarding medical costs and incurred but not yet reported medical claims.
A portion of the Company'sCompany’s business is subject to rising care costs due to an increase in the number and frequency of covered members seeking behavioral care services, and higher costs per inpatient day or outpatient visit. Many of these factors are beyond the Company'sCompany’s control. Future results of operations will be heavily dependent on management'smanagement’s ability to obtain customer rate increases that are consistent with care cost increases and/orand /or to reduce operating expenses.
The Company is a market leader in a mature market with many viable competitors. The Company is continuing its attempts to increasegrow its market sharebusiness in the managed behavioral healthcare industry through aggressive marketing and development of new products; however, due to the amountmaturity of competition,the market, the Company believes that the probability of losing market shareability to these competitorsgrow its current business lines may be greater than the probability of increasing market share. The Company anticipates a reduction in the fiscal year ending December 31, 2004 revenue compared to fiscal 2003 due to contracts that had been terminated effective in 2003 and contracts that have been terminated with an effective date in 2004, as well as potential additional contract terminations in 2004. Such terminations include the two subcontracts with respect to TRICARE discussed above, one of which expired as of April 30, 2003, and the other of which will expire on September 30, 2004.limited. In addition, it is possible that the Company'sCompany’s customers that are managed care companies may in the future, seek to provide managed behavioral healthcare services directly to their subscribers, rather than by contracting with the Company for such services.
Stock Compensation.Pursuant to employee agreements entered into as part of the Plan, on the Effective Date, the Company granted a total of 167,926 shares of Ordinary Common Stock to the
64
Company's Company’s Chief Executive Officer, Chief Operating Officer and Chief Financial Officer (the "Senior Executives"“Senior Executives”). Pursuant to his employment agreement, the Chief Executive Officer purchased 83,963 fully-vestedfully vested shares of Ordinary Common Stock on the Effective Date. Under such agreements, the Company also granted an aggregate of 2,891,022 stock options to the Senior Executives on the Effective Date and made cash payments to the Senior Executives to approximate the tax liability associated with the Senior Executives’ compensation expenseincome resulting from the stock grants, the stock purchase and the cash payments, as defined below. Also onUnder the Effective Date, pursuant to the consummation of the Plan, a2003 Management Incentive Plan, became effective under which 1,376,4001,511,500 stock options were awarded to other members of the Company'sCompany’s management and other employees.employees during fiscal 2004. All of these awards were contingent upon the Company'sCompany’s emergence from its chapter 11 proceedings, relate to underlying common stock that was not authorized until the Effective Date and relate to services to be performed by the employees subsequent to the Effective Date.
BeginningUnder APB 25, the Reorganized Company recorded stock compensation expense during the fiscal year ended December 31, 2004 of $23.2 million, as reflected in the first quarteraccompanying consolidated statements of fiscal 2004, the Company will recognize the following chargesoperations, related to stock compensation:the following:
·with respect to the grants of restricted stock to the Senior Executive officers, the Company will recordrecognized a charge equal to the fair market value of the Ordinary Common Stock at the time of grant (the price at which the stock traded on the first day of trading) multiplied by the shares granted, plus the cash amount paid to the Senior Executives with regard to income taxes related to such grants.
·with respect to the shares purchased by the Chief Executive Officer, the Company will recognizerecognized a charge equal to the extentdifference between the fair market value of the Ordinary Common Stock at the time of purchase (the price at which the stock traded on the first day of trading) exceededand the price paid for such shares multiplied by the shares purchased, plus the amount paid to the Chief Executive Officer with regard to income taxes related to such purchase.
·with respect to the grant of options to the Senior Executives and other members of management and other employees, a charge will be recognizedwas computed equal to the extentdifference between the fair market value of the Ordinary Common Stock at the time of grant (the(for the options granted to the Senior Executives, the price at which the stock traded on the first day of trading) exceededand the exercise prices of the options, multiplied by the number of shares subject to the options (approximately 4.3(4.2 million shares in the aggregate). Generally, thisThis charge will beis being recognized ratably over the vesting periods of the options, which range from three to four years. However, compensationCompensation expense related to two of the three tranches of stock options granted to the Senior Executives, covering approximately 2.1 million shares, may becould have been recognized over a period of upranging from three to seven years, depending on the market price performance of the
Ordinary Common Stock.
· with respect to 13,595 shares of Ordinary Common Stock granted to non-management members of the board of directors who are not affiliated with Onex, pursuant to the Company’s 2004 Director Stock Compensation Plan, the Company recognized a charge equal to the fair market value of the Ordinary Common Stock at the time of grant.
The Company estimates that the total amount of such charges will be $58.4$56.5 million, before taxes. Based upon a seventhree year vesting schedule for the two Senior Executive tranches, as discussed above, the Company estimates that it will recognize approximately $18.7the remaining charges of $15.0 million, $10.6 million, $10.6 million $7.4$15.0 million, and $11.1$3.3 million of such charges in fiscal years 2004, 2005, 2006, and 2007, and 2008 and beyond, respectively. However, certain of these charges may be accelerated depending on the market price performance of the Ordinary Common Stock, as discussed above.
Interest Rate Risk.Changes in interest rates affect interest income earned on the Company'sCompany’s cash equivalents and restricted cash and investments, as well as interest expense on variable interest rate borrowings under the Credit Agreement. Based on the amount of cash equivalents and investments and the borrowing levels under the Credit Agreement as of the Effective Date,December 31, 2004, a hypothetical 10 percent increase in the interest rate, with all other variables held constant, would not materially affect the Company'sCompany’s future earnings and cash outflows.
Operating Restructuring Activities. In AprilDuring the fiscal year ended September 31, 2002, the three months ended December 31, 2002, and the fiscal years ended December 31, 2003 and 2004, the Company implemented a new businessincurred special charges of $15.7 million, $3.9 million, $9.5 million and performance initiative, named Performance Improvement Plan ("PIP"). PIP is$5.0 million, respectively. The majority of the special charges were incurred related the Company’s restructuring initiatives which were generally focused on further consolidating service centers, creating more efficiencies in corporate overhead, consolidating systems, improving call center technology and instituting other operational and business efficiencies while
65
maintaining or improving service to customers. The Company does not anticipate incurring any material additional charges related to such restructuring initiatives during fiscal 2005.
Historical—Liquidity and Capital Resources
Reorganized Company year ended December 31, 2004 (“Current Year”), compared to the Predecessor Company year ended December 31, 2003 (“Prior Year”)
Operating Activities.Net cash provided by operating activities decreased by approximately $14.9 million for the Current Year as compared to the Prior Year. The decrease in operating cash flows is primarily due to net payments for liabilities related to the chapter 11 proceedings that include professional fees and claim settlements and an increase in cash interest payments. Partially offsetting these reductions to operating cash flows is the Company’s increase in segment profit and a net increase in cash receipts related to unconsolidated subsidiaries.
During the Current Year, net bankruptcy-related liabilities decreased by approximately $66.7 million, which is primarily attributable to claim settlements and the payment of professional fees. Such amount is net of the receipt of $15.2 million from Onex related to shares purchased under its commitment to fund the Cash-Out Election. Cash interest payments made in the Current Year totaled $31.5 million as compared to $15.8 million for the Prior Year. During the impendency of the Company’s chapter 11 proceedings in the Prior Year, no cash interest payments were made on the Company’s debt other than debt outstanding under the prior Credit Agreement. Segment profit was $233.2 million and $192.1 million for the Current Year and Prior Year, respectively. During the Current Year, the Company received $7.3 million in net cash distributions from unconsolidated subsidiaries, as compared to net cash distributions of $3.9 million made to unconsolidated subsidiaries in the Prior Year.
Investing Activities.Approximately $30.7 million and $29.8 million were utilized during the Current Year and Prior Year, respectively, for capital expenditures. The majority of capital expenditures related to management information systems and related equipment.
During the Current Year, the Company received proceeds of $2.3 million from the sale of a hospital facility, net of transaction costs, related to the discontinued healthcare provider and franchising segments. Proceeds of $2.6 million from the sale of assets, net of transaction costs, were received during the Prior Year. In the Prior Year, proceeds of $2.4 million were received related to the discontinued healthcare provider and franchising segments, with $1.6 million from the sale of a hospital facility and $0.8 million as a final distribution associated with a discontinued provider joint venture.
Approximately $3.7 million was utilized during the Prior Year for acquisitions and investments in businesses, and relates to earn-out payments with respect to the acquisition in 1998 of Inroads, a managed behavioral healthcare company.
During the Current Year, the Company utilized net cash of $321.0 million for the purchase of “available-for-sale” investments. The Company’s investments consist of U.S. government agencies securities, corporate debt securities, and certificates of deposit with the investments ranging in maturity at purchase date from three to twenty-seven months.
Financing Activities.Upon the consummation of the Plan in January 2004, net proceeds of $147.9 million were received from the issuance of new equity, net of issuance costs of approximately $3.1 million; net proceeds of $92.8 million were received from the issuance of long-term debt, net of issuance costs of $7.4 million; and debt repayments of $192.4 million were made. In addition, in the Current Year, the Company repaid $15.0 million of indebtedness outstanding under the Term Loan Facility and paid $8.8 million on capital lease obligations.
The debt paid upon consummation of the Plan of $192.4 million on the Effective Date was composed of payments of $160.8 million of amounts outstanding under the Old Credit Agreement, $16.6 million of principal on the Old Senior Notes and $15.0 million related to a debt obligation to Aetna.
During the Prior Year, the Company made payments on capital lease obligations of $3.0 million and had other net financing sources of $0.1 million.
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Predecessor Company fiscal year ended December 31, 2003 PIP resulted in the recognition of special charges of (a) $7.5 million to terminate 463 employees that represented both operational and corporate personnel, and (b) $2.4 million to downsize and close excess facilities, and other associated activities. The employee termination costs of $7.5 million, which are provided under an ongoing benefit arrangement, include severance and related termination benefits, including payroll taxes. All terminations are expected to be completed by June 30, 2004 and termination costs associated with such employees are expected to be paid in full by January 31, 2005. Termination liabilities attributable to ongoing benefit arrangements have been accrued when probable in accordance with SFAS No. 112, "Employers' Accounting for Postemployment Benefits". The other special charges of $2.4 million represent costs to downsize and close seven leased facilities and other associated costs. Lease termination costs are accounted for under SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"). In accordance with SFAS 146, the liability for lease termination costs is accrued at the time that all employees have vacated the leased property. These closure and exit costs include payments required under lease contracts (less any applicable existing and/or estimated sublease income) after the properties were abandoned, write-offs of leasehold improvements related to the facilities and other related expenses. At December 31, 2003, outstanding liabilities of approximately $4.8 million related to PIP are included in the consolidated balance sheet set forth elsewhere herein in "Accrued liabilities".
Implementation of PIP resulted in additional incremental costs that were expensed as incurred. Special charges for the year ended December 31, 2003 includes $0.6 million for the cost of outside consultants. Also included in special charges for the year ended December 31, 2003 is income of $1.4 million, primarily related to the collection of a previously reserved note receivable. The note receivable was related to the sale of a subsidiary sold by the Company in fiscal 2001.
The Company intends to continue implementing PIP initiatives throughout fiscal 2004. Management estimates that the Company will incur approximately $5 million to $10 million of costs related to PIP activities in fiscal 2004. The Company expects to fund these costs with internally generated funds. However, there can be no assurance that the Company will be able to successfully fund or implement these initiatives or realize the anticipated savings.
Historical Liquidity and Capital Resources
Fiscal year ended December 31, 2003 ("Current Year"(“Calendar 2003”), compared to the Predecessor Company twelve months ended December 31, 2002 ("Prior Year"(“Calendar 2002”) (unaudited)
The following table calculates condensed cash flows from operating activities, investing activities and financing activities for the twelve months ended December 31, 2002 (unaudited), by adding previously reported amountsrepresent the amalgamation of the condensed cash flows for the nine months ended September 30, 2002 (unaudited), as reported in the quarterly report on Form 10-Q for the quarter ended September 30, 2003,2002, and the three months ended
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December 31, 2002 (audited), as reported in the transition report on Form 10-K for the three month period ended December 31, 2002.
| | | Predecessor Company |
| Predecessor Company |
| |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Nine Months Ended September 30, 2002 | Three Months Ended December 31, 2002 | Twelve Months Ended December 31, 2002 |
| Nine Months |
| Three Months |
| Twelve Months |
| |||||||||||||
| | | (unaudited) | | (unaudited) |
| (unaudited) |
|
|
| (unaudited) |
| |||||||||||||
| Net cash provided by operating activities | Net cash provided by operating activities | $ | 42,605 | $ | 28,001 | $ | 70,606 |
|
| $ 42,605 |
|
|
| $ 28,001 |
|
|
| $ 70,606 |
|
| ||||
Capital expenditures | (21,585 | ) | (8,421 | ) | (30,006 | ) | ||||||||||||||||||
| Acquisitions and investments in businesses, net of cash acquired | (63,731 | ) | — | (63,731 | ) | |||||||||||||||||||
Capital expenditures |
|
| (21,585 | ) |
|
| (8,421 | ) |
|
| (30,006 | ) |
| |||||||||||
Acquisitions and investments in businesses, net of cash acquired |
|
| (63,731 | ) |
|
| — |
|
|
| (63,731 | ) |
| |||||||||||
| Net cash used in investing activities | Net cash used in investing activities | (85,316 | ) | (8,421 | ) | (93,737 | ) |
|
| (85,316 | ) |
|
| (8,421 | ) |
|
| (93,737 | ) |
| ||||
Proceeds from issuance of debt, net of issuance costs | 105,000 | — | 105,000 | |||||||||||||||||||||
| Payments on debt and capital lease obligations | (64,853 | ) | (1,196 | ) | (66,049 | ) | ||||||||||||||||||
| Other financing activities | 1,159 | (1,909 | ) | (750 | ) | |||||||||||||||||||
Proceeds from issuance of debt, net of issuance costs |
|
| 105,000 |
|
|
| — |
|
|
| 105,000 |
|
| |||||||||||
Payments on debt and capital lease obligations |
|
| (64,853 | ) |
|
| (1,196 | ) |
|
| (66,049 | ) |
| |||||||||||
Other financing activities |
|
| 1,159 |
|
|
| (1,909 | ) |
|
| (750 | ) |
| |||||||||||
| Net cash provided by (used in) financing activities | Net cash provided by (used in) financing activities | 41,306 | (3,105 | ) | 38,201 |
|
| 41,306 |
|
|
| (3,105 | ) |
|
| 38,201 |
|
| ||||||
| Net increase (decrease) in cash and cash equivalents | Net increase (decrease) in cash and cash equivalents | $ | (1,405 | ) | $ | 16,475 | $ | 15,070 |
|
| $ (1,405 | ) |
|
| $ 16,475 |
|
|
| $ 15,070 |
|
| |||
| Supplemental cash flow information: | Supplemental cash flow information: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
| Income taxes paid | Income taxes paid | $ | 593 | $ | 71 | $ | 664 |
|
| $ 593 |
|
|
| $ 71 |
|
|
| $ 664 |
|
| ||||
| Interest paid | Interest paid | $ | 76,463 | $ | 16,175 | $ | 92,638 |
|
| $ 76,463 |
|
|
| $ 16,175 |
|
|
| $ 92,638 |
|
| ||||
Operating Activities.The Company'sCompany’s net cash provided by operating activities was $70.6 million and $178.3 million for the Prior YearCalendar 2002 and Current Year,Calendar 2003, respectively. The increase in cash provided by operating activities from the Prior YearCalendar 2002 to the Current YearCalendar 2003 is primarily due to a reduction in cash interest payments. Cash interest payments in the Prior YearCalendar 2002 totaled $92.6 million, as compared to $15.8 million in the Current Year,Calendar 2003, a reduction of approximately $76.8 million. The decrease in interest payments is mainly due to the fact that the Company did not pay interest on the Old Senior Notes and Old Subordinated Notes totaling $79.7 million during the period beginning on the date the Company filed for bankruptcy protection, March 11, 2003, through the end of the Current Year.Calendar 2003. Also contributing to the increase in operating cash flows from the Prior YearCalendar 2002 to the Current YearCalendar 2003 are higher cash flows attributable to increased segment profit year over year, lower net cash outflows with respect to discontinued operations and improvedother working capital.capital changes. The Company'sCompany’s segment profit for the Prior YearCalendar 2002 was $184.4 million, as compared to $192.1 million in the Current Year.Calendar 2003. Net cash outflows with respect to discontinued operations were $5.8 million and $0.1 million in the Prior YearCalendar 2002 and Current Year,Calendar 2003, respectively.
Investing Activities. The Company utilizedApproximately $30.0 million and $29.8 million in fundswere utilized during the Prior YearCalendar 2002 and Current Year,Calendar 2003, respectively, for capital expenditures. The majority of the Company'sCompany’s capital expenditures relate to management information systems and related equipment. These expenditures have remained relatively constant year over year and are reduced from prior years as the result of the Company'sCompany’s focus on cost reduction through the ABI and PIP restructuring initiatives.
The Company used cash of $63.7 million and $3.7 million in funds during the Prior YearCalendar 2002 and Current Year,Calendar 2003, respectively, for acquisitions and investments in businesses. Included in the Prior YearCalendar 2002 is a contingent purchase price payment of $60.0 million to Aetna related to the acquisition of HAI. Included in the Prior YearCalendar 2002 and Current YearCalendar 2003 are the final two earn-out payments of $3.7 million each with respect to the acquisition in 1998 of Inroads, a managed behavioral healthcare company, by Merit Behavioral Care Corporation ("Merit") (which was later acquired by the Company).company.
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Financing Activities.The Company borrowed approximately $105.0 million and $0.1 million during the Prior YearCalendar 2002 and Current Year,Calendar 2003, respectively. The borrowings in the Prior YearCalendar 2002 were primarily draws under the revolving credit facility for short-term capital needs.
In the Prior Year, theThe Company made repayments of approximately $66.0 million and $3.0 million on debt and capital lease obligations during the Prior YearCalendar 2002 and Current year,Calendar 2003, respectively. The Prior YearCalendar 2002 repayments included scheduled term loan repayments, unscheduled term loan repayments with cash received from asset sales during the year, scheduled capital lease payments and revolving facility repayments primarily withutilizing cash generated from operations. The Current YearCalendar 2003 repayments include payments on capital lease obligations.
Fiscal year ended September 30, 2002 ("fiscal 2002"), compared to the fiscal year ended September 30, 2001 ("fiscal 2001")
Operating Activities. The Company's net cash provided by operating activities was $85.7 million and $66.7 million for fiscal 2001 and 2002, respectively. The decrease in operating cash flows from fiscal 2001 to fiscal 2002 is primarily due to the fact that fiscal 2001 benefited from approximately $30.0 million of settlements of contract appeals with respect to TRICARE in fiscal 2001 and $25.0 million in distributions from Choice related to its settlements of contract appeals in fiscal 2001 with respect to TRICARE, partially offset by the payment of approximately $44.0 million related to discontinued operations obligations during fiscal 2001. Operating cash flows for fiscal 2002 were negatively impacted by $5.4 million of cash outflows related to discontinued operations.
Investing Activities. The Company utilized $34.7 million and $27.6 million in funds during fiscal 2001 and 2002, respectively, for capital expenditures. Capital expenditures decreased 20.5 percent, or $7.1 million, from fiscal 2001 to fiscal 2002. The majority of the Company's capital expenditures relate to management information systems and related equipment. These expenditures decreased from fiscal 2001 to fiscal 2002 primarily as the result of the Company's focus on cost reduction through the ABI restructuring initiative. Also contributing to this decrease were capital leases of $3.8 million entered into by the Company during fiscal 2002 that would have otherwise required a capital expenditure.
The Company used $87.7 million and $63.7 million in funds during fiscal 2001 and 2002, respectively, net of cash acquired, for acquisitions and investments in businesses. Included in each year is a contingent purchase price payment of $60.0 million to Aetna related to the acquisition of HAI and an earn-out payment of $3.7 million with respect to the acquisition in 1998 of Inroads, a managed behavioral healthcare company, by Merit Behavioral Care Corporation ("Merit") (which was later acquired by the Company). In fiscal 2001, the Company also paid the remaining contingent purchase price of $24.0 million to the shareholders of CMG Health, Inc. ("CMG"), a managed behavioral healthcare company acquired by Merit in September 1997.
The Company received proceeds from the sale of assets, net of transaction costs and cash conveyed, of $110.6 million and $3.5 million in fiscal 2001 and 2002, respectively. The sales proceeds were generated primarily from: (i) the sale in fiscal 2001 of Mentor, two of the three remaining Provider JVs of the discontinued healthcare provider segment, assets of the psychiatric practice management business and the Company's Canadian operations and (ii) the sale of the remaining Provider JV in fiscal 2002.
Financing Activities. The Company borrowed approximately $356.6 million and $105.0 million during fiscal 2001 and 2002, respectively. The borrowings in fiscal 2002 were primarily draws under the revolving credit facility for short-term capital needs. The borrowings in fiscal 2001 represent draws under the revolving facility for short-term capital needs and the issuance of $250.0 million of Old Senior Notes, less issuance costs.
The Company made repayments of approximately $458.2 million and $65.9 million on debt and capital lease obligations during fiscal 2001 and 2002, respectively. Fiscal 2001 repayments included
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scheduled term loan repayments, scheduled capital lease payments, term loan and revolving facility repayments made with the proceeds from the sale of Mentor and term loan repayments made with proceeds from issuance of the Old Senior Notes and the sale of the Company's Canadian operations. Fiscal 2002 repayments included scheduled term loan repayments, term loan repayments with cash received from asset sales during the year, scheduled capital lease payments and revolving facility repayments primarily with cash generated from operations.
In fiscal 2001, the Company issued $250.0 million of Old Senior Notes. The gross proceeds from the issuance and sale of the Old Senior Notes were used to repay indebtedness outstanding under the Company's term loans.
Outlook—Liquidity and Capital Resources
During fiscal 2004, the Company will have significant cash inflows and outflows related to the consummation of the Plan, as well as with the refinancing of the Old Credit Agreement. In particular, the Company will record in 2004: (i) the receipt of net cash from the Equity Offering and from the Onex Investment of approximately $146.9 million (total additional equity of $150.0 million less approximately $3.1 million of issuance costs); (ii) the receipt of net cash of approximately $92.6 million from term loans as part of the new senior secured credit agreement with Deutsche Bank (the "Credit Agreement") (total term loans of $100.0 million less approximately $7.4 million of loan acquisition costs); (iii) the payment of approximately $31.6 million for debt related to the Old Senior Notes and the Aetna Note; (iv) estimated payments of approximately $74.2 million for liabilities related to the chapter 11 proceedings, including professional fees and claim settlements; and (v) the payment of $160.8 million of debt outstanding under the OldThe Credit Agreement.
In addition, during fiscal 2004, the Company expects to pay its current obligations as noted in the commitments table reflected below, and fund its capital expenditures with cash from operations. The Company estimates that its capital expenditures will be approximately $35 million to $40 million in fiscal 2004. The Company does not anticipate that it will need to draw on amounts available under the Revolving Loan Facility for its operations, capital needs or debt service in fiscal 2004.
The following table sets forth the future financial commitments of the Company as of the Effective Date, after giving effect to the debt and other liabilities to be paid upon consummation of the plan (in thousands):
| | Payments due by period | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Contractual Obligations | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||
| Long-term debt (1) | $ | 389,261 | $ | 15,000 | $ | 96,415 | $ | 277,846 | $ | — | |||||
| Interest on long-term debt (2) | 144,134 | 30,411 | 61,487 | 52,236 | — | ||||||||||
| Capital lease obligations | 12,056 | 9,785 | 2,271 | — | — | ||||||||||
| Operating leases (3) | 71,556 | 16,706 | 20,110 | 14,523 | 20,217 | ||||||||||
| $ | 617,007 | $ | 71,902 | $ | 180,283 | $ | 344,605 | $ | 20,217 | ||||||
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Credit Agreement. The Company's new senior secured credit agreement (the "Credit Agreement") provides for a Term Loan Facility in an original aggregate principal amount of $100.0 million, a Revolving Loan Facility providing for loans of up to $50.0 million and a Credit-Linked Facility for the issuance of letters of credit for the account of the Company in an original aggregate principal amount of $80.0 million. As of December 31, 2004, the Company had $85.0 million outstanding under the Term Loan Facility. On the Effective Date, the Company incurred deferred financing fees of $7.4 million related to the Credit Agreement. Additionally, effective September 29, 2004, the Credit-Linked Facility was reduced from $80.0 million to $50.0 million. The Company accounted for the reduction of the Credit-Linked Facility in accordance with the Emerging Issues Task Force (“EITF”) 98-14 “Debtor’s Accounting for Changes in Line-of-Credit or Revolving-Debt Arrangements,”and accordingly, wrote off $0.8 million of fees associated with the Credit Agreement and will amortize the remaining unamortized fees relating to the Credit Agreement over the remaining term of the Credit Agreement. Borrowings under the Credit Agreement will mature on August 15, 2008 and certain quarterly principal payments on the Term Loan Facility are also required. As of the Effective Date, the Company had outstanding $100.0 million underrequired on the Term Loan Facility. The Company hadhas not drawn on the Revolving Loan Facility, resulting in unutilized commitments of $50.0 million. As of the Effective Date,December 31, 2004, the Company had issued letters of credit in the amount of $62.7$45.1 million, resulting in unutilized commitments under the Credit-Linked Facility of $17.3$4.9 million.
Restrictive Covenants in Debt Agreements. On the Effective Date, the Company entered into an indenture governing the terms of the Senior Notes (the "Indenture"), in addition to the Credit Agreement, as discussed above. In general, the Credit Agreement and the Indenture contain a number of covenants that limit management's discretion in the operations of the Company and its subsidiaries by restricting or limiting the Company's ability to, among other things:
These restrictions may adversely affect the Company's ability to finance its future operations or capital needs or engage in other business activities that may be in its interest.
The Credit Agreement also requires the Company to comply with specified financial ratios and tests (as defined), including minimum consolidated EBITDA, interest coverage ratios and maximum leverage ratios. Failure to comply with such covenants, without waiver, would result in an event of default under the Credit Agreement and, in the event the indebtedness under the Credit Agreement were accelerated, would give rise to defaults under substantially all of the Company's other debt agreements. The Credit Agreement is guaranteed by substantially all of the subsidiaries of the Company and is secured by substantially all of the assets of the Company and the subsidiary guarantors.
On October 25, 2004 (“the First Amendment Effective Date”), the Credit Agreement was amended (the “Amendment”) to reduce the annual interest rate on borrowings under the Term Loan Facility and on the Credit-Linked Facility, each by 1.25 percent. As a result of the Amendment, the annual interest rate on borrowings under the Term Loan Facility fluctuates at a rate equal to the sum of (i) a borrowing margin of 2.25 percent (subject to reduction of up to 0.50 percent based on the Company’s debt ratings), plus (ii) (A) in the case of U.S. dollar denominated loans, the higher of the prime rate or one-half of one percent in excess of the overnight “federal funds” rate, or (B) in the case of Eurodollar denominated loans, an interest rate which is a function of the Eurodollar rate for the selected interest period. The Company has the option to borrow in U.S. dollar denominated loans or Eurodollar denominated loans at its discretion. As of December 31, 2004, all loans under the dateTerm Loan Facility were Eurodollar denominated loans at a borrowing rate of filing4.74 percent. As a result of this Form 10-K,the Amendment, the commitment fee on the Credit-Linked Facility is equal to the sum of 2.25 percent (subject to reduction of up to 0.50 percent based on the Company’s debt ratings), plus an additional amount that is based on the administrative costs and term of the Credit-Linked Facility. As of December 31, 2004, the commitment fee on the Credit-Linked
Facility was 2.37 percent. In addition, under the Amendment, certain mandatory prepayment requirements were eliminated, and several covenants that restricted or limited the Company’s ability to repurchase or refinance Senior Notes, make investments, and incur debt pertaining to letters of credit were amended. The Company paid and expensed $0.3 million in fees associated with the Amendment. See Note 7—“Long-Term Debt and Capital Lease Obligations” to the consolidated financial statements set forth elsewhere herein for further discussion of the Credit Agreement.
Liquidity.During fiscal 2005, the Company believesexpects to pay its current obligations as noted in the commitments table reflected below, and fund its capital expenditures with cash from operations. The Company estimates that its capital expenditures will be approximately $30 million to $40 million in fiscal 2005. The Company does not anticipate that it iswill need to draw on amounts available under the Revolving Loan Facility for its operations, capital needs or debt service in compliancefiscal 2005. The following table sets forth the future financial commitments of the Company as of the December 31, 2004 (in thousands):
|
| Payments due by period |
| ||||||||||||
Contractual Obligations |
|
|
| Total |
| Less than |
| 1-3 |
| 3-5 |
| More than |
| ||
Long-term debt(1) |
| $ 374,487 |
| $ 71,415 |
| $ 50,000 |
| $ 253,072 |
|
| $ — |
|
| ||
Interest on long-term debt(2) |
| 108,272 |
| 32,035 |
| 52,300 |
| 23,937 |
|
| — |
|
| ||
Capital lease obligations |
| 4,991 |
| 3,743 |
| 734 |
| 514 |
|
| — |
|
| ||
Operating leases(3) |
| 77,121 |
| 15,481 |
| 22,868 |
| 19,380 |
|
| 19,392 |
|
| ||
Purchase commitments(4) |
| 8,000 |
| 8,000 |
| — |
| — |
|
| — |
|
| ||
|
| $572,871 |
| $130,674 |
| $ 125,902 |
| $ 296,903 |
|
| $ 19,392 |
|
| ||
(1) Pursuant to the Plan, on the Effective Date, and on the subsequent First Amendment Effective Date, the Company refinanced its long-term debt. See Note 7—“Long-term Debt and Capital Lease Obligations” to the consolidated financial statements set forth elsewhere herein for discussion of the new debt financing of the Company. Long-term debt amounts in the table above reflects future obligations under the Credit Agreement, the Senior Notes and the Aetna Note. See discussion of the Credit Agreement and amounts outstanding below.
(2) Interest payments have been estimated based upon current interest rates, and include commitment fees associated with certain borrowings under the Credit Agreement.
(3) Operating lease obligations include estimated future lease payments for both open and closed offices.
(4) Purchase commitments includes open purchase orders as of December 31, 2004 relating to ongoing capital expenditure and operational activities, as well as arrangements with outside consultants for ongoing services which will be performed throughout fiscal 2005.
The Company also currently expects to have adequate liquidity to satisfy its debt covenants.existing financial commitments over the period in which they will become due.
Off-Balance Sheet Arrangements. As of December 31, 2004, the Company has no off-balance sheet arrangements of a material significance.
Restrictive Covenants in Debt Agreements.On the Effective Date, the Reorganized Company entered into the Credit Agreement and an indenture governing the terms of the Senior Notes (the “Indenture”). As discussed above, the Credit Agreement was amended as of October 25, 2004. The Indenture and the Credit Agreement each contain covenants. These covenants limit management’s discretion in operating the Company’s business by restricting or limiting the Company’s ability, among other things, to:
· incur or guarantee additional indebtedness or issue preferred or redeemable stock;
· pay dividends and make other distributions;
· repurchase equity interests;
· prepay or amend subordinated debt;
· make certain other payments called “restricted payments”;
· enter into sale and leaseback transactions;
· create liens;
· sell and otherwise dispose of assets;
· acquire or merge or consolidate with another company; and
· enter into some types of transactions with affiliates.
These restrictions could adversely affect the Company’s ability to finance future operations or capital needs or engage in other business activities that may be in the Company’s interest.
The Credit Agreement also requires the Company to comply with specified financial ratios and tests. Failure to do so, unless waived by the lenders under the Credit Agreement pursuant to its terms, would result in an event of default under the Credit Agreement and, if indebtedness under the Credit Agreement is accelerated, would give rise to defaults under most or all of the Company’s other debt agreements. The Credit Agreement is guaranteed by most of the Company’s subsidiaries and is secured by most of the Company’s assets and the Company’s subsidiaries’ assets.
Net Operating Loss Carryforwards.The Company estimates that, as of December 2004, it had approximately $525 million of reportable NOLs. �� During fiscal 2000,These estimated NOLs expire in 2009 through 2020 and are subject to examination and adjustment by the IRS. In accordance with SOP 90-7, subsequent (post-bankruptcy) utilization by the Company reached an agreement (the "IRS Agreement") withof NOLs which existed at January 5, 2004 will be accounted for as reductions to goodwill or additional paid-in capital and therefore, will only benefit cash flows due to reduced tax payments and will not benefit the Internal Revenue Service ("IRS") related to its federal incomeCompany’s tax returns for the fiscal years ended September 30, 1992 and 1993. The IRS had originally proposed to disallow approximately $162.0 million of deductions related primarily to interest expense in fiscal 1992. Under the IRS Agreement, the Company paid approximately $1.0 million in taxes and interest to the IRS in
70
the second quarter of fiscal 2001 to resolve the assessment specifically relating to taxes due for these open years, although no concession was made by either party as to the Company's ability to utilize these deductions through net operating loss carryforwards. While any IRS assessment related to these deductions is not expected to result in a material cash paymentprovision for income taxes related to prior years, the Company's federal net operating loss carryforwards could be reduced if the IRS later successfully challenges these deductions. taxes.
The Company'sCompany’s history of recent operating losses (prior(prior to reorganization benefits) and financial restructuring activities continueand its lack of substantial history of profitable operations subsequent to its emergence from bankruptcy create uncertainty as to the Company'sCompany’s ability to realize its NOL carryforwardsNOLs and other deferred tax assets. In addition,Accordingly, the Company'sCompany had a total valuation allowance covering all of the Company’s net deferred tax assets at December 31, 2003 and substantially all of its net deferred tax assets at December 31, 2004. As of December 31, 2004, net deferred tax assets, after reduction for valuation allowance, represent the Company’s estimate of those net tax assets which are more likely than not to be realizable.
The Company’s utilization of NOL carryforwards will beNOLs became subject to limitation under Internal Revenue Code Section 382 upon emergence from bankruptcy, which may affectaffects the timing of the use of orNOLs. At this time, the ultimate realization of, NOL carryforwards. Accordingly,Company does not believe these limitations will materially limit the Company’s ability to use any NOLs before they expire. Furthermore, as of December 31, 2003, and 2002, the Company maintainshad tax contingencies which created an uncertainty as to the Company’s ability to realize its NOLs. In addition to recording a totalfull valuation allowance coveringagainst all NOLs, the Company recorded this contingent liability of $23.2 million for taxes payable. During fiscal 2004, the Company received favorable guidance from the Internal Revenue Service which resolved this contingency, resulting in the reversal of the Company's net deferred tax assets. See Note 10—"Income Taxes"related liability and a reduction to the audited consolidated financial statements set forth elsewhere herein.goodwill (in accordance with SOP 90-7).
Discontinued Operations.APB 30 requires that the results of continuing operations be reported separately from those of discontinued operations for all periods presented and that any gain or loss from disposal of a segment of a business be reported in conjunction with the related results of discontinued operations. The operating results of the discontinued segments have been disclosed, net of income tax, in a
separate income statement caption "Discontinued“Discontinued operations—Income (loss) from discontinued operations".operations.” The losses the Company incurred to exit the discontinued operations are reflected, net of income tax, in the caption "Discontinued“Discontinued operations—Loss on disposal of discontinued operations".operations.” The assets, liabilities and cash flows related to discontinued operations have not been segregated from continuing operations.
As of December 31, 2003,2004, the Company has disposed of its human services segment in its entirety, and has taken the majority of the actions necessary to complete the disposal of, or shutting down of, its healthcare provider and franchising segments, and its specialty managed healthcare segment, and its human services segment but still has certain estimated liabilities totalling approximately $3.6 million for various obligations as follows:obligations.
Healthcare Provider and Healthcare Franchising:
Specialty Managed Healthcare:
As part of its financial restructuring plan and chapter 11 proceedings, the Company rejected certain leases for closed offices. As leases for closed offices were rejected, the net liability arising from such rejections was compared to the net liability already recorded by the Company, and the difference was recorded as a component of "Reorganization expense"“Reorganization expense” in the Company'sCompany’s statement of operations, in accordance with SOP 90-7.
The remaining assets and liabilities of these discontinued segments are described more fully in Note 5—"“Discontinued Operations"Operations” to the Company's auditedCompany’s consolidated financial statements set forth elsewhere herein. There can be no assurance that the reserves established will prove to be
71
adequate. In the event that any future losses or expenses exceed the amount of reserves on the balance sheet, the Company will be required to record additional losses on disposal of discontinued operations or losses from discontinued operations in the consolidated statement of operations.
Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, Consolidation“Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51 ("51” (“FIN 46"46”). FIN 46 requires consolidation of entities in which an enterprise absorbs a majority of the entity'sentity’s expected losses, receives a majority of the entity'sentity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently,Historically, entities arewere generally consolidated by an enterprise when it hashad a controlling financial interest through ownership of a majority voting interest in the entity. The Reorganized Company early adopted the provisions of FIN 46 effective December 31, 2003. Early adoption of new accounting pronouncements is required by companies implementing the fresh start reporting provisions of SOP 90-7. Based on the guidance of FIN 46, the Reorganized Company has determined that it is the primary beneficiary of Premier Behavioral Systems of Tennessee, LLC (“Premier”), a variable interest entity for which the Reorganized Company maintains a 50 percent voting interest. ConcurrentConsistent with the provisions of FIN 46, the Reorganized Company has consolidated the balance sheet of Premier into the Reorganized Company'sCompany’s balance sheet as of December 31, 2003.2003 and 2004. Through December 31, 2003, the Predecessor Company accounted for Premier under the equity method, whereby the Predecessor Company included its portion of Premier'sPremier’s earnings or loss in its consolidated statement of operations under the caption "Equity“Equity in (earnings) loss of unconsolidated subsidiaries".subsidiaries.” The creditors (or other beneficial interest holders) of Premier have no recourse to the general credit of the Company, as the primary beneficiary of Premier. The consolidation of Premier at December 31, 2003 increased total assets and total liabilities each by $43.2 million. The fair value of the accounts consolidated was equivalent to their book value at December 31, 2003. In 2004, the Reorganized Company will consolidateconsolidated the results of operations of Premier in its consolidated statement of operations. See further discussionoperations, which represented $253.0 million of revenue for the fiscal year ended December 31, 2004.
The Company currently measures compensation cost for stock-based compensation under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and discloses pro forma stock-based compensation under the requirements of SFAS No. 123, “Accounting for
Stock-Based Compensation” (“SFAS 123”) and SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure” (“SFAS 148”). Currently, the Company uses the Black-Scholes-Merton formula to estimate the value of stock options granted to employees and expects to continue to use this acceptable option valuation model upon the required July 1, 2005 adoption of Statement 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”). Since SFAS 123R must be applied not only to new awards but also to previously granted awards that are not fully vested on the effective date, and because the Company adopted SFAS 123, using the prospective transition method (which applied only to awards granted, modified or settled after the adoption date), compensation cost for some previously granted awards that were not recognized under SFAS 123 will be recognized under SFAS 123R. However, had SFAS 123R been adopted in prior periods, the impact of FIN 46, including disclosures required by FIN 46, in Note 3—"Summary of Significant Accounting Policies" tothat standard would have approximated the audited consolidated financial statements set forth elsewhere herein.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("EITF No. 94-3"). SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. The January 1, 2003 implementationimpact of SFAS 146 has not had123 as described in the disclosure of pro forma net income and earnings per share below entitled “Stock-Based Compensation.” SFAS 123R also requires the benefits of tax credits in excess of recognized compensation cost to be reported as a material impact uponfinancing cash flow, rather than as an operating cash flow as permitted under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the Company's financial position or resultsCompany cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operations.operating cash flows recognized in prior periods for such excess tax deductions were immaterial.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Changes in interest rates affect interest income earned on the Company'sCompany’s cash equivalents and restricted cash and investments, as well as interest expense on variable interest rate borrowings under the Credit Agreement. Based on the borrowing levels under the Credit Agreement as of the Effective Date, a hypothetical 10 percent increase in the interest rate, with all other variables held constant, would not materially affect the Company'sCompany’s future earnings and cash outflows. See "Business—“Business—Cautionary Statements—Restrictive Covenants in the Company’s Debt Agreements", "Management'sInstruments,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Outlook—Results of Operations", "—Operations,” “—Outlook—Liquidity and Capital Resources"Resources” and Note 7—"“Long-Term Debt and Capital Lease Obligations"Obligations” to the Company's auditedCompany’s consolidated financial statements set forth elsewhere herein for discussion of the Company'sCompany’s Credit Agreement and the interest rates thereunder.there under.
Item 8. Financial Statements and Supplementary Data
Information with respect to this item is contained in the Company's auditedCompany’s consolidated financial statements set forth elsewhere herein and financial statement schedule indicated in the Index on Page F-1 of this Report on Form 10-K, and is incorporated herein by reference.included herein.
72
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
On May 22, 2002, the Company'sCompany’s Audit Committee approved the dismissal of its independent auditors, Arthur Andersen LLP ("(“Arthur Andersen"Andersen”), and engaged Ernst & Young LLP to serve as its new independent auditors for fiscal year 2002. The Company filed a current report on Form 8-K with the SEC on May 24, 2002, the same date that the change in auditors became effective.
Arthur Andersen's report on the Predecessor Company's consolidated financial statements for the fiscal year ended September 30, 2001, as included elsewhere herein, did not contain an adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles.
During the fiscal year ended September 30, 2001 and the interim period between September 30, 2001 and May 24, 2002, there were no disagreements between the Company and Arthur Andersen on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure which, if not resolved to Arthur Andersen'sAndersen’s satisfaction, would have caused them to make reference to the subject matter of the disagreement in connection with their report for such year; and there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K.
Item 9A. Controls and Procedures
The Company'sCompany’s management evaluated, with the participation of the Company'sCompany’s principal executive and principal financial officers, the effectiveness of the Company'sCompany’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"“Exchange Act”)), as of December 31, 2003.2004. Based on their evaluation, the Company'sCompany’s principal executive and principal financial officers concluded that the Company'sCompany’s disclosure controls and procedures were effective as of December 31, 2003.
There has been no change in the Company'sCompany’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company'sCompany’s fiscal quarter ended December 31, 2003,2004, that has materially affected, or is reasonably likely to materially affect, the Company'sCompany’s internal control over financial reporting.
73
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTINGPART III
OnThe Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Effective Date, MagellanSecurities Exchange Act of 1934, as amended). Under the supervision and 88with the participation of its subsidiaries consummatedmanagement, including our Chief Executive Officer and Chief Financial Officer, the Plan under chapter 11Company assessed the effectiveness of title 11internal control over financial reporting as of December 31, 2004. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Bankruptcy Code,Treadway Commission (“COSO”), an Internal Control-Integrated Framework. The Company’s management has concluded that, as of December 31, 2004, internal control over financial reporting is effective based on these criteria. Our independent registered public accounting firm, Ernst & Young, LLP, has issued an audit report on our assessment of internal control over financial reporting, which had been confirmedfollows.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors
Magellan Health Services, Inc.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Magellan Health Services, Inc. (Magellan) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by orderthe Committee of Sponsoring Organizations of the Bankruptcy Court on October 8, 2003,Treadway Commission (the COSO criteria). Magellan’s management is responsible for maintaining effective internal control over financial reporting and accordingly the Plan became fully effective and the companies emerged from the protection of their chapter 11 proceedings. Magellan and these subsidiaries had filed voluntary petitions for relief under the Bankruptcy Code in the Bankruptcy Court on March 11, 2003.
Item 10. Directors and Executive Officersits assessment of the Registrant
Directors
Under the Company's certificateeffectiveness of incorporation, as amendedinternal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and restatedan opinion on the Effective Date, the number of directors is currently fixed at nine. The directorseffectiveness of the Company were appointedcompany’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the Planstandards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the Confirmation Orderpreparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Magellan maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the Effective Date (except for Mr. McBrideCOSO criteria. Also, in our opinion, Magellan maintained, in all material respects, effective internal control over financial reporting as noted below), and are divided into three classes: (i) Class 1, consisting of four directors, (ii) Class 2, consisting of two directors, and (iii) Class 3, consisting of three directors.December 31, 2004, based on the COSO criteria.
The Company's bylaws require a majority of directors to be independentWe also have audited, in accordance with the Nasdaq Stock Market's ("NASDAQ") listing standards. The Company's Board of Directors has determined that except for those directors who are members of managementstandards of the Public Company or are affiliated with Onex, all directors are independent as that termAccounting Oversight Board (United States), the 2004 consolidated financial statements of Magellan and our report dated February 23, 2005 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP | ||
Baltimore, Maryland | ||
February 23, 2005 | ||
70
Item 9B. Other Information
None.
The information required by Items 10 through 14 is definedincorporated by the NASDAQ listing standards.
Class 1 Directors
Steven J. Shulman, 52, is the Chairman of the Board and Chief Executive Officer of the Company. He became Chief Executive Officer of the Company in December 2002 and Chairman of the Board on the Effective Date. Prior to joining the Company, Mr. Shulman founded Internet HealthCare Group (IHCG), an early stage healthcare technology venture fund, and served as its Chairman and Chief Executive Officer from 2000 to 2002. Prior to IHCG, he was employed by Prudential Healthcare, Inc. as its Chairman, President and Chief Executive Officer from 1997 to 1999. Prior thereto, Mr. Shulman co-founded Value Health, Inc., and served as President of its Pharmacy and Disease Management Group and Director from 1987 to 1996. From 1983 to 1986, Mr. Shulman was employed by CIGNA Healthplans as President of its East Central Division. Prior thereto, he served as Director of Medical Economics for Kaiser Permanente from 1974 to 1982. Mr. Shulman is a member of the board of directors of Lumenos, Digital Insurance, RealMed, BenefitPoint Inc. and NDCHealth.
Mark L. Hilson, 46, is a Managing Director for Onex Corporation. Prior to joining Onex in 1988, he was an Associate in the Mergers and Acquisitions Group at Merrill Lynch and a Brand Manager at Procter & Gamble. Mr. Hilson is a director of ClientLogic, ONCAP and Vincor International. Mr. Hilson also serves as a governor of the Shaw Festival.
Robert Haft, 51, is the Principal Manager of Morgan Noble LLC, a healthcare investment firm. He has also been Chairman of National Pharmacies Group LLC since December 2001. Previously he was President/CEO of national drug chain Phar-Mor from 1994 to 1997. Prior thereto, he was President/CEO of Dart Group from 1983 to 1993. In addition, Mr. Haft founded four companies including Crown Books, Trak Auto, Vitamin Superstore, and Morgan Noble, LLC.
William J. McBride, 59, was appointedreference to the Board on January 21, 2004. Mr. McBride is currently retired. PriorRegistrant’s definitive proxy statement to his retirement in 1995, Mr. McBride had been a director of Value Health, Inc. a NYSE specialty managed care company which included Value Behavioral Health, one of the largest behavioral health managed care companies at the time. From 1987 to 1995, Mr. McBride served as president and chief operating officer of Value Health, Inc., overseeing all operational activities of the company and its subsidiaries. Prior to his tenure at Value Health, Mr. McBride spent 15 years in a variety of positions with INA Corporation and its successor, CIGNA Corporation, including serving as
74
president and chief executive officer of CIGNA Healthplan, Inc., vice president and controller of INA's Life and Healthcare Group and vice president of finance for CIGNA's Affiliated Business Group. Mr. McBride currently serves on the board of directors of AMERIGROUP Corporation, a managed health care company focused on providing services to Medicaid recipients, VistaCare Inc., and IHCG.
Class 2 Directors
Robert M. LeBlanc, 37, the Board's Lead Director, is a Managing Director for Onex Corporation. Prior to joining Onex in 1999, Mr. LeBlanc was with Berkshire Hathaway for seven years. He also worked for five years at GE Capital in a variety of positions, including corporate finance and corporate strategy. Mr. LeBlanc is a director of InsLogic and First Berkshire Hathaway Life. He held several other directorships during his tenure at Berkshire Hathaway.
RenéLerer, M.D., 48, became President and Chief Operating Officer of the Company in October 2003. He previously served as Chief Operating Officer of the Company since January 2003. Prior to joining the Company, Dr. Lerer co-founded IHCG and served as its President from 1999 to 2002. Prior to IHCG, Dr. Lerer was employed by Prudential Healthcare, Inc. as its Chief Operating Officer from 1997 to 1999. Prior thereto, Dr. Lerer was employed by Value Health, Inc., and served as Senior Vice President—Operations of its Pharmacy and Disease Management Group from 1995 to 1997. Prior thereto, Dr. Lerer was employed by Value Health Sciences as Senior Vice President of Corporate Development from 1992 to 1994. Dr. Lerer is a member of the board of directors of IHCG, Digital Insurance, Lumenos and RealMed.
Class 3 Directors
Michael P. Ressner, 55, currently holds the position of Adjunct Professor of Finance & Accounting at North Carolina State University and is an advisor at Southeast Interactive Technology Fund. He previously spent 22 years in a variety of positions at Nortel Networks, holding leadership positions within operations and finance. Mr. Ressner currently serves on the boards of Entrust, Inc., Proxim Corporation, Riverstone Networks and Arsenal Digital Solutions.
Michael Diament, 35, is a Portfolio Manager and Director of Bankruptcies and Restructurings for Renegade Swish, LLC which, through various contractual agreements, provides personnel services to Amalgamated Gadget, LP, the investment manager for R2 Investments, LDC. From January 2001 to December 2002, Mr. Diament served as Portfolio Manager for Acme Widget, LP. From February 2000 until January 2001, Mr. Diament was a Senior Research Analyst for Sandell Asset Management, an investment management firm and served as Vice President of Havens Advisors, an investment management firm, from July 1998 to January 2000.
Saul E. Burian, 40, is a Director in the New York office of Houlihan, Lokey, Howard & Zukin ("Houlihan") and splits his practice between Restructuring Advisory and Distressed M&A. Mr. Burian has served as a Director of Houlihan since March 2001 and he presently manages its Distressed M&A Northeast Region. From November 1988 through February 2001, Mr. Burian was a Partner of the New York law firm, Kramer Levin Naftalis & Frankel LLP and specialized in the area of creditors' rights and bankruptcy. He has been a member of the committee on bankruptcy and corporate reorganization of the Association of the Bar of the City of New York and has been approved by the chief bankruptcy judge of the Southern District of New York to serve as a court-certified bankruptcy mediator. Mr. Burian is a member of the City of New Rochelle Waterfront Commission, and a director of the New York Chapter of the Turnaround Management Association and of S/A/R Academy of Riverdale.
Director Election and Terms of Office
Messrs. Shulman, Ressner, Diament and Burian will serve for a three-year term to extend until the 2007 annual meeting of stockholders. Messrs. Lerer and Hilson will serve for a two-year term to extend until the 2006 annual meeting of stockholders. Messrs. Haft, McBride and LeBlanc will serve for a
75
one-year term to extend to the 2005 annual meeting of stockholders. In each case, the term of their successors will extend for three years and until the election and qualification of their respective successors, or in any case their earlier death, incapacity, resignation or removal.
Upon the expiration of their initial terms, the seats held by the Class 1 directors will be filled by election by vote of the holders of the Multi-Vote Common Stock only, voting as a separate class; the seats of the Class 3 directors will be filled by election by vote of the holders of the Ordinary Common Stock only, voting as a separate class; and the seats of the Class 2 directors and their successors will be filled by election by vote of the holders of the Multi-Vote Common Stock and the Ordinary Common Stock, voting together as though one class, in which vote the Multi-Vote Common Stock will be entitled to cast 50 percent of the entire vote. In addition, directors assigned to these classes can be removed, with or without cause, only by the vote of the holders of the class or classes of common stock entitled to participate in their election, except that the Class 3 directors may be so removed before the third anniversary of the Effective Date only for cause. Moreover, the filing of vacancies in these classes by the Board before the end of a director's term requires approval of the other directors of the class, subject to certain qualifications and provisions of Magellan's certificate of incorporation and bylaws. The holders of the Multi-Vote Common Stock and the Ordinary Common Stock are also entitled to a separate class vote on any amendment of these voting rights or any other amendment of Magellan's certificate of incorporation that would adversely affect their special rights or privileges. When the Minimum Hold Condition is no longer satisfied, the special voting powers of the Multi-Vote Common Stock and Ordinary Common Stock will terminate at such time and all the directors will then be elected by all the common stockholders voting together on the basis of one vote per share.
Arrangements Regarding the Nomination of Directors
The individuals selected as directors of the Company as of the Effective Date were selected in accordance with provisions of the Plan by agreement of parties in interest in the chapter 11 proceedings and as approved by the Bankruptcy Courtfiled pursuant to the Confirmation Order. To the best of the Company's knowledge, there is no agreement or arrangement whereby any such director will be re-nominated or any other individual will be nominated or selected to serve as a director of Magellan. However, certain provisions of the Company's certificate of incorporation and bylaws govern the nomination and election of Magellan's directors. In accordance with the Company's bylaws, Magellan's Board of Directors is required to nominate for election at each annual meeting of stockholders candidates who, if elected, will cause a majority of the members of the Board of Directors of the Company to be independent directors, as determined in accordance with the listing standards of NASDAQ (and to meet certain other requirements regarding independence for membership on the audit and executive compensation committee of the Board, as also as specified in the bylaws). Nominations may also be made by stockholders in accordance with certain procedures established by the bylaws and nominations not made in compliance with the requirements established thereby may not be given effect. Such provisions regarding stockholder nominations do not, however, limit nominations made by a holder of Multi-Vote Common Stock. Class 1 Directors may only be elected by the holders of Multi-Vote Common Stock and Class 3 Directors may only be elected by holders of Ordinary Common Stock. For further information regarding the selection of directors, see Item 1. "Business—Emergence from Chapter 11" and "—Cautionary Factors—Significant Stockholder."
Nominations of Candidates for Election as Directors
The Company does not currently have a Nominating Committee. As previously disclosed above, the current directors' terms extend until the 2005 Annual Shareholders' Meeting at the earliest. In addition to the nomination by the Board of candidates for election to the Board, candidates may be nominated by any shareholder of the Corporation entitled to notice of, and to vote at, any meeting called for the election of directors. Shareholder nominations are required to be in writing and to be sent to the Secretary of the Company.
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Audit Committee
The Company has appointed a separately-designated standing audit committee established in accordance with section 3(a)(58)(A) of the Exchange Act. The members of the audit committee are Michael Ressner (Committee Chairman), Robert Haft and William McBride. The Company's Board of Directors has determined that each of Messrs. Ressner, Haft and McBride is independent as that term is defined by the NASDAQ listing standards. The Company's Board of Directors has identified Michael P. Ressner as its Audit Committee Financial Expert, as defined by Item 401 of Regulation S-K. Mr. Ressner is an independent Board member, as defined by Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act. The Audit Committee has adopted a written charter pursuant to which the Audit Committee, among other things, provides assistance to the Company's Board of Directors in its oversight of the Company's accounting and financial reporting processes, and is responsible for the appointment, compensation, retention and oversight of the Company's independent auditors.
Executive Officers of the Registrant
Information for Steven J. Shulman and René Lerer, M.D. is presented above under "Directors".
Mark S. Demilio became Chief Financial Officer of the Company in October 2001. Mr. Demilio served as Executive Vice President, General Counsel of the Company from July 1999 and as Executive Vice President, Finance and Legal from December 2000. Prior thereto, Mr. Demilio was with Youth Services International, Inc., a publicly traded company that managed residential treatment centers for behaviorally troubled youth and behavioral treatment programs in juvenile correction facilities, serving as Executive Vice President, Business Development and General Counsel from March 1997 and Chief Financial Officer from June 1998. Prior thereto, Mr. Demilio was a partner with Miles & Stockbridge, a Baltimore, Maryland-based law firm.
Megan M. Arthur became Executive Vice President, General Counsel in October 2001. Ms. Arthur served as General Counsel, Magellan Behavioral Health, Inc. from July 2000 to September 2001 and as Deputy General Counsel, Magellan Behavioral Health from February 1998 to June 2000. Prior thereto, Ms. Arthur was an attorney with Magellan Behavioral Health and one of its predecessor organizations from November 1994 to January 1998.
Anthony M. Kotin became Executive Vice President, Chief Marketing and Strategy Officer in October 2003. Mr. Kotin previously served in various positions with Mercer Human Resource Consulting, most recently as the National Leader for Knowledge and Service Development for the health and group practice from April 2001 to September 2003, and also as Principle from August 1999 to June 2000. Mr. Kotin served as Senior Vice President of Operations at IHCG from July 2000 to March 2001. Prior thereto, he served as National Chief Medical Officer for Prudential Healthcare, Inc. from July 1997 to July 1999. Before joining Prudential, Mr. Kotin served as the National Practice Leader for Clinical Operations and Analysis in the integrated healthcare consulting practice of Towers Perrin from October 1994 to June 1997.
Jeff D. Emerson became Executive Vice President, Chief Information Officer in March 2003. Prior to joining the Company, Mr. Emerson served as President of CIGNA HealthCare's Mid-Atlantic Region from 2001 to 2002. Before joining CIGNA, he was Chief Operating Officer of Digital
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Insurance, a start-up Internet broker of health and related insurance plans that he helped found from 1999 to 2001. Prior thereto, Mr. Emerson served as President and Chief Executive Officer of NYLCare Health Plans of the Mid-Atlantic from 1987-1999. Prior thereto, he served as Chief Executive Officer for the start-up operations of SkyTel, Inc. from 1986 to 1987. Mr. Emerson has also served previously in a variety of leadership positions with Informatics General Corporation, Stentran Systems, Inc. and Boeing Computer Services.
Code of Ethics
In March 2004, the Company adopted a code of ethics that applies to its chief executive officer, chief financial officer and controller. The Company has posted the text of such code of ethics on its website athttp://www.magellanhealth.com. The Company intends to post on its website any amendments to, or waivers from, its Code of Ethics applicable to its senior officers.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's directors, certain officers and persons who own more than 10.0 percent of the common stock of the Company to file reports of ownership and changes in ownership with the SEC and furnish copies of such reports to the Company. Based solely on a review of the copies of such forms furnished to the Company during fiscal 2003, or written representations that no other reports were required, the Company believes that all persons who are required to comply with the Section 16(a) filing requirements during fiscal 2003 with respect to the Company's common stock have complied with such filing requirements on a timely basis, other than as described below. Magellan's reorganization proceeding occasioned uncertainties concerning the status of certain executives as officers required to make such reports, resulting in their making Section 16(a) filings late when such uncertainties were resolved in connection with the consummation of the Plan, as follows:
In addition, commencing with the Effective Date and until the date of this report, certain Section 16(a) reports have been filed late. These reports were required with respect to the consummation of the Plan and related stock ownership transactions and clarification of the impact of the filing requirements on these transactions and the need to obtain EDGAR filings codes by persons not previously required to have such codes in order to file such reports resulted in the following late filings:
Item 11. Executive Compensation
Executive Compensation
The following table sets forth, for the fiscal year endedafter December 31, 2003, the two preceding fiscal years ended September 30, 2002 and 2001, respectively, and the three-month transition period ended December 31, 2002, the compensation paid by the Company to the Company's Chief Executive2004.
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Officer and the Company's four next most highly compensated executive officers serving at December 31, 2003 (collectively, the "Named Executive Officers").
Summary Compensation Table
Option/SAR Grants in Last Fiscal Year
There were no options to purchase pre-petition common stock granted by the Company in fiscal 2003. All outstanding options to purchase pre-petition common stock were canceled as of the Effective
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Date. In January and February of 2004, options to purchase shares of the Ordinary Common Stock of the Company were granted as follows:
Individual Grants
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Aggregated Option/SAR Exercises in Fiscal 2003, and Option/SAR Values at December 31, 2003
No Named Executive Officer exercised options to purchase shares of pre-petition common stock of the Company during the fiscal year ended December 31, 2003. The pre-petition common stock and all outstanding options to purchase shares of stock were canceled as of the Effective Date. The following table sets forth the number and value of outstanding options to purchase pre-petition common stock as of December 31, 2003. No options held by any Named Executive Officer were "In-the-Money Options" as of December 31, 2003.
Aggregated Option/SAR Exercises since the Effective Date, and Option/SAR Values as of March 4, 2004
No Named Executive Officer has exercised options to purchase shares of the Ordinary Common Stock of the Company since the Effective Date. The following table sets forth the number and value of outstanding options to purchase shares of the Ordinary Common Stock at March 4, 2004.
| | | | Number of Securities Underlying Unexercised Options/SARs at March 4, 2004 | Value of Unexercised In-the-Money Options/SARs at March 4, 2004 ($)(1) | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Name | Shares Acquired on Exercise (#) | Value Realized ($) | ||||||||||
| Exercisable | Unexercisable | Exercisable | Unexercisable | |||||||||
| Steven J. Shulman | — | — | — | 1,445,511 | — | 23,307,833 | ||||||
| René Lerer, M.D. | — | — | — | 867,307 | — | 13,984,706 | ||||||
| Mark S. Demilio | — | — | — | 578,204 | — | 9,323,127 | ||||||
| Henry T. Harbin, M.D. | — | — | — | — | — | — | ||||||
| Megan M. Arthur | — | — | — | 40,000 | — | 451,970 | ||||||
Compensation of Directors
Pursuant to a January 5, 2004 Board resolution, in return for their services on behalf of the Company as directors, the individuals who serve as members of the Board of Directors after the Effective Date will receive the compensation listed below; provided however, that no compensation shall be given to those members who are employees of either the Company or Onex (or its affiliates):
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In addition, on January 5, 2004 the Board approved, as further compensation for the services of those directors commencing service on the Board in 2004 (as of January 21, 2004) who are not members of management and not associated with Onex, a grant of 2,152 shares of Ordinary Common Stock plus the number of additional shares of Ordinary Common Stock equivalent to $13,333 divided by 85 percent of the average closing price of the shares in Nasdaq trading for the 20 consecutive trading days following the Effective Date, which was 567 shares, for a total grant of 2,719 shares. Such shares may not be sold by a director until January 5, 2006 or the earlier termination of a director's service and in compliance with certain regulatory requirements. This action did not provide for (nor does it prohibit) a grant of stock compensation for service as a director in any future year (i.e., after the 2005 annual meeting of shareholders).
Employment Agreements
Steven J. Shulman and René Lerer, M.D.The Company entered into a consulting agreement with HPI, a newly formed entity whose principals are Steven J. Shulman and René Lerer, M.D., on December 4, 2002, as described in Item 13 below. This consulting agreement remained in effect through fiscal 2003 and until the Effective Date. Upon the Effective Date, the following employment agreements were entered into by Mr. Shulman and Dr. Lerer as described below.
Steven J. Shulman.Under the Employment Agreement between Mr. Shulman and Magellan Health Services, Inc., effective January 5, 2004, Mr. Shulman will serve as Chairman and Chief Executive Officer and member of the Board of Directors of the Company. The Agreement is for a three-year term beginning on the Effective Date, with automatic renewals for additional one-year terms, unless sooner terminated as provided in the Agreement. The Company will pay Mr. Shulman a base salary of $1,000,000 per year, with annual review for increase by the Board or a duly authorized committee thereof. Mr. Shulman is entitled to an annual target bonus opportunity of 100 percent of base salary, subject to achievement of performance targets fixed by the Board or a duly authorized committee thereof. Under the Agreement, the Company granted Mr. Shulman 83,963 fully-vested shares of Ordinary Common Stock on the Effective Date. The Agreement also provided for Mr. Shulman to purchase on the Effective Date for $1,000,000 in cash 83,963 fully-vested shares of Ordinary Common Stock for $11.91 per share in cash, the average price paid by Onex for all of the shares of common stock it acquired in connection with the Plan. Mr. Shulman will receive a cash payment equal to a portion of the income taxes that he may incur as a result of such purchase. Additionally, under the Agreement, the Company granted to Mr. Shulman options to purchase a total of 1,445,511 shares of Ordinary Common Stock with a ten-year term as noted in the "Individual Grants" table above. The Agreement provides for benefits commensurate with Mr. Shulman's position. The Agreement also provides for severance payments upon termination by the Company as follows:
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continued participation by himself and his eligible dependents in various benefits programs for a two-year period.
René Lerer, M.D.Under the Employment Agreement between Dr. Lerer and Magellan Health Services, Inc., effective January 5, 2004, Dr. Lerer will serve as President and Chief Operating Officer and member of the Board of Directors of the Company. The Agreement is for a three-year term beginning on the Effective Date, with automatic renewals for additional one-year terms, unless sooner terminated as provided in the Agreement. The Company will pay Dr. Lerer a base salary of $600,000 per year, with annual review for increase by the Chief Executive Officer, subject to approval of the Board or a duly authorized committee thereof. Dr. Lerer is entitled to an annual target bonus opportunity of 75 percent of base salary, subject to achievement of performance targets fixed by the Board or a duly authorized committee thereof. Under the Agreement, the Company granted Dr. Lerer 50,378 fully-vested shares of Ordinary Common Stock on the Effective Date. Additionally, under the Agreement, the Company granted to Dr. Lerer options to purchase a total of 867,307 shares of Ordinary Common Stock with a ten-year term as noted in the "Individual Grants" table above. The Agreement provides for benefits commensurate with Dr. Lerer's position. The Agreement also provides for severance payments upon termination by the Company as follows:
Mark S. Demilio.Under the Employment Agreement between Mr. Demilio and Magellan Health Services, Inc., effective January 5, 2004, Mr. Demilio will serve as Executive Vice President and Chief Financial Officer of the Company. The Agreement is for a three-year term beginning on the Effective Date, with automatic renewals for additional one-year terms, unless sooner terminated as provided in the Agreement. The Company will pay Mr. Demilio a base salary of $500,000 per year, with annual review for increase by the Chief Executive Officer, subject to approval of the Board or a duly authorized committee thereof. Mr. Demilio is entitled to an annual target bonus opportunity of 60 percent of base salary, subject to achievement of performance targets fixed by the Board or a duly authorized committee thereof. Under the Agreement, the Company granted Mr. Demilio 33,585 fully-vested shares of Ordinary Common Stock on the Effective Date. Additionally, under the Agreement, the Company granted to Mr. Demilio options to purchase a total of 578,204 shares of Ordinary Common Stock with a ten-year term as noted in the "Individual Grants" table above. The Agreement
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provides for benefits commensurate with Mr. Demilio's position. The Agreement also provides for severance payments upon termination by the Company as follows:
Henry T. Harbin, M.D. As of the Effective Date, Dr. Harbin was replaced as Chairman of the Board by Mr. Shulman. Dr. Harbin remained an employee of the Company from that time up to the termination date of his employment agreement, which expired on March 17, 2004. The Company and Dr. Harbin have entered into a consulting agreement, effective as of March 18, 2004, under which Dr. Harbin will provide services on behalf of the Company on an as-needed basis.
Megan M. Arthur. The Company has an Employment Agreement with Ms. Arthur effective November 1, 2003 for a term extending to May 22, 2004, unless terminated earlier in accordance with terms of the agreement. Thereafter the agreement will automatically renew for thirty-day periods, unless terminated sooner as provided in the agreement, until January 31, 2005. Under the agreement, Ms. Arthur will serve the Company as General Counsel or Deputy General Counsel, or a comparable position as the Company determines from time to time. The agreement provides for a base salary of $270,000 per year and benefits commensurate with Ms. Arthur's position.
Benefit Plans
Annual Incentive Plan. In fiscal year 2003, the executive officers were eligible for participation in the Short-Term Incentive Plan ("STIP"), which was designed to award officers (and other employees) for meeting or exceeding specific financial targets approved by the Compensation Committee for fiscal year 2003. The Target Bonus Award levels for the executive officers range from 50.0 percent to 60.0 percent of base salary, and based on performance in relation to goals, the amount of bonus can range from 0 percent to 200 percent of target percentage. Incentive Awards are funded based on meeting or exceeding threshold goals and are awarded based on corporate and individual performance. Based on the financial results attained for fiscal year 2003, the STIP was funded at 120 percent and bonuses were paid in the first quarter of 2004.
2003 Management Incentive Plan. This plan replaces the Company's former 1994, 1996, 1997 and 1998 Stock Option Plans and the 2000 Long-Term Incentive Plan, all of which were terminated as of the Effective Date. The 2003 Management Incentive Plan (the "MIP"), which is administered by the Compensation Committee of the Board, allows approval of several types of long-term incentives including stock options, stock appreciation rights, restricted stock awards and stock units. A total of 6,373,689 shares of Ordinary Common Stock have been reserved for issuance pursuant to the MIP over a period not to exceed ten years after the Effective Date. Pursuant to the MIP and their employment
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agreements, as of the Effective Date, options to purchase 2,891,022 shares of Ordinary Common Stock and restricted stock awards for 167,926 shares of Ordinary Common Stock were issued to the three senior executive officers of the Company (Mr. Shulman, Dr. Lerer and Mr. Demilio). Stock options covering 1,376,400 additional shares were issued to other members of management of the Company in connection with the consummation of the Plan, leaving 2,106,267 options issuable under the MIP. The options to executive officers were granted with exercise prices ranging from the reorganization value under the Plan, as set forth in the Plan's disclosure statement ($10.43 per share), to the average price paid by Onex for all of the shares it acquired in connection with the Plan ($11.91 per share). The options granted to other members of management have exercise prices ranging from the price paid in the Onex Investment ($12.39 per share) to the price that is 85 percent of the average closing price of the common stock over the first 20 trading days ($23.52 per share).
The maximum number of shares of Ordinary Common Stock that may be granted or measured to any individual participant under the MIP in any one calendar year may not exceed 2,000,000. The MIP allows the Compensation Committee flexibility in developing appropriate long-term incentive strategies to retain the Company's key executive officers. The Compensation Committee is authorized, subject to the provisions of the MIP, to make and administer grants under the MIP, and to establish such rules as it deems necessary for the proper administration of the MIP.
Executive Benefits Plan. The Magellan Health Services, Inc. Supplemental Accumulation Plan (the "SAP"), was approved by the Compensation Committee for plan year 2000. The SAP, a calendar year based plan, is funded through a fixed component that has been structured to provide an incentive for executive officers to remain with the Company. It may also be funded by the executive officers through voluntary deferrals of base and/or incentive compensation. Annually, the Compensation Committee approves the fixed percentage contribution for the Executive Officers. For calendar 2003, the Chief Executive Officer and other executive officers were each eligible for a Company contribution of 11 percent of base salary. Both Company and voluntary contributions are paid to a trust and invested in one or more mutual funds selected by the respective executive officer.
The fixed percentage amount contributed to the trust and any appreciation thereon is paid to the executive officer on a date at least two years from the date of funding, if such officer is still employed at that time, or two years following the date of termination from the Company, provided that the executive officer has complied with covenants not to compete with the Company during that time period and the termination was not "for cause".
The terms of the SAP provide that the amounts deposited in the trust on behalf of executive officers are to be immediately and fully vested upon a change of control of the Company (as defined in the SAP document).
Key Employee Retention Plan. Subsequent to the Commencement Date, the Board of Directors adopted and the Bankruptcy Court approved the Key Employee Retention Plan ("KERP"). The purpose of KERP is to provide supplemental compensation to certain employees, including certain executive members of management, in order to retain such employees through the Company's financial restructuring process. KERP does not include individuals retained by the Company pursuant to the consulting agreement with HPI. KERP supplemental compensation awards range up to 50.0 percent of base salary and were paid 33 percent on July 31, 2003, and the remainder on February 19, 2004, 45 days after consummation of the plan of reorganization.
Certain Compensation Expenses
Based on the terms established for certain of the stock and option compensation arrangements provided for members of management under the Plan and implemented on the Effective Date and shortly thereafter, as described above, the related compensation expense will be charged against the Company's income periodically over subsequent periods as described in Note 8—"Stockholders Equity—Stock Option Plans" to the accompanying audited consolidated financial statements set forth elsewhere herein.
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Compensation Committee Interlocks and Insider Participation
During fiscal 2003, the Compensation Committee was comprised of former Board members, Gerald L. McManis and James B. Williams, each a non-employee director. Mr. Williams was affiliated with the Texas Pacific Group, which previously engaged in certain transactions with the Company. Neither Mr. McManis nor Mr. Williams engaged in related party transactions with the Company.
The new Compensation Committee, effective as of the Effective Date and as of the date hereof, consists of Messrs. Burian, Diament and Haft, each a non-employee director. Mr. Burian and Mr. Haft are affiliated with entities that have engaged in certain transactions with the Company or the Company's affiliates. Mr. Diament has not engaged in related party transactions with the Company or its affiliates.
None of the Company's executive officers serves as a member of a board of directors or compensation committee of any entity that has one or more executive officers who serves on the Company's Board or on the Compensation Committee.
Item 12. Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters
Security Ownership of Management
Information with respect to securities authorized for issuance under equity compensation plans is provided in Item 5 of Part I of this Form 10-K, and is incorporated herein by reference.
The following table sets forth information concerning the beneficial ownership of Ordinary Common Stock by: (i) directors, (ii) Named Executive Officers and (iii) directors and executive officers as a group, as of March 4, 2004.
| Name of Beneficial Owner | Amount and Nature of Beneficial Ownership (1) (2) | Percent of Class (3) | |||
|---|---|---|---|---|---|
| Steve Shulman (4) | 167,926 | * | |||
| René Lerer, M.D. (5) | 50,378 | * | |||
| Robert M. LeBlanc (6) | 5,166 | * | |||
| Mark L. Hilson (6) | 4,583 | * | |||
| Saul E. Burian (7) | 2,719 | * | |||
| Michael Diament (7) | 2,719 | * | |||
| Michael P. Ressner (7) | 2,719 | * | |||
| William J. McBride (7) | 2,719 | * | |||
| Robert Haft (8) | 85,573 | * | |||
| Mark Demilio (9) | 33,617 | * | |||
| Henry Harbin (10) | 206 | * | |||
| Megan Arthur (11) | 6 | * | |||
| All directors and executive officers as a group (14 persons) (12) | 358,395 | 1.3 | % |
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The following table sets forth information concerning the beneficial ownership of Multi-Vote Common Stock by: (i) directors, (ii) Named Executive Officers and (iii) directors and executive officers as a group, as of March 4, 2004.
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Security Ownership of Certain Beneficial Owners
The following table sets forth certain information as of March 4, 2004 (except as otherwise noted) with respect to any person known by the Company to be the beneficial owner of more than 5.0 percent of the outstanding Ordinary Common Stock or the Multi-Vote Common Stock:
| Title of Class | Name of Beneficial Owner | Amount and Nature of Beneficial Ownership (1) | Percent of Class (1) | |||
|---|---|---|---|---|---|---|
Multi-Vote Common Stock | Magellan Holdings LP 712 Fifth Avenue New York, NY 10019 | 8,469,846 | 100.0% | |||
Ordinary Common Stock | Magellan Holdings LP (2) 712 Fifth Avenue New York, NY 10019 | 8,469,846 | 23.9% | |||
Ordinary Common Stock | Amalgamated Gadget LP (3) 301 Commerce Street Suite 2975 Fort Worth, TX 76102 | 2,459,431 | 9.1% | |||
Ordinary Common Stock | Paul Tudor Jones (4) c/o Tudor Investment Corporation 1275 King Street Greenwich, CT 06831 | 2,457,283 | 9.1% | |||
Ordinary Common Stock | Third Point Management Co LLC (5) 360 Madison Avenue 24th Floor New York, NY 10017 | 2,047,443 | 7.6% |
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In accordance with a registration rights agreement dated as of January 5, 2004 that was entered into in connection with the consummation of the Plan (the "Registration Rights Agreement"), Holdings (and a permitted transferee) is entitled to have Magellan, subject to certain terms and conditions, register under the Securities Act for public sale the shares of Ordinary Common Stock it may acquire upon conversion of the shares of Multi-Vote Common Stock it owns. Such shares, when registered, may be sold in an underwritten public offering or from time to time in the NASDAQ trading market or by other means, as Holdings may elect, and as is provided in the applicable registration statement. In accordance with the Registration Rights Agreement, Magellan currently expects to register shares of Ordinary Common Stock for sale in the NASDAQ trading market by Holdings commencing in the Spring of 2004, permitting such sales, on the conditions permitted by the agreement, at such time, if ever, and in such amount, if any, as Holdings may choose from time to time. Based solely upon the information contained in Holding's Schedule 13D report dated January 15, 2004 referred to above, the Company has no reason to believe that Holdings (or any permitted transferee thereof) presently intends to so sell publicly any shares of Ordinary Common Stock pursuant to such contemplated registration statement (or otherwise), but Magellan has no control over the timing or amount of any shares that Holdings (or a permitted transferee thereof) may decide to sell.
Equity Compensation Plan Information
The following table sets forth certain information as of March 4, 2004 with respect to the Management Incentive Plan.
| Plan category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||||
|---|---|---|---|---|---|---|---|---|
| Equity compensation plans approved by security holders | 4,267,422 | $ | 12.83 | 2,106,267 | ||||
| Equity compensation plans not approved by security holders | — | — | — | |||||
| Total | 4,267,422 | $ | 12.83 | 2,106,267 | ||||
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Item 13. Certain Relationships and Related Transactions
On December 4, 2002, the Company entered into a consulting agreement with Healthcare Partners, Inc. ("HPI"), a newly formed entity whose principals are Steven J. Shulman and René Lerer, M.D. (the "HPI Agreement"). Pursuant to the HPI Agreement, HPI, Mr. Shulman and Dr. Lerer, as well as Danna Mezin and Keith Kudla (the "Officers"), became part of the management of the Company, with Mr. Shulman becoming the chief executive officer of the Company. All of the Officers have devoted substantially all of their time to the management of the Company. For such services, the Company has paid to HPI, per the agreement, $250,000 per month for every month or portion thereof from December 2002 through the Effective Date and a bonus payment of $1.95 million based upon the achievement of certain targets under the agreement. This agreement terminated on the Effective Date, at which time Mr. Shulman and Dr. Lerer entered into employment agreements with the Company, as discussed above and Ms. Mezin and Mr. Kudla became employees of the Company.
Robert M. LeBlanc and Mark L. Hilson are affiliated with Onex. Pursuant to the Plan, Magellan Holdings LP, an affiliate of Onex, purchased 8,552,700 shares of Multi-Vote Common Stock of the Company. In January 2004, Onex sold 82,854 of these shares to Morgan Noble LLC.
Michael Diament is a Portfolio Manager and Director of Bankruptcies and Restructurings for Renegade Swish, LLC which, through various contractual agreements, provides investment management services to Amalgamated Gadget, LP, the investment manager for R2 Investments, LDC. On the Effective Date, Amalgamated Gadget, LP, for and on behalf of R2 Investments, LDC, acquired beneficial ownership of 3,198,106 shares of Ordinary Common Stock of the Company. On January 6, 2004, Amalgamated LP sold 738,675 shares, leaving it with beneficial ownership of 2,459,431 shares or approximately 9.1 percent of the total shares outstanding as of that date.
Saul E. Burian is a Director in the New York office of Houlihan, Lokey, Howard & Zukin ("Houlihan"). Houlihan represented the Pre-Petition Unofficial Committee of the Company's Unsecured Noteholders and the Official Committee of Unsecured Creditors of the Company in connection with the Company's financial restructuring process. The Company estimates that the total compensation to be paid to Houlihan for services rendered to the Committees as financial advisor will be approximately $2.9 million in cash, 166,966 shares of Ordinary Common Stock, and $1.8 million of Series B Notes, subject to finalization when the recoveries under the Plan by general unsecured creditors are finalized. In addition, Mr. Burian, as a Director of Houlihan, received an economic interest in 4,000 shares Houlihan received pursuant to the Plan. Mr. Burian did not have record ownership, nor did he possess either investment or dispositive power over the shares; however, Mr. Burian did, as a Director of Houlihan, possess the economic risk and benefit of the ownership of these shares. Such shares were sold by Houlihan shortly following the consummation of the Plan.
Robert Haft, a Director of the Company, is the Principal Manager of Morgan Noble LLC, which purchased 82,854 shares of Multi-Vote Common Stock from Magellan Holdings LP in January 2004 at $12.07 per share. The Multi-Vote Common stock immediately converted to Ordinary Common Stock upon the transfer of the shares.
Item 14. Principal Accountant Fees and Services
On May 22, 2002, the Company determined to dismiss its independent auditors, Arthur Andersen LLP, and to engage Ernst & Young LLP to serve as its new independent auditors. The change in auditors became effective May 24, 2002. The determination was approved by Magellan's Audit Committee of the Board of Directors. All fees disclosed below relate to Ernst & Young LLP services.
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Audit Fees
Aggregate fees totaled $1,519,272, $1,076,291 million and $2,871,029 for services such as audits of the consolidated annual financial statements, review of interim consolidated financial statements and audits of various subsidiaries, contracts and joint ventures due to regulatory requirements relating to the fiscal year ended September 30, 2002, the three months ended December 31, 2002 and the year ended December 31, 2003, respectively.
Audit-Related Fees
Aggregate fees totaled $191,824, $9,500 and $817,933 for audit-related services during the fiscal year ended September 30, 2002, the three months ended December 31, 2002 and the year ended December 31, 2003, respectively. Audit-related services included benefit plan audits, and assurance and advisory services including assistance with internal control documentation related to Section 404 of the Sarbanes-Oxley Act of 2002 and assistance with a proposed debt offering in the fiscal year ended September 30, 2002.
Tax Fees
Aggregate fees totaled $0, $62,080 and $469,413 for tax compliance, tax advice and tax planning services during the fiscal year ended September 30, 2002, the three months ended December 31, 2002 and the year ended December 31, 2003, respectively. Such services included federal and state and local tax advisory services.
All Other Fees
Aggregate fees totaled $0, $30,854 and $233,256 for certain services provided in connection with the Company's financial restructuring under chapter 11 of the U.S. Bankruptcy Code, and for unclaimed property advisory services during the fiscal year ended September 30, 2002, the three months ended December 31, 2002 and the year ended December 31, 2003, respectively.
The Company's Audit Committee pre-approves all services provided by Ernst & Young LLP. The Company has been advised by Ernst & Young LLP that substantially all of the work done in conjunction with the audit of the Company's financial statements for the year ended December 31, 2003, was performed by permanent full time employees and partners of Ernst & Young LLP.
92
Item 15. Exhibits, Financial Statement Schedule and Reports on Form 8-K
Additional Information
(a)
1. Financial Statements
Information with respect to this item is contained on Pages F-1 to F-68F-54 of this Report on Form 10-K.
2. Financial Statement Schedule
Information with respect to this item is contained on page S-1 of this Report on Form 10-K.
3. Exhibits
Exhibit No. | Description of Exhibit | |||||
2.1 | Master Service Agreement, dated August 5, 1997, between the Company, Aetna U.S. Healthcare, Inc. and Human Affairs International, Incorporated, which was filed as Exhibit 2(b) to the | |||||
2.2 | First Amendment to Master Services Agreement, dated December 4, 1997, between the Company, Aetna U.S. Healthcare, Inc. and Human Affairs International, Incorporated, which was filed as Exhibit 2(d) to the | |||||
2.3 | ||||||
93
Debtors’ Joint Plan of Reorganization under Chapter 11 of the Bankruptcy Code, which was filed as Exhibit 2.1 to the | ||||
2.4 | Second Amendment to the Aetna Master Service Agreement, dated as of March 11, 2003 which was filed as Exhibit 10.1 to the Company’s current report on Form 8-K, which was filed on March 12, 2003, and is incorporated herein by reference. | |||
2.5 | ||||
Debtors’ First Amended Joint Plan of Reorganization under Chapter 11 of the Bankruptcy Code, which was filed as Exhibit 99.1 to the | ||||
2.6 | Disclosure Statement for the | |||
2.7 | Debtors’ Second Amended Joint Plan of Reorganization under Chapter 11 of the Bankruptcy Code, which was filed as Exhibit 99.1 to the | |||
2.8 | Disclosure Statement for the | |||
2.9 | Debtors’ Third Amended Joint Plan of Reorganization under Chapter 11 of the Bankruptcy Code, which was filed as Exhibit 2(a) to the | |
2.10 |
94
| Disclosure Statement for the | ||
2.11 | Modifications to | |
2.12 | Modifications to | |
2.13 | Confirmation of | |
2.14 | Third Amendment to the Aetna Master Services Agreement, dated as of January 5, 2004 which was filed as Exhibit 2.7 to the | |
2.15 | Stock Purchase Agreement, dated December 18, 2003, among the Company and Magellan Holdings LP, which was filed as Exhibit 2.4 to the | |
2.16 | Asset Purchase Agreement, dated February 23, 2005, by and | |
3.1 | Amended and Restated Certificate of Incorporation of the Company, which was filed as Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2004, which was filed on March 30, 2004, and is incorporated herein by | |
3.2 | Bylaws of the Company, which were filed as Exhibit 3.1 to the Company’s current report on Form 8-K, which was filed on November 5, 2004, and is incorporated herein by reference. | |
4.1 | Credit Agreement, dated January 5, 2004, among the Company, various lenders listed therein and Deutsche Bank AG, New York Branch, as administrative agent, which was filed as Exhibit 2.2 to the | |
4.2 | Indenture, dated as of January 5, 2004, between the Company and HSBC Bank USA, as trustee, relating to the 93 | |
4.3 | Warrant Agreement, dated as of January 5, 2004, between the Company and Wachovia Bank, National Association, as Warrant Agent, which was filed as Exhibit 2.5 to the |
4.4 | Amendment No. 1 to the Warrant Agreement, dated as of January 7, 2004, between the Company and Wachovia Bank, National Association, as Warrant Agent, which was filed as Exhibit 10.1 to the | |
4.5 |
95
| Amended and Restated Warrant Agreement, dated as of January 5, 2004, between the Company and Wachovia Bank, National Association, as Warrant Agent, which was filed as Exhibit 10.2 to the | ||
4.6 | New Aetna Note, dated as of January 5, 2004, issued by the Company to Aetna, Inc., with a final maturity date of December 31, 2005, which was filed as Exhibit 2.6 to the | |
4.7 | New Aetna Warrant to purchase 1.0% of the common stock of the Company, | |
4.8 | Registration Rights Agreement, dated as of January 5, 2004, | |
4.9 | Amendment to Credit Agreement, dated | |
*10.1 | ||
Magellan Health Services, Inc. | ||
*10.2 |
96
| Employment Agreement, dated January 5, 2004, between the Company and Steven J. Shulman, Chairman and Chief Executive Officer of the Company, which was filed as Exhibit 2.11 to the | ||
* | Employment Agreement, dated January 5, 2004, between the Company and | |
* | Employment Agreement, dated January 5, 2004, between the Company and Mark S. Demilio, Executive Vice President and Chief Financial Officer of the Company, which was filed as Exhibit 2.13 to the | |
#*10.5 | Employment Agreement, dated September 5, 2003, between the Company and Jeff D. Emerson, Chief Information Officer | |
#*10.6 | Employment Agreement, dated October 27, 2003, between the Company and Anthony M. Kotin, Chief Marketing Officer | |
#*10.7 | Amendment to the October 27, 2003 Employment Agreement between the Company and Anthony M. Kotin, Chief Marketing Officer, dated October 27, 2003 | |
*10.8 | Employment Agreement, dated January 17, 2005, between the Company and Daniel N. Gregoire, Executive Vice President, General Counsel and Secretary of the Company, which was filed as Exhibit 99.1 to the Company’s current report on Form 8-K, which was filed on January 18, 2005, and is incorporated herein by reference. |
*10.9 | Magellan Health Services, Inc.—2003 Management Incentive Plan, effective as of January 5, 2004, which was filed as Exhibit 2.14 to the | |
*10.10 | ||
Magellan Health Services, Inc.—2003 Short-Term Incentive | ||
#*10.11 | Magellan Health Services, Inc.—2004 Management Bonus Plan. | |
#21 | List of subsidiaries of the Company. | |
#31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
#31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
†32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
†32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
*
#
†
97
Exhibits required to be filed by the Company pursuant to Item 601 of Regulation S-K are contained in a separate volume.
(c) Financial statements and schedules required by Regulation S-X Item 14(d):
(1)
(2)
(3)
98
4.SIGNATURES
Additional Information
The Company will provide to any person without charge, upon request, a copy of its annual Report on Form 10-K (without exhibits) for the fiscal year ended December 31, 2004, as filed with the Securities and Exchange Commission. The Company will also provide to any person without charge, upon request, copies of its Code of Ethics for Directors, Code of Ethics for Covered Officers, and Corporate Compliance Handbook for all employees (hereinafter referred to as the “Codes of Ethics”). Any such requests should be made in writing to the Investor Relations Department, Magellan Health Services, Inc., 16 Munson Road, Farmington, Connecticut 06032. The documents referred to above and other Securities and Exchange Commission filings of the Company are available on the Internet at www.Magellanhealth.com. The Company intends to disclose any future amendments to the provisions of the Codes of Ethics and waivers from such Codes of Ethics, if any, made with respect to any of its directors and executive officers, on its Internet site.
74
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
MAGELLAN HEALTH SERVICES, INC. | |
(Registrant) | |
/s/ MARK S. DEMILIO | |
Mark S. Demilio | |
Date: March 3, 2005 | Executive Vice President and Chief Financial Officer |
/s/ JEFFREY N. WEST | |
Jeffrey N. West | |
Date: March 3, 2005 | Senior Vice President and Controller |
Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the Registrant and in the capacities and on the dates indicated have signed this Report below.
Signature | Title | Date | |||||||||||||
/s/ STEVEN J. SHULMAN | Chief Executive Officer and Chairman of the Board | March | |||||||||||||
Steven J. Shulman | of Directors (Principal Executive Officer) | ||||||||||||||
/s/ SAUL E. BURIAN | Director | March 3, 2005 | |||||||||||||
Saul E. Burian | |||||||||||||||
/s/ MICHAEL DIAMENT | Director | March | |||||||||||||
Michael Diament | |||||||||||||||
/s/ ROBERT HAFT | Director | March | |||||||||||||
Robert Haft | |||||||||||||||
/s/ BARRY SMITH | Director | March 3, 2005 | |||||||||||||
Barry Smith | |||||||||||||||
/s/ ROBERT M. LE BLANC | Director | March 3, 2005 | |||||||||||||
Robert M. Le Blanc | |||||||||||||||
/s/ RENE LERER | Chief Operating Officer and Director | March | |||||||||||||
René Lerer | |||||||||||||||
99
/s/ WILLIAM J. MCBRIDE | Director | March 3, 2005 | ||||||||
William J. McBride | ||||||||||
/s/ MICHAEL P. RESSNER | Director | March 3, 2005 | ||||||||
Michael P. Ressner | ||||||||||
100
75
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
The following consolidated financial statements of the registrant and its subsidiaries are submitted herewith in response to Item 8 and Item 15(a)1:
Page(s) | ||||||
Magellan Health Services, Inc. | ||||||
Audited Consolidated Financial Statements | ||||||
| F-2 | |||||
F-4 | ||||||
F-5 | ||||||
F-6 | ||||||
F-7 | ||||||
F-8 | ||||||
The following financial statement schedule of the registrant and its subsidiaries is submitted
The following financial statement schedule of the registrant and its subsidiaries is submitted
herewith in response to Item 15(a)2:
S-1 |
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
F-1
REPORT OF INDEPENDENT AUDITORSREGISTERED PUBLIC ACCOUNTING FIRM ON
FINANCIAL STATEMENTS
Board of Directors
Magellan Health Services, Inc.
We have audited the accompanying consolidated balance sheetsheets of Reorganized Magellan Health Services, Inc. and subsidiaries (“Reorganized Company”) as of December 31, 2003 and 2004, and the related consolidated statements of operations, stockholders’ equity and cash flows of Predecessor Magellan Health Services, Inc. and subsidiaries ("(“Predecessor Company") as of December 31, 2002, the accompanying consolidated balance sheet of Reorganized Magellan Health Services, Inc. and subsidiaries ("Reorganized Company") as of December 31, 2003, and the related consolidated statements of operations, stockholders' equity and cash flows of Predecessor Company for the year ended September 30, 2002, the three months ended December 31, 2002 and the year ended December 31, 2003. Our audits also included the financial statement schedule of Magellan Health Services, Inc. ("Magellan"Company”) for the year ended September 30, 2002, the three months ended December 31, 2002 and the year ended December 31, 2003 and the consolidated statement of operations, stockholders’ equity and cash flows of the Reorganized Company for the year ended December 31, 2004. Our audits also included the financial statement schedule of Magellan Health Services, Inc. (“Magellan”) for the year ended September 30, 2002, the three months ended December 31, 2002 and the years ended December 31, 2003 and 2004 listed in the Index at Item 15(a).2. These financial statements and schedule are the responsibility of Magellan'sMagellan’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. The consolidated financial statements and schedule of Predecessor Company for the year ended September 30, 2001 were audited by other auditors, who have ceased operations, and whose report dated December 6, 2001 (except with respect to the matters discussed in Note 14, as to which the date was December 27, 2001) expressed an unqualified opinion on those statements before the restatement adjustments described in Note 3 and Note 16.
We conducted our audits in accordance with auditingthe standards generally accepted inof the United States.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Predecessor Company at December 31, 2002, the consolidated financial position of Reorganized Company at December 31, 2003 and 2004, and the consolidated results of the Predecessor Company'sCompany’s operations and its cash flows for the year ended September 30, 2002, the three months ended December 31, 2002 and the year ended December 31, 2003 and the consolidated results of the Reorganized Company’s operations and its cash flows for the year ended December 31, 2004, in conformity with accounting principlesU.S. generally accepted in the United States.accounting principles. Also, in our opinion, the related financial statement schedule for the year ended September 30, 2002, the three months ended December 31, 2002 and the yearyears ended December 31, 2003 and 2004, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Reorganized Company’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 23, 2005 expressed an unqualified opinion thereon.
As discussed in Note 3 to the consolidated financial statements, effective October 1, 2001, the Predecessor Company adopted Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets (" (“SFAS No. 142"142”), which resulted in the Predecessor Company changing the method in which it accounts for goodwill.
As discussed in Note 1 to the consolidated financial statements, effective December 29, 2003, Magellan received final clearance of significant contingencies related to the implementation of its plan of reorganization, which had been confirmed on October 8, 2003 by the United States Bankruptcy Court for the Southern District of New York. Magellan officially emerged from bankruptcy as of January 5, 2004. In connection with its reorganization, Magellan applied fresh start reporting as of December 31, 2003.
F-2
As more fully discussed in Note 2, the accompanying consolidated balance sheetsheets of the Reorganized Company as of December 31, 2003 reflectsand 2004, reflect the adjustments required under fresh start
F-2
reporting. As a result, the December 31, 2003 balance sheet of Reorganized Company is presented on a basis different from that of Predecessor Company and, therefore, is not comparable to prior periods.
As discussed in Note 3 to the consolidated financial statements, in connection with the application of fresh start reporting as of December 31, 2003, the Reorganized Company early adopted Financial Accounting Standards Board Interpretation No. 46,Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51, which requires consolidation of certain variable interest entities.
/s/ ERNST & YOUNG LLP | |
Baltimore, Maryland | |
February 23, 2005 |
As discussed above, the consolidated financial statements of Predecessor Company as of September 30, 2001, and for the year then ended were audited by other auditors who have ceased operations. As described in Note 3, these financial statements have been revised to include the transitional disclosures required by SFAS No. 142, which was adopted by Predecessor Company as of October 1, 2001. Our audit procedures with respect to the disclosures in Note 3 with respect to 2001 included (a) agreeing the previously reported net income to the previously issued financial statements and the adjustments to reported net income representing amortization expense (including any related tax effects) recognized in those periods related to goodwill that is no longer being amortized to Predecessor Company's underlying records obtained from management, and (b) testing the mathematical accuracy of the reconciliation of adjusted net income to reported net income, and the related earnings-per-share amounts. In our opinion, the disclosures for 2001 in Note 3 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 consolidated financial statements of Predecessor Company other than with respect to such disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 consolidated financial statements taken as a whole.
As discussed above, the consolidated financial statements of Predecessor Company as of September 30, 2001, and for the year then ended were audited by other auditors who have ceased operations. As described in Note 16, Predecessor Company changed the composition of its reportable segments in 2003, and the amounts in the 2001 consolidated financial statements relating to reportable segments have been restated to conform to the 2003 composition of reportable segments. We audited the adjustments that were applied to restate the disclosures for reportable segments reflected in the 2001 consolidated financial statements. Our procedures included (F-a) agreeing the adjusted amounts of segment revenues, segment profit and assets to Predecessor Company's underlying records obtained from management, and (b) testing the mathematical accuracy of the reconciliations of segment amounts to the consolidated financial statements. In our opinion, such adjustments are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 2001 consolidated financial statements of Predecessor Company other than with respect to such adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 2001 consolidated financial statements taken as a whole.3
/s/ Ernst & Young LLPBaltimore, MarylandMarch 19, 2004
F-3
The following report is a copy of a report previously issued by Arthur Andersen LLP ("Andersen"), which report has not been reissued by Andersen. Certain financial information for the year ended September 30, 2001 was not reviewed by Andersen and includes: (i) reclassifications to conform to the Company's September 30, 2002, December 31, 2002 and December 31, 2003 financial statement presentation and (ii) additional disclosures to conform with new accounting pronouncements and SEC rules and regulations issued during such fiscal periods. The Andersen report reflected below is dual dated with a reference to Note 14 from the fiscal 2001 Annual Report on Form 10-K. See Item 1—"Business—Cautionary Statements" for discussion of risks.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Magellan Health Services, Inc.:
We have audited the accompanying consolidated balance sheets of Magellan Health Services, Inc. (a Delaware corporation) and subsidiaries as of September 30, 2000 and 2001, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended September 30, 2001. These consolidated financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Magellan Health Services, Inc. and subsidiaries as of September 30, 2000 and 2001 and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2001 in conformity with accounting principles generally accepted in the United States.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ Arthur Andersen LLPBaltimore, MarylandDecember 6, 2001,Except with respect to the matters discussed in Note 14, as to which the date isDecember 27, 2001
F-4
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
See accompanying notes.
F-5
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
|
| Predecessor Company |
|
| Reorganized |
| |||||||||||||||||||||
|
| Fiscal Year Ended |
| Three Months Ended |
|
| Year Ended |
| |||||||||||||||||||
|
| September 30, |
| December 31, |
| December 31, |
| December 31, |
|
| December 31, |
| |||||||||||||||
|
|
|
|
|
| (unaudited) |
|
|
|
|
|
| |||||||||||||||
Net revenue |
|
| $ | 1,753,058 |
|
|
| $ | 1,510,746 |
|
|
| $ | 444,842 |
|
|
| $ | 445,890 |
|
|
|
| $ | 1,795,402 |
|
|
Costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Salaries, cost of care and other operating expenses |
|
| 1,585,314 |
|
|
| 1,324,886 |
|
|
| 395,093 |
|
|
| 391,433 |
|
|
|
| 1,567,465 |
|
| |||||
Equity in earnings of unconsolidated subsidiaries |
|
| (13,006 | ) |
|
| (6,202 | ) |
|
| (3,177 | ) |
|
| (2,138 | ) |
|
|
| (5,277 | ) |
| |||||
Depreciation and amortization |
|
| 47,558 |
|
|
| 48,047 |
|
|
| 11,190 |
|
|
| 14,380 |
|
|
|
| 42,489 |
|
| |||||
Interest expense (contractual interest of $106,328 in fiscal 2003) |
|
| 97,596 |
|
|
| 61,016 |
|
|
| 23,719 |
|
|
| 25,333 |
|
|
|
| 37,124 |
|
| |||||
Interest income |
|
| (5,365 | ) |
|
| (2,873 | ) |
|
| (1,310 | ) |
|
| (1,010 | ) |
|
|
| (6,127 | ) |
| |||||
Stock compensation expense |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| 23,152 |
|
| |||||
Reorganization benefit, net (See Note 2) |
|
| — |
|
|
| (438,217 | ) |
|
| — |
|
|
| — |
|
|
|
| — |
|
| |||||
Goodwill impairment charges |
|
| 415,880 |
|
|
| 28,780 |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
| |||||
Special charges |
|
| 15,729 |
|
|
| 9,528 |
|
|
| 4,485 |
|
|
| 3,907 |
|
|
|
| 5,038 |
|
| |||||
|
|
| 2,143,706 |
|
|
| 1,024,965 |
|
|
| 430,000 |
|
|
| 431,905 |
|
|
|
| 1,663,864 |
|
| |||||
Income (loss) from continuing operations before income taxes and minority interest |
|
| (390,648 | ) |
|
| 485,781 |
|
|
| 14,842 |
|
|
| 13,985 |
|
|
|
| 131,538 |
|
| |||||
Provision for income taxes |
|
| 151,609 |
|
|
| 33,813 |
|
|
| 6,086 |
|
|
| 3,129 |
|
|
|
| 46,584 |
|
| |||||
Income (loss) from continuing operations before minority interest |
|
| (542,257 | ) |
|
| 451,968 |
|
|
| 8,756 |
|
|
| 10,856 |
|
|
|
| 84,954 |
|
| |||||
Minority interest |
|
| 47 |
|
|
| 253 |
|
|
| 16 |
|
|
| 27 |
|
|
|
| 333 |
|
| |||||
Income (loss) from continuing operations |
|
| (542,304 | ) |
|
| 451,715 |
|
|
| 8,740 |
|
|
| 10,829 |
|
|
|
| 84,621 |
|
| |||||
Discontinued operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Income (loss) from discontinued operations(1) |
|
| 4,894 |
|
|
| (25,028 | ) |
|
| 158 |
|
|
| 803 |
|
|
|
| 4,781 |
|
| |||||
Income (loss) on disposal of discontinued operations(2) |
|
| (92 | ) |
|
| 4,756 |
|
|
| 820 |
|
|
| 97 |
|
|
|
| (1,030 | ) |
| |||||
Reorganization benefit, net(3) (See Note 2) |
|
| — |
|
|
| 20,327 |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
| |||||
|
|
| 4,802 |
|
|
| 55 |
|
|
| 978 |
|
|
| 900 |
|
|
|
| 3,751 |
|
| |||||
Income (loss) before cumulative effect of change in accounting principle |
|
| (537,502 | ) |
|
| 451,770 |
|
|
| 9,718 |
|
|
| 11,729 |
|
|
|
| 88,372 |
|
| |||||
Cumulative effect of change in accounting principle, net of income tax benefit of $16,249 in fiscal 2002 (See Note 3) |
|
| (191,561 | ) |
|
| — |
|
|
| (191,561 | ) |
|
| — |
|
|
|
| — |
|
| |||||
Net income (loss) |
|
| (729,063 | ) |
|
| 451,770 |
|
|
| (181,843 | ) |
|
| 11,729 |
|
|
|
| 88,372 |
|
| |||||
Preferred dividends (contractual dividends of $4,788 for the year ended December 31, 2003) |
|
| 4,657 |
|
|
| 883 |
|
|
| 1,075 |
|
|
| 1,243 |
|
|
|
| — |
|
| |||||
Amortization of redeemable preferred stock issuance costs, and other |
|
| 540 |
|
|
| 172 |
|
|
| 143 |
|
|
| 136 |
|
|
|
| — |
|
| |||||
Preferred stock reorganization items, net |
|
| — |
|
|
| 2,668 |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
| |||||
Income (loss) available to common stockholders |
|
| (734,260 | ) |
|
| 448,047 |
|
|
| (183,061 | ) |
|
| 10,350 |
|
|
|
| 88,372 |
|
| |||||
Other comprehensive loss(4) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| (506 | ) |
| |||||
Comprehensive income (loss) |
|
| $ | (734,260 | ) |
|
| $ | 448,047 |
|
|
| $ | (183,061 | ) |
|
| $ | 10,350 |
|
|
|
| $ | 87,866 |
|
|
Weighted average number of common shares outstanding—basic |
|
| 34,854 |
|
|
| 35,305 |
|
|
| 34,670 |
|
|
| 35,139 |
|
|
|
| 35,367 |
|
| |||||
Weighted average number of common shares outstanding—diluted |
|
| 34,854 |
|
|
| 41,605 |
|
|
| 42,075 |
|
|
| 41,439 |
|
|
|
| 36,361 |
|
| |||||
Income (loss) per common share available to common stockholders—basic: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Income (loss) from continuing operations |
|
| $ | (15.71 | ) |
|
| $ | 12.69 |
|
|
| $ | 0.22 |
|
|
| $ | 0.27 |
|
|
|
| $ | 2.39 |
|
|
Income from discontinued operations |
|
| 0.14 |
|
|
| — |
|
|
| 0.03 |
|
|
| 0.02 |
|
|
|
| 0.11 |
|
| |||||
Cumulative effect of change in accounting principle |
|
| (5.50 | ) |
|
| — |
|
|
| (5.53 | ) |
|
| — |
|
|
|
| — |
|
| |||||
Net income (loss) |
|
| $ | (21.07 | ) |
|
| $ | 12.69 |
|
|
| $ | (5.28 | ) |
|
| $ | 0.29 |
|
|
|
| $ | 2.50 |
|
|
Income (loss) per common share available to common stockholders—diluted: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Income (loss) from continuing operations |
|
| $ | (15.71 | ) |
|
| $ | 10.86 |
|
|
| $ | 0.21 |
|
|
| $ | 0.26 |
|
|
|
| $ | 2.33 |
|
|
Income from discontinued operations |
|
| 0.14 |
|
|
| — |
|
|
| 0.02 |
|
|
| 0.02 |
|
|
|
| 0.10 |
|
| |||||
Cumulative effect of change in accounting principle |
|
| (5.50 | ) |
|
| — |
|
|
| (4.55 | ) |
|
| — |
|
|
|
| — |
|
| |||||
Net income (loss) |
|
| $ | (21.07 | ) |
|
| $ | 10.86 |
|
|
| $ | (4.32 | ) |
|
| $ | 0.28 |
|
|
|
| $ | 2.43 |
|
|
(1)
| | Predecessor Company | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Fiscal Year Ended September 30, | Fiscal Year Ended December 31, | Three Months Ended December 31, | |||||||||||||
| | 2001 | 2002 | 2003 | 2001 | 2002 | |||||||||||
| | | | | (unaudited) | | |||||||||||
| Net revenue | $ | 1,755,512 | $ | 1,753,058 | $ | 1,510,746 | $ | 444,842 | $ | 445,890 | ||||||
| Costs and expenses: | ||||||||||||||||
| Salaries, cost of care and other operating expenses | 1,557,042 | 1,585,314 | 1,324,886 | 395,093 | 391,433 | |||||||||||
| Equity in earnings of unconsolidated subsidiaries | (36,566 | ) | (13,006 | ) | (6,202 | ) | (3,177 | ) | (2,138 | ) | ||||||
| Depreciation and amortization | 68,294 | 47,558 | 48,047 | 11,190 | 14,380 | |||||||||||
| Interest expense (Contractual interest of $106,328 in fiscal 2003) | 110,423 | 97,596 | 61,016 | 23,719 | 25,333 | |||||||||||
| Interest income | (10,121 | ) | (5,365 | ) | (2,873 | ) | (1,310 | ) | (1,010 | ) | ||||||
| Reorganization benefit, net (See Note 2) | — | — | (438,217 | ) | — | — | ||||||||||
| Goodwill impairment charges | — | 415,880 | 28,780 | — | — | |||||||||||
| Special charges | 3,340 | 15,729 | 9,528 | 4,485 | 3,907 | |||||||||||
| 1,692,412 | 2,143,706 | 1,024,965 | 430,000 | 431,905 | ||||||||||||
| Income (loss) from continuing operations before income taxes and minority interest | 63,100 | (390,648 | ) | 485,781 | 14,842 | 13,985 | ||||||||||
| Provision for income taxes | 33,732 | 151,609 | 33,813 | 6,086 | 3,129 | |||||||||||
| Income (loss) from continuing operations before minority interest | 29,368 | (542,257 | ) | 451,968 | 8,756 | 10,856 | ||||||||||
| Minority interest | 78 | 47 | 253 | 16 | 27 | |||||||||||
| Income (loss) from continuing operations | 29,290 | (542,304 | ) | 451,715 | 8,740 | 10,829 | ||||||||||
| Discontinued operations: | ||||||||||||||||
| Income (loss) from discontinued operations (1) | 4,624 | 4,894 | (25,028 | ) | 158 | 803 | ||||||||||
| Income (loss) on disposal of discontinued operations (2) | (9,359 | ) | (92 | ) | 4,756 | 820 | 97 | |||||||||
| Reorganization benefit, net (3) (See Note 2) | — | — | 20,327 | — | — | |||||||||||
| (4,735 | ) | 4,802 | 55 | 978 | 900 | |||||||||||
| Income (loss) before cumulative effect of change in accounting principle | 24,555 | (537,502 | ) | 451,770 | 9,718 | 11,729 | ||||||||||
| Cumulative effect of change in accounting principle, net of income tax benefit of $16,249 in fiscal 2002 (Note 3) | — | (191,561 | ) | — | (191,561 | ) | — | |||||||||
| Net income (loss) | 24,555 | (729,063 | ) | 451,770 | (181,843 | ) | 11,729 | |||||||||
| Preferred dividends (Contractual dividends of $4,788 for the fiscal year ended December 31, 2003) | 4,527 | 4,657 | 883 | 1,075 | 1,243 | |||||||||||
| Amortization of redeemable preferred stock issuance costs, and other | 522 | 540 | 172 | 143 | 136 | |||||||||||
| Preferred stock reorganization items, net | — | — | 2,668 | — | — | |||||||||||
| Income (loss) available to common stockholders | 19,506 | (734,260 | ) | 448,047 | (183,061 | ) | 10,350 | |||||||||
| Other comprehensive loss | (68 | ) | — | — | — | — | ||||||||||
| Comprehensive income (loss) | $ | 19,438 | $ | (734,260 | ) | $ | 448,047 | $ | (183,061 | ) | $ | 10,350 | ||||
| Weighted average number of common shares outstanding — basic | 33,448 | 34,854 | 35,305 | 34,670 | 35,139 | |||||||||||
| Weighted average number of common shares outstanding — diluted | 34,935 | 34,854 | 41,605 | 42,075 | 41,439 | |||||||||||
| Income (loss) per common share available to common stockholders — basic: | ||||||||||||||||
| Income (loss) from continuing operations | $ | 0.72 | $ | (15.71 | ) | $ | 12.69 | $ | 0.22 | $ | 0.27 | |||||
| Income (loss) from discontinued operations | (0.14 | ) | 0.14 | — | 0.03 | 0.02 | ||||||||||
| Cumulative effect of change in accounting principle | — | (5.50 | ) | — | (5.53 | ) | — | |||||||||
| Net income (loss) | $ | 0.58 | $ | (21.07 | ) | $ | 12.69 | $ | (5.28 | ) | $ | 0.29 | ||||
| Income (loss) per common share available to common stockholders — diluted: | ||||||||||||||||
| Income (loss) from continuing operations | $ | 0.69 | $ | (15.71 | ) | $ | 10.86 | $ | 0.21 | $ | 0.26 | |||||
| Income (loss) from discontinued operations | (0.13 | ) | 0.14 | — | 0.02 | 0.02 | ||||||||||
| Cumulative effect of change in accounting principle | — | (5.50 | ) | — | (4.55 | ) | — | |||||||||
| Net income (loss) | $ | 0.56 | $ | (21.07 | ) | $ | 10.86 | $ | (4.32 | ) | $ | 0.28 | ||||
(2)
(3)
(4)Net of income tax benefit of $(338) for the fiscal year ended December 31, 2004.
See accompanying notes.
F-6
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS'STOCKHOLDERS’ EQUITY (DEFICIT)
(In thousands)
| Predecessor |
| Reorganized |
| Reorganized |
| Additional |
| Retained |
| Warrants |
| Predecessor |
| Accumulated |
| Total |
| |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||
Balance year ended December,19, 2004 |
|
| $— |
|
|
| $— |
|
|
| $— |
|
|
| $— |
|
|
| $— |
|
|
| $— |
|
|
| $— |
|
|
| $— |
|
|
| $— |
|
|
Predecessor Company: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2001 |
|
| 9,238 |
|
|
| — |
|
|
| — |
|
|
| 358,273 |
|
|
| (185,803 | ) |
|
| 25,050 |
|
|
| (44,309 | ) |
|
| (261 | )(1) |
|
| 162,188 |
|
|
Exercise of options and warrants |
|
| 118 |
|
|
| — |
|
|
| — |
|
|
| 1,185 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 1,303 |
|
|
Preferred dividend requirement and amortization of redeemable preferred stock issuance costs |
| �� | — |
|
|
| — |
|
|
| — |
|
|
| (5,197 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (5,197 | ) |
|
Other |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (164 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (164 | ) |
|
Net income (loss) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (729,063 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (729,063 | ) |
|
Other comprehensive loss—other |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 261 | (1) |
|
| 261 |
|
|
Balance at September 30, 2002 |
|
| 9,356 |
|
|
| — |
|
|
| — |
|
|
| 354,097 |
|
|
| (914,866 | ) |
|
| 25,050 |
|
|
| (44,309 | ) |
|
| — |
|
|
| (570,672 | ) |
|
Preferred dividend requirement and amortization of redeemable preferred stock issuance costs |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (1,379 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (1,379 | ) |
|
Net income (loss) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 11,729 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 11,729 |
|
|
Balance at December 31, 2002 |
|
| 9,356 |
|
|
| — |
|
|
| — |
|
|
| 352,718 |
|
|
| (903,137 | ) |
|
| 25,050 |
|
|
| (44,309 | ) |
|
| — |
|
|
| (560,322 | ) |
|
Employee stock purchase plan activity |
|
| 45 |
|
|
| — |
|
|
| — |
|
|
| (19 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 26 |
|
|
Preferred dividend requirement and amortization of redeemable preferred stock issuance costs |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (1,055 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (1,055 | ) |
|
Preferred stock reorganization items |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (2,668 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (2,668 | ) |
|
Net income (loss), excluding reorganization adjustments gain |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (43,372 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (43,372 | ) |
|
Subtotal |
|
| 9,401 |
|
|
| — |
|
|
| — |
|
|
| 348,976 |
|
|
| (946,509 | ) |
|
| 25,050 |
|
|
| (44,309 | ) |
|
| — |
|
|
| (607,391 | ) |
|
Fresh Start Adjustments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net reorganization fresh start gain (See Note 2)—Predecessor Company |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 495,142 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 495,142 |
|
|
Other reorganization adjustments (See Note 2)—Predecessor Company |
|
| (9,401 | ) |
|
| — |
|
|
| — |
|
|
| (348,976 | ) |
|
| — |
|
|
| (25,050 | ) |
|
| 44,309 |
|
|
| — |
|
|
| (339,118 | ) |
|
Accumulated deficit reorganization adjustments (See Note 2) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 451,367 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 451,367 |
|
|
Issuance of common stock and warrants under Plan of Reorganization—Reorganized Company |
|
| — |
|
|
| 265 |
|
|
| 86 |
|
|
| 379,067 |
|
|
| — |
|
|
| 8,493 |
|
|
| — |
|
|
| — |
|
|
| 387,911 |
|
|
Reorganized Company: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2003 |
|
| — |
|
|
| 265 |
|
|
| 86 |
|
|
| 379,067 |
|
|
| — |
|
|
| 8,493 |
|
|
| — |
|
|
| — |
|
|
| 387,911 |
|
|
Stock compensation expense |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 20,276 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 20,276 |
|
|
Issuance of equity |
|
| — |
|
|
| 3 |
|
|
| — |
|
|
| 997 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 1,000 |
|
|
Conversion of ordinary common stock |
|
| — |
|
|
| 1 |
|
|
| (1 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
Net income |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 88,372 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 88,372 |
|
|
Other comprehensive loss—other |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (506 | )(2) |
|
| (506 | ) |
|
Balance at December 31, 2004 |
|
| $ — |
|
|
| $ 269 |
|
|
| $ 85 |
|
|
| $ 400,340 |
|
|
| $ 88,372 |
|
|
| $ 8,493 |
|
|
| $ — |
|
|
| $ (506 | ) |
|
| $ 497,053 |
|
|
(1)Amount relates to the Predecessor company’s cumulative foreign currency translation adjustments and related reclassification.
| | Predecessor Company Common Stock | Reorganized Company Ordinary common stock | Reorganized Company Multi-Vote common stock | Additional paid-in capital | Accumulated Deficit | Warrants outstanding | Predecessor Company Common stock in treasury | Predecessor Company Cumulative foreign currency adjustments included in other comprehensive income | Total Stockholders' Equity (Deficit) | |||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Predecessor Company: | ||||||||||||||||||||||||||||||
| Balance at September 30, 2000 | $ | 8,733 | $ | — | $ | — | $ | 349,541 | $ | (210,358 | ) | $ | 25,050 | $ | (44,309 | ) | $ | (193 | ) | $ | 128,464 | |||||||||
| Exercise of options and warrants | 505 | — | — | 7,980 | — | — | — | — | 8,485 | |||||||||||||||||||||
| Stock option expense | — | — | — | 636 | — | — | — | — | 636 | |||||||||||||||||||||
| Tax benefit on exercise of stock options | — | — | — | 4,799 | — | — | — | — | 4,799 | |||||||||||||||||||||
| Preferred dividend requirement and amortization of redeemable preferred stock issuance costs | — | — | — | (5,049 | ) | — | — | — | — | (5,049 | ) | |||||||||||||||||||
| Net income (loss) | — | — | — | — | 24,555 | — | — | — | 24,555 | |||||||||||||||||||||
| Other | — | — | — | 366 | — | — | — | — | 366 | |||||||||||||||||||||
| Other comprehensive loss: | ||||||||||||||||||||||||||||||
| Unrealized foreign currency translation loss | — | — | — | — | — | — | — | (113 | ) | (113 | ) | |||||||||||||||||||
| Benefit from income taxes | — | — | — | — | — | — | — | 45 | 45 | |||||||||||||||||||||
| Balance at September 30, 2001 | 9,238 | — | — | 358,273 | (185,803 | ) | 25,050 | (44,309 | ) | (261 | ) | 162,188 | ||||||||||||||||||
| Exercise of options and warrants | 118 | — | — | 1,185 | — | — | — | — | 1,303 | |||||||||||||||||||||
| Preferred dividend requirement and amortization of redeemable preferred stock issuance costs | — | — | — | (5,197 | ) | — | — | — | — | (5,197 | ) | |||||||||||||||||||
| Other | — | — | — | (164 | ) | — | — | — | — | (164 | ) | |||||||||||||||||||
| Net income (loss) | — | — | — | — | (729,063 | ) | — | — | — | (729,063 | ) | |||||||||||||||||||
| Other comprehensive loss — other | — | — | — | — | — | — | — | 261 | 261 | |||||||||||||||||||||
| Balance at September 30, 2002 | 9,356 | — | — | 354,097 | (914,866 | ) | 25,050 | (44,309 | ) | — | (570,672 | ) | ||||||||||||||||||
| Preferred dividend requirement and amortization of redeemable preferred stock issuance costs | — | — | — | (1,379 | ) | — | — | — | — | (1,379 | ) | |||||||||||||||||||
| Net income (loss) | — | — | — | — | 11,729 | — | — | — | 11,729 | |||||||||||||||||||||
| Balance at December 31, 2002 | 9,356 | — | — | 352,718 | (903,137 | ) | 25,050 | (44,309 | ) | — | (560,322 | ) | ||||||||||||||||||
| Employee stock purchase plan activity | 45 | — | — | (19 | ) | — | — | — | — | 26 | ||||||||||||||||||||
| Preferred dividend requirement and amortization of redeemable preferred stock issuance costs | — | — | — | (1,055 | ) | — | — | — | — | (1,055 | ) | |||||||||||||||||||
| Preferred stock reorganization items | — | — | — | (2,668 | ) | — | — | — | — | (2,668 | ) | |||||||||||||||||||
| Net income (loss), excluding reorganization adjustments gain | — | — | — | — | (43,372 | ) | — | — | — | (43,372 | ) | |||||||||||||||||||
| Subtotal | 9,401 | — | — | 348,976 | (946,509 | ) | 25,050 | (44,309 | ) | — | (607,391 | ) | ||||||||||||||||||
| Fresh Start Adjustments: | ||||||||||||||||||||||||||||||
| Net reorganization fresh start gain (Note 2) — Predecessor Company | — | — | — | — | 495,142 | — | — | — | 495,142 | |||||||||||||||||||||
| Other reorganization adjustments (Note 2) — Predecessor Company | (9,401 | ) | — | — | (348,976 | ) | — | (25,050 | ) | 44,309 | — | (339,118 | ) | |||||||||||||||||
| Accumulated deficit reorganization adjustments (Note 2) | — | — | — | — | 451,367 | — | — | — | 451,367 | |||||||||||||||||||||
| Issuance of common stock and warrants under Plan of Reorganization — Reorganized Company | — | 265 | 86 | 379,067 | — | 8,493 | — | — | 387,911 | |||||||||||||||||||||
| Balance at December 31, 2003, Reorganized Company | $ | — | $ | 265 | $ | 86 | $ | 379,067 | $ | — | $ | 8,493 | $ | — | $ | — | $ | 387,911 | ||||||||||||
(2)Amount relates to the Reorganized company’s unrealized losses on investments classified as available-for-sale, as discussed in Note 3—“Summary of Significant Accounting Policies” and is shown net of $(338) income tax benefit.
See accompanying notes.notes to consolidated financial statements.
F-6
F-7
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
| | Predecessor Company | ||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Fiscal Year Ended | | Three Months Ended |
| Predecessor Company |
|
| Reorganized |
| |||||||||||||||||||||||||||||
| | | Fiscal Year Ended December 31, 2003 |
| Fiscal Year Ended |
| Three Months Ended |
|
| Fiscal Year Ended |
| |||||||||||||||||||||||||||||
| | | September 30, 2001 | September 30, 2002 | December 31, 2001 | December 31, 2002 |
| September 30, |
| December 31, |
| December 31, |
| December 31, |
|
| December 31, |
| ||||||||||||||||||||||
| | | | | | (unaudited) | |
|
|
|
|
| (unaudited) |
|
|
|
|
|
| |||||||||||||||||||||
| Cash Flows From Operating Activities: | Cash Flows From Operating Activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Net income (loss) | Net income (loss) | $ | 24,555 | $ | (729,063 | ) | $ | 451,770 | $ | (181,843 | ) | $ | 11,729 |
|
| $(729,063 | ) |
|
| $ 451,770 |
|
|
| $(181,843 | ) |
|
| $ 11,729 |
|
|
|
| $ 88,372 |
|
| ||||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| (Gain) loss on sale of assets | (Gain) loss on sale of assets | 1,918 | (1,262 | ) | (4,460 | ) | (1,262 | ) | — |
|
| (1,262 | ) |
|
| (4,460 | ) |
|
| (1,262 | ) |
|
| — |
|
|
|
| 141 |
|
| ||||||||
| Depreciation and amortization | Depreciation and amortization | 70,277 | 47,558 | 48,047 | 11,190 | 14,380 |
|
| 47,558 |
|
|
| 48,047 |
|
|
| 11,190 |
|
|
| 14,380 |
|
|
|
| 42,489 |
|
| |||||||||||
| Goodwill impairment charges | Goodwill impairment charges | — | 415,880 | 28,780 | — | — |
|
| 415,880 |
|
|
| 28,780 |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
| |||||||||||
| Cumulative effect of change in accounting principle | Cumulative effect of change in accounting principle | — | 191,561 | — | 191,561 | — |
|
| 191,561 |
|
|
| — |
|
|
| 191,561 |
|
|
| — |
|
|
|
| — |
|
| |||||||||||
| Equity in earnings of unconsolidated subsidiaries | Equity in earnings of unconsolidated subsidiaries | (36,566 | ) | (13,006 | ) | (6,202 | ) | (3,177 | ) | (2,138 | ) |
|
| (13,006 | ) |
|
| (6,202 | ) |
|
| (3,177 | ) |
|
| (2,138 | ) |
|
|
| (5,277 | ) |
| ||||||
| Stock option expense | 636 | — | — | — | — | ||||||||||||||||||||||||||||||||||
Non-cash stock compensation |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| 20,276 |
|
| |||||||||||||||||
| Non-cash fresh start reorganization gain | Non-cash fresh start reorganization gain | — | — | (495,142 | ) | — | — |
|
| — |
|
|
| (495,142 | ) |
|
| — |
|
|
| — |
|
|
|
| — |
|
| ||||||||||
| Other non-cash reorganization expense | Other non-cash reorganization expense | — | — | 6,902 | — | — |
|
| — |
|
|
| 6,902 |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
| |||||||||||
| Other non-cash interest expense | Other non-cash interest expense | 11,718 | 5,424 | 4,662 | 1,231 | 1,642 |
|
| 5,424 |
|
|
| 4,662 |
|
|
| 1,231 |
|
|
| 1,642 |
|
|
|
| 2,343 |
|
| |||||||||||
| Cash flows from changes in assets and liabilities, net of effects from sales and acquisitions of businesses: | Cash flows from changes in assets and liabilities, net of effects from sales and acquisitions of businesses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Accounts receivable, net | Accounts receivable, net | (6,881 | ) | 3,156 | 11,650 | (572 | ) | 13,896 |
|
| 3,156 |
|
|
| 11,650 |
|
|
| (572 | ) |
|
| 13,896 |
|
|
|
| 25,069 |
|
| |||||||||
| Restricted cash, investments and deposits | (4,725 | ) | (2,291 | ) | (39 | ) | (8,861 | ) | (2,578 | ) | |||||||||||||||||||||||||||||
Restricted cash |
|
| (2,291 | ) |
|
| (39 | ) |
|
| (8,861 | ) |
|
| (2,578 | ) |
|
|
| (2,058 | ) |
| |||||||||||||||||
| Net cash flows related to unconsolidated subsidiaries | Net cash flows related to unconsolidated subsidiaries | 38,353 | 10,685 | (3,881 | ) | 2,828 | 3,175 |
|
| 10,685 |
|
|
| (3,881 | ) |
|
| 2,828 |
|
|
| 3,175 |
|
|
|
| 7,322 |
|
| ||||||||||
| Income taxes payable and deferred income taxes | Income taxes payable and deferred income taxes | 45,042 | 153,731 | 1,966 | 6,760 | 129 |
|
| 153,731 |
|
|
| 1,966 |
|
|
| 6,760 |
|
|
| 129 |
|
|
|
| — |
|
| |||||||||||
| Other assets | Other assets | 2,754 | 4,980 | (837 | ) | 7,265 | 3,424 |
|
| 4,980 |
|
|
| (837 | ) |
|
| 7,265 |
|
|
| 3,424 |
|
|
|
| 38,018 |
|
| ||||||||||
| Accounts payable and accrued liabilities | Accounts payable and accrued liabilities | (37,739 | ) | (20,796 | ) | 178,355 | 4,817 | (19,257 | ) |
|
| (20,796 | ) |
|
| 178,355 |
|
|
| 4,817 |
|
|
| (19,257 | ) |
|
|
| (72,757 | ) |
| ||||||||
| Medical claims payable | Medical claims payable | (11,310 | ) | (2,088 | ) | (47,403 | ) | (6,988 | ) | 3,568 |
|
| (2,088 | ) |
|
| (47,403 | ) |
|
| (6,988 | ) |
|
| 3,568 |
|
|
|
| 17,497 |
|
| |||||||
| Other liabilities | Other liabilities | (13,402 | ) | 257 | (450 | ) | (148 | ) | (21 | ) |
|
| 257 |
|
|
| (450 | ) |
|
| (148 | ) |
|
| (21 | ) |
|
|
| 23 |
|
| |||||||
| Minority interest, net of dividends paid | Minority interest, net of dividends paid | 130 | 78 | 352 | 26 | 42 |
|
| 78 |
|
|
| 352 |
|
|
| 26 |
|
|
| 42 |
|
|
|
| 591 |
|
| |||||||||||
| Other | Other | 926 | 1,856 | 4,223 | 1,228 | 10 |
|
| 1,856 |
|
|
| 4,223 |
|
|
| 1,228 |
|
|
| 10 |
|
|
|
| 1,389 |
|
| |||||||||||
| Total adjustments | Total adjustments | 61,131 | 795,723 | (273,477 | ) | 205,898 | 16,272 |
|
| 795,723 |
|
|
| (273,477 | ) |
|
| 205,898 |
|
|
| 16,272 |
|
|
|
| 75,066 |
|
| ||||||||||
| Net cash provided by operating activities | 85,686 | 66,660 | 178,293 | 24,055 | 28,001 | ||||||||||||||||||||||||||||||||||
Net cash provided by operating activities |
|
| 66,660 |
|
|
| 178,293 |
|
|
| 24,055 |
|
|
| 28,001 |
|
|
|
| 163,438 |
|
| |||||||||||||||||
| Cash Flows From Investing Activities: | Cash Flows From Investing Activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Capital expenditures | Capital expenditures | (34,709 | ) | (27,596 | ) | (29,773 | ) | (6,011 | ) | (8,421 | ) |
|
| (27,596 | ) |
|
| (29,773 | ) |
|
| (6,011 | ) |
|
| (8,421 | ) |
|
|
| (30,703 | ) |
| ||||||
| Acquisitions and investments in businesses | Acquisitions and investments in businesses | (87,731 | ) | (63,731 | ) | (3,731 | ) | — | — |
|
| (63,731 | ) |
|
| (3,731 | ) |
|
| — |
|
|
| — |
|
|
|
| — |
|
| ||||||||
Purchases of investments |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| (827,564 | ) |
| |||||||||||||||||
Maturity of investments |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| 506,518 |
|
| |||||||||||||||||
| Proceeds from sale of assets | Proceeds from sale of assets | 110,551 | 3,500 | 2,588 | 3,500 | — |
|
| 3,500 |
|
|
| 2,588 |
|
|
| 3,500 |
|
|
| — |
|
|
|
| 2,302 |
|
| |||||||||||
| Net cash used in investing activities | (11,889 | ) | (87,827 | ) | (30,916 | ) | (2,511 | ) | (8,421 | ) | |||||||||||||||||||||||||||||
Net cash used in investing activities |
|
| (87,827 | ) |
|
| (30,916 | ) |
|
| (2,511 | ) |
|
| (8,421 | ) |
|
|
| (349,447 | ) |
| |||||||||||||||||
| Cash Flows From Financing Activities: | Cash Flows From Financing Activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Payments on long-term debt and capital lease obligations | Payments on long-term debt and capital lease obligations | (458,221 | ) | (65,840 | ) | (3,018 | ) | (987 | ) | (1,196 | ) |
|
| (65,840 | ) |
|
| (3,018 | ) |
|
| (987 | ) |
|
| (1,196 | ) |
|
|
| (216,226 | ) |
| ||||||
| Proceeds from issuance of long-term debt, net of issuance costs | Proceeds from issuance of long-term debt, net of issuance costs | 356,648 | 105,000 | 76 | — | — |
|
| 105,000 |
|
|
| 76 |
|
|
| — |
|
|
| — |
|
|
|
| 92,806 |
|
| |||||||||||
| Credit agreement amendment fees and other | Credit agreement amendment fees and other | — | (1,499 | ) | — | (1,403 | ) | (1,909 | ) |
|
| (1,499 | ) |
|
| — |
|
|
| (1,403 | ) |
|
| (1,909 | ) |
|
|
| — |
|
| ||||||||
Proceeds from issuance of equity, net of issuance costs |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| 147,871 |
|
| |||||||||||||||||
| Proceeds from exercise of stock options and warrants and employee stock purchase plan | Proceeds from exercise of stock options and warrants and employee stock purchase plan | 8,485 | 1,303 | 25 | 48 | — |
|
| 1,303 |
|
|
| 25 |
|
|
| 48 |
|
|
| — |
|
|
|
| — |
|
| |||||||||||
| Net cash provided by (used in) financing activities | (93,088 | ) | 38,964 | (2,917 | ) | (2,342 | ) | (3,105 | ) | ||||||||||||||||||||||||||||||
Net cash provided by (used in) financing activities |
|
| 38,964 |
|
|
| (2,917 | ) |
|
| (2,342 | ) |
|
| (3,105 | ) |
|
|
| 24,451 |
|
| |||||||||||||||||
| Net increase (decrease) in cash and cash equivalents | Net increase (decrease) in cash and cash equivalents | (19,291 | ) | 17,797 | 144,460 | 19,202 | 16,475 |
|
| 17,797 |
|
|
| 144,460 |
|
|
| 19,202 |
|
|
| 16,475 |
|
|
|
| (161,558 | ) |
| ||||||||||
| Cash and cash equivalents at beginning of period | Cash and cash equivalents at beginning of period | 47,507 | 28,216 | 62,488 | 28,216 | 46,013 |
|
| 28,216 |
|
|
| 62,488 |
|
|
| 28,216 |
|
|
| 46,013 |
|
|
|
| 206,948 |
|
| |||||||||||
| Cash and cash equivalents at end of period | Cash and cash equivalents at end of period | $ | 28,216 | $ | 46,013 | $ | 206,948 | $ | 47,418 | $ | 62,488 |
|
| $ 46,013 |
|
|
| $ 206,948 |
|
|
| $ 47,418 |
|
|
| $ 62,488 |
|
|
|
| $ 45,390 |
|
| ||||||
See accompanying notes.
F-8
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003
2004
(All information pertaining to December 31, 2001 or
the
three months ended December 31, 2001 is unaudited.)
Basis of Presentation
The consolidated financial statements as of December 31, 20022003 and 2004 and for the years ended September 30, 2001, September 30, 2002 and December 31, 2003, and for the three months ended December 31, 2001 and 2002 and the year ended December 31, 2004 of Magellan Health Services, Inc., a Delaware corporation ("Magellan" or the "Company"(“Magellan”), include the accounts of the Company andMagellan, its majority owned subsidiaries. The consolidated financial statements as of December 31, 2003, also includesubsidiaries and all variable interest entities ("VIEs"(“VIEs”) for which the CompanyMagellan is the primary beneficiary.beneficiary (together with Magellan, the “Company”). The Company'sCompany’s principal offices and operations are in the United States. All significant intercompany accounts and transactions have been eliminated in consolidation.
As discussed further in Note 2—"“Fresh Start Reporting,"” the Company applied the fresh start reporting provisions of American Institute of Certified Public Accountants ("AICPA"(“AICPA”) Statement of Position 90-7, "Financial“Financial Reporting by Entities in Reorganization under the Bankruptcy Code" ("Code” (“SOP 90-7"90-7”) as of December 31, 2003. Accordingly, the consolidated balance sheets of the Company prior to December 31, 2003 are not comparable with the consolidated balance sheetsheets as of, and subsequent to December 31, 2003. Therefore, allAll balance sheet data as of, and subsequent to December 31, 2003 has been disclosed herein asrepresents balances of the Reorganized“Reorganized Company,” and all balance sheet data prior to December 31, 2003, has been disclosed aswhere presented, represents balances of the Predecessor“Predecessor Company.” Statement of operations and statement of cash flows data for all periods presented hereinprior to January 1, 2004 represents the results of the Predecessor Company. Accordingly, all references to the Company with respect to disclosures of amounts recorded (i) through or prior to December 31, 2003 in relation to income statement of operations or cash flow items; and (ii) prior to December 31, 2003 in relation to balance sheet items, relate to the Predecessor Company. All references to the Company with respect to disclosures of amounts recorded or to be recorded (i) after December 31, 2003 in relation to income statement of operations or cash flow items; and (ii) on or after December 31, 2003 in relation to balance sheet items, relate to the Reorganized Company.
Change in Fiscal Year
In May 2003, the Predecessor Company'sCompany’s board of directors approved a change in the Predecessor Company'sCompany’s fiscal year. Instead of a fiscal year ending on September 30, Magellan has adopted a fiscal year that coincides with the calendar year, effective December 31, 2002. On August 12, 2003, the Predecessor Company filed with the Securities and Exchange Commission ("SEC"(“SEC”) a Transition Report on Form 10-K for the three-month period ended December 31, 2002. As a result of this change, the audited consolidated statements of operations, changes in stockholders'stockholders’ equity and cash flows presented herein include the three-month transition period ended December 31, 2002 and each of the two previous fiscal yearsyear ended September 30, 2001 and 2002. The accompanying consolidated financial statements and notes to the consolidated financial statements also include comparative, unaudited financial information for the three months ended December 31, 2001. Throughout these financial statements, references to the Predecessor Company'sCompany’s historical financial information prior to December 31, 2002 will refer to the Predecessor Company'sCompany’s former fiscal year end of September 30. For example, fiscal years 2001 and 2002 correspond to the twelve-month periods ended September 30, 2001 and 2002, respectively. References to fiscal 2003 relate to the Predecessor Company'sCompany’s fiscal year ended December 31, 2003.
F-9F-8
Emergence Fromfrom Chapter 11
On January 5, 2004 (the "Effective Date"“Effective Date”), Magellan and 88 of its subsidiaries consummated their Third Joint Amended Plan of Reorganization, as modified and confirmed (the "Plan"“Plan”), under chapter 11 of title 11 of the United States Bankruptcy Code (the "Bankruptcy Code"“Bankruptcy Code”), which had been confirmed by order of the United States Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"“Bankruptcy Court”) on October 8, 2003, and accordingly the Plan became fully effective and the companies emerged from the protection of their chapter 11 proceedings. The cash and other distributions to which the Company’s former creditors and stockholders became entitled under the Plan were made on the Effective Date or shortly thereafter, except that distributions in respect of certain disputed claims were reserved as of the Effective Date, to be made upon resolution of the disputed claims. As discussed below, all but an immaterial portion of such disputed claims were resolved and the required distributions were completed during 2004. Magellan and these subsidiaries had filed voluntary petitions for relief under the Bankruptcy Code in the Bankruptcy Court on March 11, 2003.
The following is a summary of the transactions which became effective on the Effective Date pursuant to or in connection with the consummation of the Plan. The distributions to which the Company'sCompany’s former creditors and shareholders became entitled under the Plan were made by the Company on the Effective Date or were disbursed in accordance with the Plan soon thereafter, except for certain immaterial distributions that were subsequently made or will be made in the future as provided for by the Plan upon certain conditions being satisfied. This summary only highlights certain of the substantive provisions of the Plan and the documents implementing the Plan.Plan and is qualified in its entirety by reference to (i) the full text of the Plan, a copy of which was filed as Exhibit 2(a) to Magellan’s Quarterly Report on Form 10-Q filed with the SEC on August 19, 2003, as first supplemented by the modification filed as Exhibit 99.2 to Magellan’s Current Report on Form 8-K filed with the SEC on September 30, 2003 and further supplemented by the modification filed as Exhibit 2.3 to Magellan’s Current Report on Form 8-K filed with the SEC on October 9, 2003 and as to be implemented pursuant to the confirmation order, a copy of which was filed as Exhibit 2.4 to Magellan’s Current Report on Form 8-K filed with the SEC on October 9, 2003, and (ii) the implementing documents, which are referred to below in this summary, filed as Exhibits 2.2 - 2.15 to Magellan’s Current Report on Form 8-K filed with the SEC on January 6, 2004, and as amended in certain instances by Magellan’s Current Reports on Form 8-K and Form 8-K/A filed with the SEC on January 7, 2004.
Giving effect to the Plan, Magellan and its subsidiaries continued, in their previous organizational form, to conduct their business as previously conducted, with the same assets in all material respects (except for cash to be distributed under the Plan to former creditors of the Company), but the Company was recapitalized. Specifically, the Company'sCompany’s secured bank loans, as existing before the Effective Date, were paid in full, and other then existingthen-existing indebtedness (i.e., two classes of notes and general unsecured creditor claims) and the then existingthen-existing equity interests in Magellan were cancelled as of the Effective Date in exchange for the distributions provided for by the Plan, as further described below, all as of the Effective Date.
On the Effective Date, the Company entered into a credit agreement with Deutsche Bank, as lender and administrative agent, and other lenders providing for a $100.0 million term loan, an $80.0 million letter of credit facility and a $50.0 million revolving credit facility (collectively,facility. The interest rate on term loan and revolving credit borrowings fluctuates, and originally was at a rate that was equal to the "Credit Agreement")higher of (i) the prime rate established by Deutsche Bank or (ii) one-half of one percent in excess of the overnight “federal funds” rate, as from time to time in effect, plus in either case two and one-half percent per year, subject to the Company’s election to have interest calculated based on the “Eurodollar rate” offered by Deutsche Bank plus three and one-half percent per year (see discussion of credit agreement amendment below). The interest rate on letter of credit-related borrowings was fixed at 3.5 percent. However, in each case the interest rate could be reduced upon achievement of certain conditions. Borrowings under the credit
F-9
agreement will mature on August 15, 2008 and certain quarterly principal payments on the term loan are also required. Magellan’s obligations under the credit agreement are guaranteed by substantially all of the subsidiaries of Magellan and are secured by substantially all of the assets of Magellan and the subsidiary guarantors. On the Effective Date, in accordance with the Plan, the proceeds of the term loan, together with other existing funds, were used on the Effective Date to repay in full the Company'sCompany’s senior secured bank indebtedness under its previous credit agreement (the "Old“Old Credit Agreement"Agreement”) of approximately $161 million, to make other cash payments contemplated by the Plan, to pay fees and expenses related to the chapter 11 cases, and for general working capital purposes. In addition, the letter of credit facility has been utilized to back letters of credit outstanding on the Effective Date and to provide additional letters of credit when needed for the Company'sCompany’s business. In September 2004, the Company reduced the letter of credit facility from $80.0 million to $50.0 million. Also, in October 2004 the credit agreement was amended to reduce the annual interest rate on borrowings under the term loan facility and the letter of credit facility, each by 1.25 percent. This credit agreement as initially entered into and as amended is referred to hereafter as the “Credit Agreement.” For a further discussion of the Credit Agreement, see Note 7—"“Long-Term Debt and Capital Lease Obligations".Obligations.”
As of the Effective Date, in satisfaction of the $250$250.0 million of principal owed on the 9.375% senior notes due 2007 (the "Old“Old Senior Notes"Notes”) and all accrued and unpaid interest thereon, the Company issued to the holders of such notes approximately $233.5 million in original principal amount of Series A notes of a new issue of senior notes due November 15, 2008 (the "Series“Series A Notes",Notes,” together with the Series B Notes (see below), the "Senior Notes"“Senior Notes”) and made a cash payment of
F-10
approximately $46.1 million. The terms of the Senior Notes are substantially similar to those of the Old Senior Notes, except that they mature on November 15, 2008. For a further discussion of the Senior Notes, see Note 7—"“Long-Term Debt and Capital Lease Obligations".Obligations.”
Under the Plan, holders of the Company's previousCompany’s previously outstanding 9% Senior Subordinated Notes due 2008 in the principal amount of $625.0 million (the "Old“Old Subordinated Notes"Notes”) and holders of general unsecured creditor claims, (otherother than claims on the Old Senior Notes and Old Subordinated Notes) ("Notes (“Other GUCs"GUCs”), were to receive in the aggregate approximately 97 percent of the Ordinary Common Stock par value $0.01 per share (“Ordinary Common Stock”) (or approximately 22.3 million shares) of the reorganized Company (before giving effect to the Cash-Out Elections discussed below). The actual number of shares allocated between these two classes of creditors, as well as the number of shares allocated to each individual creditor in such creditor classes, is dependentwas made, in accordance with the Plan, based upon the final,estimated, total aggregate claims value of claims for the two creditor classes, as discussed further below.
As of the Effective Date, the Company estimated that the holders of the Old Subordinated Notes would receive in satisfaction of their claims (including all accrued and unpaid interest), approximately 20.5 million shares of Ordinary Common Stock of Magellan (before giving effect to the Cash-Out Elections discussed below). Accordingly, the Company distributed, as of the Effective Date, approximately 32.83 shares per $1,000 of principal amount of such notes (although no fractional shares or cash in lieu thereof were issued or paid). The share distribution amount has been adjusted during 2004 and is subject to adjustmentfurther adjustments as set forth below.
As ofIn accordance with the Effective Date, the Company estimated that total claims ofPlan, Other GUCs would be approximately $78 million (including unresolved disputed claims). Under the Plan, and based upon this total estimated claim value, such creditor class was estimated to receivereceived in satisfaction of their claims (including any unpaid interest accrued thereon) the following consideration for each $1,000 of claim value: (i) $50.34 in cash, (ii) $254.99 of Series B of the Senior Notes ("(“Series B Notes"Notes”), and (iii) 22.41 shares of Ordinary Common Stock (although no fractional shares or cash in lieu thereof were or will be issued or paid), for an aggregate of 1.8 million shares (before giving effect to the Cash-Out Elections discussed below). AsReflected on the Company’s balance sheet as of March 4,December 31, 2003 and 2004 the Company has issuedwere approximately $5.1 million and $5.3 million, respectively, of Series B Notes for the settled claims of Other GUCs. Also, the Company issued $1.8 million of Series B Notes as partial consideration for services performed by one of the financial advisers involved with the reorganization efforts. The Series B Notes portionsconsideration for claims of certain other claims of
F-10
Other GUCs werewas settled for cash, based upon claim settlement terms between the Company and such individual general unsecured creditors.claimants. The Ordinary Common Stock share distribution amount has been adjusted during 2004 and is subject to further adjustment as set forth below.
The Company currently estimates thatAs of February 22, 2005, the total claim valueamount of outstanding, disputed claims for Other GUCs is $6.3 million (“Disputed Claims”). The Company does not believe that it is probable that liability for the Disputed Claims will ultimately be resolved for approximately $55.0 million, of which $50.5 millionincurred, and thus no liability has been settledrecorded for the Disputed Claims as of March 4,December 31, 2004. IfNonetheless, the claims of Other GUCs are ultimately resolved for the Company's current estimate of $55.0 million, the Other GUCs would receive additional consideration of approximately 0.53Company has reserved, but treated as outstanding, 144,437 shares of Ordinary Common Stock per $1,000 of claim value (although no fractional shares or cash in lieu thereofwhich will be issued or paid) anddistributed in accordance with the terms of the Plan to holders of claims on the Old Subordinated Notes would receive an additional 0.77 sharesor Other GUCs (including holders of Ordinary Common Stock per $1,000Disputed Claims to the extent their claims are allowed) upon the final resolution of principalthe Disputed Claims, subject, however, to adjustment on account of Cash-Out Elections as described below. If the Disputed Claims were to be resolved for their full amount of such notes (although no fractional shares or$6.3 million, then the Company would also be required to issue to the individual claimants that filed the Disputed Claims additional consideration of $0.3 million in cash in lieu thereof will be issued or paid).and Series B Notes of $1.6 million.
F-11
Also on the Effective Date, the previously outstanding shares of Common Stock and Preferred Stock of Magellan were cancelled, three new classes of capital stock were authorized and Magellan'sMagellan’s certificate of incorporation and bylaws were amended and restated. Specifically, 100 million shares of Ordinary Common Stock, $0.01 par value per share ("Ordinary Common Stock"), and 40 million shares of Multiple and Variable Vote Restricted Convertible Common Stock, $0.01 par value per share ("(“Multi-Vote Common Stock"Stock”) were authorized, as were 10 million shares of Preferred Stock, $0.01 par value per share (the “Preferred Stock”), that are issuable at the discretion of the Board of Directors in the manner provided by law in one or more series with such powers, privileges and rights as may be determined by the Board (except that no non-voting shares shall be issued). No shares of Preferred Stock were issued or are to be issued under the Plan. Shares of the Multi-Vote Common Stock may only be issued to, and held by, Onex Corporation, a Canadian corporation, or an affiliate thereof (collectively, "Onex"“Onex”). As described below, Onex, in connection with the Plan, invested in the equity of Magellan in the form of shares of Multi-Vote Common Stock. Upon transfer of any shares of Multi-Vote Common Stock to any party other than Onex, the shares of Multi-Vote Common Stock will automatically convert on a share-for-share basis into shares of Ordinary Common Stock. In addition, any shares of Ordinary Common Stock that Onex may come to own at any time when the Multi-Vote Common Stock is outstanding will automatically convert into shares of Multi-Vote Common Stock.
In general, the Multi-Vote Common Stock and Ordinary Common Stock have the same powers, privileges and rights, and each share represents an equivalent interest in Magellan'sMagellan’s equity, except that the shares of Multi-Vote Common Stock will have the number of votes per share from time to time sufficient so that all the outstanding shares of Multi-Vote Common Stock will have an equal number of votes as all the outstanding shares of Ordinary Common Stock (i.e., the Multi-Vote Common Stock will be entitled to exercise 50 percent of the voting power of all the classes of common stock of Magellan). The Multi-Vote Common Stock and Ordinary Common Stock also differ in that each class has different voting rights in the election of directors and certain other voting rights and other special rights and privileges. The Multi-Vote Common Stock will cease to have any special voting rights or any other special rights or powers in the event the outstanding shares of Multi-Vote Common Stock cease to represent at least 15.33 percent of the total number of shares of common stock (both Ordinary Common Stock and Multi-Vote Common Stock) issued on the Effective Date (approximately 35.1 million shares) or at least 10 percent of the total number of shares of common stock outstanding at any time (the "Minimum“Minimum Hold Condition"Condition”). Shares of the Ordinary Common Stock and Multi-Vote Common Stock are referred to below collectively as “Shares of Common Stock.”
As part of the Plan, Magellan offered to holders of its Old Subordinated Notes, its general unsecured creditorsthe Other GUCs and one holder of an administrative claim the opportunity to purchase, on the effective date of the Plan, shares of common stock equivalentup to 6,052,632 shares of Ordinary Common Stock for a total purchase price of $75 million ($12.39 per share).
F-11
The Company also received as part of the Plan a commitment from Onex to purchase on the same terms anya number of shares of Multi-Vote Common Stock equal to the amount of shares of Ordinary Common Stock not purchased in the Equity Offering by the creditors to whom such shares were offered. Pursuant to the equity offering included in the Plan, creditors purchased 5,111,019 shares of Ordinary Common Stock and Onex purchased 941,613 shares.shares of Multi-Vote Common Stock.
Onex also purchased, pursuant to an additional commitment under the Plan, 6,052,632 shares of common stockMulti-Vote Common Stock for a total purchase price of $75 million (the "Onex Investment"“Onex Investment”), or $12.39 per share. In addition, Onex committed, under the Plan, to fund an offer made by Magellan pursuant to the Plan
F-12
to holders of its Old Subordinated Notes and to the Company'sCompany’s other general unsecured creditors permitting them to elect to receive $9.78 in cash per share in lieu of the shares of Ordinary Common Stock they would otherwise receive under the Plan (the "Cash-Out Election"“Cash-Out Election”). Onex committed to fund the Cash-Out Election by purchasing that amount of shares of Multi-Vote Common Stock at $9.78 per share equal to the amount of shares of Ordinary Common Stock cashed out pursuant to the Cash-Out Election. As of the Effective Date,December 31, 2003, Onex had purchased 1,421,335 shares pursuant to this commitment. Also pursuant to this commitment, Onexand committed to purchase subsequent to the Effective Date, up to an additional 137,1208,552,700 shares pursuant to this commitment as a result of the settlement of claims that had elected the Cash-Out Election but were disputed and unresolved at the Effective Date. Onex has purchased and will purchase 8,552,700Multi-Vote Common Stock shares in the aggregate (in(941,613 shares in the Equity Offering, 6,052,632 shares pursuant to the Onex Investment and 1,558,455 shares to fund the Cash-Out Election), all. In January 2004, Onex sold 82,854 shares of which areMulti-Vote Common Stock to Morgan Noble LLC, resulting in the conversion of such shares to Ordinary Common Stock upon the transfer of the shares. Also during fiscal 2004, Onex purchased another 17,904 shares of Multi-Vote Common Stock as a result of its commitment under the Cash-Out Election. Therefore, as of December 31, 2004, Onex owned 8,487,750 shares of Multi-Vote Common Stock. These shares represented approximately 24.0 percent of the shares of common stock outstanding as of December 31, 2004, and 23.3 percent of the common stock on a fully diluted basis as of December 31, 2004. As stated above,part of Onex’s commitment under the allocationCash-Out Election, as of stock among creditors will changeFebruary 22, 2005, Onex is required to purchase an additional 17,850 shares of Multi-Vote Common Stock based on the valueresolution of alldisputed claims as ultimately resolved. If all claims are ultimately resolved for the amount of the Company's current estimate, 36,592 additional shares would be allocatedOther GUCs through such date. Also in relation to claims that had electedOnex’s commitment under the Cash-Out Election, which would result insubsequent to February 22, 2005, Onex acquiring anmay be required to purchase additional 36,592Multi-Vote Common Stock shares, at $9.78 per share (fortotaling up to a totalmaximum of 8,589,292 shares). Issuance costs11,269shares, based upon the ultimate resolution of approximately $3.1 million were incurred in relation to the Onex transactions.remaining Disputed Claims.
The previously outstanding Series A Redeemable Preferred Stock of Magellan was cancelled on the Effective Date and the holders thereof were issued 456,660 shares of Ordinary Common Stock, as well as warrants to purchase until January 5, 2011 for $30.46 per share, 456,660 shares of Ordinary Common Stock. The previously outstanding common stock of Magellan also was cancelled on the Effective Date and the holders thereof received 114,165 shares of Ordinary Common Stock, as well as warrants to purchase at any time until January 5, 2011 for $30.46 per share, 114,165 shares of Ordinary Common Stock, which equals approximately one share of Ordinary Common Stock and a warrant to purchase one share of Ordinary Common Stock for every 310 shares of the previously outstanding common stock.Stock. For further information regarding the warrants issued under the Plan, see Note 8—"Stockholders' Equity".“Stockholders’ Equity.” Pursuant to the Plan, on the Effective Date all previously outstanding options and warrants to purchase common stock of Magellan were cancelled.
As part of the consummation of the Plan, an agreement became effective between Aetna, Inc. ("Aetna"(“Aetna”) and the Company to renew their behavioral health services contract. Undercontract, relating to the renewed agreement, the Company will continue to manageCompany’s management of the behavioral health care of members of Aetna'sAetna’s healthcare programs through December 31, 2005. On December 8, 2004, the Company was informed that Aetna planned to not renew such contract as of December 31, 2005, with anand that Aetna planned to exercise its option for Aetna at that time to either extend the agreement or to purchase, on December 31, 2005, certain assets of the Company used solely in the management of the behavioral healthcare of Aetnahealth care services for Aetna’s members (the "Aetna-Dedicated Assets"“Aetna Assets”). Pursuant to the Plan, on February 23, 2005, the Company and Aetna executed an asset purchase agreement related to Aetna’s purchase of the Aetna Assets. Pursuant to the Plan, on the Effective Date, the Company paid $15.0 million to Aetna, out of a debt obligation allowed under the Plan of $60.0 million plus accrued interest, and issued to Aetna an interest-bearing note (the "Aetna Note"“Aetna Note”) for the balance of $48.9 million, which will mature on
F-12
December 31, 2005. The Aetna Note is guaranteed by substantially all of the subsidiaries of Magellan and is secured by a second lien on substantially all of the assets of Magellan and the subsidiary guarantors. Additionally, if the behavioral health services contract is extended by Aetna at its option through at least December 31, 2006, one-halfUpon Aetna’s purchase of the Aetna Note would be payable on December 31, 2005, and the remainder would
F-13
be payable on December 31, 2006. If Aetna opts to purchase the Aetna-Dedicated Assets, the purchase price (or a portion thereof) could be offset against any amounts owing under the Aetna Note. In addition,Also pursuant to the Plan, the Company issued to Aetna a warrant to purchase 230,000 shares of Ordinary Common Stock from January 1, 2006 to January 5, 2009 at a purchase price of $10.48 per share. For further information regarding the Company'sCompany’s agreement with Aetna, the Aetna Note and the warrant issued to Aetna under the Plan, see Note 7—"“Long-Term Debt and Capital Lease Obligations"Obligations” and Note 8—"Stockholders' Equity".“Stockholders’ Equity.”
On the Effective Date, Magellan’s Board of Directors was reconstituted to consist of nine members, as specified in accordance with the Plan.
The Company'sCompany’s senior executive officers before the Effective Date (Steven J. Shulman, René Lerer, M.D. and other key officersMark S. Demilio) entered into employment agreements with Magellan as of the Effective Date in a form provided by the Plan and continued in their current positions. In general, the Company’s other senior officers continued in Magellan’s employment in substantially the same positions after the Effective Date and entered into employment agreements with Magellan in a form provided by the Plan. AThe 2003 Management Incentive Plan became effective on the Effective Date in accordance with the Plan, under which restricted stock awards, stock options and other equity incentives may be issued to members of the Company'sCompany’s management and other employees. The Company'sCompany’s employment agreements with its senior executive officers provided for the purchase by the Company's Chief Executive OfficerMr. Shulman of certain shares of Ordinary Common Stock and for the grant to each such officer (pursuantpursuant to the 2003 Management Incentive Plan)Plan of certain restricted shares of Ordinary Common Stock, all as of the Effective Date, and for certain cash payments to such officers related to the income taxes incurred by them in connection with such transactions. Options for a total of 4.34.4 million shares of Ordinary Common Stock were issued under the 2003 Management Incentive Plan in January and Februaryduring fiscal 2004. See Note 8—"Stockholders' Equity"“Stockholders’ Equity” for a discussion of charges anticipated to be recorded by the Company related to stock grants, stock options and related cash payments.payments pursuant to the employment agreements and stock options under the 2003 Management Incentive Plan.
On November 24, 2004, the Company and its pertinent subsidiaries filed an application with the Bankruptcy Court for a final decree to close their chapter 11 case. The application was entered by the Bankruptcy Court on January 19, 2005 thereby closing the chapter 11 case.
In connection with the consummation of the Plan, the Company adopted the fresh start reporting provisions SOP 90-7, with respect to its financial reports, which requiresrequired the Company to restate its assets and liabilities to their fair values based upon the provisions of the Plan and certain valuations which the Company has made in connection with the implementation of the Plan. The Company iswas required to apply the fresh-start provisions of SOP 90-7 to its financial statements because it hashad concluded that (a) the reorganization value of the assets of the emerging entity immediately before the date of confirmation was less than the total of all post-petition liabilities and allowed claims and (b) the holders of existing voting shares of the Company immediately before confirmation (i.e., the holders of shares of Magellan'sMagellan’s pre-petition common stock that were issued and outstanding prior to the commencement of the chapter 11 proceedings) received less than 50 percent of the voting shares of the emerging entity. SOP 90-7 sets forth the principles regarding the date at which a company that has emerged from a chapter 11 proceeding should apply fresh start reporting to account for the effects of the plan of reorganization. Under SOP 90-7, application of fresh start reporting is required on the date on which the plan of reorganization is confirmed by the bankruptcy court, but SOP 90-7 further provides that fresh start reporting shouldis not be applied until all material conditions are satisfied. All material conditions to the Plan were satisfied as of December 29, 2003 (the "Material“Material Conditions Date"Date”). Due to the proximity of the Material Conditions Date to year end and the immateriality of the results of operations for the intervening two-day period through December 31,
F-13
2003, the Company applied fresh start reporting as if the material conditions were satisfied on December 31, 2003.
F-14
The fair value of the Reorganized Company, or the reorganization value, of approximately $675.0 million, prior to $146.9 million of net proceeds from new equity in the Company as discussed in Note 1—"General",“General,” was allocated to long-term debt and equity in accordance with SOP 90-7. The reorganization value was estimated by independent appraisers utilizing comparable-company trading multiples and discounted cash-flow methodologies. Based on the Plan, the Company'sCompany’s reorganization value, excluding debt, resulted in equity reorganization value, as disclosed in the Plan, of $241.0 million (prior to the aforementioned new equity transactions). Fresh start reporting requires that the reorganization value be allocated to the entity'sentity’s net assets in conformity with procedures specified by Statement of Financial Accounting Standards ("SFAS"(“SFAS”) No. 141, "Business“Business Combinations," ("” (“SFAS 141"141”). The Company engaged another independent appraiser to assist in the allocation of the reorganization value to the Reorganized Company'sCompany’s assets and liabilities by determining the fair market value of the Company'sCompany’s property and equipment and intangible assets. The fair value adjustments primarily impacted goodwill, intangible assets, fixed assets and certain liabilities.
F-14
A reconciliation of the adjustments to be recorded in connection with the reorganization of debt and equity and the adoption of fresh start reporting is presented below (in thousands):
| | | Predeccesor Company December 31, 2003 | Reorganization of Debt and Equity (1) | Issuance of New Securities (2) | Fresh Start Adjustments (3) | Reorganized Company December 31, 2003 |
| Predecessor |
| Reorganization |
| Issuance |
| Fresh |
| Reorganized |
| ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| ASSETS | ASSETS |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
| Current Assets: | Current Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
| Cash and cash equivalents | Cash and cash equivalents | $ | 206,948 | $ | — | $ | — | $ | — | $ | 206,948 |
|
| $ 206,948 |
|
|
| $ — |
|
|
| $ — |
|
|
| $ — |
|
|
| $ 206,948 |
|
| |||||
Restricted cash |
|
| 102,356 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 102,356 |
|
| ||||||||||||||||
| Stock subscriptions receivable | Stock subscriptions receivable | — | — | 146,871 | — | 146,871 |
|
| — |
|
|
| — |
|
|
| 146,871 |
|
|
| — |
|
|
| 146,871 |
|
| ||||||||||
| Accounts receivable, net | Accounts receivable, net | 83,775 | 144 | — | — | 83,919 |
|
| 83,775 |
|
|
| 144 |
|
|
| — |
|
|
| — |
|
|
| 83,919 |
|
| ||||||||||
| Restricted cash, investments and deposits | 161,923 | — | — | — | 161,923 | ||||||||||||||||||||||||||||||||
Short-term investments. |
|
| 24,405 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 24,405 |
|
| ||||||||||||||||
| Other current assets | Other current assets | 15,317 | 15,245 | — | — | 30,562 |
|
| 50,479 |
|
|
| 15,245 |
|
|
| — |
|
|
| — |
|
|
| 65,724 |
|
| ||||||||||
| Total current assets | 467,963 | 15,389 | 146,871 | — | 630,223 | ||||||||||||||||||||||||||||||||
Total current assets |
|
| 467,963 |
|
|
| 15,389 |
|
|
| 146,871 |
|
|
| — |
|
|
| 630,223 |
|
| ||||||||||||||||
Property and equipment, net | Property and equipment, net | 83,860 | — | — | 38,222 | (4) | 122,082 |
|
| 83,860 |
|
|
| — |
|
|
| — |
|
|
| 38,222 | (4) |
|
| 122,082 |
|
| |||||||||
| Investments in unconsolidated subsidiaries | Investments in unconsolidated subsidiaries | 13,034 | — | — | — | 13,034 |
|
| 13,034 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 13,034 |
|
| ||||||||||
| Other long-term assets | Other long-term assets | 19,513 | — | — | (1,179 | )(4) | 18,334 |
|
| 19,513 |
|
|
| — |
|
|
| — |
|
|
| (1,179 | )(4) |
|
| 18,334 |
|
| |||||||||
| Goodwill, predecessor | Goodwill, predecessor | 472,818 | — | — | (472,818 | )(4) | — |
|
| 472,818 |
|
|
| — |
|
|
| — |
|
|
| (472,818 | )(4) |
|
| — |
|
| |||||||||
| Goodwill, reorganized | Goodwill, reorganized | — | — | — | 450,244 | 450,244 |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 450,244 |
|
|
| 450,244 |
|
| ||||||||||
| Other intangible assets | Other intangible assets | 51,261 | — | — | 6,839 | (4) | 58,100 |
|
| 51,261 |
|
|
| — |
|
|
| — |
|
|
| 6,839 | (4) |
|
| 58,100 |
|
| |||||||||
|
| $1,108,449 |
|
|
| $ 15,389 |
|
|
| $146,871 |
|
|
| $ 21,308 |
|
|
| $1,292,017 |
|
| |||||||||||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Current Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Accounts payable |
|
| $ 22,006 |
|
|
| $ 1,349 |
|
|
| $ — |
|
|
| $ — |
|
|
| $ 23,355 |
|
| ||||||||||||||||
Accrued liabilities |
|
| 110,756 |
|
|
| 157,313 |
|
|
| — |
|
|
| (62,201 | )(4) |
|
| 205,868 |
|
| ||||||||||||||||
Medical claims payable |
|
| 172,700 |
|
|
| 4,441 |
|
|
| — |
|
|
| — |
|
|
| 177,141 |
|
| ||||||||||||||||
Current maturities of long-term debt |
|
| 170,623 |
|
|
| (145,838 | ) |
|
| — |
|
|
| — |
|
|
| 24,785 |
|
| ||||||||||||||||
Debt paid upon consummation of the Plan |
|
| — |
|
|
| 92,382 |
|
|
| — |
|
|
| — |
|
|
| 92,382 |
|
| ||||||||||||||||
Current liabilities subject to compromise |
|
| 1,160,675 |
|
|
| (1,160,675 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||||||||||
Total current liabilities |
|
| 1,636,760 |
|
|
| (1,051,028 | ) |
|
| — |
|
|
| (62,201 | ) |
|
| 523,531 |
|
| ||||||||||||||||
Long-term debt and capital lease obligations |
|
| 2,271 |
|
|
| 374,261 |
|
|
| — |
|
|
| — |
|
|
| 376,532 |
|
| ||||||||||||||||
Deferred credits and other long-term liabilities |
|
| 1,175 |
|
|
| 627 |
|
|
| — |
|
|
| — |
|
|
| 1,802 |
|
| ||||||||||||||||
Minority interest |
|
| 2,241 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 2,241 |
|
| ||||||||||||||||
Long-term liabilities subject to compromise |
|
| 627 |
|
|
| (627 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||||||||||
Predecessor Company redeemable preferred stock subject to compromise |
|
| 72,766 |
|
|
| (72,766 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||||||||||
Stockholders’ Equity: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Predecessor Company common stock and warrants |
|
| 339,118 |
|
|
| (339,118 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
| ||||||||||||||||
Reorganized Company common stock, warrants and additional paid-in capital |
|
| — |
|
|
| 242,163 |
|
|
| 146,871 |
|
|
| (1,123 | ) |
|
| 387,911 |
|
| ||||||||||||||||
Accumulated deficit |
|
| (946,509 | ) |
|
| 861,877 | (4) |
|
| — |
|
|
| 84,632 |
|
|
| — |
|
| ||||||||||||||||
Total Stockholders’ Equity (Deficit) |
|
| (607,391 | ) |
|
| 764,922 |
|
|
| 146,871 |
|
|
| 83,509 |
|
|
| 387,911 |
|
| ||||||||||||||||
| $ | 1,108,449 | $ | 15,389 | $ | 146,871 | $ | 21,308 | $ | 1,292,017 |
|
| $1,108,449 |
|
|
| $ 15,389 |
|
|
| $146,871 |
|
|
| $ 21,308 |
|
|
| $1,292,017 |
|
| |||||||
F-15
| LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) | ||||||||||||||||
| Current Liabilities: | ||||||||||||||||
| Accounts payable | $ | 22,006 | $ | 1,349 | $ | — | $ | — | $ | 23,355 | ||||||
| Accrued liabilities | 110,756 | 157,313 | — | (62,201 | )(4) | 205,868 | ||||||||||
| Medical claims payable | 172,700 | 4,441 | — | — | 177,141 | |||||||||||
| Current maturities of long-term debt | 170,623 | (145,838 | ) | — | — | 24,785 | ||||||||||
| Debt paid upon consummation of the Plan | — | 92,382 | — | — | 92,382 | |||||||||||
| Current liabilities subject to compromise | 1,160,675 | (1,160,675 | ) | — | — | — | ||||||||||
| Total current liabilities | 1,636,760 | (1,051,028 | ) | — | (62,201 | ) | 523,531 | |||||||||
| Long-term debt and capital lease obligations | 2,271 | 374,261 | — | — | 376,532 | |||||||||||
| Deferred credits and other long-term liabilities | 1,175 | 627 | — | — | 1,802 | |||||||||||
| Minority interest | 2,241 | — | — | — | 2,241 | |||||||||||
| Long-term liabilities subject to compromise | 627 | (627 | ) | — | — | — | ||||||||||
| Predecessor Company redeemable preferred stock subject to compromise | 72,766 | (72,766 | ) | — | — | — | ||||||||||
| Stockholders' Equity: | ||||||||||||||||
| Predecessor Company common stock and warrants | 339,118 | (339,118 | ) | — | — | — | ||||||||||
| Reorganized Company common stock, warrants and additional paid-in capital | — | 242,163 | 146,871 | (1,123 | ) | 387,911 | ||||||||||
| Accumulated deficit | (946,509 | ) | 861,877 | (4) | — | 84,632 | — | |||||||||
| Total Stockholders' Equity (Deficit) | (607,391 | ) | 764,922 | 146,871 | 83,509 | 387,911 | ||||||||||
| $ | 1,108,449 | $ | 15,389 | $ | 146,871 | $ | 21,308 | $ | 1,292,017 | |||||||
(1)To record the reorganization of debt and equity in accordance with the Plan, including the discharge of pre-petition liabilities comprised principally of $625.0 million of Old Subordinated Notes, accrued interest on Old Subordinated Notes of $32.2 million, redeemable preferred stock of $72.8 million and estimated other general unsecured claims of $55.0 million.F-16
(2)
(3)
(4)
| Net gain resulting from reorganization of debt, preferred stock and equity | $ | 861,877 | |||
| Net loss resulting from fresh start value adjustments to assets and liabilities, excluding Reorganized Company goodwill | (366,735 | ) | |||
| Net fresh start reorganization gain | $ | 495,142 | |||
Net gain resulting from reorganization of debt, preferred stock and equity |
| $ 861,877 | |
Net loss resulting from fresh start value adjustments to assets and liabilities, excluding Reorganized Company goodwill | (366,735 | ) | |
Net fresh start reorganization gain | $ 495,142 |
Certain transactions that occurred on the Effective Date, while consummated in connection with the Plan, were not required by the Plan and thus, pursuant to SOP 90-7, are not recorded as part of the fresh start reporting as of December 31, 2003. Accordingly, these transactions will bewere recorded in the first quarter of 2004. In addition, cash transfers related to various transactions associated with the Plan occurred on the Effective Date, or shortly thereafter, and also are not recorded until 2004. These transactions and cash transfers include, among others, the entering into of the Credit Agreement and the repayment of the amounts outstanding under the Old Credit Agreement; the receipt of cash from the sale of equity to creditors pursuant to the Equity Offering and to Onex pursuant to the Onex Investment, the Equity Offering and the Cash-Out Election; the issuance of stock and options to management and other employees and other cash payments to management pursuant to their employment agreements entered into on the Effective Date; and cash payments related to certain liabilities incurred in the chapter 11 proceedings, including professional fees and success fees.
Net proceeds from new equity in the Company received on the Effective Date are reflected as stock subscriptions receivable at December 31, 2003.
3. Summary of Significant Accounting Policies
Review of Significant Accounting Policies
As discussed in Note 2—“Fresh Start Reporting,” the Company adopted fresh start reporting as of December 31, 2003, creating, in substance, per SOP 90-7, a new reporting entity. The Reorganized Company has adopted the same acountingaccounting policies as the Predecessor Company with the exception of the date on which the Reorganized Company intends to perform its annual goodwill impairment test under SFAS No. 142. The ReorganizationReorganized Company will perform its annual goodwill impairment test on October 1, as opposedcompared to the previous date of September 1.
F-17Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51” (“FIN 46”). FIN 46 requires consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Historically, entities were generally consolidated by an enterprise when it had a controlling financial interest through ownership of a majority voting interest in the entity. The Reorganized Company early adopted the provisions of FIN 46 effective December 31, 2003. Early adoption of new accounting pronouncements is required by companies implementing the fresh start reporting provisions of SOP 90-7. Based on the guidance of FIN 46, the Reorganized Company determined that it is the primary beneficiary of Premier Behavioral Systems of Tennessee, LLC (“Premier”), a variable interest entity for which the Reorganized Company maintains a 50 percent voting interest. Consistent with the provisions of FIN 46, the Reorganized Company consolidated the balance
F-16
sheet of Premier into the Reorganized Company’s balance sheet as of December 31, 2003 and 2004. Through December 31, 2003, the Predecessor Company accounted for Premier under the equity method, whereby the Predecessor Company included its portion of Premier’s earnings or loss in its consolidated statement of operations under the caption “Equity in (earnings) loss of unconsolidated subsidiaries.” The creditors (or other beneficial interest holders) of Premier have no recourse to the general credit of the Company, as the primary beneficiary of Premier. The consolidation of Premier at December 31, 2003 increased total assets and total liabilities each by $43.2 million. The fair value of the accounts consolidated was equivalent to their book value at December 31, 2003. In 2004, the Reorganized Company consolidated the results of operations of Premier in its consolidated statement of operations, which represented $253.0 million of revenue for the fiscal year ended December 31, 2004.
The Company currently measures compensation cost for stock-based compensation under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and discloses pro forma stock-based compensation under the requirements of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure” (“SFAS 148”). Currently, the Company uses the Black-Scholes-Merton formula to estimate the value of stock options granted to employees and expects to continue to use this acceptable option valuation model upon the required July 1, 2005 adoption of Statement 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”). Since SFAS 123R must be applied not only to new awards but also to previously granted awards that are not fully vested on the effective date, and because the Company adopted SFAS 123, using the prospective transition method (which applied only to awards granted, modified or settled after the adoption date), compensation cost for some previously granted awards that were not recognized under SFAS 123 will be recognized under SFAS 123R. However, had SFAS 123R been adopted in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net income and earnings per share below entitled “Stock-Based Compensation.” SFAS 123R also requires the benefits of tax credits in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as permitted under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the Company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions were immaterial.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates of the Company include, among other things, accounts receivable realization, valuation allowances for deferred tax assets, valuation of goodwill and intangible assets, medical claims payable and legal liabilities. Actual results could differ from those estimates.
Financial Reporting Under the Bankruptcy Code
From March 11, 2003 (the "Commencement Date"“Commencement Date”) to December 31, 2003, the Company accounted for its operations under SOP 90-7. In accordance with SOP 90-7, certain expenses incurred and benefits realized by the Company during the bankruptcy period were recorded as "Reorganization“Reorganization benefit, net"net” in the accompanying audited consolidated statements of operations. In order to record its debt instruments at the amount of claim expected to be allowed by the Bankruptcy Court in accordance with SOP 90-7, as of the Commencement Date, Magellan wrote off as reorganization expense its capitalized deferred financing fees
F-17
associated with the Old Senior Notes and Old Subordinated Notes. Reorganization expense also includes professional fees and other expenses directly associated with the bankruptcy process. As part of its financial restructuring plan, the Company rejected certain leases for closed offices. To the extent the estimated cost to the Company as a result of rejecting such leases was different than the liability previously recorded, such difference was recorded as a component of reorganization benefit, net, in accordance with SOP 90-7. Furthermore, in accordance with SOP 90-7, reorganization benefit, net includes the estimated interest income that the Company earned attributable to additional unrestricted cash balances that accumulated as a result of the chapter 11 proceedings.
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The following table summarizes reorganization expense (benefit) for the fiscal year ended December 31, 2003 (in thousands):
| | Predecessor Company | ||||
|---|---|---|---|---|---|
| Continuing operations: | |||||
| Deferred financing costs | $ | 18,459 | |||
| Professional fees and expenses | 31,589 | ||||
| Interest income | (1,096 | ) | |||
| Net benefit from lease rejections and court approved claim reductions | (7,475 | ) | |||
| Net fresh start reorganization gain | (479,694 | ) | |||
| Net benefit from resolution of claims through Bankruptcy Court proceedings | $ | (438,217 | ) | ||
Discontinued operations, before taxes: | |||||
| Net benefit from lease rejections and court approved claim reductions | (4,062 | ) | |||
| Net fresh start reorganization gain | (15,448 | ) | |||
| Net benefit from resolution of claims through Bankruptcy Court proceedings | $ | (19,510 | ) | ||
| Preferred stock: | |||||
| Issuance costs and other | $ | 2,668 | |||
Predecessor | |||
Continuing operations: | |||
Deferred financing costs | $ 18,459 | ||
Professional fees and expenses | 31,589 | ||
Interest income | (1,096 | ) | |
Net benefit from lease rejections and court approved claim reductions | (7,475 | ) | |
Net fresh start reorganization gain | (479,694 | ) | |
Net benefit from resolution of claims through Bankruptcy Court proceedings | $(438,217 | ) | |
Discontinued operations, before taxes: | |||
Net benefit from lease rejections and court approved claim reductions | $ (4,062 | ) | |
Net fresh start reorganization gain | (15,448 | ) | |
Net benefit from resolution of claims through Bankruptcy Court proceedings | $ (19,510 | ) | |
Preferred stock: | |||
Issuance costs and other | $ 2,668 |
Managed Care Revenue.Revenue
Managed care revenue is recognized over the applicable coverage period on a per member basis for covered members. Managed care risk revenues earned for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003 approximated $1,540.7 million, $1,537.9 million and $1,292.5 million, respectively. Managed care risk revenuesrespectively and $390.3 million and $388.7 million for the three months ended December 31, 2001 and 2002, were approximately $390.3 million and $388.7 million, respectively. Managed care risk revenues earned for the fiscal year ended December 31, 2004 approximated $1,583.9 million.
Performance-based Revenue
The Company has the ability to earn performance-based revenue primarily under certain risk and non-risk contracts. Performance-based revenue generally is based on either the ability of the Company to manage care for its administrative services only ("ASO") clients below specified targets.targets, or on other operating metrics. For each such contract, the Company estimates and records performance-based revenue after considering the relevant contractual terms and the data available for the performance-based revenue calculation. Pro-rata performance-based revenue is recognized on an interim basis pursuant to the rights and obligations of each party upon termination of the contracts. Performance-based revenues were approximately $22.7 million, $13.0 million and $7.7 million in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively. Forrespectively and $3.4 million and $1.0 million for the three months ended December 31, 2001 and 2002, performance-basedrespectively. Performance-based revenues were approximately $3.4$9.7 million and $1.0 million, respectively.
The Company provides mental health and substance abuse services toin the beneficiaries of TRICARE, formerly the Civilian Health and Medical Program of the Uniformed Services
F-19
("CHAMPUS"), under a separate subcontract with a health plan that contracts with TRICARE. One of these subcontracts associated with TRICARE expired on April 30, 2003. The second subcontract expires on September 30, 2004 and will not be renewed. The health plan with which the Company has this second subcontract has not included the Company as a subcontractor in its bid to the government for a contract that is to take effect October 1, 2004. See discussion of these subcontracts in "Significant Customers" below. The Company receives fixed fees under its TRICARE subcontract for the management of the TRICARE services, which are subject to certain bid price adjustments ("BPAs"). The BPAs are calculated in accordance with contractual provisions and are based on actual healthcare utilization from historical periods as well as changes in certain factors during the contract period. The Company has information to record, on a quarterly basis, reasonable estimates of the BPAs as part of its managed care risk revenues. These estimates are based upon information available, on a quarterly basis, from both the TRICARE program and the Company's information systems. Under the contracts, the Company settles the BPAs at set intervals over the term of the contracts.
The Company recorded estimated receivables of approximately $3.6 million and $2.5 million as offiscal year ended December 31, 2002 and 2003, respectively, based upon the interim calculations of the estimated BPAs and certain other settlements. Such amounts were recorded as adjustments to revenues. While management believes that the estimated TRICARE adjustments are reasonable, ultimate settlement resulting from adjustments and available appeal processes may vary from the amounts provided.2004.
F-18
Significant Customers
Net revenues from two of the Company'sCompany’s customers each exceeded ten percent of consolidated net revenues in each of the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, as well as for the three months ended December 31, 2001 and 2002.2002 and for the fiscal year ended December 31, 2004.
Net revenuesrevenue from the Aetna approximated $315.6 million,contract was $250.3 million and $193.6 million for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively. Net revenues from Aetna wererespectively, $78.8 million and $54.8 million duringfor the three months ended December 31, 2001 and 2002, respectively.respectively, and $228.1 million for the fiscal year ended December 31, 2004. As described abovediscussed in Note 1 as part of—“General,” the consummation of the Plan,contract with Aetna and Magellan agreed to renew their contract, under which the Company will continue to manage the behavioral healthcare of Aetna's members throughterminate on December 31, 2005.
The Company provides managed behavioral healthcare services to the State of Tennessee'sTennessee’s TennCare program, both through a direct contract with the Company'sCompany’s wholly owned subsidiary Tennessee Behavioral Health, Inc. ("TBH"(“TBH”) and through Premier, Behavioral Systems of Tennessee, LLC ("Premier"), a joint venture in which the Company owns a fifty percent interest. In addition, the Company contracts with Premier to provide certain services to the joint venture. The Company'sCompany’s direct TennCare contract (exclusive of Premier'sPremier’s contract with TennCare) accounted for approximately $248.9 million, $237.5 million and $157.3 million of consolidated net revenue in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and approximately $60.0 million and $63.0 million of consolidated net revenue for the three months ended December 31, 2001 and 2002, respectively. Such revenue amounts include revenue recognized by the Company associated with services performed on behalf of Premier totaling $102.0 million, $134.9 million and $39.8 million for
F-20
fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and $33.6 million and $34.6 million for the three months ended December 31, 2001 and 2002, respectively. The Company’s direct TennCare contract (exclusive of Premier’s contract with TennCare) accounted for $178.5 million of consolidated net revenue in the fiscal year ended December 31, 2004. As previously noted, the Company started consolidating Premier in accordance with FIN 46 as of December 31, 2003. The Company recorded $253.0 million of revenue from Premier’s TennCare contract during the year ended December 31, 2004.
In September 2003, the State of Tennessee (“the State”) issued a request for proposal ("RFP"(“RFP”) relating to the TennCare program under which the program willwas to be divided into three regions. The Company, through TBH, submitted a proposal for the East region only and was awarded the contract. The new contract, with respect to the East region will become effectivewhich has a term from July 1, 2004.2004 through December 31, 2005, with extensions at the State’s option through December 31, 2008. When contract negotiations between the State and the vendor that had been awarded the contracts for the Middle and West regions were discontinued, the State asked TBH and Premier to continue with their current contracts for those regions through December 31, 2004. The East region contract has an initial term that runsEffective July 1, 2004 agreements with the State were reached, under which TBH and Premier will continue serving the Middle and West regions of TennCare through December 31, 2005. As a result of these agreements, the Company will continue to manage behavioral health care for the entire TennCare program.
On January 10, 2005, the Governor of Tennessee stated that, because of the increased costs of the TennCare program, the State will cease providing coverage to approximately 323,000 adults who do not qualify for Medicaid, and will limit benefits to be delivered under the TennCare program. The Governor stated that he wishes to begin implementing such membership and benefit changes in March 2005 and includes a provision for extensions atcomplete them by the State's option through December 31, 2008.
The Company managesend of 2005. Certain advocacy groups have filed suits in attempts to prevent the mental healthGovernor from implementing any membership and substance abuse services for certainbenefits reductions. A reduction in membership would, and benefit changes could adversely affect the Company’s revenues and profitability. However, because of the beneficiaries of TRICARE under a subcontract with a healthopposition to the Governor’s plan, that contracts with TRICARE. Theand because, even if the Governor were to prevail the Company recognized net revenues from this subcontract of $61.5 million, $48.0 million, and $47.3 million in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and $12.7 million and $14.0 million during the three months ended December 31, 2001 and 2002, respectively. This subcontract expires on September 30, 2004 and willdoes not yet know which members would be renewed. The Company previously had a second subcontract with another health plan that contracted with TRICARE. This second subcontract expired on April 30, 2003. The Company recognized net revenueseliminated from the second TRICARE subcontractprogram, the timing of $39.3 million, $31.2 million and $9.9 million for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and $8.3 million and $8.9 million duringmembership reductions, the three months ended December 31, 2001 and 2002, respectively.benefit changes being proposed or the timing of those changes, it cannot estimate the impact of these potential developments at this time.
F-19
The Company derives a significant portion of its revenue from contracts with various counties in the state of Pennsylvania (the "Pennsylvania Counties"“Pennsylvania Counties”). Although these are separate contracts with individual counties, they all pertain to the Pennsylvania Medicaid program. Revenues from the Pennsylvania Counties in the aggregate totaled approximately $121.1 million, $181.9 million and $189.6 million in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and approximately $36.0 million and $56.2 million for the three months ended December 31, 2001 and 2002, respectively.respectively, and $187.7 million in the fiscal year ended December 31, 2004. The Company'sCompany’s contract with one of the counties was terminated as of December 31, 2003. Revenue related to this particular county totaled approximately $19.6 million, $22.8 million and $24.0 million in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and approximately $5.1 million and $6.4 million for the three months ended December 31, 2001 and 2002, respectively.
Income Taxes
The Company files a consolidated federal income tax return for the Company and its wholly owned consolidated subsidiaries. The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting“Accounting for Income Taxes". Taxes.” The deferredCompany estimates income taxes for each of the jurisdictions in which it operates. This process involves estimating current tax exposures together with assessing temporary differences resulting from differing treatment of items for tax and book purposes. Deferred tax assets and/or liabilities are determined by multiplying the differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or
F-21
settled. The Company then assesses the likelihood that the deferred tax assets will be recovered from the reversal of temporary timing differences and future taxable income, and to the extent the Company cannot conclude that recovery is more likely than not, it establishes a valuation allowance. The effect of a change in tax rates on deferred taxes is recognized in income in the period that includes the enactment date. Valuation allowances on deferred tax assets are estimated based on the Company's assessment of the realizability of such amounts.
Advertising Costs
Advertising costs consist primarily of radio and television airtime and printed media services, which are expensed as incurred. Advertising expensecosts for continuing operations was approximatelywere $2.9 million and $2.1 million in each of the fiscal years ended September 30, 20012002 and 2002, respectively, and approximately $2.1 million in the fiscal year ended December 31, 2003. Advertising expenses for continuing operations was approximately2003, respectively, $0.7 million and $0.7 million for the three months ended December 31, 2002.2001 and 2002, respectively, and $2.2 million for the fiscal year ended December 31, 2004.
Cash and Cash equivalents
Cash equivalents are short-term, highly liquid interest-bearing investments with maturity dates of three months or less when purchased, consisting primarily of money market instruments.
F-20
Restricted Cash and InvestmentsAssets
Restricted cash and investments at December 31, 2002 and December 31, 2003 include approximately $127.3 million and $161.9 million, respectively, that is heldThe Company has certain assets which are considered restricted for: (i) the payment of claims under the terms of certain managed behavioral care contracts; (ii) regulatory purposes related to the payment of claims in certain jurisdictions; and (iii) the maintenance of minimum required tangible net equity levels for certain of the Company'sCompany’s subsidiaries. Significant restricted assets of the Company as of December 31, 2003 and 2004 were as follows (in thousands):
|
| 2003 |
| 2004 |
|
Restricted cash |
| $ 102,356 |
| $ 104,414 |
|
Restricted short-term investments |
| 24,405 |
| 35,600 |
|
Restricted deposits (included in other current assets) |
| 35,162 |
| 17,098 |
|
Restricted long-term investments. |
| — |
| 592 |
|
Total |
| $ 161,923 |
| $ 157,704 |
|
Investments
Investments consist primarily of U.S. Government agency securities, corporate debt securities, and certificates of deposit. The Company accounts for its investments in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). Prior to fiscal 2004, the Company classified its investments as “held to maturity,” and reclassified its investments as “available-for-sale” during fiscal 2004. Investments classified as available-for-sale are carried at fair value, based on quoted market prices. The Company’s policy is to classify all investments with contractual maturities within one year as current. Investment income is recognized when earned and reported net of investment expenses. Unrealized holding gains and losses are excluded from earnings and are reported, net of tax, as “accumulated other comprehensive loss” in the accompanying consolidated balance sheets and statements of changes in stockholders’ equity (deficit) until realized, unless the losses are deemed to be other-than-temporary. Realized gains or losses, including any provision for other-than-temporary declines in value, are included in the consolidated statements of operations.
The Company periodically evaluates whether any declines in the fair value of investments are other-than-temporary. This evaluation consists of a review of several factors, including but not limited to: the length of time and extent that a security has been in an unrealized loss position; the existence of an event that would impair the issuer’s future earnings potential; the near-term prospects for recovery of the market value of a security; and the intent and ability of the Company to hold the security until the market value recovers. Declines in value below cost for investments where it is considered probable that all contractual terms of the investment will be satisfied, the decline is due primarily to changes in interest rates (and not because of increased credit risk), and where the Company intends and has the ability to hold the investment for a period of time sufficient to allow a market recovery, are not assumed to be other-than-temporary. In accordance with EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” (“EITF 03-1”), the Company periodically reviews those investment securities whose unrealized losses have remained unrealized for more than six months to determine if such unrealized losses are other-than-temporary. Unrealized losses related to investments greater and less than one year are not material.
In relation to its investment securities, the Company is not aware of the existence of any financial difficulties for any of the issuers of such investment securities which would cause the Company to question whether such issuers will be able to honor such investment securities upon maturity. Further, the Company believes the declines in fair value of its investment securities were caused by changes in market interest rates. The Company intends to hold these related investment securities to maturity and has the ability to do so. As of December 31, 2004, there were no unrealized losses that the Company believed to be other-than-temporary. No realized gains or losses were recorded for the fiscal years ended September 30, 2002 and
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December 31, 2003, the three months ended December 31, 2001 and 2002, or the fiscal year ended December 31, 2004. The investments as of December 31, 2003 were classified as held to maturity and consisted entirely of U.S. Government agency securities. The amortized cost of $24.4 million for such investments approximated their fair value. The following is a summary of short-term and long-term investments at December 31, 2004 (in thousands):
| Amortized |
| Gross |
| Gross |
| Estimated |
| |||||
U.S. Government agency securities |
| $ 220,091 |
|
| $ — |
|
|
| $ (474 | ) |
| $ 219,617 |
|
Corporate debt securities |
| 126,376 |
|
| — |
|
|
| (370 | ) |
| 126,006 |
|
Certificates of Deposit |
| 467 |
|
| — |
|
|
| — |
|
| 467 |
|
Total investments at December 31, 2004 |
| $ 346,934 |
|
| $ — |
|
|
| $ (844 | ) |
| $ 346,090 |
|
The maturity dates of the Company’s investments as of December 31, 2004 are summarized below (in thousands):
|
| Amortized |
| Estimated |
|
Due in 2005 |
| $ 295,374 |
| $ 294,803 |
|
Due in 2006 |
| 51,560 |
| 51,287 |
|
Total investments at December 31, 2004 |
| $ 346,934 |
| $ 346,090 |
|
Accounts Receivable
The Company'sCompany’s accounts receivable consist of amounts due from customers throughout the United States. Collateral is generally not required. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. Management believes the allowance for doubtful accounts is adequate to provide for normal credit losses.
Concentration of Credit Risk
Accounts receivable subjectsubjects the Company to a concentration of credit risk with third party payors that include health insurance companies, managed healthcare organizations, healthcare providers and governmental entities. As of December 31, 2002, no single customer comprised greater than 10 percent of the Company's net accounts receivable balance. As of December 31, 2003, one customer comprised greater than 10 percent of the Company'sCompany’s net accounts receivable balance.
As of December 31, 2004, two customers each comprised greater than 10 percent of the Company’s net accounts receivable balance. The Company holdsbelieves the allowance for doubtful accounts is adequate for its estimated losses as of December 31, 2004, however, the Company has a $10.0 million note receivable in connection with the salerisk of Mentor in March 2001. This note receivablerecovery losses if such allowance is included in other long-term assets in the accompanying consolidated balance sheets (see Note 5—"Discontinued Operations").not adequate.
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Long-lived Assets
Long-lived assets, including property and equipment and intangible assets to be held and used, are currently reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount should be addressed pursuant to SFAS No. 144, "Accounting“Accounting for the Impairment or Disposal of Long-Lived Assets" ("Assets” (“SFAS 144"144”). Pursuant to this guidance, impairment is determined by comparing the carrying value of these long-lived assets to management'smanagement’s best estimate of the future undiscounted cash flows expected to result from the use of the assets and their eventual disposition. The cash flow projections used to make this assessment are consistent with the cash flow projections that management uses internally to assist in making key decisions. In the event an impairment exists, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the asset, which is generally determined by using quoted market prices or the discounted present value of expected future cash flows.
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Property and Equipment
Property and equipment is stated at cost, except for assets that have been impaired, for which the carrying amount ishas been reduced to estimated fair value. Property and equipment is stated at fair value as of December 31, 2003 as part of the Company'sCompany’s application of fresh start reporting, as discussed in Note 2—"“Fresh Start Reporting."” Expenditures for renewals and improvements are capitalized to the property accounts. Replacements and maintenance and repairs that do not improve or extend the life of the respective assets are expensed as incurred. Internal-use software is capitalized in accordance with AICPA Statement of Position 98-1, "Accounting“Accounting for Cost of Computer Software Developed or Obtained for Internal Use".Use.” Amortization of capital lease assets is included in depreciation expense.expense and is included in accumulated depreciation as reflected in the table below. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets, which is generally two to ten years for buildings and improvements, three to ten years for equipment and three to five years for capitalized internal-use software. Depreciation expense for continuing operations was $28.2 million, $37.2 million and $30.5 million for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, $8.7 million and was $9.5 million for the three months ended December 31, 2002. Depreciation expense for discontinued operations was $1.22001 and 2002, respectively, and $28.6 million for the fiscal year ended September 30, 2001.
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December 31, 2004. Property and equipment, net, consisted of the following at December 31, 20022003 and at December 31, 20032004 (in thousands):
| | Predecessor Company | Reorganized Company |
| 2003 |
| 2004 |
| ||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| | December 31, 2002 | December 31, 2003 | |||||||||
| Land | $ | 114 | $ | — | |||||||
| Buildings and improvements | 7,206 | 3,447 |
| $ 3,447 |
| $ 1,230 |
| ||||
| Equipment | 129,248 | 60,973 |
| 52,961 |
| 71,597 |
| ||||
Capital leases—equipment |
| 8,012 |
| 8,529 |
| ||||||
| Capitalized internal-use software | 85,427 | 57,662 |
| 57,662 |
| 67,110 |
| ||||
| 122,082 |
| 148,466 |
| |||||||
| 221,995 | 122,082 | ||||||||||
| Accumulated depreciation | (136,336 | ) | — |
| — |
| (27,862 | ) | |||
| Property and equipment, net | $ | 85,659 | $ | 122,082 |
| $ 122,082 |
| $ 120,604 |
| ||
In the first quarter of fiscal 2002, the Company approved and implemented a plan to consolidate the Company's information systems. As a result of this plan, the Company reduced the remaining estimated useful life of certain capitalized internal use claims processing software to eighteen months. In addition, management also reevaluated the estimated useful lives of certain other computer software and hardware, and reduced the estimated useful lives from five to three years. At the end of the second quarter of fiscal 2002, the Company approved a plan to further accelerate the consolidation of certain information systems. As a result of this plan, the Company reduced, as of April 1, 2002, the remaining useful lives of certain other information systems to periods ranging from twelve to twenty-four months. The net book value of assets affected by these changes in useful lives at December 31, 2002 was $7.5 million.
These changes resulted in increased depreciation of these assets on a prospective basis. The effect of these changes in useful lives was to increase depreciation expense for the fiscal year ended September 30, 2002 and for the three months ended December 31, 2002 by $5.7 million and $1.0 million, respectively. These changes reduced net income for fiscal 2002 and for the three months ended December 31, 2002 by $3.4 million ($0.10 per diluted share) and $0.7 million ($0.02 per diluted share), respectively.
Predecessor Company Goodwill
Goodwill represents the excess of the cost of businesses acquired over the fair value of the net identifiable assets at the date of acquisition. As of December 31, 2003, the Company'sPredecessor Company’s goodwill was written-off in accordance with the fresh start reporting provisions of SOP 90-7.
In the first quarter of fiscal 2002, the Company early adopted SFAS No. 142, "Goodwill“Goodwill and Other Intangible Assets" ("Assets” (“SFAS 142"142”). Under SFAS 142, the Company no longer amortizes goodwill over its estimated useful life. Instead, the Company is required to test the goodwill for impairment based upon fair values at least on an annual basis. In accordance with the early adoption of SFAS 142, the Company assigned the book value of goodwill to its reporting units, and performed an initial impairment test as of October 1, 2001.
F-24
The Company determined that its reporting units are identical to its reporting segments. In the first quarter of fiscal 2002, the Company recorded an impairment charge of $207.8 million, before taxes ($191.6 million after taxes), to write-down the balance of goodwill related to the Employer Solutions reporting unit to estimated fair value, based on independently appraised values. This initial impairment charge was recognized by the Company as a cumulative effect of a change in accounting principle, separate from operating results, in the consolidated statement of operations. The Company proceeded with the annual impairment test, which is the comparison of the adjusted recorded goodwill balance at September 1, 2002 to the estimated fair value of the goodwill. The Company selected September 1 as its annual measurement date under SFAS 142. During the fourth fiscal quarter of 2002, the Company recorded an impairment charge of $415.9 million to write-down the balance of goodwill related to the Health Plan Solutions, Employer Solutions and Public Sector Solutions reporting units to estimated fair
F-23
value, based on independently appraised values. This write-down occurred due to changes in the Company'sCompany’s financial performance and its business outlook from the beginning of the year through September 1, 2002, which decreased the estimated fair value of the Company'sCompany’s reporting units.
In fiscal 2003, the Company recorded an impairment charge of $28.8 million to write-down the balance of goodwill related to the Employer Solutions and Public Sector Solutions reporting units to estimated fair value, based on independently appraised values. This write-down was attributable to the Company'sCompany’s financial performance and its business outlook as of the annual measurement date, and resulted in the complete write-down of goodwill related to the Employer Solutions and Public Sector Solutions reporting units.
The annual goodwill impairment charges are presented in the accompanying audited consolidated statementstatements of operations as "Goodwill“Goodwill impairment charges",charges,” a component of income (loss) from continuing operations.
There were no changes in the carrying amount of goodwill during the three months ended December 31, 2002. The changes in the carrying amount of goodwill for the year ended December 31, 2003 are reflected in the table below (amounts in(in thousands).:
| | Health Plan Solutions | Employer Solutions | Public Sector Solutions | Total |
| Health |
| Employer |
| Public |
| Total |
| |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Predecessor Company Balance as of December 31, 2002 | $ | 473,141 | $ | 7,074 | $ | 22,119 | $ | 502,334 |
| $ 473,141 |
| $ 7,074 |
| $ 22,119 |
| $ 502,334 |
| |||||
| Fiscal 2003 goodwill impairment charges | — | (6,909 | ) | (21,871 | ) | (28,780 | ) |
| — |
| (6,909 | ) | (21,871 | ) | (28,780 | ) | ||||||
| Other changes | (323 | ) | (165 | ) | (248 | ) | (736 | ) |
| (323 | ) | (165 | ) | (248 | ) | (736 | ) | |||||
| Fresh start adjustments (Note 2) | (472,818 | ) | — | — | (472,818 | ) |
| (472,818 | ) | — |
| — |
| (472,818 | ) | |||||||
| Predecessor Company Balance as of December 31, 2003 | $ | — | $ | — | $ | — | $ | — |
| $ — |
| $ — |
| $ — |
| $ — |
| |||||
Adoption of SFAS 142 resulted in the Company not recording amortization expense of approximately $31.1 million and $31.8 million in the fiscal years ended September 30, 2002 and December 31, 2003, respectively, and $7.9 million and $7.8 million during the three months ended
F-25
December 31, 2001 and 2002, respectively. Had the Company adopted SFAS 142 effective October 1, 2000, the Company would not have recorded approximately $30.2 million of amortization expense in continuing operations and $0.7 million of amortization expense in discontinued operations during the fiscal year ended September 30, 2001. The following table summarizes the proforma effects on fiscal 2001 had SFAS 142 been adopted October 1, 2000.
| | Predecessor Company | |||||
|---|---|---|---|---|---|---|
| | Fiscal Year Ended September 30, 2001 | |||||
| | Reported | Adjusted | ||||
| Net income (loss) | $ | 24,555 | $ | 51,772 | ||
| Net income (loss) — per diluted share | $ | 0.56 | $ | 1.26 | ||
Reorganized Company Goodwill
Goodwill has beenwas recorded at December 31, 2003 for the amount of reorganization value in excess of amounts allocated to tangible and identified intangible assets resulting from the application of the fresh start reporting provisions of SOP 90-7. Reorganized Company goodwill is accounted for in accordance with SFAS 142. The balance of goodwill of approximately $450.2 million has not been allocated by segment at December 31, 2003. Pursuant to SFAS 142, the Company will beis required to test its goodwill for impairment on at least an annual basis. The Reorganized Company has selected October 1 as the date of its annual impairment test. The balance of goodwill of $450.2 million and $392.3 million at December 31, 2003 and 2004, respectively, has been allocated entirely to the Health Plan Solutions segment. The changes in the carrying amount of Reorganized Company goodwill for the year ended December 31, 2004 are reflected in the table below (in thousands):
Reorganized Company Balance as of December 31, 2003. | $ 450,244 | ||
Adjustment to goodwill as a result of the removal of tax contingency and the projected realization of net operating loss carryforwards subsequent to fresh-start reporting(1) | (57,977 | ) | |
Reorganized Company Balance as of December 31, 2004 | $ 392,267 |
(1) Adjustments primarily relate to the following:
(a) As of December 31, 2003, the Company had tax contingencies which created an uncertainty as to the Company’s ability to realize its net operating loss carryforwards (“NOLs”). In addition to recording a full valuation allowance against all NOLs, the Company recorded this contingent liability
F-24
for taxes payable. During fiscal 2004, the Company received favorable guidance from the Internal Revenue Service which resolved this contingency. In accordance with SOP 90-7 and SFAS No. 109, “Accounting for Income Taxes,” any future changes in these balances that existed as of the fresh-start date will be adjusted against goodwill.
(b) During fiscal 2004, the Company utilized a tax benefit from the utilization of pre-bankruptcy NOLs. This tax benefit has been reflected as a reduction of goodwill rather than as a reduction to the provision for income taxes in the consolidated statements of operations, in accordance with SOP 90-7.
See further discussion in Note 10—“Income Taxes.”
Intangible Assets
The following is a summary of intangible assets at December 31, 20022003 and December 31, 2003,2004, and the estimated remaining useful lives for such assets (dollars in(in thousands):
| | Predecessor Company | Reorganized Company | |||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | December 31, 2002 | December 31, 2003 |
|
| December 31, 2003 |
| |||||||||||||||||||||||||
| Asset | Estimated Remaining Useful Life | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Estimated Remaining Useful Life | Gross Carrying Amount |
|
|
| Estimated |
| Gross |
| Accumulated |
| Net |
| ||||||||||||||
| Customer agreements and lists | 3 to 8 years | $ | 109,975 | $ | (46,967 | ) | $ | 63,008 | 2 to 18 years | $ | 51,600 | Customer agreements and lists |
|
| 2 to 18 years |
|
| $ 51,600 |
|
| $ — |
|
| $ 51,600 |
| ||||||
| Provider networks | 18 years | 6,210 | (1,050 | ) | 5,160 | 16 years | 6,500 | Provider networks |
|
| 16 years |
|
| 6,500 |
|
| — |
|
| 6,500 |
| ||||||||||
| Trademarks and copyrights | 1 year | 3,984 | (3,382 | ) | 602 | — | |||||||||||||||||||||||||
|
|
|
|
|
| $ 58,100 |
|
| $ — |
|
| $ 58,100 |
| ||||||||||||||||||
| $ | 120,169 | $ | (51,399 | ) | $ | 68,770 | $ | 58,100 | |||||||||||||||||||||||
Predecessor Company intangible assets acquired were identified at the time of acquisition and were valued based upon independent appraisals at that time.
|
| December 31, 2004 |
| ||||||||||||
Asset |
|
|
| Estimated |
| Gross |
| Accumulated |
| Net |
| ||||
Customer agreements and lists |
|
| 2 to 18 years |
|
| $ 51,600 |
|
| $ (13,438) |
|
| $ 38,162 |
| ||
Provider networks |
|
| 16 years |
|
| 6,500 |
|
| (406) |
|
| 6,094 |
| ||
|
|
|
|
|
| $ 58,100 |
|
| $ (13,844) |
|
| $ 44,256 |
| ||
Reorganized Company intangible assets were valued, and related estimated useful lives were determined, based upon independent appraisals at December 31, 2003.
F-26
Amortization expense for continuing operations was $9.9 million, $10.3 million and $17.5 million for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and approximately $2.5 million and $4.9 million for the three months ended December 31, 2001 and 2002, respectively. During the three months ended December 31, 2002, management reevaluated the estimated useful lives of the intangible assets, which resulted in changing the remaining useful lives of certain customer agreementsrespectively and lists and provider networks. Such changes reflected management's estimates, given the Company's business environment at that time. The effect of these changes in remaining useful lives was to increase amortization expense$13.8 million for the three months ended December 31, 2002 and the fiscal year ended December 31, 2003 by $1.8 million and $7.0 million, respectively, and to reduce net income for the same periods by $1.8 million or $0.04 per diluted share and $7.0 million or $0.17 per diluted share, respectively.2004. The Company estimates amortization expense will be $13.8 million, $13.8$8.6 million, $8.6 million, $8.6$1.0 million and $1.0 million for the fiscal years ending December 31, 2004, 2005, 2006, 2007, 2008 and 2008,2009, respectively.
Cost of Care and Medical Claims Payable
Cost of care, recorded as a component of operating expenses, is recognized in the period in which members received behavioral health services. In addition to actual benefits paid, cost of care includes the impact of accruals for estimates of medical claims payable.
Medical claims payable represents the liability for healthcare claims reported but not yet paid and claims incurred but not yet reported ("IBNR"(“IBNR”) related to the Company'sCompany’s managed healthcare businesses. The IBNR portion of medical claims payable is estimated based on past claims payment experience for member groups, enrollment data, utilization statistics, authorized healthcare services and other factors. This data is incorporated into contract-specific actuarial reserve models. Although considerable variability is inherent in such estimates, management believes the liability for medical claims payable is adequate.
F-25
Medical claims payable balances are continually monitored and reviewed. Changes in assumptions for cost of care caused by changes in actual experience could cause these estimates to change in the near term.
The following table presents the components of the change in medical claims payable for the years ended December 31, 2003 and 2004 (in thousands):
|
| 2003 |
| 2004 |
|
Medical claims payable, beginning of period |
| $ 205,331 |
| $ 177,141 |
|
Cost of care: |
|
|
|
|
|
Current year |
| 918,358 |
| 1,197,658 |
|
Prior years |
| (11,874 | ) | (7,064 | ) |
Total reported cost of care |
| 906,484 |
| 1,190,594 |
|
Claim payments: |
|
|
|
|
|
Payments for current year |
| 765,872 |
| 1,021,209 |
|
Payments for prior years |
| 168,802 |
| 151,888 |
|
Total claim payments |
| 934,674 |
| 1,173,097 |
|
Medical claims payable, end of period |
| $ 177,141 |
| $ 194,638 |
|
The Company believes that the amount of medical claims payable is adequate to cover its ultimate liability for unpaid claims as of December 31, 2004; however, actual claims payments and other items may differ from established estimates.
Net Income (Loss) Per Common Share
Net income (loss) per common share is computed based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period (see Note 8—"Stockholders' Equity"“Stockholders’ Equity”).
F-26
Stock-Based Compensation
Under SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), which established new financial accounting and reporting standards for stock-based compensation plans, entities are allowed to measure compensation cost for stock-based compensation under SFAS 123 or Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees". Entities electing to remain with the accounting in APB 25 are required to make pro forma disclosures of net income and income per share as if the provisions of SFAS 123 had been applied.
F-27
The Company measures compensation cost for stock-based compensation under APB 25, and discloses stock-based compensation under the requirements of SFAS 123 and SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure" as shown below. At December 31, 2003 and 2004, the Company had stock-based employee incentive plans, which are described more fully in Note 8—"Stockholders' Equity".“Stockholders’ Equity.” Had the Company elected to adopt the fair value recognition provisions of SFAS No. 123, pro forma net income and net income per share would be as follows.follows (in thousands, except per share amounts):
| | Predecessor Company | ||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Fiscal Year Ended | | | ||||||||||||||||||||||||||||||||||||
| | Three Months Ended December 31, | ||||||||||||||||||||||||||||||||||||||
| | | September 30, | |
| Predecessor Company |
|
| Reorganized |
| ||||||||||||||||||||||||||||||
| | | December 31, 2003 | Three Months Ended December 31, |
| Fiscal Year Ended |
| Three Months Ended |
|
| Fiscal Year |
| ||||||||||||||||||||||||||||
| | | 2001 | 2002 | 2001 | 2002 |
| September 30, |
| December 31, |
| December 31, |
| December 31, |
|
| December 31, |
| ||||||||||||||||||||||
| | | | | | (unaudited) | |
|
|
|
|
| (unaudited) |
|
|
|
|
|
| |||||||||||||||||||||
| Net income (loss), as reported | Net income (loss), as reported | $ | 24,555 | $ | (729,063 | ) | $ | 451,770 | $ | (181,843 | ) | $ | 11,729 |
|
| $ (729,063 | ) |
|
| $ 451,770 |
|
|
| $ (181,843 | ) |
|
| $ 11,729 |
|
|
|
| $ 88,372 |
|
| ||||
| Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects | Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects | 382 | — | — | — | — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| 8,994 |
|
| |||||||||||
| Deduct: Total stock-based employee compensation expense determined under fair value method, net of related tax effects | Deduct: Total stock-based employee compensation expense determined under fair value method, net of related tax effects | (2,938 | ) | (2,142 | ) | (2,027 | ) | (562 | ) | (265 | ) |
|
| (2,142 | ) |
|
| (2,027 | ) |
|
| (562 | ) |
|
| (265 | ) |
|
|
| (11,270 | ) |
| ||||||
| Pro forma net income (loss) | Pro forma net income (loss) | $ | 21,999 | $ | (731,205 | ) | $ | 449,743 | $ | (182,405 | ) | $ | 11,464 |
|
| $ (731,205 | ) |
|
| $ 449,743 |
|
|
| $ (182,405 | ) |
|
| $ 11,464 |
|
|
|
| $ 86,096 |
|
| ||||
| Earnings (loss) per share: | Earnings (loss) per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Basic — as reported | $ | 0.58 | $ | (21.07 | ) | $ | 12.69 | $ | (5.28 | ) | $ | 0.29 | |||||||||||||||||||||||||||
| Basic — pro forma | 0.51 | (21.13 | ) | 12.63 | (5.30 | ) | 0.29 | ||||||||||||||||||||||||||||||||
| Diluted — as reported | 0.56 | (21.07 | ) | 10.86 | (4.32 | ) | 0.28 | ||||||||||||||||||||||||||||||||
| Diluted — pro forma | 0.49 | (21.13 | ) | 10.81 | (4.34 | ) | 0.28 | ||||||||||||||||||||||||||||||||
Basic—as reported |
|
| $ (21.07 | ) |
|
| $ 12.69 |
|
|
| $ (5.28 | ) |
|
| $ 0.29 |
|
|
|
| $ 2.50 |
|
| |||||||||||||||||
Basic—pro forma |
|
| (21.13 | ) |
|
| 12.63 |
|
|
| (5.30 | ) |
|
| 0.29 |
|
|
|
| 2.43 |
|
| |||||||||||||||||
Diluted—as reported |
|
| (21.07 | ) |
|
| 10.86 |
|
|
| (4.32 | ) |
|
| 0.28 |
|
|
|
| 2.43 |
|
| |||||||||||||||||
Diluted—pro forma |
|
| (21.13 | ) |
|
| 10.81 |
|
|
| (4.34 | ) |
|
| 0.28 |
|
|
|
| 2.37 |
|
| |||||||||||||||||
The fair values of the stock options granted were estimated on the date of their grant/acquisition using the Black-ScholesBlack-Scholes-Merton option-pricing model based on the following weighted average assumptions:
| | Fiscal Year Ended | | | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Three Months Ended December 31, | ||||||||||||||||||||||||||
| | September 30, | |
| Predecessor Company |
| ||||||||||||||||||||||
| | December 31, 2003 |
| Fiscal Year Ended |
| Three Months Ended |
| |||||||||||||||||||||
| | 2001 | 2002 | 2001 | 2002 |
| September 30, |
| December 31, |
| December 31, |
| December 31, |
| ||||||||||||||
| | | | | (unaudited) | |
|
|
|
|
| (unaudited) |
|
|
| |||||||||||||
| Risk-free interest rate | 5.5% | 3.7% | — | 5.5% | — |
|
| 3.7% |
|
|
| — |
|
|
| 5.5% |
|
|
| — |
|
| |||||
| Expected life | 3 years | 10 years | — | 3 years | — |
|
| 10 years |
|
|
| — |
|
|
| 3 years |
|
|
| — |
|
| |||||
| Expected volatility | 88.0% | 100.0% | — | 88.0% | — |
|
| 100.0% |
|
|
| — |
|
|
| 88.0% |
|
|
| — |
|
| |||||
| Expected dividend yield | 0.0% | 0.0% | — | 0.0% | — |
|
| 0.0% |
|
|
| — |
|
|
| 0.0% |
|
|
| — |
|
| |||||
|
| Reorganized Company |
| ||||||
|
| Fiscal Year Ended |
| ||||||
|
| December 31, 2004 |
| ||||||
|
| Senior Executive |
| Other Options |
| ||||
Risk-free interest rate |
|
| 3.35% |
|
|
| 2.97% |
|
|
Expected life |
|
| 5 years |
|
|
| 4 years |
|
|
Expected volatility |
|
| 39.1% |
|
|
| 37.8% |
|
|
Expected dividend yield |
|
| 0.0% |
|
|
| 0.0% |
|
|
F-27
The weighted average fair value of options granted during the fiscal yearsyear ended September 30, 2001 and 2002 was $1.50 and $6.84, respectively.$6.84. The Company granted no options during the three months ended December 31, 2002 or the fiscal year ended December 31, 2003. All options then outstanding were cancelled as part of the emergence from bankruptcy. Atbankruptcy, therefore at December 31, 2003, there arewere no
F-28
outstanding options. On the Effective Date, the Reorganized Company adopted a new stock option plan. See Note 8—"Stockholders' Equity".“Stockholders’ Equity.”
Fair Value of Financial Instruments
SFAS No. 107, "Disclosure“Disclosure about Fair Value of Financial Instruments",Instruments,” requires disclosure of fair value information about financial instruments for which it is practicable to estimate the value. The carrying amounts for the Company'sCompany’s financial instruments classified as current assets (other than short-term investments) and current liabilities approximate their fair value due to their short maturities. TheShort-term and long-term investments classified as “available-for-sale” are carried at fair value, of long-term debt as of December 31, 2002 was approximately $530.2 million. based on quoted market prices.
The fair value of long-term debt is the same as its recorded value at December 31, 2003.
Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51" ("FIN 46"). FIN 46 requires consolidation of entities in which an enterprise absorbs a majority At December 31, 2004, approximately 37% of the entity's expected losses, receives a majoritycarrying value of the entity's expected residual returns,Company’s debt instruments have fair values that approximate their carrying values due to the short maturity or both, as a resultrecent repricings, while approximately 63% of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by an enterprise when it has a controlling financial interest through ownershipcarrying value of a majority voting interest in the entity. The Reorganized Company early adopted the provisions of FIN 46 effectiveCompany’s debt instruments have fair values that were based upon quoted market prices at December 31, 2003. Early adoption2004. The fair value of new accounting pronouncements is required by companies implementing the fresh start reporting provisions of SOP 90-7. Based on the guidance of FIN 46, the Reorganized Company has determined that it is the primary beneficiary of Premier Behavioral Systems of Tennessee, LLC ("Premier"), a variable interest entity for which the Reorganized Company maintains a 50 percent voting interest. Consistent with the provisions of FIN 46, the Reorganized Company has consolidated the balance sheet of Premier into the Reorganized Company's balance sheetlong-term debt as of December 31, 2003. Through December 31, 2003, the Predecessor Company accounted for Premier under the equity method, whereby the Predecessor Company included its portion of Premier's earnings or loss in its consolidated statement of operations under the caption "Equity in (earnings) loss of unconsolidated subsidiaries". The consolidation of Premier at December 31, 2003 increased total assets and total liabilities each by $43.22004 was $400.2 million. The fair value of the accounts consolidated was equivalent to their book value at December 31, 2003. In 2004, the Reorganized Company will consolidate the results of operations of Premier in its consolidated statement of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"). This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("EITF No. 94-3"). SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. The January 1, 2003 implementation of SFAS 146 did not have a material impact upon the Company's financial position or results of operations.Reclassifications
F-29
Reclassifications
Certain prior year amounts have been reclassified to conform with the current year presentation.
4. Acquisitions and Joint Ventures
HAI Acquisition
On December 4, 1997, the Company consummated the purchase of HAI from Aetna for approximately $122.1 million, which the Company funded from cash on hand. HAI managed behavioral healthcare programs primarily through employee assistance programs ("EAPs"(“EAPs”) and other managed behavioral healthcare plans. In addition, the Company agreed to make additional contingent payments of up to $60.0 million annually to Aetna through 2003 in the event certain targets were achieved with respect to the number of HAI'sHAI’s covered lives in specified products. The Company made additional purchase price payments totaling $240.0 million through December 31, 2003. The final payment of $60.0 million was accrued in June 2002 and was originally due to be paid by March 31, 2003. The Company has recorded these additional purchase price payments as goodwill. As part of the Company'sCompany’s emergence from bankruptcy, the Company renegotiated the terms of the amounts due to Aetna. Refer to Note 7—"“Long-term Debt and Capital Lease Obligations"Obligations” for discussion of the Aetna Note.
Joint Ventures
Prior to October 29, 2002, the Company was a 50.0 percent partner with Value Options, Inc. in the Choice Behavioral Health Partnership ("Choice"(“Choice”), a managed behavioral healthcare company. Choice derived all of its revenues from a subcontract with a health plan under which it provided managed behavioral healthcare services to TRICARE beneficiaries. The Company accounted for its investment in Choice using the equity method of accounting with the Company'sCompany’s share of net income or loss of Choice recognized in the statement of operations. The Company's investment in Choice at December 31, 2002 and 2003 was approximately $0.2 million and $0.0 million, respectively. The Company'sCompany’s equity in incomeearnings of Choice for fiscal years 2001 andyear 2002 was approximately $36.4 million and $11.2 million, respectively.million. The Company'sCompany’s equity in earnings of Choice for the three months ended December 31, 2001 and 2002 was approximately $3.0 million and $0.8 million, respectively. The Company received $38.0 million and $9.6 million in partnership distributions from Choice in fiscal years 2001year 2002 and 2002, respectively. The Company received $2.1 million and $2.3 million in partnership distributions from Choice during the three months ended December 31, 2001 and 2002, respectively. The
F-28
Company received its final partnership distribution of $0.2 million from Choice in 2003 and had no remaining investment in Choice as of December 31, 2003.
Premier was formed to manage behavioral healthcare benefits for the State of Tennessee'sTennessee’s TennCare program. Substantially all of the activities of Premier are conducted on behalf of the Company. Through fiscal 2003, the Company accounted for its investment in Premier using the equity method. Effective December 31, 2003, the Company early adopted FIN 46, under which the Company consolidated the balance sheet of Premier in its consolidated balance sheet as of December 31, 2003. The Company's investment increditors (or other beneficial interest holders) of Premier at December 31, 2002 was $3.2 million.have no recourse to the general credit of the Company, as the primary beneficiary of Premier. The Company'sCompany’s equity in loss of Premier for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003 was $(2.5) million $(2.5) million and $(1.1) million, respectively. The Company'sCompany’s equity in (loss) earnings of
F-30
Premier for the three months ended December 31, 2001 and 2002 was $(0.7) million and $0.1 million, respectively. The Company has not received a partnership distribution from Premier during any of the periods presented in the audited consolidated statement of operations. The Company made capital contributions totaling approximately $6.4 million and $0 million into Premier during fiscal 2003.2003 and 2004, respectively. See Note 3—"“Summary of Significant Accounting Policies—Significant Customers"Customers” and "—“—Recent Accounting Pronouncements"Pronouncements” above for further discussion of Premier.
The Company currently owns a 36.337.5 percent interest in Royal Health Care, LLC ("Royal"(“Royal”). Royal is a managed services organization that receives management fees for the provision of administrative, marketing, management and support services to fiveseven managed care organizations. Royal does not provide any services to the Company. The Company accounts for its investment in Royal using the equity method. The Company'sCompany’s investment in Royal at December 31, 20022003 and 20032004 was $8.8$13.0 million and $13.0$11.0 million, respectively. The Company'sCompany’s equity in income of Royal for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003 was $2.6 million, $4.3 million and $6.6 million, respectively. The Company's equity in earnings of Royalrespectively, $0.8 million and $1.2 million for the three months ended December 31, 2001 and 2002, was $0.8respectively, and $5.3 million and $1.2 million, respectively.for the fiscal year ended December 31, 2004. The Company received $0.4 million, $1.1 million and $2.2 million in partnership distributions from Royal in the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively. Forrespectively, $0.7 million and $0.9 million for the three months ended December 31, 2001 and 2002, respectively and $7.5 million for the Company received partnership distributions from Royal of $0.7 million and $0.9 million, respectively.fiscal year ended December 31, 2004.
5. Discontinued Operations
Healthcare Provider and Franchising Segments
During fiscal 1997, the Company sold substantially all of its domestic acute-care psychiatric hospitals and residential treatment facilities (collectively, the "Psychiatric Hospital Facilities") to Crescent Real Estate Equities ("Crescent") for $417.2 million in cash and certain other consideration (the "Crescent Transactions"). Simultaneously with the sale of the Psychiatric Hospital Facilities, the Company and Crescent Operating, Inc. ("COI"), an affiliate of Crescent, formed Charter Behavioral Health Systems, LLC ("CBHS") to conduct the operations of the Psychiatric Hospital Facilities and certain other facilities transferred to CBHS by the Company. The Company retained a 50 percent ownership of CBHS; the other 50 percent ownership interest of CBHS was owned by COI.
On
In September 10, 1999, the Company transferred certain assets and other interests and forgave certain receivables pursuant to an agreement with Crescent, COI and CBHS that effected the Company's exit fromdisposed of its healthcare provider and healthcare franchising businesses (the "CBHS Transactions"). The CBHS Transactions, together with the formal plan of disposal authorized by the Company's Board of Directors on September 2, 1999 (the measurement date), represented the disposal of the Company's healthcare provider and healthcare franchising business segments.
Specialty Managed Healthcare Segment
On In October 4, 2000, the Company adopted a formal plan to dispose of the business and interest comprised by the Company'sCompany’s specialty managed healthcare segment. The Company exited the specialty
F-31
managed healthcare business through the sale and/or abandonment of businesses and related assets, certain of which activities had already occurred in the normal course prior to October 4, 2000. The Company has exited all operating contracts entered into in connection with the specialty managed healthcare segment; however, the Company is obligated to satisfy lease agreements, subject to the Company's chapter 11 proceedings, for which the Company believes it has adequate reserves at December 31, 2003.
Human Services Segment
OnIn January 18, 2001, the Company'sCompany’s Board of Directors approved and the Company entered into a definitive agreement for the sale of National Mentor, Inc. ("Mentor"(“Mentor”), which represented the business and interest comprised by the Company'sCompany’s human services segment. On March 9, 2001, the Company consummated the sale of the stock of Mentor for approximately $113.5 million, net of approximately $2.0 million in transaction costs. The Company'sCompany’s consideration consisted of $103.5 million in cash and $10.0 million in the form of an interest-bearing note. Additionally, the Companynote and assumed liabilities of approximately $3.0 million. At December 31, 2004, $7.0 million of the interest-bearing note was included in other current assets within the accompanying consolidated balance sheets, while the remaining $3.0 million was included within other long-term assets. The Company subsequently collected the current portion of the note in January 2005. The agreement for the sale of Mentor included provisions whereby the Company indemnified the purchaser for certain potential liabilities that existed prior to the transaction’s effective date. As part of the Company’s bankruptcy proceedings, this indemnification has been capped at $10.0 million.
F-29
Accounting for Discontinued Operations
The Company has accounted for the disposal of the discontinued segments under Accounting Principles Board OpinionAPB No. 30, "Reporting“Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("Transactions” (“APB 30"30”). APB 30 requires that the results of continuing operations be reported separately from those of discontinued operations for all periods presented and that any gain or loss from disposal of a segment of a business be reported in conjunction with the related results of discontinued operations. The losses the Company incurred to exit the discontinued operations are reflected, net of income tax, in the caption "Discontinued“Discontinued operations—Income (loss) on disposal of discontinued operations". All activity related to the healthcare provider and franchising segments are reflected as discontinued operations for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, as well as for the three months ended December 31, 2001 and 2002.operations.” As permitted, the assets, liabilities and cash flows related to discontinued operations have not been segregated from those related to continuing operations.
F-32
The summarized resultssummary of the income (loss) from the discontinued operations segments areis as follows (in thousands):
| | Predecessor Company | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Fiscal Year Ended | | | |||||||||||||
| | Three Months Ended December 31, | |||||||||||||||
| | September 30, | | ||||||||||||||
| | December 31, 2003 | |||||||||||||||
| | 2001 | 2002 | 2001 | 2002 | ||||||||||||
| | | | | (unaudited) | | |||||||||||
| Healthcare Provider and Healthcare Franchising | ||||||||||||||||
| Net revenue (1) | $ | 6,302 | $ | 12,587 | $ | 389 | $ | 1,918 | $ | 631 | ||||||
| Salaries, cost of care and other operating expenses (2) | 6,744 | 5,362 | 26,622 | 1,678 | (605 | ) | ||||||||||
| Other expenses (income) (3) (4) | (2,899 | ) | 1,662 | (3,828 | ) | (738 | ) | 433 | ||||||||
| Reorganization benefit, net (5) | — | — | (15,942 | ) | — | — | ||||||||||
| Income (loss) from discontinued operations | $ | 2,457 | $ | 5,563 | $ | (6,463 | ) | $ | 978 | $ | 803 | |||||
| Specialty Managed Healthcare | ||||||||||||||||
| Net revenue | $ | 16,849 | $ | — | $ | — | $ | — | $ | — | ||||||
| Salaries, cost of care and other operating expenses | 11,987 | (304 | ) | 131 | — | — | ||||||||||
| Other expenses (income) (3) (4) | 1,702 | 1,748 | (2,264 | ) | — | — | ||||||||||
| Reorganization benefit, net (5) | — | — | (4,333 | ) | — | — | ||||||||||
| Income (loss) from discontinued operations | $ | 3,160 | $ | (1,444 | ) | $ | 6,466 | $ | — | $ | — | |||||
| Human Services | ||||||||||||||||
| Net revenue | $ | 91,654 | $ | — | $ | — | $ | — | $ | — | ||||||
| Salaries, cost of care and other operating expenses | 86,546 | — | — | — | — | |||||||||||
| Depreciation and amortization | 1,983 | — | — | — | — | |||||||||||
| Other expenses (income) (3) (4) | 13,477 | (683 | ) | (52 | ) | — | (97 | ) | ||||||||
| Income (loss) from discontinued operations | $ | (10,352 | ) | $ | 683 | $ | 52 | $ | — | $ | 97 | |||||
| Discontinued Operations — Combined | ||||||||||||||||
| Net revenue | $ | 114,805 | $ | 12,587 | $ | 389 | $ | 1,918 | $ | 631 | ||||||
| Salaries, cost of care and other operating expenses | 105,277 | 5,058 | 26,753 | 1,678 | (605 | ) | ||||||||||
| Depreciation and amortization | 1,983 | — | — | — | — | |||||||||||
| Other expenses (income) (3) (4) | 12,280 | 2,727 | (6,092 | ) | (738 | ) | 336 | |||||||||
| Reorganization benefit, net (5) | — | — | (20,327 | ) | — | — | ||||||||||
| Income (loss) from discontinued operations | $ | (4,735 | ) | $ | 4,802 | $ | 55 | $ | 978 | $ | 900 | |||||
|
| Predecessor Company |
|
| Reorganized |
| ||||||||||||||||
|
| Fiscal Year Ended |
| Three Months Ended |
|
| Fiscal Year |
| ||||||||||||||
|
| September 30, |
| December 31, |
| December 31, |
| December 31, |
|
| December 31, |
| ||||||||||
|
|
|
|
|
| (unaudited) |
|
|
|
|
|
| ||||||||||
Net revenue(1) |
|
| $ 12,587 |
|
|
| $ 389 |
|
|
| $ 1,918 |
|
|
| $ 631 |
|
|
|
| $ 118 |
|
|
Salaries, cost of care and other operating expenses(2)(3) |
|
| 5,058 |
|
|
| 26,753 |
|
|
| 1,678 |
|
|
| (605 | ) |
|
|
| 3,447 |
|
|
Income tax provision (benefit)(4) |
|
| 2,635 |
|
|
| (1,336 | ) |
|
| 82 |
|
|
| 433 |
|
|
|
| (8,110 | ) |
|
Income (loss) from discontinued |
|
| $ 4,894 |
|
|
| $(25,028 | ) |
|
| $ 158 |
|
|
| $ 803 |
|
|
|
| $ 4,781 |
|
|
(1)
F-33
(3)
(4)
GainF-30
Income (loss) on Disposal of Healthcare Provider and Franchising SegmentsDiscontinued Operations
The summary of the gainincome (loss) on disposal recorded in fiscal 2001 related toof the Company's healthcare provider and healthcare franchisingCompany’s discontinued operations segments is as follows (in thousands):
| | Predecessor Company | |||
|---|---|---|---|---|
| Basis in Provider JVs | $ | 10,831 | ||
| Increase in estimated accrued liabilities | (6,267 | ) | ||
| Other | (343 | ) | ||
| Gain before income taxes | 4,221 | |||
| Income tax provision | (1,477 | ) | ||
| $ | 2,744 | |||
|
|
|
| Reorganized |
| |||||||||||||||||
|
|
|
|
| Fiscal Year |
| ||||||||||||||||
|
|
|
|
|
|
| December 31, |
| ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||
Gain associated with provider joint ventures |
|
|
|
|
|
|
|
|
|
|
| $ — |
|
|
|
| $ — |
|
| |||
Gain (loss) on sale of assets |
|
| — |
|
|
| 650 |
|
|
| — |
|
|
| — |
|
|
|
| (141 | ) |
|
Cash received on a fully reserved note |
|
| — |
|
|
| 1,350 |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
|
Change in estimate of leasehold obligations |
|
| (3,604 | ) |
|
| 499 |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
|
Change in estimate of other exit-related reserves |
|
| 2,130 |
|
|
| — |
|
|
| — |
|
|
| 149 |
|
|
|
| — |
|
|
Income (loss) before |
|
| (141 | ) |
|
| 6,103 |
|
|
| 1,262 |
|
|
| 149 |
|
|
|
| (141 | ) |
|
Income tax provision (benefit) |
|
| (49 | ) |
|
| 1,347 |
|
|
| 442 |
|
|
| 52 |
|
|
|
| 889 |
|
|
|
|
| $ (92 | ) |
|
| $ 4,756 |
|
|
| $ 820 |
|
|
| $ 97 |
|
|
|
| $ (1,030 | ) |
|
The summary
During the year ended December 31, 2003, the Company recognized a reorganization benefit, net of the gain on disposal recorded in fiscal 2002taxes related to the Company's healthcare providerdiscontinued operations segments of $20.3 million, with such amount being net of an income tax benefit of $0.8 million. See Note 2—“Fresh Start Reporting,” and healthcare franchising segments is as follows (in thousands):
| | Predecessor Company | |||
|---|---|---|---|---|
| Net proceeds from sale of Provider JV | $ | 3,500 | ||
| Less: Net book value of Investment in Provider JV | (2,167 | ) | ||
| Gain before income taxes | 1,333 | |||
| Income tax provision | (466 | ) | ||
| $ | 867 | |||
The summaryNote 3—“Summary of the gain on disposal recorded in fiscal 2003 related to the Company's healthcare provider and franchising segments is as follows (in thousands):Significant Accounting Policies” for discussion of reorganization benefit, net of taxes.
| | Predecessor Company | |||
|---|---|---|---|---|
| Change in estimate of joint venture liabilities | $ | 2,793 | ||
| Gain on distribution of joint venture cash | 811 | |||
| Gain on sale of assets | 650 | |||
| Gain before taxes | 4,254 | |||
| Income tax provision | (1,503 | ) | ||
| $ | 2,751 | |||
F-34
The remaining assets and liabilities of the healthcare provider and franchisingCompany’s discontinued operations segments at December 31, 2003 include, among other things, (i) cash and cash equivalents of $0.7 million; (ii) restricted cash of $2.0 million; (iii) investment in provider joint ventures of $1.9 million; (v)(iv) hospital-based real estate of $2.4 million; (v) accounts payable and accrued liabilities of $13.1 million, of which $11.5 relates to chapter 11 claim settlements; and (vi) long-term debt of $6.4 million related to the hospital-based real estate; and (vii) accounts payable and accrued liabilities of $12.8 million, of which $11.5 million relates to chapter 11 claim settlements.estate.
The remaining assets and liabilities of the healthcare provider and franchisingCompany’s discontinued operations segments at December 31, 20022004 include, among other things, (i) cash and cash equivalents of $0.7$1.0 million; (ii) restricted cash of $2.0 million;$0.6 million, (iii) accounts receivable of $0.6 million; (iv) investment in provider joint ventures of $2.4$1.8 million; (v) hospital-based real estate of $3.4 million; (vi) long-term debt of $6.4 million related to the hospital-based real estate; and (vii)(iv) accounts payable and accrued liabilities of $7.7$3.6 million.
Loss on Disposal of Specialty Managed Healthcare Segment
The summary of the loss on disposal recorded during fiscal 2002 related to the Company's specialty managed healthcare segment is as follows (in thousands):
| | Predecessor Company | |||
|---|---|---|---|---|
| Change in estimate of leasehold obligations | $ | (3,604 | ) | |
| Change in estimate of other exit-related reserves | 1,079 | |||
| Loss before income taxes | (2,525 | ) | ||
| Income tax benefit | 883 | |||
| $ | (1,642 | ) | ||
The summary of the gain on disposal recorded in fiscal 2003 related to the Company's specialty managed healthcare segment is as follows (in thousands):
| | Predecessor Company | ||
|---|---|---|---|
| Cash received on a fully reserved note receivable | $ | 1,350 | |
| Change in estimate of leasehold obligations | 499 | ||
| Gain before taxes | 1,849 | ||
| Income tax benefit | 104 | ||
| $ | 1,953 | ||
The remaining assets and liabilities of the specialty managed healthcare segment at December 31, 2003 include: (i) reserve related to the discontinuance of operations of $0.2 million and (ii) accounts payable and accrued liabilities of $0.1 million.
The remaining assets and liabilities of the specialty managed healthcare segment at December 31, 2002 include, among other things: (i) reserve related to the discontinuance of operations of $5.8 million and (ii) accounts payable and accrued liabilities of $0.4 million.
F-35
The following tables provide a roll-forward of reserves related to the discontinuance of the specialty managed healthcare segment (in thousands):
| Type of Cost | Predecessor Company Balance September 30, 2000 | Additions | Payments | Adjustments | Predecessor Company Balance September 30, 2001 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Accrued losses | $ | 3,531 | $ | — | $ | (3,531 | ) | $ | — | $ | — | ||||
| Lease exit costs | 5,051 | — | (1,409 | ) | — | 3,642 | |||||||||
| $ | 8,582 | $ | — | $ | (4,940 | ) | $ | — | $ | 3,642 | |||||
Type of Cost | Predecessor Company Balance September 30, 2001 | Additions | Payments | Adjustments | Predecessor Company Balance September 30, 2002 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Lease exit costs | $ | 3,642 | $ | 3,604 | $ | (1,140 | ) | $ | — | $ | 6,106 | ||||
Type of Cost | Predecessor Company Balance September 30, 2002 | Additions | Payments | Adjustments | Predecessor Company Balance December 31, 2002 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Lease exit costs | $ | 6,106 | $ | — | $ | (297 | ) | $ | — | $ | 5,809 | ||||
Type of Cost | Predecessor Company Balance December 31, 2002 | Additions | Payments | Adjustments (1) | Reorganization Benefit and Fresh Start Adjustments (2) | Reorganized Company Balance December 31, 2003 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Lease exit costs | $ | 5,809 | $ | — | $ | (365 | ) | $ | (499 | ) | $ | (4,724 | ) | $ | 221 | |||
F-36
Loss on Disposal of Human Services Segment
The summary of the loss on disposal recorded during fiscal 2001 related to the disposal of the Company's human services segment is as follows (in thousands):
| | Predecessor Company | |||
|---|---|---|---|---|
| Net proceeds from sale (1) | $ | 110,469 | �� | |
| Less: Net book value of assets | (113,269 | ) | ||
| Loss before taxes | (2,800 | ) | ||
| Income tax provision (2) | (9,303 | ) | ||
| $ | (12,103 | ) | ||
The income on disposal of $0.7 million ($1.1 million, less tax provision of $0.4 million) recorded during fiscal 2002 represents a revision of estimated liabilities related to the sale of the Company's human services segment. The Company recorded changes in estimates related to a gain on disposal of approximately $0.1 million during the three months ended December 31, 2002, as well as during fiscal 2003.
6. Benefit Plans
The Company has a defined contribution retirement plan (the "401(k) Plan"“401(k) Plan”). Employee participants can elect to voluntarily contribute up to 1575 percent of their compensation, subject to IRS deferral limitations, to the 401(k) Plan. The Company makes contributions to the 401(k) Plan based on employee compensation and contributions. The Company matches 50 percent of each employee'semployee’s contribution up to 36 percent of their annual compensation. Additionally, the Company can elect to make a discretionary contribution of up to 2 percent of each eligible employee'semployee’s compensation. The Company recognized $4.1 million, $4.0 million and $3.3 million of expense for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, respectively, and $1.0 million and $0.9 million for the three months ended December 31, 2001 and 2002, respectively, and $3.0 for the fiscal year ended December 31, 2004 for matching contributioncontributions to the 401(k) Plan.
F-37F-31
7. Long-Term Debt and Capital Lease Obligations
Information with regard to the Company'sThe Company’s long-term debt and capital lease obligations at December 31, 20022003 and December 31, 2003 is as follows2004 consisted of the following (in thousands):
| | Predecessor Company | Reorganized Company | ||||||
|---|---|---|---|---|---|---|---|---|
| | December 31, 2002 | December 31, 2003 | ||||||
| Old Credit Agreement: | ||||||||
| Old Revolving Facility (4.9375% and 6.5000% at December 31, 2002 and 2003, respectively) due through 2004 | $ | 45,000 | $ | 45,076 | ||||
| Old Term Loan Facility (5.6875% to 5.9375% and 7.2500% to 7.5000% at December 31, 2002 and 2003, respectively) due through 2006 | 115,762 | 115,762 | ||||||
| Old Senior Notes | 250,000 | — | ||||||
| Old Subordinated Notes | 625,000 | — | ||||||
| 9.375% Series A Senior Notes due 2008 | — | 250,000 | ||||||
| 9.375% Series B Senior Notes due 2008 | — | 6,890 | ||||||
| Note Payable to Aetna | — | 63,915 | ||||||
| 1.20% to 10.0% capital lease obligations due through 2008 | 12,396 | 12,056 | ||||||
| 1,048,158 | 493,699 | |||||||
| Less debt paid upon consummation of the Plan | — | (92,382 | ) | |||||
| Less current maturities of long term debt | (22,140 | ) | (24,785 | ) | ||||
| Less long-term debt in default, classified as current | (1,016,794 | ) | — | |||||
| $ | 9,224 | $ | 376,532 | |||||
|
| December 31, |
| ||
|
| 2003 |
| 2004 |
|
Old Credit Agreement: |
|
|
|
|
|
Old Revolving Facility (6.50% at December 31, 2003) |
| $ 45,076 |
| $ — |
|
Old Term Loan Facility (7.25% to 7.50% at December 31, 2003) |
| 115,762 |
| — |
|
Credit Agreement: |
|
|
|
|
|
Revolving Facility due through 2008 |
| — |
| — |
|
Term Loan Facility(4.74% at December 31, 2004) due through 2008 |
| — |
| 85,000 |
|
9.375% Series A Senior Notes due 2008 |
| 250,000 |
| 233,456 |
|
9.375% Series B Senior Notes due 2008 |
| 6,890 |
| 7,116 |
|
Note payable to Aetna (8.50% at December 31, 2004), due through 2005 |
| 63,915 |
| 48,915 |
|
4.5625% to 4.875% capital lease obligations due through 2009 |
| 12,056 |
| 4,991 |
|
|
| 493,699 |
| 379,478 |
|
Less debt paid upon consummation of the Plan |
| (92,382 | ) | — |
|
Less current maturities of long-term debt and capital lease obligations |
| (24,785 | ) | (75,158 | ) |
|
| $ 376,532 |
| $ 304,320 |
|
Under fresh start reporting, the Company'sCompany’s reorganization transactions involving the cancellation of the Old Senior Notes and Old Subordinated Notes, and the issuance of Series A Notes and Series B Notes, as contemplated by the Plan, are reflected as if consummated on December 31, 2003, except for cash payments made on the Old Senior Notes.
In order to record its debt instruments at the amount of claim expected to be allowed by the Bankruptcy Court in accordance with SOP 90-7, as of the Commencement Date, Magellanthe Company wrote off, as reorganization expense, its unamortized deferred financing fees associated with the Old Senior Notes and Old Subordinated Notes in the amount of $18.5 million.million, which has been reflected as a component of Reorganization benefit, net, within the consolidated statement of operations for the fiscal year ended December 31, 2003.
F-38
As of the Effective Date, giving effect to the Credit Agreement, and the use of proceeds thereof, theThe aggregate scheduled maturities of long-term debt and capital lease obligations during the next five fiscal years and beyond are as follows (in thousands):
| | Reorganized Company | |||||||
|---|---|---|---|---|---|---|---|---|
| Fiscal Year | ||||||||
| Amount | ||||||||
| Debt paid upon consummation of the Plan | $ | 92,382 | ||||||
| 2004 | 24,785 | |||||||
Fiscal Years Ended December 31, |
|
|
|
|
| |||
| 2005 | 73,686 | 2005 |
| $ 75,158 |
| |||
| 2006 | 25,000 | 2006 |
| 25,361 |
| |||
| 2007 | 25,000 | 2007 |
| 25,373 |
| |||
| 2008 | 252,846 | 2008 |
| 253,457 |
| |||
2009 | 2009 |
| 129 |
| ||||
|
| $ 379,478 |
| |||||
| $ | 493,699 | |||||||
F-32
Credit Agreement
On the Effective Date, the Company repaid amounts outstanding under the Old Credit Agreement totaling $160.8 million utilizing proceeds from the new credit agreement with Deutsche Bank AG (the "Credit Agreement"“Credit Agreement”) and the additional capital provided by the Equity Offering and the Onex Investment, as contemplated by the Plan. See below for further discussion of the Credit Agreement. Amounts repaid on the Effective Date under the Old Credit Agreement in excess of amounts advanced under the Credit Agreement have been classified as "Debt“Debt paid upon consummation of the Plan"Plan” in the accompanying consolidated balance sheet as of December 31, 2003.
The Credit Agreement provides for a Term Loan Facility in an original aggregate principal amount of $100.0 million, a Revolving Loan Facility providing for loans of up to $50.0 million and a Credit-Linked Facility for the issuance of letters of credit for the account of the Company in an original aggregate principal amount of $80.0 million. Borrowings under the Credit Agreement will mature on August 15, 2008 and certain quarterly principal payments on the Term Loan Facility are also required. As of the Effective Date,December 31, 2004, the Company had $85.0 million outstanding $100.0 million under the Term Loan Facility. On the Effective Date, the Company incurred deferred financing fees of approximately $7.4 million related to the Credit Agreement. Additionally, effective September 29, 2004, the Credit-Linked Facility was reduced from $80 million to $50.0 million. The Company hadaccounted for the reduction of the Credit-Linked Facility in accordance with EITF 98-14 “Debtor’s Accounting for Changes in Line-of-Credit or Revolving-Debt Arrangements,” and accordingly, wrote off $0.8 million of fees associated with the Credit Agreement and will amortize the remaining unamortized fees relating to the Credit Agreement over the remaining term of the Credit Agreement. Borrowings under the Credit Agreement will mature on August 15, 2008 and quarterly principal payments are required on the Term Loan Facility. The Company has not drawn on the Revolving Loan Facility, resulting in unutilized commitments of $50.0 million. As of the Effective Date,December 31, 2004, the Company had issued letters of credit in the amount of $62.7$45.1 million, resulting in unutilized commitments under the Credit-Linked Facility of $17.3$4.9 million. The Term Loan Facility amortizes in installments in amounts equal to $15.0 million in 2004, $22.5 million in 2005, $25.0 million in 2006, $25.0 million in 2007 and $12.5 million in 2008. The Credit Agreement is guaranteed by substantially all of the subsidiaries of the Company and is secured by substantially all of the assets of the Company and the subsidiary guarantors.
On October 25, 2004 (“the First Amendment Effective Date”), the Credit Agreement was amended (the “Amendment”) to reduce the annual interest rate on borrowings under the Term Loan Facility and on the Credit-Linked Facility, each by 1.25 percent. As a result of the Amendment, the annual interest rate on borrowings under the Term Loan Facility fluctuates at a rate equal to the sum of (i) a borrowing margin of 2.25 percent (subject to reduction of up to 0.50 percent based on the Company’s debt ratings), plus (ii) (A) in the case of U.S. dollar denominated loans, the higher of the prime rate or one-half of one percent in excess of the overnight “federal funds” rate, or (B) in the case of Eurodollar denominated loans, an interest rate which is a function of the Eurodollar rate for the selected interest period. The Company has the option to borrow in U.S. dollar denominated loans or Eurodollar denominated loans at its discretion. As of December 31, 2004, all loans under the Term Loan Facility were Eurodollar denominated loans at a borrowing rate of 4.74 percent. As a result of the Amendment, the commitment fee on the Credit-Linked Facility is equal to the sum of 2.25 percent (subject to reduction of up to 0.50 percent based on the Company’s debt ratings), plus an additional amount that is based on the administrative costs and term of the Credit-Linked Facility. As of December 31, 2004, the commitment fee on the Credit-Linked Facility was 2.37 percent. In addition, under the Amendment, certain mandatory prepayment requirements were eliminated, and several covenants that restricted or limited the Company’s ability to repurchase or refinance Senior Notes, make investments, and incur debt pertaining to letters of credit were amended. The Company paid and expensed $0.3 million in fees associated with the Amendment.
The Revolving Loan Facility and Term Loan Facility are subject to mandatory prepayment and reductions in an amount equal to (i) 50 percent of the net equity proceeds of any capital contribution or any sale or issuance of the Company's or any of its subsidiaries' common or preferred equity (including from the sale or issuance of options, warrants, or rights to purchase any such equity),
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(ii) 100 percent of each capital contribution made to cure a default or event of default, (iii)(ii) 100 percent of any net debt proceeds from anycertain issuance or incurrence by the Company or any of its subsidiaries of indebtedness for borrowed money, (iv)other than permitted new senior
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or subordinated notes and other permitted indebtedness, and (iii) 100 percent of the net proceeds from assets sales not made in the ordinary course of business.
The Credit Agreement, as amended, contains a number of covenants that restrict or limit the Company'sCompany’s ability to engage in various transactions that may affect the interests of the lenders, including requirements limiting the ability to enter into partnerships, joint ventures, merger or consolidation transactions, to make capital expenditures and to issue capital stock. In addition, the Credit Agreement, as amended, requires the Company to comply with specified financial ratios and tests (as defined), including minimum consolidated EBITDA, interest coverage ratios and maximum leverage ratios. Failure to comply with such covenants, without waiver, would result in an event of default under the Credit Agreement, as amended, and in the event the indebtedness under the Credit Agreement, as amended, were accelerated, would give rise to defaults under substantially all of the Company'sCompany’s other debt agreements. As of the date of filing of this Form 10-K, theThe Company believes that it is in compliance with these covenants.
The annual interest rate on borrowings under the Term Loan Facility and the Revolving Loan Facility fluctuate at a rate equal to the sum of (i) a borrowing margin of 3.50 percent (subject to reduction of up to 0.50 percent based on the Company's debt ratings), plus (ii) (A) in the case of U.S. denominated loans, the higher of the prime rate or one-half of one percent in excess of the overnight "federal funds" rate, or (B) in the case of a Eurodollar loan, an interest rate which is a function of the Eurodollar rate for the selected interest period. The Company has the option to borrow in U.S. denominated loans or Eurodollar loans. As of the Effective Date, all loans under the Term Loan Facility were Eurodollar loans and the borrowing rate on the Term Loan Facility was 4.75%.
The Company incurs a commitment fee on the Revolving Loan Facility ranging from 0.50 percent to 0.75 percent of the total available amount under the facility. The commitment fee percentage varies with the percentage of unutilized amounts under the Revolving Loan Facility. The Company also incurs a commitment fee on its Credit-Linked Facility, which is equal to the sum of 3.50 percent (subject to reduction of up to 0.50 percent based on the Company's debt ratings), plus an additional amount, which is dependent on the administrative costs and term of the Credit-Linked Facility. In addition, the Company incurs a fee in the amount of 0.125% for all letters of credit issued. The obligations of the Company and the Subsidiary Borrowers under the Credit Agreement, as amended, are unconditionally and irrevocably guaranteed by, subject to certain exceptions, each wholly owned subsidiary of the Company. In addition, security interests in and pledges of or liens on substantially all the material tangible and intangible assets of the guarantors, subject to certain exceptions, secure the Revolving Loan Facility, the Term Loan Facility and the guarantees.
Senior Notes
On the Effective Date, the Company issued $233.4$233.5 million of Series A Notes, which mature on November 15, 2008, and are general senior unsecured obligations of the Company. As noted above, this transaction was reflected as of December 31, 2003 (except for the corresponding payment of principal on the Old Senior Notes on the Effective Date in the amount of $16.6 million, paid, which is reflected as "Debt“Debt paid upon consummation of the Plan"Plan” in the accompanying consolidated balance sheet as of December 31, 2003). Interest on the Series A Notes is payable semi-annually on each May 15 and
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November 15, commencing on May 15, 2004. These notes plus cash were issued in satisfaction of the Company'sCompany’s Old Senior Notes and accrued interest thereon.
Through March 4,As of December 31, 2004, the Company has issued $6.9$7.1 million of Series B Notes, which mature on November 15, 2008. The Series B Notes were issued to the holders of other general unsecured claims of the predecessor Company and to Houlihan Lokey Howard & Zukin Capital ("Houlihan"(“Houlihan”) for services rendered during the financial restructuring.chapter 11 proceedings. Interest on the Series B Notes is payable semi-annually on each May 15 and November 15, commencing on May 15, 2004.
Except as set forth in the following paragraph, the Senior Notes will not be redeemable at the option of the Company prior to November 15, 2005. The Senior Notes will be redeemable at the option of the Company on or after such date, in whole or in part, with prior notice, at the following redemption prices (expressed as percentages of principal amount), plus accrued and unpaid interest, if redeemed during the 12-month period beginning on November 15 of the years set forth below:
| Year | Redemption Prices |
|
|
| Redemption |
| |||
|---|---|---|---|---|---|---|---|---|---|
| 2005 | 104.688% | 2005 |
|
| 104.688 | % |
| ||
| 2006 | 102.344% | 2006 |
|
| 102.344 | % |
| ||
| 2007 | 101.172% | 2007 |
|
| 101.172 | % |
| ||
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In addition, at any time prior to November 15, 2005, the Company may, at its option, redeem up to 35 percent of the original aggregate principal amount of Senior Notes at a redemption price (expressed as a percentage of the principal amount) of 109.375 percent, plus accrued and unpaid interest thereon, if any, to the redemption date, with the net cash proceeds of one or more equity offerings; provided that at least 65 percent of such original aggregate principal amount of Senior Notes remains outstanding immediately after the occurrence of such redemption; and provided, further, that such redemption shall occur within sixty days of the date of the closing of any such equity offering. Any such redemption shall be made upon not less than thirty nor more than sixty days notice mailed to each holder of Senior Notes being redeemed and otherwise in accordance with the procedures set forth in the Senior Notes Indenture (the "Indenture"“Indenture”).
The Indenture imposes certain limitations on the ability of the Company and its Restricted Subsidiaries (as defined) to, among other things, (i) make certain investments and other restricted payments, (ii) pay dividends and other distributions, (iii) incur indebtedness, (iv) enter into consensual restrictions upon the payment of certain dividends and distributions by such Restricted Subsidiaries, (v) enter into or permit certain transactions with affiliates, (vi) create or incur liens, (vii) enter into sale and leaseback transactions, (viii) make asset sales, (ix) acquire or retire certain assets, and (x) prepay subordinated obligations. The Indenture also imposes limitations on the ability of the Company to consolidate or merge with or into any other person or convey, transfer or lease all or substantially all of the property of the Company.
Aetna Note
As part of the consummation of the Plan, an agreement became effective between Aetna, Inc. ("Aetna") and the Company to renew their behavioral health services contract. Under the renewed agreement, the Company will continue to manage the behavioral health care of members of Aetna's
F-41
healthcare programs through December 31, 2005, with an option for Aetna at that time to either extend the agreement or to purchase certain assets of the Company used solely in the management of the behavioral healthcare of Aetna members (the "Aetna-Dedicated Assets"). Pursuant to the Plan, on the Effective Date, the Company paid $15.0 million to Aetna, out of a debt obligation allowed under the Plan of $60.0 million plus accrued interest, and issued to Aetna an interest-bearing note (the "Aetna Note"“Aetna Note”) for the balance, including accrued interest, of $48.9 million, which will mature on December 31, 2005. As of December 31, 2003, the $15.0 million payment to Aetna is reflected in "Debt“Debt paid upon consummation of the Plan"Plan” in the accompanying audited consolidated balance sheet. The Aetna Note is guaranteed by substantially all of the subsidiaries of Magellan and is secured by a second lien on substantially all of the assets of Magellan and the subsidiary guarantors. Additionally, if the behavioral health services contract is extended byAt such time when Aetna at its option through at least December 31, 2006, one-half ofpurchases the Aetna Assets (as discussed in Note would be payable on December 31, 2005, and the remainder would be payable on December 31, 2006. If Aetna opts to purchase the Aetna-Dedicated Assets,1—“General”), the purchase price could be offset against any amounts owing under the Aetna Note. The full amount of the Aetna Note is reflected by the Company as due and payable on December 31, 2005 in the schedule of maturities above.
The annual interest rate on the Aetna Note is calculated as the sum of (i) the higher of the prime rate or one-half of one percent in excess of the overnight "federal funds"“federal funds” rate, plus (ii) 3.25 percent, plus (iii) an additional 2.00 percent for overdue amounts of principal or interest. Interest on the Aetna Note is payable quarterly on the last day of March, June, September and December, beginning on March 31, 2004. The effective rate of interest on the Aetna Note as of the Effective Dateat December 31, 2004 was 7.258.50 percent.
The Company may, at any time, prepay all or a portion of the unpaid principal amount of the Aetna Note, plus unpaid accrued interest without premium or penalty, subject to restrictions in the Company'sCompany’s other debt agreements.
Capital LeasesLease Obligations
The Company'sCompany’s capital lease obligations represent amounts due under a lease for certain real property and leased computer equipment. Included in the current maturities of long-term debt as of December 31, 2003 in the table above is $6.4 million related to a real property capital lease, which iswas an obligation of the Company'sCompany’s discontinued healthcare provider segment. In March 1984, a subsidiary of the Company acquired a psychiatric hospital in Albuquerque, New Mexico from the City of Albuquerque. The construction of the facility was funded through the issuance of $6.4 million in revenue bonds by the City of
F-35
Albuquerque, which arewere guaranteed by the Company and arewere due on March 1, 2014. The Company then sold the property to the City of Albuquerque, and leased it back. The terms of the lease agreement provide that the Company shall purchase the facility for a purchase price of $1 upon repayment of the bonds. On February 27,April 2, 2004, the Company gave notice to the bond trustee that it intendselected to repay the principal of the bond plus accrued interest, on April 2, 2004.interest. As a result of this election, the Company has reclassified the principal amount of $6.4 million from a long-term obligation to a current obligation.obligation as of December 31, 2003. The recorded value of this property at December 31, 2003 was approximately $2.4 million. The Company sold the property in 2004. The recorded value of other capital leased assets was approximately $8.0 million and $8.5 million at December 31, 2003.2003 and December 31, 2004, respectively.
F-42
Old Credit Agreement
The Old Credit Agreement, as amended, which was refinanced on the Effective Date with proceeds from the Credit Agreement and other cash, as described above, provided for a term loan facility (the "Old“Old Term Loan Facility"Facility”) in an original aggregate principal amount of $550 million, and a revolving facility (the "Old“Old Revolving Facility"Facility”) providing for revolving loans and the issuance of letters of credit in an aggregate principal amount (including the aggregate stated amount of letters of credit) of $150.0 million. Loans outstanding under the Old Term Loan Facility as of December 31, 2003 totaled approximately $115.8 million. Amounts outstanding under the Old Revolving Facility as of December 31, 2003 totaled $101.3 million, including approximately $45.1 million in revolving loans and letters of credit of approximately $56.2 million, resulting in unutilized commitments of approximately $48.7 as of December 31, 2003. The Old Revolving Facility was to mature on February 12, 2004. Fifty percent of the total amount outstanding under the Term Loan Facility was to mature on February 12, 2005 and the remainder was to mature on February 12, 2006.million.
The Old Credit Agreement, as amended, contained a number of covenants that, among other things, restricted the ability of the Company and its subsidiaries: (i) to dispose of assets, (ii) incur additional indebtedness, (iii) incur or guarantee obligations, (iv) prepay other indebtedness or amend other debt instruments (including the indentures for the Old Senior Notes and the Old Subordinated Notes), (v) pay dividends, (vi) create liens on assets, (vii) make investments, (viii) make loans or advances, (ix) redeem or repurchase common stock, (x) make acquisitions, engage in mergers or consolidations, (xi) change the business conducted by the Company and its subsidiaries and (xii) make capital expenditures. In addition, the Old Credit Agreement required the Company to comply with specified financial ratios and tests (as defined), including minimum coverage ratios, maximum leverage ratios and maximum senior debt ratios.
As of December 31, 2002, the Predecessor Company was in default of certain of the covenants under the Old Credit Agreement, a condition which led to the Predecessor Company filing for bankruptcy under chapter 11 on March 11, 2003. See Note 1—"General" for discussion of the Company's filing for bankruptcy under, and subsequent emergence from, chapter 11. Due to such default, all amounts outstanding under the Old Credit Agreement were reflected as current obligations of the Predecessor Company as of December 31, 2002. As of December 31, 2003, amounts outstanding under the Old Credit Agreement are reflected, to the extent refinanced, as current or long-term obligations of the Reorganized Company, based on the scheduled maturity dates, as the Company had the intent and the ability to refinance amounts outstanding in accordance with the Plan.
Old Senior Notes and Old Subordinated Notes
The Old Senior Notes were issued by the Company in fiscal 2001 and were to mature on November 15, 2007 and were general senior unsecured obligations of the Company. Interest on the Old Senior Notes accrued at the rate of 9.375 percent per annum and was payable semi-annually on each May 15 and November 15.
In connection with the issuance of the Old Senior Notes, the Company recognized an extraordinary loss from early extinguishment of debt of approximately $4.0 million, net of income tax benefit, during fiscal 2001, to write-off unamortized deferred financing costs related to repayment of indebtedness. The Company adopted SFAS No. 145, "Recession of FASB Statements No. 4, 44 and 64,
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Amendment of FASB Statement No. 13 and Technical Corrections" ("SFAS 145") in fiscal 2002. In accordance with SFAS No. 145, the Company reclassified its fiscal 2001 extraordinary loss on early extinguishment of debt of $4.0 million, net of income taxes, to interest expense (an increase of $6.6 million) and provision for income taxes (a decrease of $2.6 million).
The Old Subordinated Notes were general unsecured senior subordinated obligations of the Company. The Old Subordinated Notes were limited in aggregate principal amount to $625.0 million and were to mature on February 15, 2008. Interest on the Old Subordinated Notes accrued at the rate of 9.0 percent per annum and was payable semi-annually on each February 15 and August 15.
The Indentures for the Old Senior Notes and Old Subordinated Notes (the "Indenture") limited, among other things: (i) the incurrence of additional indebtedness by the Company and its restricted subsidiaries; (ii) the payment of dividends on, and redemption or repurchase of, capital stock of the Company and its restricted subsidiaries and the redemption of certain subordinated obligations of the Company; (iii) certain other restricted payments, including investments; (iv) sales of assets; (v) certain transactions with affiliates; (vi) the creation of liens and (vii) consolidations, mergers and transfers of all or substantially all the Company's assets. The Indentures also prohibited certain restrictions on distributions from restricted subsidiaries. However, all such limitations and prohibitions were subject to certain qualifications and exceptions. Events of default under the covenants of the Old Credit Agreement, as discussed above, triggered events of default under the Indenture as of December 31, 2002. As a result, all amounts outstanding under the Old Senior Notes and Old Subordinated Notes were reflected as current obligations as of December 31, 2002.
Pursuant to the Plan, the Old Senior Notes and Old Subordinated Notes were canceledcancelled as of the Effective Date. In accordance with fresh start reporting, the Company reflected the cancellation of the Old Senior Notes and the Old Subordinated Notes, and the issuance of the Senior Notes as of December 31, 2003. See Note 1—"General"“General” for discussion of the Company'sCompany’s emergence from chapter 11.
8. Stockholders'Stockholders’ Equity
Common Stock
On the Effective Date, the previously outstanding shares of Common Stock and Preferred Stock of Magellan were cancelled, and three new classes of capital stock were authorized. For a detailed discussion of such activity, see Note 1—"General".“General.”
The number of issued and outstanding shares of Ordinary Common Stock and Multi-Vote Common Stock at December 31, 20032004 was 26,552,56326,883,016 and 8,552,700,8,487,750, respectively. The Company is prohibited from paying dividends on its common stock under the terms of the Indentures for the Senior Notes and the Credit Agreement except under very limited circumstances.
F-36
Stock Option Plans
All outstanding options and warrants to purchase existing common stock outstanding prior to the Effective Date were cancelled as of the Effective Date. On the Effective Date, the Company established the 2003 Management Incentive Plan which allows for the issuance of up to 6,373,689 shares of stock options. The Company made grants of 4,267,422Common Stock pursuant to stock options in January and February 2004. Suchor stock grants. During fiscal 2004, the Company granted options for the purchase of 4.4 million shares of common stock. These options vest over three to sevenfour years
F-44
and have a 10 year life. In addition, certain of the stock options contain vesting acceleration clauses if stated stock price targets are met. At March 4,December 31, 2004, there were 2,106,2671,901,578 shares available for future grants under the terms of the 2003 Management Incentive Plan.
Summarized information relative to the Company'sCompany’s stock options outstanding on March 4,December 31, 2004 is as follows:
| | Reorganized Company | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Options Outstanding | Options Exercisable | ||||||||||
| Exercise Price | Options | Weighted Average Remaining Contractual Life | Weighted Average Exercise Price | Options | Weighted Average Exercise Price | |||||||
| $10.43 – $12.39 | 3,808,537 | 10 years | $ | 11.54 | — | $ | — | |||||
| $23.52 | 458,885 | 10 years | $ | 23.52 | — | — | ||||||
| 4,267,422 | $ | 12.83 | — | $ | — | |||||||
|
| Options Outstanding |
| Options Exercisable |
| ||||||||||||||||||
Exercise Price |
|
|
| Options |
| Weighted Average |
| Weighted |
| Options |
| Weighted |
| ||||||||||
$10.43 - $12.39 |
| 3,690,347 |
|
| 9 years |
|
|
| $11.52 |
|
|
| — |
|
|
| $ | — |
|
| |||
$23.52 - $38.46 |
| 529,875 |
|
| 9 years |
|
|
| 26.06 |
|
|
| — |
|
|
| — |
| |||||
|
| 4,220,222 |
|
|
|
|
|
| $ | 13.34 |
|
|
| — |
|
|
| $ | — |
|
| ||
Pursuant to employee agreements entered into as part of the Plan, on the Effective Date, the Company granted a total of 167,926 shares of Ordinary Common Stock to the Company'sCompany’s Chief Executive Officer, Chief Operating Officer and Chief Financial Officer (the "Senior Executives"“Senior Executives”). Pursuant to his employment agreement, the Chief Executive Officer purchased 83,963 fully-vestedfully vested shares of Ordinary Common Stock on the Effective Date. Under such agreements, the Company also granted an aggregate of 2,891,022 stock options to the Senior Executives on the Effective Date and made cash payments to the Senior Executives to approximate the tax liability associated with the Senior Executives’ compensation expenseincome resulting from the stock grants, the stock purchase and the cash payments, as defined below. Also onUnder the Effective Date, pursuant to the consummation of the Plan, a2003 Management Incentive Plan, became effective under which 1,376,4001,511,500 stock options were awarded to other members of the Company'sCompany’s management and other employees.employees during the fiscal year ended December 31, 2004. All of these awards were contingent upon the Company'sCompany’s emergence from its chapter 11 proceedings, relate to underlying common stock that was not authorized until the Effective Date and relate to services to be performed by the respective employees beginning on the Effective Date.
BeginningUnder APB 25, the Reorganized Company recorded stock compensation expense during the fiscal year ended December 31, 2004 of $23.2 million, as reflected in the first quarteraccompanying consolidated statements of fiscal 2004, the Company will recognize the following chargesoperations, related to stock compensation:the following:
·with respect to the grants of restricted stock to the Senior Executive officers, the Company will recordrecognized a charge equal to the fair market value of the Ordinary Common Stock at the time of grant (the price at which the stock traded on the first day of trading) multiplied by the shares granted, plus the cash amount paid to the Senior Executives with regard to income taxes related to such grants;
·with respect to the shares purchased by the Chief Executive Officer, the Company will recognizerecognized a charge equal to the extentdifference between the fair market value of the Ordinary Common Stock at the time of purchase (the price at which the stock traded on the first day of trading) exceededand the price paid for such shares multiplied by the shares purchased, plus the amount paid to the Chief Executive Officer with regard to income taxes related to such purchase.
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the options, multiplied by the number of shares subject to the options (approximately 4.3(4.2 million shares in the aggregate). Generally, thisThis charge will beis being recognized ratably over the vesting periods of the options, which range from three to four years. However, compensationCompensation expense related to two of the three tranches of stock options granted to the Senior Executives, covering approximately 2.1 million shares, may becould have been recognized over a period of upranging from three to seven years, depending on the market price performance of the Ordinary Common Stock.
· with respect to 13,595 shares of Ordinary Common Stock granted to non-management members of the board of directors who are not affiliated with Onex, pursuant to the Company’s 2004 Director Stock Compensation Plan, the Company recognized a charge equal to the fair market value of the Ordinary Common Stock at the time of grant.
The Company estimates that the total amount of such charges will be $58.4$56.5 million, before taxes. Based upon a seventhree year vesting schedule for the two Senior Executive tranches, as discussed above, the Company estimates that it will recognize approximately $18.7the remaining charges of $15.0 million, $10.6 million, $10.6 million $7.4$15.0 million, and $11.1$3.3 million of such charges in fiscal years 2004, 2005, 2006, and 2007, and 2008 and beyond, respectively. However, certain of these charges may be accelerated depending on the market price performance of the Ordinary Common Stock, as discussed above.
As noted above, all previously outstanding options to purchase existing common stock were cancelled as of the Effective Date. The Predecessor Company maintained stock option plans under which employees and non-employee directors were granted options to purchase shares of Company common stock at the fair market value at the time of grant.
Summarized information relative to the Predecessor Company'sCompany’s stock option plansoptions issued under the 2003 Management Incentive Plan is as follows:
| | Predecessor Company | |||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Fiscal Year Ended September 30, | | | | | |||||||||||||||||||||||
| | Three Months Ended December 31, 2002 | Fiscal Year Ended December 31, 2003 | ||||||||||||||||||||||||||
| | 2001 | 2002 |
| Fiscal Year Ended |
| |||||||||||||||||||||||
| | Options | Weighted Average Exercise Price | Options | Weighted Average Exercise Price | Options | Weighted Average Exercise Price | Options | Weighted Average Exercise Price |
| Options |
| Weighted |
| |||||||||||||||
| Balance, beginning of period | 5,379,105 | $ | 5.57 | 4,113,151 | $ | 4.95 | 4,247,952 | $ | 5.25 | 3,847,073 | $ | 5.34 |
| — |
|
| $ | — |
|
| ||||||||
| Granted | 1,129,410 | 3.35 | 570,000 | 6.78 | — | — | — | — |
| 4,402,522 |
|
| 13.34 |
|
| |||||||||||||
| Canceled | (837,510 | ) | 6.36 | (288,482 | ) | 5.83 | (400,879 | ) | 4.42 | (3,847,073 | ) | 5.34 | ||||||||||||||||
Cancelled |
| (182,300 | ) |
| 16.10 |
|
| |||||||||||||||||||||
| Exercised | (1,557,854 | ) | 4.95 | (146,717 | ) | 3.56 | — | — | — | — |
| — |
|
| — |
|
| |||||||||||
| Balance, end of period | 4,113,151 | $ | 4.95 | 4,247,952 | $ | 5.25 | 3,847,073 | $ | 5.34 | — | $ | — |
| 4,220,222 |
|
| $ | 13.34 |
|
| ||||||||
| Exercisable, end of period | 2,272,958 | $ | 5.77 | 2,818,989 | $ | 5.49 | 2,870,853 | $ | 5.49 | — | $ | — |
| — |
|
| $ | — |
|
| ||||||||
F-46
Employee Stock Purchase Plans. The 2000 Employee Stock Purchase Plan (the "2000 ESPP"), as amended, covered 1.5 million shares of common stock that could be purchased by eligible employees of the Predecessor Company. The 2000 ESPP offering periods had a term not less than three months and not more than twelve months. The first offering period under the 2000 ESPP began January 1, 2000 and the last offering period ended on December 31, 2003. The purchase price of each offering period was the lesser of: (i) 85.0 percent of the fair value of a share of common stock on the first day of the offering period or (ii) 85.0 percent of the fair value of a share of common stock on the last day of the offering period. A summary of the 2000 ESPP is as follows:
| Offering Period | Began | Ended | Shares Purchased | Purchase Price | |||||
|---|---|---|---|---|---|---|---|---|---|
| 1 | January 1, 2000 | June 30, 2000 | 481,922 | $ | 1.0625 | ||||
| 2 | July 1, 2000 | December 31, 2000 | 415,642 | $ | 1.0625 | ||||
| 3 | April 1, 2001 | June 30, 2001 | 37,271 | $ | 7.8625 | ||||
| 4 | July 1, 2001 | December 31, 2001 | 114,008 | $ | 5.3975 | ||||
| 5 | January 1, 2002 | June 30, 2002 | 212,807 | $ | 0.8500 | ||||
| 6 | July 1, 2002 | December 31, 2002 | 180,240 | $ | 0.1400 | ||||
| 7 | January 1, 2003 | June 30, 2003 | — | — | |||||
| 8 | July 1, 2003 | December 31, 2003 | — | — | |||||
The shares for the period from July 1, 2002 to December 31, 2002 were purchased and issued to employees in January 2003. No shares of common stock were purchased or issued in fiscal 2003 under the 2000 ESPP due to the fact that there were only 58,110 shares left for allocation, and due to the Company's bankruptcy filing on March 11, 2003.
Common Stock Warrants. The Company issued 114,690 warrants in fiscal 1992 that expired on June 30, 2002 (the "2002 Warrants") to purchase one share each of the Predecessor Company's common stock. The 2002 Warrants had an exercise price of $5.24 per share. During the fiscal year ended September 30, 2001, 6,267 shares were issued upon the exercise of 2002 Warrants. No shares were issued upon exercises of warrants during the fiscal years ended September 30, 2002 and December 31, 2003, or during the three months ended December 31, 2002. Pursuant to the Plan, on the Effective Date all previously outstanding warrants to purchase common stock of Magellan were cancelled.
Pursuant to the Plan, the previous Series A Redeemable Preferred Stock of Magellan was cancelled on the Effective Date (see Note 9—"“Redeemable Preferred Stock"Stock” below) and the holders thereof were issued 456,660 shares of Ordinary Common Stock, as well as warrants to purchase until the seventh anniversary of the Effective Date (January 5, 2011) for $30.46 per share, a like number of shares of Ordinary Common Stock. The previously outstanding common stock of Magellan also was also cancelled on the Effective Date (see above) and the holders thereof became entitled to receive 114,165 shares of Ordinary Common Stock, as well as warrants to purchase at any time until January 5, 2011 for $30.46 per share a like number of shares of Ordinary Common Stock (i.e., 114,165), which equals approximately one share of Ordinary Common Stock and a warrant to purchase one share of
F-47
Ordinary Common Stock for every 310 shares of the previously outstanding common stock. Taken together, such warrants (the "2004 Warrants"“2004 Warrants”) total 570,825.
F-38
Also on the Effective Date and pursuant to the Plan, the Company entered into a warrant agreement with Aetna whereby Aetna has the option to purchase, between January 1, 2006 and January 5, 2009, 230,000 shares of Ordinary Common Stock at a purchase price of $10.48 per share (the "Aetna Warrants"“Aetna Warrants”).
The following table summarizes the common stock warrants in effect as of the Effective Date:
| Description | Shares | Exercise Price per Share | Expiration Date | Approximate FMV Per Warrant |
|
|
| Shares |
| Exercise Price |
| Expiration Date |
| Approximate FMV |
| ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 Warrants | 570,825 | $ | 30.46 | January 5, 2011 | $ | 13.50 | 2004 Warrants |
| 570,825 |
|
| $ | 30.46 |
|
| January 5, 2011 |
|
| $ | 9.44 |
|
| |||||
| Aetna Warrants | 230,000 | $ | 10.48 | January 5, 2009 | $ | 9.44 | Aetna Warrants |
| 230,000 |
|
| $ | 10.48 |
|
| January 5, 2009 |
|
| $ | 13.50 |
|
| |||||
During the fiscal year ended December 31, 2004, 19 warrants of the 2004 Warrants were exercised, which reduced the total shares issuable pursuant to the 2004 Warrants to 570,806 as of December 31, 2004. The effect on the consolidated financial statements as a result of this exercise was not material. The Company estimated the fair market value of the 2004 Warrants and the Aetna Warrants as of the Effective Date. The Company recorded the fair market value of the 2004 Warrants as an increase to warrants outstanding, a component of additional paid-in capital. The fair values of the common stock warrants were estimated on the date of their grant/acquisition using the Black-ScholesBlack-Scholes-Merton option-pricing model based on the following weighted average assumptions:
| | 2004 Warrants | Aetna Warrants |
| 2004 |
| Aetna |
| ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Risk-free interest rate | 3.92% | 1.95% |
|
| 3.92 | % |
|
| 1.95 | % |
| ||
| Expected life | 7 years | 5 years |
|
| 7 years |
|
| 5 years |
| ||||
| Expected volatility | 39.5% | 32.2% |
|
| 39.5 | % |
|
| 32.2 | % |
| ||
| Expected dividend yield | 0.0% | 0.0% |
|
| 0.0 | % |
|
| 0.0 | % |
| ||
Income (Loss) Per Common Share
Income (loss) per common share for the fiscal year ended December 31, 2003 was calculated using the Company'sCompany’s pre-petition common stock which was outstanding through the close of business on December 31, 2003, at which time it was cancelled pursuant to the Plan. See Note 2—"“Fresh Start Reporting"Reporting” for a discussion of the implementation of fresh start reporting and the adjustments recorded as a result of its implementation. Income per common share for the fiscal year ended December 31, 2004 was calculated using the Reorganized Company’s Ordinary Common Stock and Multi-Vote Common Stock which was outstanding at December 31, 2004.
F-39
The following table reconciles income (numerator) and
F-48
shares (denominator) used in the Company'sCompany’s computations of income per share from continuing operations (in thousands)thousands, except per share amounts):
| | Predecessor Company | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Fiscal Year Ended September 30, | | Three Months Ended December 31, | ||||||||||||
| | Fiscal Year Ended December 31, 2003 | ||||||||||||||
| | 2001 | 2002 | 2001 | 2002 | |||||||||||
| | | | | (unaudited) | | ||||||||||
| Numerator: | |||||||||||||||
| Income (loss) from continuing operations | $ | 29,290 | $ | (542,304 | ) | $ | 451,715 | $ | 8,740 | $ | 10,829 | ||||
| Less: preferred dividend requirement (Contractual dividends of $4,788 for the fiscal year ended December 31, 2003) | 4,527 | 4,657 | 883 | 1,075 | 1,243 | ||||||||||
| Less: amortization of redeemable preferred stock issuance costs | 522 | 540 | 172 | 143 | 136 | ||||||||||
| Less: preferred stock reorganization items, net | — | — | 2,668 | — | — | ||||||||||
| Income (loss) from continuing operations available to common stockholders — basic | 24,241 | (547,501 | ) | 447,992 | 7,522 | 9,450 | |||||||||
| Add: presumed conversion of redeemable preferred stock | — | — | 3,723 | 1,218 | 1,379 | ||||||||||
| Income (loss) from continuing operations available to common stockholders — diluted | $ | 24,241 | $ | (547,501 | ) | $ | 451,715 | $ | 8,740 | $ | 10,829 | ||||
Denominator: | |||||||||||||||
| Weighted average common shares outstanding — basic | 33,448 | 34,854 | 35,305 | 34,670 | 35,139 | ||||||||||
| Common stock equivalents — stock options | 847 | — | — | 1,100 | — | ||||||||||
| Common stock equivalents — warrants | 4 | — | — | 5 | — | ||||||||||
| Common stock equivalents — redeemable preferred stock | 553 | — | 6,300 | 6,300 | 6,300 | ||||||||||
| Common stock equivalents — redeemable preferred stock option | 83 | — | — | — | — | ||||||||||
| Weighted average common shares outstanding — diluted | 34,935 | 34,854 | 41,605 | 42,075 | 41,439 | ||||||||||
Income (loss) from continuing operations available to common stockholders per common share: | |||||||||||||||
| Basic (basic numerator/basic denominator) | $ | 0.72 | $ | (15.71 | ) | $ | 12.69 | $ | 0.22 | $ | 0.27 | ||||
Diluted (diluted numerator/diluted denominator) | $ | 0.69 | $ | (15.71 | ) | $ | 10.86 | $ | 0.21 | $ | 0.26 | ||||
F-49
|
| Predecessor Company |
|
| Reorganized |
| ||||||||||||||||
|
| Fiscal Year Ended |
| Three Months Ended |
|
| Fiscal Year Ended |
| ||||||||||||||
|
| September 30, |
| December 31, |
| December 31, |
| December 31, |
|
| December 31, |
| ||||||||||
|
|
|
|
|
| (unaudited) |
|
|
|
|
| |||||||||||
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations |
|
| $ (542,304 | ) |
|
| $ 451,715 |
|
|
| $ 8,740 |
|
|
| $ 10,829 |
|
|
|
| $ 84,621 |
|
|
Less: preferred dividend requirement (Contractual dividends of $4,788 for the fiscal year ended December 31, 2003) |
|
| 4,657 |
|
|
| 883 |
|
|
| 1,075 |
|
|
| 1,243 |
|
|
|
| — |
|
|
Less: amortization of redeemable preferred stock issuance costs |
|
| 540 |
|
|
| 172 |
|
|
| 143 |
|
|
| 136 |
|
|
|
| — |
|
|
Less: preferred stock reorganization items, net |
|
| — |
|
|
| 2,668 |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
|
Income (loss) from continuing operations available to common stockholders—basic |
|
| (547,501 | ) |
|
| 447,992 |
|
|
| 7,522 |
|
|
| 9,450 |
|
|
|
| 84,621 |
|
|
Add: presumed conversion of redeemable preferred stock |
|
| — |
|
|
| 3,723 |
|
|
| 1,218 |
|
|
| 1,379 |
|
|
|
| — |
|
|
Income (loss) from continuing operations available to common stockholders—diluted |
|
| $ (547,501 | ) |
|
| $ 451,715 |
|
|
| $ 8,740 |
|
|
| $ 10,829 |
|
|
|
| $ 84,621 |
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding—basic |
|
| 34,854 |
|
|
| 35,305 |
|
|
| 34,670 |
|
|
| 35,139 |
|
|
|
| 35,367 |
|
|
Common stock equivalents—stock options |
|
| — |
|
|
| — |
|
|
| 1,100 |
|
|
| — |
|
|
|
| 797 |
|
|
Common stock equivalents—warrants |
|
| — |
|
|
| — |
|
|
| 5 |
|
|
| — |
|
|
|
| 197 |
|
|
Common stock equivalents—redeemable preferred stock |
|
| — |
|
|
| 6,300 |
|
|
| 6,300 |
|
|
| 6,300 |
|
|
|
| — |
|
|
Weighted average common shares outstanding—diluted |
|
| 34,854 |
|
|
| 41,605 |
|
|
| 42,075 |
|
|
| 41,439 |
|
|
|
| 36,361 |
|
|
Income (loss) from continuing operations available to common stockholders per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
| $ (15.71 | ) |
|
| $ 12.69 |
|
|
| $ 0.22 |
|
|
| $ 0.27 |
|
|
|
| $ 2.39 |
|
|
Diluted |
|
| $ (15.71 | ) |
|
| $ 10.86 |
|
|
| $ 0.21 |
|
|
| $ 0.26 |
|
|
|
| $ 2.33 |
|
|
Conversion of redeemable preferred stock was not presumed for fiscal 2001 and 2002 due to the anti-dilutive effect. Conversion of the redeemable preferred stock was presumed outstanding for the fiscal year ended December 31, 2003, and the three months ended December 31, 2001 and 2002, respectively. Additionally, redemption of the TPG series "A" option (the "Option") (seeThe Option (as defined in Note 9—"“Redeemable Preferred Stock"Stock”) was not presumed in fiscal 2001 due to the anti-dilutive effect. The Option expired on August 19, 2002. Certain stock options and warrants which were outstanding during the fiscal yearsyear ended September 30, 2001 and December 31, 2003, as well as duringand the three months ended December 31, 2001 and 2002, were not included in the computation of diluted earnings per share
F-40
because of the anti-dilutive effect. Because the Company reported a loss from continuing operations in fiscal 2002, no common stock equivalents have been included in the computation of weighted average common shares outstanding for fiscal 2002. See Note 9—"“Redeemable Preferred Stock",Stock,” for further discussion of the redeemable preferred stock.
TPG Investment
On December 5, 1999, TPG Magellan, LLC, an affiliate of the investment firm Texas Pacific Group ("TPG"(“TPG”) purchased approximately $59.1 million of the Predecessor Company'sCompany’s Series A Cumulative Convertible Preferred Stock (the "Series“Series A Preferred Stock"Stock”) and an Option (the "Option"“Option”) to purchase approximately $21.0 million of additional Series A Preferred Stock. The Option expired, without being exercised, on August 19, 2002. The Series A Preferred Stock was cancelled on the Effective Date as discussed in Note 8—"Stockholders'“Stockholders’ Equity."” The Series A Preferred Stock carried a dividend of 6.5% per annum, payable in quarterly installments in cash or common stock through December 15, 2001 (cash only thereafter), subject to certain conditions. Dividends not paid in cash or common stock accumulated. No dividends had been paid to the holders of Series A Preferred Stock. TPG had the right to nominate three representatives to the Predecessor Company'sCompany’s Board of Directors. TPG had two representatives on the Predecessor Company'sCompany’s seven-member Board of Directors. Additionally, the Company'sCompany’s Board of Directors was reconstituted on the Effective Date to consist of nine members, none of which are affiliated with TPG.
Upon adoption of SOP 90-7, the Company wrote off all of its unamortized issuance costs of approximately $2.7 million (net of a tax benefit of approximately $0.8 million) as "Preferred“Preferred stock reorganization items, net"net” in the accompanying consolidated statements of operations.
F-50
10. Income Taxes
The provision for income taxes related to continuing operations consisted of the following (in thousands):
| | Predecessor Company | ||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Fiscal Year Ended September 30, | | Three Months Ended December 31, |
| Predecessor Company |
|
| Reorganized |
| ||||||||||||||||||||||||||||
| | Fiscal Year Ended December 31, 2003 |
| Fiscal Year Ended |
| Three Months Ended |
|
| Fiscal Year |
| ||||||||||||||||||||||||||||
| | 2001 | 2002 | 2001 | 2002 |
| September 30 |
| December 31, |
| December 31, |
| December 31, |
|
| December 31, |
| |||||||||||||||||||||
| | | | | (unaudited) | |
|
|
|
|
| (unaudited) |
|
|
|
|
|
| ||||||||||||||||||||
| Income taxes currently payable: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
| Federal | $ | — | $ | — | $ | 30,615 | $ | — | $ | 2,929 |
|
| $ — |
|
|
| $ 3,402 |
|
|
| $ — |
|
|
| $ 2,929 |
|
|
|
| $ 15,484 |
|
| |||||
| State | 1,500 | 900 | 3,198 | 940 | 200 |
|
| 900 |
|
|
| 2,007 |
|
|
| 940 |
|
|
| 200 |
|
|
|
| 5,574 |
|
| ||||||||||
| Foreign | 14 | — | — | — | — | ||||||||||||||||||||||||||||||||
| Deferred income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
| Federal | 27,079 | 125,810 | — | 5,146 | — |
|
| 125,810 |
|
|
| 27,213 |
|
|
| 5,146 |
|
|
| — |
|
|
|
| 22,218 |
|
| ||||||||||
| State | 5,139 | 24,899 | — | — | — |
|
| 24,899 |
|
|
| 1,191 |
|
|
| — |
|
|
| — |
|
|
|
| 3,308 |
|
| ||||||||||
|
| $ 151,609 |
|
|
| $ 33,813 |
|
|
| $ 6,086 |
|
|
| $ 3,129 |
|
|
|
| $ 46,584 |
|
| ||||||||||||||||
| $ | 33,732 | $ | 151,609 | $ | 33,813 | $ | 6,086 | $ | 3,129 | ||||||||||||||||||||||||||||
F-41
A reconciliation of the Company'sCompany’s income tax provision (benefit) for continuing operations to that computed by applying the statutory federal income tax rate is as follows (in thousands):
| | Predecessor Company | |||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Fiscal Year Ended September 30, | | Three Months Ended December 31, |
| Predecessor Company |
|
| Reorganized |
| |||||||||||||||||||||||||||||
| | Fiscal Year Ended December 31, 2003 |
| Fiscal Year Ended |
| Three Months Ended |
|
| Fiscal Year |
| |||||||||||||||||||||||||||||
| | 2001 | 2002 | 2001 | 2002 |
| September 30, |
| December 31, |
| December 31, |
| December 31, |
|
| December 31, |
| ||||||||||||||||||||||
| | | | | (unaudited) | |
|
|
|
|
| (unaudited) |
|
|
|
|
|
| |||||||||||||||||||||
| Income tax provision at federal statutory income tax rate | $ | 22,085 | $ | (136,726 | ) | $ | 170,023 | $ | 5,195 | $ | 4,895 |
|
| $ (136,726 | ) |
|
| $ 170,023 |
|
|
| $ 5,195 |
|
|
| $ 4,895 |
|
|
|
| $ 46,038 |
|
| |||||
| State income taxes, net of federal income tax benefit | 3,155 | (15,235 | ) | 2,078 | 611 | 130 |
|
| (15,235 | ) |
|
| 2,078 |
|
|
| 611 |
|
|
| 130 |
|
|
|
| 8,882 |
|
| ||||||||||
| Goodwill impairment | — | 102,183 | 9,052 | — | — |
|
| 102,183 |
|
|
| 9,052 |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
| |||||||||||
| Differences in reorganization benefit, net | — | — | (150,773 | ) | — | — |
|
| — |
|
|
| (150,773 | ) |
|
| — |
|
|
| — |
|
|
|
| — |
|
| ||||||||||
| Valuation allowance adjustment | — | 200,537 | — | — | — |
|
| 200,537 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
| |||||||||||
| Non-deductible amortization | 8,726 | 449 | 2,857 | 157 | 640 |
|
| 449 |
|
|
| 2,857 |
|
|
| 157 |
|
|
| 640 |
|
|
|
| 936 |
|
| |||||||||||
| Other — net | (234 | ) | 401 | 576 | 123 | (2,536 | ) | |||||||||||||||||||||||||||||||
Other—net |
|
| 401 |
|
|
| 576 |
|
|
| 123 |
|
|
| (2,536 | ) |
|
|
| (9,272 | ) |
| ||||||||||||||||
| Income tax provision | $ | 33,732 | $ | 151,609 | $ | 33,813 | $ | 6,086 | $ | 3,129 |
|
| $ 151,609 |
|
|
| $ 33,813 |
|
|
| $ 6,086 |
|
|
| $ 3,129 |
|
|
|
| $ 46,584 |
|
| ||||||
The Company notes that for federal income tax purposes, the cancellation of indebtedness event takes placeoccurred on the date of the Company'sCompany’s emergence from bankruptcy (January 5, 2004) and the actual attribute reduction calculation as set forth under Internal Revenue Code Section 108 occurs at oroccurred immediately after December 31, 2004 (the taxable year of discharge) and generally after determining the income tax liability for 2004. The Company plans to changechanged its income tax reporting year to a calendar year basis in conformity with its financial reporting year effective December 31, 2003. For
F-51
financial reporting purposes, the emergence from bankruptcy is deemed to occur in 2003; however, since the Company did not emerge from bankruptcy until January 5, 2004, for federal income tax purposes, the emergence from bankruptcy is a 2004 event.
After consideration of the effect of bankruptcy emergence, including the effect of cancellation of indebtedness income and the related attribute reduction effects as provided under Internal Revenue Code Section 108, the Company estimates that it has reportable NOLs as of December 31, 2003, the Company has estimated tax net operating loss ("NOL") carryforwards2004 of approximately $507.3$525 million available to reduce future federal taxable income. These estimated NOL carryforwardsNOLs expire in 20062009 through 2019. 2020 and are subject to examination and adjustment by the Internal Revenue Service. In accordance with SOP 90-7, subsequent (post-bankruptcy) utilization by the Company of NOLs which existed at January 5, 2004 will be accounted for as reductions to goodwill or additional paid-in capital and therefore, will only benefit cash flows due to reduced tax payments and will not benefit the Company’s tax provision for income taxes.
Valuation allowances on deferred tax assets (including NOLs) are estimated based on the Company'sCompany’s assessment of the realizability of such amounts. The Company'sCompany’s history of recent operating losses (prior to reorganization benefits) and financial restructuring activities and its lack of substantial history of profitable operations subsequent to its emergence from bankruptcy have created uncertainty as to the Company'sCompany’s ability to realize its NOL carryforwardsNOLs and other deferred tax assets. In addition, the Company's utilization of NOL carryforwards will be subject to limitation under Internal Revenue Code Section 382 upon emergence from bankruptcy, which may affect the timing of the use of, or ultimate realization of, NOL carryforwards. During fiscal 2002, in light of its financial situation, the Company recorded a full valuation allowance against its net deferred tax assets. As of December 31, 2003 and 2002, theThe Company continuescontinued to maintain a full valuation allowance covering all of the Company'sCompany’s net deferred tax assets.
The Company recognized current tax expense attributable to estimated current taxable income for the three months endedassets as of December 31, 20022003 and the year endedsubstantially all of its net deferred tax assets at December 31, 2003. This expense was recorded due2004. As of December 31, 2004, net deferred tax assets, after reduction for valuation allowance, represent the Company’s estimate of those net tax assets which are more likely than not to be realizable.
F-42
In addition, the Company’s utilization of NOLs became subject to limitation under Internal Revenue Code Section 382 upon emergence from bankruptcy, which affects the timing of the use of NOLs. At this time, the Company does not believe these limitations will materially limit the Company’s ability to use any NOLs before they expire. Furthermore, as of December 31, 2003, the Company had tax contingencies which created an uncertainty as to the estimated utilizationCompany’s ability to realize its NOLs. In addition to recording a full valuation allowance against all NOLs, the Company recorded this contingent liability of NOL carryforwards generated prior$23.2 million for taxes payable. During fiscal 2004, the Company received favorable guidance from the Internal Revenue Service which resolved this contingency, resulting in the reversal of the related liability and a reduction to a previous bankruptcy filing in 1992 and prior to the occurrence of certain other events which may cause limitations on its NOL carryforwards. goodwill (in accordance with SOP 90-7).
Under SOP 90-7, the deferred tax benefit related to the realization of the pre-1992 bankruptcy NOL carryforwardspre-bankruptcy NOLs is not reflected in the consolidated statements of operations. The Company's currentCompany recognized tax expense in fiscal 2003 also includes changes in estimates regarding the Company's utilization of the above-referenced NOL carryforwards due to amendments of prior year tax returns.
F-52
Components of the net deferred income tax assets (liabilities) at December 31, 2002 and 2003 are as follows (in thousands):
| | Predecessor Company | Reorganized Company | ||||||
|---|---|---|---|---|---|---|---|---|
| | December 31, 2002 | December 31, 2003 | ||||||
| Deferred tax liabilities: | ||||||||
| Property and depreciation | $ | (13,382 | ) | $ | (22,552 | ) | ||
| Long-term debt and interest | (2,036 | ) | — | |||||
| Discontinued operations liabilities | — | (375 | ) | |||||
| Other | (42,615 | ) | — | |||||
| Total deferred tax liabilities | (58,033 | ) | (22,927 | ) | ||||
| Deferred tax assets: | ||||||||
| Goodwill and intangible assets | 38,369 | 110,499 | ||||||
| Operating loss carryforwards | 281,481 | 202,909 | ||||||
| Discontinued operations assets | 7,404 | — | ||||||
| Other | 15,607 | 53,121 | ||||||
| Total deferred tax assets | 342,861 | 366,529 | ||||||
| Valuation allowance | (284,828 | ) | (343,602 | ) | ||||
| Deferred tax assets after valuation allowance | 58,033 | 22,927 | ||||||
| Net deferred tax assets | $ | — | $ | — | ||||
11. Accrued Liabilities
Accrued liabilities consist of the following (in thousands):
| | Predecessor Company | Reorganized Company | ||||
|---|---|---|---|---|---|---|
| | December 31, 2002 | December 31, 2003 | ||||
| Liabilities related to chapter 11 proceedings, including professional fees and claim settlements | $ | — | $ | 74,222 | ||
| HAI contingent purchase price | 60,000 | — | ||||
| Other | 157,837 | 131,646 | ||||
| $ | 217,837 | $ | 205,868 | |||
F-53
12. Special Charges
At the beginning of fiscal 2001 the Company had recorded $5.9 million of accrued severance, $4.7 million of accrued lease termination costs and $0.9 million of other exit costs. The following tables provide a roll-forward of liabilities resulting from these liabilities (in thousands):
| Type of Cost | Predecessor Company Balance September 30, 2000 | Additions | Payments | Adjustments (1) | Predecessor Company Balance September 30, 2001 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Employee severance and termination benefits | $ | 5,866 | $ | — | $ | (5,968 | ) | $ | 876 | $ | 774 | ||||
| Lease termination and other costs | 5,578 | — | (2,514 | ) | (876 | ) | 2,188 | ||||||||
| $ | 11,444 | $ | — | $ | (8,482 | ) | $ | — | $ | 2,962 | |||||
| Type of Cost | Predecessor Company Balance September 30, 2001 | Additions (2) | Payments | Adjustments | Predecessor Company Balance September 30, 2002 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Employee severance and termination benefits | $ | 774 | $ | 68 | $ | (821 | ) | $ | — | $ | 21 | ||||
| Lease termination and other costs | 2,188 | 1,335 | (1,375 | ) | — | 2,148 | |||||||||
| $ | 2,962 | $ | 1,403 | $ | (2,196 | ) | $ | — | $ | 2,169 | |||||
| Type of Cost | Predecessor Company Balance September 30, 2002 | Additions | Payments | Adjustments | Predecessor Company Balance December 31, 2002 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Employee severance and termination benefits | $ | 21 | $ | — | $ | (21 | ) | $ | — | $ | — | ||||
| Lease termination and other costs | 2,148 | — | (258 | ) | — | 1,890 | |||||||||
| $ | 2,169 | $ | — | $ | (279 | ) | $ | — | $ | 1,890 | |||||
| Type of Cost | Predecessor Company Balance December 31, 2002 | Additions | Payments | Adjustments (3) | Reorganization Benefit and Fresh Start Adjustments (4) | Reorganized Company Balance December 31, 2003 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Lease termination and other costs | $ | 1,890 | $ | 34 | $ | (374 | ) | $ | (519 | ) | $ | (972 | ) | $ | 59 | |||
F-54
During the first quarter of fiscal 2001, the Company sold its Canadian managed behavioral care operations, CHC, to Family Guidance Group, Inc. for approximately $9.7 million net of transaction costs of $0.3 million. The sale of the Canadian operations resulted in a non-recurring loss of approximately $3.3 million before provision for income taxes. The Company received net proceeds of approximately $8.4 million at the date of the sale, an additional $0.7 million in January 2002 and an additional $0.6 million in December 2002. Proceeds received from the sale were used to reduce debt outstanding under the Company's previous term loan facility.
As of December 31, 2001, management committed the Company to a restructuring plan to eliminate certain duplicative functions and facilities (the "2002 Restructuring Plan") primarily related to the Health Plan Solutions segment. The Company's 2002 Restructuring Plan resulted in the recognition of special charges of approximately $8.2 million during fiscal 2002, with special charges of $4.5 million being recorded during the three months ended December 31, 2001. The fiscal 2002 special charges consisted of (i) $6.3 million to terminate 277 employees, the majority of which were field operational personnel in the Health Plan Solutions segment and (ii) $1.9 million to downsize and close excess facilities, and other associated activities.
The employee termination costs include severance and related termination benefits, including payroll taxes. All terminations were completed by September 30, 2002. The majority of the employee termination costs were paid in full by March 31, 2003. The special charges of $1.9 million represent costs to downsize and close 14 leased facilities. These closure and exit costs include payments required under lease contracts (less any applicable existing and/or estimated sublease income) after the properties were abandoned, write-offs of leasehold improvements related to the facilities and other related expenses. The leased facilities were originally scheduled to terminate at various dates through fiscal 2006; however, all of such leases have been rejected as part of the chapter 11 proceedings. At December 31, 2003, outstanding liabilities of $0.1 million related to the 2002 Restructuring Plan are included in "Accrued liabilities" in the accompanying December 31, 2003 consolidated balance sheet.
F-55
The following tables provide a roll-forward of liabilities resulting from these special charges (in thousands):
| Type of Cost | Predecessor Company Balance September 30, 2001 | Additions | Payments | Adjustments | Predecessor Company Balance September 30, 2002 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Employee severance and termination benefits | $ | — | $ | 6,257 | $ | (5,119 | ) | $ | 352 | $ | 1,490 | ||||
| Lease termination and other costs | — | 1,951 | (723 | ) | (352 | ) | 876 | ||||||||
| $ | — | $ | 8,208 | $ | (5,842 | ) | $ | — | $ | 2,366 | |||||
Type of Cost | Predecessor Company Balance September 30, 2002 | Payments | Adjustments | Predecessor Company Balance December 31, 2002 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Employee severance and termination benefits | $ | 1,490 | $ | (602 | ) | $ | (65 | ) | $ | 823 | ||
| Lease termination and other costs | 876 | (158 | ) | (282 | ) | 436 | ||||||
| $ | 2,366 | $ | (760 | ) | $ | (347 | ) | $ | 1,259 | |||
Type of Cost | Predecessor Company Balance December 31, 2002 | Payments | Adjustments (1) | Reorganization Benefit and Fresh Start Adjustments (2) | Reorganized Company Balance December 31, 2003 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Employee severance and termination benefits | $ | 823 | $ | (694 | ) | $ | (21 | ) | $ | — | $ | 108 | |||
| Lease termination and other costs | 436 | (115 | ) | (208 | ) | (91 | ) | 22 | |||||||
| $ | 1,259 | $ | (809 | ) | $ | (229 | ) | $ | (91 | ) | $ | 130 | |||
F-56
In June 2002, the Company implemented a new business improvement initiative, named Accelerated Business Improvement ("ABI"). ABI was instituted to expand the initiatives of the 2002 Restructuring Plan to the Company as a whole, and was focused on reducing operational and administrative costs while maintaining or improving service to customers. During fiscal 2002, ABI resulted in recognition of costs of (a) $2.9 million to terminate 228 employees, the majority of which were field operational personnel, and (b) $1.0 million to downsize and close excess facilities and other associated activities.
During the three months ended December 31, 2002, the Company's ABI initiative resulted in the recognition of special charges of (a) $2.0 million to terminate 172 employees that comprised both field operational and corporate personnel, and (b) $0.5 million to downsize and close excess facilities and other associated activities.
During the fiscal year ended December 31, 2003, the Company continuedthree months ended December 31, 2002 and the ABI initiative, which resulted infiscal year ended December 31, 2004 due to the recognitionuncertainty as to the Company’s ability to realize deferred tax assets based on its history of special chargesrecent operating losses (prior to reorganization benefits) and financial restructuring activities and the lack of (a) $1.8 millionsubstantial history of profitable operations subsequent to terminate an additional 73 employeesits emergence from bankruptcy.
The tax effects of temporary differences that represented both field operational and corporate personnel, and (b) $0.1 milliongive rise to downsize and close additional excess facilities and other associated activities. The employee termination costs of $1.8 million include severance and related termination benefits, including payroll taxes. Allsignificant portions of the terminations completed by June 30, 2003. Atdeferred tax assets and liabilities at December 31, 2003 outstanding liabilities of approximately $0.3 million related to ABIand 2004 are included in "Accrued liabilities" in the accompanying December 31, 2003 consolidated balance sheet.
F-57
The following tables provide a roll-forward of liabilities resulting from the special charges incurred in the implementation of this planas follows (in thousands):
| Type of Cost | Predecessor Company Balance September 30, 2001 | Additions | Payments | Predecessor Company Balance September 30, 2002 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Employee severance and termination benefits | $ | — | $ | 2,920 | $ | (435 | ) | $ | 2,485 | |||
| Lease termination and other costs | — | 984 | (27 | ) | 957 | |||||||
| $ | — | $ | 3,904 | $ | (462 | ) | $ | 3,442 | ||||
Type of Cost | Predecessor Company Balance September 30, 2002 | Additions | Payments | Predecessor Company Balance December 31, 2002 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Employee severance and termination benefits | $ | 2,485 | $ | 2,040 | $ | (2,562 | ) | $ | 1,963 | |||
| Lease termination and other costs | 957 | 455 | (296 | ) | 1,116 | |||||||
| $ | 3,442 | $ | 2,495 | $ | (2,858 | ) | $ | 3,079 | ||||
Type of Cost | Predecessor Company Balance December 31, 2002 | Additions | Payments | Adjustments (1) | Reorganization Benefit and Fresh Start Adjustments (2) | Reorganized Company Balance December 31, 2003 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Employee severance and termination benefits | $ | 1,963 | $ | 1,755 | $ | (3,457 | ) | $ | — | $ | — | $ | 261 | |||||
| Lease termination and other costs | 1,116 | 61 | (461 | ) | (412 | ) | (284 | ) | 20 | |||||||||
| $ | 3,079 | $ | 1,816 | $ | (3,918 | ) | $ | (412 | ) | $ | (284 | ) | $ | 281 | ||||
|
| December 31, |
| ||
|
| 2003 |
| 2004 |
|
Deferred tax assets: |
|
|
|
|
|
Goodwill and intangible assets |
| $ 110,499 |
| $ 97,265 |
|
Operating loss carryforwards |
| 202,909 |
| 155,797 |
|
Other |
| 53,121 |
| 30,061 |
|
Total deferred tax assets |
| 366,529 |
| 283,123 |
|
Valuation allowance |
| (343,602 | ) | (242,906 | ) |
Deferred tax assets after valuation allowance |
| 22,927 |
| 40,217 |
|
Deferred tax liabilities: |
|
|
|
|
|
Property and depreciation |
| (22,552 | ) | (25,403 | ) |
Other |
| (375 | ) | (452 | ) |
Total deferred tax liabilities |
| (22,927 | ) | (25,855 | ) |
Net deferred tax assets |
| $ — |
| $ 14,362 |
|
As part of its financial restructuring plan and chapter 11 proceedings, the Company has rejected certain leases for closed offices. The estimated cost to the Company as a result of rejecting such leases is different than the liability previously recorded. In accordance with SOP 90-7, such difference has been recorded in the accompanying audited consolidated statements of operations as "Reorganization expense (benefit)", a component of income (loss) from continuing operations. In addition, the Company's application of fresh start reporting as of December 31, 2003, resulted in a net reductionthe only individual current liability that exceeded five percent of total current liabilities related to the $74.2 million that the Company had accrued pertaining to its chapter 11 proceedings, inclusive of professional fees and claims settlements. As of December 31, 2004, there were no individual current liabilities that exceeded five percent of total current liabilities.
F-43
Special charges incurred by the Company principally relate to restructuring activities, which are discussed further below. A summary of the liability. See further discussion in Note 2—"Fresh Start Reporting."
|
| Predecessor Company |
| Reorganized |
| ||||||||||||||||
|
| Fiscal Year Ended |
| Three Months Ended |
| Fiscal Year |
| ||||||||||||||
|
| September 30, |
| December 31, |
| December 31, |
| December 31, |
| December 31, |
| ||||||||||
|
| (unaudited) |
| ||||||||||||||||||
Restructuring activity |
|
| $ 15,729 |
|
|
| $ 10,946 |
|
|
| $ 4,485 |
|
|
| $ 3,907 |
|
|
| $ 5,038 |
|
|
Other(1) |
|
| — |
|
|
| (1,418 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
Total |
|
| $ 15,729 |
|
|
| $ 9,528 |
|
|
| $ 4,485 |
|
|
| $ 3,907 |
|
|
| $ 5,038 |
|
|
In April
(1) Special charges for the year ended December 31, 2003 includes a credit of $1.4 million, primarily related to the collection of a previously reserved note receivable. The note receivable was related to the sale of a subsidiary sold by the Company implemented a new business and performance initiative, named Performance Improvement Plan ("PIP"). PIP isin fiscal 2001.
The Company’s restructuring activities have focused on furthereliminating certain duplicative functions and facilities, consolidating service centers, creating more efficiencies in corporate overhead, consolidating systems, improving call center
F-58
technology and instituting other operational and business efficiencies while maintaining or improving service to customers. During the fiscal year ended December 31, 2003, PIPSeptember 30, 2002, the Company’s restructuring activities resulted in the recognition of special charges of (a) $7.5$15.7 million which consisted of (i) $9.6 million to terminate 463505 employees, that represented both operational and corporate personnel, and (b) $2.4(ii) $3.9 million to downsize and close excess facilities, and other associated activities. (iii) $2.2 million for costs expensed as incurred related to services from outside consultants. During the three months ended December 31, 2002, the Company’s restructuring activities resulted in the recognition of special charges of $3.9 million which consisted of (i) $2.0 million to terminate 172 employees, (ii) $0.1 million to downsize and close excess facilities, and (iii) $1.8 million for costs expensed as incurred related to services from outside consultants. During the fiscal year ended December 31, 2003, the Company’s restructuring activities resulted in the recognition of special charges of $10.9 million which consisted of (i) $9.2 million to terminate 536 employees, (ii) $1.2 million to downsize and close excess facilities, and (iii) $0.5 million for costs expensed as incurred related to services from outside consultants. During the fiscal year ended December 31, 2004, the Company’s restructuring activities resulted in the recognition of special charges of $5.0 million, which consisted of (i) $2.7 million to terminate 143 employees, and (ii) $2.3 million to downsize and close excess facilities.
F-44
The employee termination costs of $7.5 million, which are provided under an ongoing benefit arrangement, includeand consist of severance and related termination benefits, including payroll taxes. All terminations are expected to be completed by June 30, 2004 and termination costs associated with such employees are expected to be paid in full by January 31, 2005. Termination liabilities attributable to ongoing benefit arrangements have been accrued when probable in accordance with SFAS No. 112, "Employers'“Employers’ Accounting for PostemploymentPost-employment Benefits."” All terminations for which liabilities were accrued as of December 31, 2004 were completed by January 31, 2005 and such liabilities will be paid in full by August 1, 2005. The other special charges of $2.4 million represent costs to downsize and close sevenexcess leased facilities, and other associated costs. Lease termination costs are accounted for under SFAS No. 146, "Accounting“Accounting for Costs Associated with Exit or Disposal Activities" ("Activities” (“SFAS 146"146”). In accordance with SFAS 146, the liability for lease termination costs is accrued at the time that all employees have vacated the leased property. These closure and exit costs include payments required under lease contracts (less any applicable existing and/or estimated sublease income) after the properties were abandoned, write-offs of leasehold improvements related to the facilities and other related expenses. At December 31, 2003, outstandingA roll-forward of restructuring liabilities is as follows (in thousands):
Type of Cost |
|
|
| Predecessor |
| Additions |
| Payments |
| Predecessor |
| ||||
Employee severance and termination benefits |
|
| $ 774 |
|
| $ 9,597 |
| $ (6,375 | ) |
| $ 3,996 |
|
| ||
Lease termination and other costs |
|
| 2,188 |
|
| 3,918 |
| (2,125 | ) |
| 3,981 |
|
| ||
Consulting costs |
|
| — |
|
| 2,214 |
| (2,214 | ) |
| — |
|
| ||
|
|
| $ 2,962 |
|
| $ 15,729 |
| $ (10,714 | ) |
| $ 7,977 |
|
| ||
Type of Cost |
|
|
| Predecessor |
| Additions |
| Payments |
| Predecessor |
| ||||
Employee severance and termination benefits |
|
| $ 3,996 |
|
| $ 1,975 |
| $ (3,185 | ) |
| $ 2,786 |
|
| ||
Lease termination and other costs |
|
| 3,981 |
|
| 173 |
| (712 | ) |
| 3,442 |
|
| ||
Consulting costs |
|
| — |
|
| 1,759 |
| (1,759 | ) |
| — |
|
| ||
|
|
| $ 7,977 |
|
| $ 3,907 |
| $ (5,656 | ) |
| $ 6,228 |
|
| ||
Type of Cost |
|
|
| Predecessor |
| Additions |
| Payments |
| Reorganization |
| Reorganized |
| ||||||||||
Employee severance and termination benefits |
|
| $ 2,786 |
|
|
| $ 9,202 |
|
|
| $ (6,917 | ) |
|
| $ — |
|
|
| $ 5,071 |
|
| ||
Lease termination and other costs |
|
| 3,442 |
|
|
| 1,190 |
|
|
| (986 | ) |
|
| (3,399 | ) |
|
| 247 |
|
| ||
Consulting costs |
|
| — |
|
|
| 554 |
|
|
| (554 | ) |
|
| — |
|
|
| — |
|
| ||
|
|
| $ 6,228 |
|
|
| $ 10,946 |
|
|
| $ (8,457 | ) |
|
| $ (3,399 | ) |
|
| $ 5,318 |
|
| ||
F-45
Type of Cost |
|
|
| Reorganized |
| Additions |
| Payments |
| Reorganized |
| ||||||||
Employee severance and termination benefits |
|
| $ 5,071 |
|
|
| $ 2,743 |
|
|
| $ (6,948 | ) |
|
| $ 866 |
|
| ||
Lease termination and other costs |
|
| 247 |
|
|
| 2,295 |
|
|
| (1,094 | ) |
|
| 1,448 |
|
| ||
|
|
| $ 5,318 |
|
|
| $ 5,038 |
|
|
| $ (8,042 | ) |
|
| $ 2,314 |
|
| ||
(1) As part of approximately $4.8 million related to PIP are included inits financial restructuring plan and chapter 11 proceedings, the accompanying consolidated balance sheet in "Accrued liabilities".
Implementation of PIP resulted in additional incremental costs that were expensed as incurred. Special chargesCompany rejected certain leases for the year ended December 31, 2003 includes $0.6 million for theclosed offices. The estimated cost of outside consultants. Also included in special charges for the year ended December 31, 2003 is income of $1.4 million, primarily related to the collectionCompany as a result of arejecting such leases was different than the liability previously reserved note receivable. The note receivable was related to the sale of a subsidiary sold by the Company in fiscal 2001.
F-59
The following table provides a roll-forward of liabilities resulting from the special charges incurred in the implementation of this plan (in thousands):
| Type of Cost | Predecessor Company Balance December 31, 2002 | Additions | Payments | Adjustments (1) | Reorganization Benefit and Fresh Start Adjustments (2) | Reorganized Company Balance December 31, 2003 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Employee severance and termination benefits | $ | — | $ | 7,468 | $ | (2,779 | ) | $ | 13 | $ | — | $ | 4,702 | |||||
| Lease termination and other costs | — | 2,367 | (498 | ) | 329 | (2,052 | ) | 146 | ||||||||||
| $ | — | $ | 9,835 | $ | (3,277 | ) | $ | 342 | $ | (2,052 | ) | $ | 4,848 | |||||
13. Supplemental Cash Flow Information
Supplemental cash flow information is as follows (in thousands):
| | Predecessor Company | ||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | Three Months Ended December 31, | |||||||||||||||||||||||||||||||||
| | Fiscal Year Ended September 30, | |
| Predecessor Company |
|
| Reorganized |
| |||||||||||||||||||||||||||||
| | Fiscal Year Ended December 31, 2003 | 2001 (unaudited) | |
| Fiscal Year |
| Fiscal Year |
| Three Months |
| Three Months |
|
| Fiscal Year |
| ||||||||||||||||||||||
| | 2001 | 2002 | 2002 |
|
|
|
|
| (unaudited) |
|
|
|
|
|
| ||||||||||||||||||||||
| Income taxes paid, net of refunds (received) | $ | 7,139 | $ | 433 | $ | (1,168 | ) | $ | (161 | ) | $ | 71 |
|
| $ 433 |
|
|
| $ (1,168 | ) |
|
| $ (161 | ) |
|
| $ 71 |
|
|
|
| $ 6,579 |
|
| |||
| Interest paid | 91,139 | 89,740 | 15,770 | 13,277 | 16,175 |
|
| $ 89,740 |
|
|
| $ 15,770 |
|
|
| $ 13,277 |
|
|
| $ 16,175 |
|
|
|
| $ 31,547 |
|
| ||||||||||
14. Commitments and Contingencies
Insurance
The Company maintains a program of insurance coverage for a broad range of risks in its business. As part of this program of insurance, the Company is self-insured for a portion of its general and
F-60
current professional liability risks. Prior to July 1999, the Company maintained certain reserves related primarily to the professional liability risks of the Company'sCompany’s healthcare provider segment arising prior to the sale of its domestic acute-care psychiatric hospitals and residential treatment facilities to Crescent Transactions.Real Estate Equities in fiscal 1997. On July 2, 1999, the Company transferred its remaining medical malpractice claims portfolio (the "Loss“Loss Portfolio Transfer"Transfer”) to a third-party insurer for approximately $22.3 million. The Loss Portfolio Transfer was funded from assets restricted for settlement of unpaid claims. The insurance limit obtained through the Loss Portfolio Transfer for future medical malpractice claims is $26.3 million. The Company continually evaluates the adequacy of these insured limits and management believes these amounts are sufficient; however, there can be no assurance in that regard.
The Company maintained general, professional and managed care liability insurance policies with unaffiliated insurers covering the two-year period from June 17, 2000 to June 16, 2002. The policies were written on a "claims-made" basis, subject to a $0.25 million per claim and $1.0 million annual aggregate self-insured retention for general and professional liability, and also subject to a $0.5 million per claim and $2.5 million annual aggregate self-insured retention for managed care liability. The Company renewed its general, professional and managed care liability insurance policies with unaffiliated insurers for the one-year period from June 17, 2002 to June 16, 2003. These policies were also written on a "claims-made" basis, and were subject to a $1.0 million per claim ($5.0 million per class action claim) un-aggregated self-insured retention for managed care liability and a $0.25 million per claim un-aggregated self-insured retention for general and professional liability. The Companyrecently renewed its general, professional and managed care liability insurance policies with unaffiliated insurers for a one-year period from June 17, 20032004 to June 16, 2004.17, 2005. The general liability policies are alsowritten on an “occurrence” basis, subject to a $0.1 million per claim un-aggregated self-insured retention. The professional liability and managed care errors and omissions liability policies are written on a "claims-made"“claims-made” basis, subject to a $1.25 million per claim ($10.0 million per class action claim) un-aggregated self-insured retention for managed care liability, and a $0.25$0.1 million per claim un-aggregated self-insured retention for general and professional liability. The Company also purchases excess liability coverage in an amount deemedthat management believes to be reasonable by management for the size and profile of the organization. The Company is responsible for claims within its self-insured retentions, excluding portions of claims reported after the expiration date of the policies if they are not renewed, or if policy limits are exceeded.
F-46
Regulatory Issues.The healthcare industry is subject to numerous laws and regulations. The subjects of such laws and regulations cover, but are not limited to, matters such as licensure, accreditation, government healthcare program participation requirements, information privacy and security, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Over the past several years, government activity has increased with respect to investigations and/or allegations concerning possible violations of fraud and abuse and false claims statutes and/or regulations by healthcare organizations and insurers. Entities that are found to have violated these laws and regulations may be excluded from participating in government healthcare programs, subjected to fines or penalties or required to repay amounts received from the government for previously billed patient services. Compliance with such laws and regulations can be subject to future government review and interpretation, as well as regulatory actions unknown or unasserted at this time.
In addition, regulators of certain of the Company'sCompany’s subsidiaries may exercise certain discretionary rights under regulations including increasing its supervision of such entities, requiring additional restricted cash or other security or seizing or otherwise taking control of the assets and operations of such subsidiaries. In particular, the State of California has taken certain actions to increase its
F-61
supervision of one of the Company's regulated subsidiaries in California due primarily to the Company's financial condition prior to the bankruptcy filing.
Legal.The Company is subject to or party to certain class action suits, litigation and claims relating to its operations and business practices. LitigationExcept as otherwise provided under the Plan, litigation asserting claims against the Company and its subsidiaries that were parties to the chapter 11 proceedings for pre-petition obligations (the "Pre-petition Litigation"“Pre-petition Litigation”) were, was enjoined as of the Effective Date as a consequence of the commencementconfirmation of the Company's chapter 11 proceedings.Plan by the Bankruptcy Court. The Company believes that the Pre-petition Litigation claims constitute pre-petition general unsecured claims and, to the extent allowed by the Bankruptcy Court, would be resolved as Other General Unsecured Claims under the Plan. See Note 1—"General—“Business—Emergence from Chapter 11".11.”
In the opinion of management, the Company has recorded reserves that are adequate to cover litigation, claims or assessments that have been or may be asserted against the Company, and for which the outcome is probable and reasonably estimable. Management believes that the resolution of such litigation and claims will not have a material adverse effect on the Company'sCompany’s financial position or results of operations; however, there can be no assurance in this regard.
Operating Leases.The Company leases certain of its operating facilities. The leases, which expire at various dates through January 2013, generally require the Company to pay all maintenance, property tax and insurance costs.
At December 31, 2003,2004, aggregate amounts of future minimum payments under operating leases were as follows: 2004 – $16.72005—$15.5 million; 2005 – $11.62006—$12.0 million; 2006 – $8.52007—$10.9 million; 2007 – $7.52008—$10.3 million; 2008 – $7.02009—$9.1 million; 20092010 and beyond – $20.2- $19.4 million. Operating lease obligations include estimated future lease payments for both open and closed offices. Such future lease amounts exclude leases that have been rejected as part of the Company'sCompany’s chapter 11 proceedings.
Rent expense for continuing operations was $33.3 million, $32.9 million and $27.6$27.1 million, respectively, for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, and was $8.0 million for the three months ended December 31, 2002.2002 and $20.6 million for the fiscal year ended December 31, 2004. Rent expense for discontinued operations was $6.3 million, $3.6 million and $0.9$0.4 million, respectively, for the fiscal years ended September 30, 2001 and 2002 and December 31, 2003, and was $0.7 million for the three months ended December 31, 2002.2002, and was $0.1 million for the fiscal year ended December 31, 2004.
15. Certain Relationships and Related Transactions
On December 4, 2002, the Company entered into a consulting agreement with Healthcare Partners, Inc. ("HPI"(“HPI”), a newly formed entity whose principals arewere Steven J. Shulman and René Lerer,
F-47
M.D. (the "HPI Agreement"“HPI Agreement”). Pursuant to the HPI Agreement, HPI, Mr. Shulman and Dr. Lerer, as well as Danna Mezin and Keith Kudla (the "Officers"“Officers”), became part of the management of the Company, with Mr. Shulman becoming the chief executive officerChief Executive Officer of the Company. All of the Officers have devoted substantially all of their time to the management of the Company. For such services, the Company has paid to HPI, per the agreement, $250,000 per month for every month or portion thereof from December 2002 through the Effective Date and a bonus payment of $1.95 million based upon the achievement of certain targets under the agreement. This agreement was terminated on the Effective
F-62
Date, at which time Mr. Shulman and Dr. Lerer entered into employment agreements with the Company and Ms. Mezin and Mr. Kudla became employees of the Company.
Robert M. LeBlanc and Mark L. Hilson, DirectorsLe Blanc, Director of the Company, areis affiliated with Onex. Through March 4, 2004, Magellan Holdings LP, an affiliate of Onex, purchased 8,552,700which owns 8,487,750 shares of Multi-Vote Common Stock of the Company. Onex then sold 82,854Company as of these shares to Morgan Noble LLC on the Effective Date, leaving it with 8,469,846 shares.December 31, 2004
Michael Diament, a Director of the Company, is a Portfolio Manager and Director of Bankruptcies and Restructurings for Renegade Swish, LLC which, through various contractual agreements, provides investment management services to Amalgamated Gadget, LP, the investment manager for R2 Investments, LDC. On the Effective Date, Amalgamated Gadget, LP, for and on behalf of R2 Investments, LDC, acquired beneficial ownership of 3,198,106 shares of Ordinary Common Stock of the Company. On January 6, 2004, Amalgamated LP sold 738,675Company, of which they owned 500,000 shares leaving it with beneficial ownership of 2,459,431 shares or approximately 9.1 percent of the total shares outstanding as of that date.December 31, 2004.
Saul E. Burian is a Director in the New York office of Houlihan, Lokey, Howard & Zukin ("Houlihan"). Houlihanwhich represented the Pre-Petition Unofficial Committee of the Company'sCompany’s Unsecured Noteholders and the Official Committee of Unsecured Creditors of the Company in connection with the Company'sCompany’s financial restructuring process. The Company estimates that thepaid total compensation to be paid to Houlihan for services rendered to the Committees as financial advisor will beof approximately $2.9 million in cash, 166,966 shares of Ordinary Common Stock, and $1.8 million of Series B Notes, subject to finalizationfinal adjustment when the recoveries under the Plan by general unsecured creditors are finalized. In addition, Mr. Burian, as a Director of Houlihan, received an economic interest in 4,000 shares Houlihan received pursuant to the Plan. Mr. Burian did not have record ownership, nor did he possess either investment or dispositive power over the shares; however, Mr. Burian did possess the economic risk and benefit of the ownership of these shares. Such shares were sold by Houlihan shortly following the consummation of the Plan.
Robert Haft, a Director of the Company, is the Principal Manager of Morgan Noble LLC, which purchased 82,854 shares of Multi-Vote Common Stock from Magellan Holdings LPOnex in January 2004 at $12.07 per share. The Multi-Vote Common stock automatically converted to Ordinary Common Stock upon the transfer of the shares.
16. Business Segment Information
The Company is engaged in the managed behavioral healthcare business. The Company provides managed behavioral healthcare services to health plans, insurance companies, corporations, labor unions and various governmental agencies. Within the managed behavioral healthcare business, the Company is further divided into the following four segments, based on the services it provides and/or the customers that it serves, as described below.
Health Plan Solutions.The Company'sCompany’s Health Plan Solutions segment generally reflects managed behavioral healthcare services provided under contracts with managed care companies, health insurers and other health plans. This segment'ssegment’s contracts encompass both risk-based and ASO contracts.
F-63
Although certain health plans provide their own managed behavioral healthcare services, many health plans "carve out"“carve out” behavioral healthcare from their general healthcare services and subcontract such services to managed behavioral healthcare companies such as the Company. In the Health Plan Solutions segment, the Company'sCompany’s members are the beneficiaries of the health plan (the employees and dependents of the
F-48
customer of the health plan), for which the behavioral healthcare services have been carved out to the Company.
Employer Solutions.The Company'sCompany’s Employer Solutions (formerly "Workplace"“Workplace”) segment generally reflects the provision of EAP services, managed behavioral healthcare services and integrated products under contracts with employers, including corporations and governmental agencies, and labor unions. This segment'ssegment’s managed behavioral healthcare services are primarily ASO products.
Public Sector Solutions.The Company'sCompany’s Public Sector Solutions segment generally reflects managed behavioral healthcare services provided to Medicaid recipients under contracts with state and local governmental agencies. This segment'ssegment’s contracts encompass both risk-based and ASO contracts. The Company provides managed behavioral healthcare services to the State of Tennessee's TennCare program, both through a direct contract and through Premier, a joint venture in which the Company owns a 50.0 percent interest.
Corporate and Other.This segment of the Company is comprised primarily of operational support functions such as claims administration, network services, sales and marketing and information technology as well as corporate support functions such as executive, finance, human resources and legal. Discontinued operations activity is not included in the Corporate and Other segment operating results.
The accounting policies of these segments are the same as those described in Note 3—"“Summary of Significant Accounting Policies".Policies.” The Company evaluates performance of its segments based on profit or loss from continuing operations before depreciation, amortization, interest (net), stock compensation expense, bankruptcy reorganization charges and benefits, goodwill impairment charges, special charges, income taxes and minority interest ("(“Segment Profit"Profit”). Management uses segment profit information for internal reporting and control purposes and considers it important in making decisions regarding the allocation of capital and other resources, risk assessment and employee compensation, among other matters. Intersegment sales and transfers are not significant.
The Company'sCompany’s behavioral customer segments are defined above. In certain limited cases, customer contracts that would otherwise meet the definition of one segment are managed and reported internally in another segment, in which cases the membership and financial results of such contracts are reflected in the segment in which it is managed and reported internally. In fiscal 2003,During the quarter ended September 30, 2004, the Company’s internal reporting of certain of these contracts was transferred betweenoperational and corporate support costs, such as claims administration and network services, changed to allocate such costs from the Corporate and Other segment to the Health Plan Solutions, Employer Solutions and Public Sector Solutions segments. Accordingly, the Company has restatedreclassified the membership and financial results of such contracts for all prior periods to allocate such costs into the corresponding segments consistent with its internal reporting. This restatement didreclassification does not affect consolidated membership or financial results for any periodperiods presented. In fiscal 2003, management also changed the name of its "Workplace" segment to the "Employer Solutions" segment. All periods presented were adjusted to conform with the fiscal 2003 restatement.2004 reclassification.
F-64F-49
The following table summarizes, for the periods indicated, operating results and other financial information, by business segment (in thousands):
| | Predecessor Company |
| Health |
| Employer |
| Public |
| Corporate |
| Consolidated |
| |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Health Plan Solutions | Employer Solutions | Public Sector Solutions | Corporate and Other | Consolidated | ||||||||||||||||||||||||||||||||
| Fiscal Year Ended September 30, 2001 | |||||||||||||||||||||||||||||||||||||
| Net revenue | $ | 1,079,549 | $ | 189,625 | $ | 486,338 | $ | — | $ | 1,755,512 | |||||||||||||||||||||||||||
| Cost of care | 621,817 | 64,649 | 410,982 | — | 1,097,448 | ||||||||||||||||||||||||||||||||
| Direct service costs | 179,836 | 73,363 | 38,225 | — | 291,424 | ||||||||||||||||||||||||||||||||
| Other operating expenses | — | — | — | 168,170 | 168,170 | ||||||||||||||||||||||||||||||||
| Equity in (earnings) loss of unconsolidated subsidiaries | (39,103 | ) | — | 2,537 | — | (36,566 | ) | ||||||||||||||||||||||||||||||
| Segment profit (loss) | 316,999 | 51,613 | 34,594 | (168,170 | ) | 235,036 | |||||||||||||||||||||||||||||||
| Identifiable assets by business segment: | |||||||||||||||||||||||||||||||||||||
| Restricted cash, investments and deposits | 28,227 | 8,914 | 85,307 | — | 122,448 | ||||||||||||||||||||||||||||||||
| Net accounts receivable | 53,773 | 39,270 | 10,024 | 575 | (1) | 103,642 | |||||||||||||||||||||||||||||||
| Investment in unconsolidated subsidiaries | $ | 5,292 | $ | — | $ | 5,607 | $ | — | $ | 10,899 | |||||||||||||||||||||||||||
Predecessor Company: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Fiscal Year Ended September 30, 2002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Net revenue | $ | 1,013,033 | $ | 188,703 | $ | 551,322 | $ | — | $ | 1,753,058 |
|
| $1,013,033 |
|
|
| $188,703 |
|
|
| $551,322 |
|
|
| $ — |
|
|
| $1,753,058 |
|
| ||||||
| Cost of care | 596,811 | 72,446 | 456,497 | — | 1,125,754 |
|
| 596,811 |
|
|
| 72,446 |
|
|
| 456,497 |
|
|
| — |
|
|
| 1,125,754 |
|
| |||||||||||
| Direct service costs | 174,926 | 76,752 | 41,423 | — | 293,101 |
|
| 226,141 |
|
|
| 85,799 |
|
|
| 53,256 |
|
|
| — |
|
|
| 365,196 |
|
| |||||||||||
| Other operating expenses | — | — | — | 166,459 | 166,459 |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 94,364 |
|
|
| 94,364 |
|
| |||||||||||
| Equity in (earnings) loss of unconsolidated subsidiaries | (15,537 | ) | — | 2,531 | — | (13,006 | ) |
|
| (15,537 | ) |
|
| — |
|
|
| 2,531 |
|
|
| — |
|
|
| (13,006 | ) |
| |||||||||
| Segment profit (loss) | 256,833 | 39,505 | 50,871 | (166,459 | ) | 180,750 |
|
| 205,618 |
|
|
| 30,458 |
|
|
| 39,038 |
|
|
| (94,364 | ) |
|
| 180,750 |
|
| ||||||||||
| Identifiable assets by business segment: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Restricted cash, investments and deposits | 19,388 | 7,356 | 95,976 | 2,020 | (1) | 124,740 |
|
| 19,388 |
|
|
| 7,356 |
|
|
| 95,976 |
|
|
| 2,020 | (1) |
|
| 124,740 |
|
| ||||||||||
| Net accounts receivable | 53,246 | 27,314 | 13,624 | 940 | (1) | 95,124 |
|
| 53,246 |
|
|
| 27,314 |
|
|
| 13,624 |
|
|
| 940 | (1) |
|
| 95,124 |
|
| ||||||||||
| Investment in unconsolidated subsidiaries | $ | 10,144 | $ | — | $ | 3,076 | $ | — | $ | 13,220 |
|
| 10,144 |
|
|
| — |
|
|
| 3,076 |
|
|
| — |
|
|
| 13,220 |
|
| ||||||
Fiscal Year Ended December 31, 2003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Net revenue | $ | 870,540 | $ | 159,034 | $ | 481,172 | $ | — | $ | 1,510,746 |
|
| $ 870,540 |
|
|
| $159,034 |
|
|
| $481,172 |
|
|
| $ — |
|
|
| $1,510,746 |
|
| ||||||
| Cost of care | 464,128 | 44,858 | 397,498 | — | 906,484 |
|
| 464,128 |
|
|
| 44,858 |
|
|
| 397,498 |
|
|
| — |
|
|
| 906,484 |
|
| |||||||||||
| Direct service costs | 130,731 | 68,135 | 28,759 | — | 227,625 |
|
| 180,336 |
|
|
| 79,071 |
|
|
| 40,466 |
|
|
| — |
|
|
| 299,873 |
|
| |||||||||||
| Other operating expenses | — | — | — | 190,777 | 190,777 |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 118,529 |
|
|
| 118,529 |
|
| |||||||||||
| Equity in (earnings) loss of unconsolidated subsidiaries | (6,560 | ) | — | 358 | — | (6,202 | ) |
|
| (6,560 | ) |
|
| — |
|
|
| 358 |
|
|
| — |
|
|
| (6,202 | ) |
| |||||||||
| Segment profit (loss) | 282,241 | 46,041 | 54,557 | (190,777 | ) | 192,062 |
|
| 232,636 |
|
|
| 35,105 |
|
|
| 42,850 |
|
|
| (118,529 | ) |
|
| 192,062 |
|
| ||||||||||
| Reorganized Company: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Identifiable assets by business segment: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Restricted cash |
|
| 2,179 |
|
|
| 3,702 |
|
|
| 94,231 |
|
|
| 2,244 | (1) |
|
| 102,356 |
|
| ||||||||||||||||
Investments |
|
| 9,145 |
|
|
| 414 |
|
|
| 14,373 |
|
|
| 473 |
|
|
| 24,405 |
|
| ||||||||||||||||
Net accounts receivable |
|
| 28,191 |
|
|
| 22,276 |
|
|
| 31,572 |
|
|
| 1,880 | (1) |
|
| 83,919 |
|
| ||||||||||||||||
Investment in unconsolidated subsidiaries |
|
| 13,034 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 13,034 |
|
| ||||||||||||||||
Goodwill |
|
| 450,244 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 450,244 |
|
| ||||||||||||||||
Three Months Ended December 31, 2001 (unaudited) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Net revenue |
|
| $ 270,149 |
|
|
| $ 45,870 |
|
|
| $128,823 |
|
|
| $ — |
|
|
| $ 444,842 |
|
| ||||||||||||||||
Cost of care |
|
| 152,430 |
|
|
| 17,462 |
|
|
| 105,779 |
|
|
| — |
|
|
| 275,671 |
|
| ||||||||||||||||
Direct service costs |
|
| 61,410 |
|
|
| 21,998 |
|
|
| 12,969 |
|
|
| — |
|
|
| 96,377 |
|
| ||||||||||||||||
Other operating expenses |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 23,045 |
|
|
| 23,045 |
|
| ||||||||||||||||
Equity in (earnings) loss of unconsolidated subsidiaries |
|
| (3,831 | ) |
|
| — |
|
|
| 654 |
|
|
| — |
|
|
| (3,177 | ) |
| ||||||||||||||||
Segment profit (loss) |
|
| 60,140 |
|
|
| 6,410 |
|
|
| 9,421 |
|
|
| (23,045 | ) |
|
| 52,926 |
|
| ||||||||||||||||
Three Months Ended December 31, 2002 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Net revenue |
|
| $ 245,581 |
|
|
| $ 46,700 |
|
|
| $153,609 |
|
|
| $ — |
|
|
| $ 445,890 |
|
| ||||||||||||||||
Cost of care |
|
| 137,501 |
|
|
| 17,368 |
|
|
| 126,841 |
|
|
| — |
|
|
| 281,710 |
|
| ||||||||||||||||
Direct service costs |
|
| 47,339 |
|
|
| 20,608 |
|
|
| 14,377 |
|
|
| — |
|
|
| 82,324 |
|
| ||||||||||||||||
Other operating expenses |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 27,399 |
|
|
| 27,399 |
|
| ||||||||||||||||
Equity in earnings of unconsolidated subsidiaries |
|
| (1,993 | ) |
|
| — |
|
|
| (145 | ) |
|
| — |
|
|
| (2,138 | ) |
| ||||||||||||||||
Segment profit (loss) |
|
| 62,734 |
|
|
| 8,724 |
|
|
| 12,536 |
|
|
| (27,399 | ) |
|
| 56,595 |
|
| ||||||||||||||||
Identifiable assets by business segment: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
| Restricted cash, investments and deposits | 21,176 | 4,107 | 134,665 | 1,975 | (1) | 161,923 |
|
| 20,817 |
|
|
| 6,283 |
|
|
| 98,216 |
|
|
| 2,002 | (1) |
|
| 127,318 |
|
| ||||||||||
| Net accounts receivable | 28,191 | 22,276 | 31,572 | 1,880 | (1) | 83,919 |
|
| 49,853 |
|
|
| 24,972 |
|
|
| 6,184 |
|
|
| 219 | (1) |
|
| 81,228 |
|
| ||||||||||
| Investment in unconsolidated subsidiaries | $ | 13,034 | $ | — | $ | — | $ | — | $ | 13,034 |
|
| 8,962 |
|
|
| — |
|
|
| 3,221 |
|
|
| — |
|
|
| 12,183 |
|
| ||||||
F-50
F-65
Reorganized Company: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue |
|
| $ 904,872 |
|
|
| $135,676 |
|
|
| $754,854 |
|
|
| $ — |
|
|
| $1,795,402 |
|
|
Cost of care |
|
| 484,047 |
|
|
| 37,168 |
|
|
| 669,379 |
|
|
| — |
|
|
| 1,190,594 |
|
|
Direct service costs |
|
| 170,131 |
|
|
| 66,294 |
|
|
| 40,528 |
|
|
| — |
|
|
| 276,953 |
|
|
Other operating expenses |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 99,918 |
|
|
| 99,918 |
|
|
Equity in earnings of unconsolidated subsidiaries |
|
| (5,277 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (5,277 | ) |
|
Segment profit (loss) |
|
| 255,971 |
|
|
| 32,214 |
|
|
| 44,947 |
|
|
| (99,918 | ) |
|
| 233,214 |
|
|
Identifiable assets by business segment: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted cash |
|
| 1,694 |
|
|
| 3,996 |
|
|
| 98,592 |
|
|
| 132 |
|
|
| 104,414 |
|
|
Investments |
|
| 9,918 |
|
|
| 446 |
|
|
| 25,355 |
|
|
| 310,371 |
|
|
| 346,090 |
|
|
Net accounts receivable |
|
| 18,069 |
|
|
| 17,620 |
|
|
| 21,977 |
|
|
| 1,184 |
|
|
| 58,850 |
|
|
Investment in unconsolidated subsidiaries |
|
| 10,989 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 10,989 |
|
|
Goodwill |
|
| 392,267 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 392,267 |
|
|
Three Months Ended December 31, 2001 (unaudited) | ||||||||||||||||
| Net revenue | $ | 270,149 | $ | 45,870 | $ | 128,823 | $ | — | $ | 444,842 | ||||||
| Cost of care | 152,430 | 17,462 | 105,779 | — | 275,671 | |||||||||||
| Direct service costs | 47,136 | 19,367 | 10,197 | — | 76,700 | |||||||||||
| Other operating expenses | — | — | — | 42,722 | 42,722 | |||||||||||
| Equity in (earnings) loss of unconsolidated subsidiaries | (3,831 | ) | — | 654 | — | (3,177 | ) | |||||||||
| Segment profit (loss) | $ | 74,414 | $ | 9,041 | $ | 12,193 | $ | (42,722 | ) | $ | 52,926 | |||||
Three Months Ended December 31, 2002 | ||||||||||||||||
| Net revenue | $ | 245,581 | $ | 46,700 | 153,609 | — | 445,890 | |||||||||
| Cost of care | 137,501 | 17,368 | 126,841 | — | 281,710 | |||||||||||
| Direct service costs | 36,234 | 18,307 | 10,923 | — | 65,464 | |||||||||||
| Other operating expenses | — | — | — | 44,259 | 44,259 | |||||||||||
| Equity in (earnings) loss of unconsolidated subsidiaries | (1,993 | ) | — | (145 | ) | — | (2,138 | ) | ||||||||
| Segment profit (loss) | 73,839 | 11,025 | 15,990 | (44,259 | ) | 56,595 | ||||||||||
| Identifiable assets by business segment: | ||||||||||||||||
| Restricted cash, investments and deposits | 20,817 | 6,283 | 98,216 | 2,002 | (1) | 127,318 | ||||||||||
| Net accounts receivable | 49,853 | 24,972 | 6,184 | 219 | (1) | 81,228 | ||||||||||
| Investment in unconsolidated subsidiaries | $ | 8,962 | $ | — | $ | 3,221 | $ | — | $ | 12,183 |
(1)Includes assets of discontinued operations.
The following table reconciles segment profit to consolidated income from continuing operations before income taxes and minority interest.
| | Predecessor Company | |||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Fiscal Year Ended September 30, | | Three Months Ended December 31, | |||||||||||||||||||||||||||||||||||
| | Fiscal Year Ended December 31, 2003 |
| Predecessor Company |
|
| Reorganized |
| |||||||||||||||||||||||||||||||
| | 2001 | 2002 | 2001 | 2002 |
| Fiscal Year |
| Fiscal Year |
| Three Months |
| Three Months |
|
| Fiscal Year |
| ||||||||||||||||||||||
| | | | | (unaudited) | |
|
|
|
|
| (unaudited) |
|
|
|
|
|
| |||||||||||||||||||||
| Segment profit | $ | 235,036 | $ | 180,750 | $ | 192,062 | $ | 52,926 | $ | 56,595 |
|
| $ 180,750 |
|
|
| $192,062 |
|
|
| $ 52,926 |
|
|
| $ 56,595 |
|
|
|
| $233,214 |
|
| ||||||
| Depreciation and amortization | (68,294 | ) | (47,558 | ) | (48,047 | ) | (11,190 | ) | (14,380 | ) |
|
| 47,558 |
|
| 48,047 |
|
| 11,190 |
|
| 14,380 |
|
|
| 42,489 |
| |||||||||||
| Interest expense | (110,423 | ) | (97,596 | ) | (61,016 | ) | (23,719 | ) | (25,333 | ) |
|
| 97,596 |
|
| 61,016 |
|
| 23,719 |
|
| 25,333 |
|
|
| 37,124 |
| |||||||||||
| Interest income | 10,121 | 5,365 | 2,873 | 1,310 | 1,010 |
|
| (5,365 | ) |
|
| (2,873 | ) |
|
| (1,310 | ) |
|
| (1,010 | ) |
|
|
| (6,127 | ) |
| |||||||||||
Stock compensation expense |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| 23,152 |
| |||||||||||||||||
| Reorganization benefit, net | — | — | 438,217 | — | — |
|
| — |
|
|
| (438,217 | ) |
|
| — |
|
|
| — |
|
|
|
| — |
|
| |||||||||||
Goodwill impairment charges |
|
| 415,880 |
|
| 28,780 |
|
| — |
|
|
| — |
|
|
|
| — |
|
| ||||||||||||||||||
| Special charges | (3,340 | ) | (15,729 | ) | (9,528 | ) | (4,485 | ) | (3,907 | ) |
|
| 15,729 |
|
| 9,528 |
|
| 4,485 |
|
| 3,907 |
|
|
| 5,038 |
| |||||||||||
| Goodwill impairment charges | — | (415,880 | ) | (28,780 | ) | — | — | |||||||||||||||||||||||||||||||
| Income (loss) from continuing operations before income taxes and minority interest | $ | 63,100 | $ | (390,648 | ) | $ | 485,781 | $ | 14,842 | $ | 13,985 |
|
| $(390,648 | ) |
|
| $485,781 |
|
|
| $ 14,842 |
|
|
| $ 13,985 |
|
|
|
| $131,538 |
| ||||||
F-66
F-51
17. Selected Quarterly Financial Data (Unaudited)
The following is a summary of the unaudited quarterly results of operations for the fiscal years ended September 30, 2002 and December 31, 2003. Results2003 and 2004:
|
| Predecessor Company |
| ||||||||||||
|
| For the Quarter Ended |
| ||||||||||||
|
| March 31, |
| June 30, |
| September 30, |
| December 31, |
| ||||||
|
| (in thousands, except per share amounts) |
| ||||||||||||
Fiscal Year Ended December 31, 2003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Revenue |
|
| $408,974 |
|
| $390,270 |
|
| $373,707 |
|
|
| $ 337,795 |
|
|
Cost and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries, cost of care and other operating expenses |
|
| 368,839 |
|
| 351,576 |
|
| 331,587 |
|
|
| 272,884 |
|
|
Equity in earnings of unconsolidated subsidiaries |
|
| (615 | ) |
| (1,184 | ) |
| (1,362 | ) |
|
| (3,041 | ) |
|
Depreciation and amortization |
|
| 13,652 |
|
| 11,020 |
|
| 11,593 |
|
|
| 11,782 |
|
|
Interest expense |
|
| 21,788 |
|
| 4,938 |
|
| 4,748 |
|
|
| 29,542 |
|
|
Interest income |
|
| (827 | ) |
| (676 | ) |
| (670 | ) |
|
| (700 | ) |
|
Reorganization expense (benefit), net |
|
| 23,154 |
|
| 4,551 |
|
| 4,540 |
|
|
| (470,462 | ) |
|
Goodwill impairment charges |
|
| — |
|
| — |
|
| 28,780 |
|
|
| — |
|
|
Special charges |
|
| 1,705 |
|
| 387 |
|
| 3,230 |
|
|
| 4,206 |
|
|
|
|
| 427,696 |
|
| 370,612 |
|
| 382,446 |
|
|
| (155,789 | ) |
|
Income (loss) from continuing operations before income taxes and minority interest |
|
| (18,722 | ) |
| 19,658 |
|
| (8,739 | ) |
|
| 493,584 |
|
|
Provision for (benefit from) income taxes |
|
| (2,729 | ) |
| 6,162 |
|
| 20,825 |
|
|
| 9,555 |
|
|
Income (loss) from continuing operations before minority interest |
|
| (15,993 | ) |
| 13,496 |
|
| (29,564 | ) |
|
| 484,029 |
|
|
Minority interest |
|
| 60 |
|
| 107 |
|
| 3 |
|
|
| 83 |
|
|
Income (loss) from continuing operations |
|
| (16,053 | ) |
| 13,389 |
|
| (29,567 | ) |
|
| 483,946 |
|
|
Discontinued operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from discontinued operations, net of income taxes |
|
| 238 |
|
| (854 | ) |
| (25,233 | ) |
|
| 821 |
|
|
Income (loss) on disposal of discontinued operations, net of income taxes |
|
| 378 |
|
| 1,772 |
|
| 4,271 |
|
|
| (1,665 | ) |
|
Reorganization benefit, net |
|
| 3,035 |
|
| 132 |
|
| 314 |
|
|
| 16,846 |
|
|
|
|
| 3,651 |
|
| 1,050 |
|
| (20,648 | ) |
|
| 16,002 |
|
|
Net income (loss) |
|
| (12,402 | ) |
| 14,439 |
|
| (50,215 | ) |
|
| 499,948 |
|
|
Preferred dividends |
|
| 883 |
|
| — |
|
| — |
|
|
| — |
|
|
Amortization of redeemable preferred stock issuance costs, and other |
|
| 172 |
|
| — |
|
| — |
|
|
| — |
|
|
Preferred stock reorganization items, net |
|
| 2,668 |
|
| — |
|
| — |
|
|
| — |
|
|
Income (loss) available to common stockholders |
|
| $ (16,125 | ) |
| $ 14,439 |
|
| $ (50,215 | ) |
|
| $ 499,948 |
|
|
Weighted average number of common shares |
|
| 35,261 |
|
| 35,319 |
|
| 35,319 |
|
|
| 35,319 |
|
|
Weighted average number of common shares |
|
| 35,261 |
|
| 41,619 |
|
| 35,319 |
|
|
| 41,619 |
|
|
Income (loss) per common share available to common stockholders—basic: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations |
|
| $ (0.56 | ) |
| $ 0.38 |
|
| $ (0.84 | ) |
|
| $ 13.70 |
|
|
Income (loss) from discontinued operations |
|
| $ 0.10 |
|
| $ 0.03 |
|
| $ (0.58 | ) |
|
| $ 0.45 |
|
|
Net income (loss) |
|
| $ (0.46 | ) |
| $ 0.41 |
|
| $ (1.42 | ) |
|
| $ 14.15 |
|
|
Income (loss) per common share available to common stockholders—diluted: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations |
|
| $ (0.56 | ) |
| $ 0.32 |
|
| $ (0.84 | ) |
|
| $ 11.63 |
|
|
Income (loss) from discontinued operations |
|
| $ 0.10 |
|
| $ 0.03 |
|
| $ (0.58 | ) |
|
| $ 0.38 |
|
|
Net income (loss) |
|
| $ (0.46 | ) |
| $ 0.35 |
|
| $ (1.42 | ) |
|
| $ 12.01 |
|
|
F-52
|
| Reorganized Company |
| ||||||||||
|
| For the Quarter Ended |
| ||||||||||
|
| March 31, |
| June 30, |
| September 30, |
| December 31, |
| ||||
|
| (in thousands, except per share amounts) |
| ||||||||||
Fiscal Year Ended December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Revenue |
| $440,176 |
| $452,104 |
|
| $457,954 |
|
|
| $445,168 |
|
|
Cost and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries, cost of care and other operating expenses |
| 393,928 |
| 393,879 |
|
| 394,374 |
|
|
| 385,284 |
|
|
Equity in earnings of unconsolidated subsidiaries |
| (1,844 | ) | (1,854 | ) |
| (1,863 | ) |
|
| 284 |
|
|
Depreciation and amortization |
| 10,249 |
| 10,517 |
|
| 10,712 |
|
|
| 11,011 |
|
|
Interest expense |
| 9,334 |
| 9,056 |
|
| 9,109 |
|
|
| 9,625 |
|
|
Interest income |
| (781 | ) | (1,052 | ) |
| (1,760 | ) |
|
| (2,534 | ) |
|
Stock compensation expense |
| 10,777 |
| 2,541 |
|
| 2,580 |
|
|
| 7,254 |
|
|
Special charges |
| 1,908 |
| 626 |
|
| 1,770 |
|
|
| 734 |
|
|
|
| 423,571 |
| 413,713 |
|
| 414,922 |
|
|
| 411,658 |
|
|
Income from continuing operations before income taxes and minority interest |
| 16,605 |
| 38,391 |
|
| 43,032 |
|
|
| 33,510 |
|
|
Provision for income taxes |
| 3,568 |
| 9,696 |
|
| 15,712 |
|
|
| 17,608 |
|
|
Income from continuing operations before minority interest |
| 13,037 |
| 28,695 |
|
| 27,320 |
|
|
| 15,902 |
|
|
Minority interest |
| 129 |
| 240 |
|
| 157 |
|
|
| (193 | ) |
|
Income from continuing operations |
| 12,908 |
| 28,455 |
|
| 27,163 |
|
|
| 16,095 |
|
|
Discontinued operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from discontinued operations, net of income taxes |
| 30 |
| 40 |
|
| (579 | ) |
|
| 5,290 |
|
|
Income on disposal of discontinued operations, net of income taxes |
| — |
| (71 | ) |
| (28 | ) |
|
| (931 | ) |
|
|
| 30 |
| (31 | ) |
| (607 | ) |
|
| 4,359 |
|
|
Net income |
| 12,938 |
| 28,424 |
|
| 26,556 |
|
|
| 20,454 |
|
|
Income available to common stockholders |
| $ 12,938 |
| $ 28,424 |
|
| $ 26,556 |
|
|
| $ 20,454 |
|
|
Weighted average number of common shares outstanding—basic |
| 35,355 |
| 35,371 | �� |
| 35,371 |
|
|
| 35,371 |
|
|
Weighted average number of common shares outstanding—diluted |
| 36,856 |
| 36,303 |
|
| 36,594 |
|
|
| 36,734 |
|
|
Income per common share available to common stockholders—basic: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations |
| $ 0.37 |
| $ 0.80 |
|
| $ 0.77 |
|
|
| $ 0.46 |
|
|
Income (loss) from discontinued operations |
| $ — |
| $ — |
|
| $ (0.02 | ) |
|
| $ 0.12 |
|
|
Net income |
| $ 0.37 |
| $ 0.80 |
|
| $ 0.75 |
|
|
| $ 0.58 |
|
|
Income per common share available to common stockholders—diluted: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations |
| $ 0.35 |
| $ 0.78 |
|
| $ 0.74 |
|
|
| $ 0.44 |
|
|
Income (loss) from discontinued operations |
| $ — |
| $ — |
|
| $ (0.01 | ) |
|
| $ 0.12 |
|
|
Net income |
| $ 0.35 |
| $ 0.78 |
|
| $ 0.73 |
|
|
| $ 0.56 |
|
|
F-53
18. Shelf Registration Statement
Magellan filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission on November 15, 2004with respect to the shares of operationsOrdinary Commons Stock issuable by automatic conversion on transfer of Multi-Vote Common Stock owned by Onex through its affiliate, Magellan Holdings, L.P. The registration statement was filed pursuant to provisions of the Registration Rights Agreement dated as of January 5, 2004 between the Company and Onex that was entered into in connection with the issuance of the Multi-Vote Common Stock to Onex, which provisions required the Company to file such registration statement within a specified time after the issuance of the shares. The shares of Multi-Vote Common Stock were issued to Onex in a private placement and thus were not registered under the Securities Act of 1933, as amended, or any state securities laws. The registration statement has not yet been declared effective by the Securities and Exchange Commission. See Note 1—“General” for a detailed discussion of the three month transition period ended December 31, 2002 were audited and are included in the accompanying consolidated statementCompany’s classes of operations.
| | Predecessor Company | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | For the Quarter Ended | ||||||||||||
| | March 31, 2003 | June 30, 2003 | September 30, 2003 | December 31, 2003 | |||||||||
| | (in thousands, except per share amounts) | ||||||||||||
| Fiscal Year Ended December 31, 2003 | |||||||||||||
| Net Revenue | $ | 408,974 | $ | 390,270 | $ | 373,707 | $ | 337,795 | |||||
| Cost and expenses: | |||||||||||||
| Salaries, cost of care and other operating expenses | 368,839 | 351,576 | 331,587 | 272,884 | |||||||||
| Equity in earnings of unconsolidated subsidiaries | (615 | ) | (1,184 | ) | (1,362 | ) | (3,041 | ) | |||||
| Depreciation and amortization | 13,652 | 11,020 | 11,593 | 11,782 | |||||||||
| Goodwill impairment charges | — | — | 28,780 | — | |||||||||
| Interest expense | 21,788 | 4,938 | 4,748 | 29,542 | |||||||||
| Interest income | (827 | ) | (676 | ) | (670 | ) | (700 | ) | |||||
| Reorganization expense (benefit), net | 23,154 | 4,551 | 4,540 | (470,462 | ) | ||||||||
| Special charges | 1,705 | 387 | 3,230 | 4,206 | |||||||||
| 427,696 | 370,612 | 382,446 | (155,789 | ) | |||||||||
| Income (loss) from continuing operations before income taxes and minority interest | (18,722 | ) | 19,658 | (8,739 | ) | 493,584 | |||||||
| Provision for (benefit from) income taxes | (2,729 | ) | 6,162 | 20,825 | 9,555 | ||||||||
| Income (loss) from continuing operations before minority interest | (15,993 | ) | 13,496 | (29,564 | ) | 484,029 | |||||||
| Minority interest | 60 | 107 | 3 | 83 | |||||||||
| Income (loss) from continuing operations | (16,053 | ) | 13,389 | (29,567 | ) | 483,946 | |||||||
| Discontinued operations: | |||||||||||||
| Income (loss) from discontinued operations, net of income taxes | 238 | (854 | ) | (25,233 | ) | 821 | |||||||
| Income on disposal of discontinued operations, net of income taxes | 378 | 1,772 | 4,271 | (1,665 | ) | ||||||||
| Reorganization benefit, net | 3,035 | 132 | 314 | 16,846 | |||||||||
| 3,651 | 1,050 | (20,648 | ) | 16,002 | |||||||||
| Net income (loss) | (12,402 | ) | 14,439 | (50,215 | ) | 499,948 | |||||||
| Preferred dividends | 883 | — | — | — | |||||||||
| Amortization of redeemable preferred stock issuance costs, and other | 172 | — | — | — | |||||||||
| Preferred stock reorganization items, net | 2,668 | — | — | — | |||||||||
| Income (loss) available to common stockholders | $ | (16,125 | ) | $ | 14,439 | $ | (50,215 | ) | $ | 499,948 | |||
| Weighted average number of common shares outstanding — basic | 35,261 | 35,319 | 35,319 | 35,319 | |||||||||
| Weighted average number of common shares outstanding — diluted | 35,261 | 41,619 | 35,319 | 41,619 | |||||||||
| Income (loss) per common share available to common stockholders — basic: | |||||||||||||
| Income (loss) from continuing operations | $ | (0.56 | ) | $ | 0.38 | $ | (0.84 | ) | $ | 13.70 | |||
| Income (loss) from discontinued operations | $ | 0.10 | $ | 0.03 | $ | (0.58 | ) | $ | 0.45 | ||||
| Net income (loss) | $ | (0.46 | ) | $ | 0.41 | $ | (1.42 | ) | $ | 14.15 | |||
| Income (loss) per common share available to common stockholders — diluted: | |||||||||||||
| Income (loss) from continuing operations | $ | (0.56 | ) | $ | 0.32 | $ | (0.84 | ) | $ | 11.63 | |||
| Income (loss) from discontinued operations | $ | 0.10 | $ | 0.03 | $ | (0.58 | ) | $ | 0.38 | ||||
| Net income (loss) | $ | (0.46 | ) | $ | 0.35 | $ | (1.42 | ) | $ | 12.01 | |||
F-67
| | Predecessor Company | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | For the Quarter Ended | ||||||||||||
| | December 31, 2001(1) | March 31, 2002 | June 30, 2002 | September 30, 2002 | |||||||||
| | (in thousands, except per share amounts) | ||||||||||||
| Fiscal Year Ended September 30, 2002 | |||||||||||||
| Net Revenue | $ | 444,842 | $ | 437,919 | $ | 437,066 | $ | 433,231 | |||||
| Cost and expenses: | |||||||||||||
| Salaries, cost of care and other operating expenses | 395,093 | 395,616 | 394,165 | 400,440 | |||||||||
| Equity in earnings of unconsolidated subsidiaries | (3,177 | ) | (4,347 | ) | (140 | ) | (5,342 | ) | |||||
| Depreciation and amortization | 11,190 | 11,128 | 12,192 | 13,048 | |||||||||
| Interest, net | 22,409 | 23,388 | 23,583 | 22,851 | |||||||||
| Goodwill impairment charges | — | — | — | 415,880 | |||||||||
| Special charges | 4,485 | 3,376 | 1,329 | 6,539 | |||||||||
| 430,000 | 429,161 | 431,129 | 853,416 | ||||||||||
| Income (loss) from continuing operations before income taxes and minority interest | 14,842 | 8,758 | 5,937 | (420,185 | ) | ||||||||
| Provision for income taxes | 6,086 | 3,638 | 2,581 | 139,304 | |||||||||
| Income (loss) from continuing operations before minority interest | $ | 8,756 | $ | 5,120 | $ | 3,356 | $ | (559,489 | ) | ||||
| Minority interest | 16 | 30 | (27 | ) | 28 | ||||||||
| Income (loss) from continuing operations | 8,740 | 5,090 | 3,383 | (559,517 | ) | ||||||||
| Discontinued operations: | |||||||||||||
| Income from discontinued operations, net of income taxes | 158 | 1,022 | 1,711 | 2,003 | |||||||||
| Income (loss) on disposal of discontinued operations, net of income taxes | 820 | 203 | (785 | ) | (330 | ) | |||||||
| 978 | 1,225 | 926 | 1,673 | ||||||||||
| Income (loss) before cumulative effect of change in accounting principle | 9,718 | 6,315 | 4,309 | (557,844 | ) | ||||||||
| Cumulative effect of change in accounting principle, net of income taxes | 191,561 | — | — | — | |||||||||
| Net income (loss) | (181,843 | ) | 6,315 | 4,309 | (557,844 | ) | |||||||
| Preferred dividend requirement and amortization of redeemable preferred stock issuance costs | 1,218 | 1,297 | 1,327 | 1,355 | |||||||||
| Income (loss) available to common stockholders | $ | (183,061 | ) | $ | 5,018 | $ | 2,982 | $ | (559,199 | ) | |||
| Weighted average number of common shares outstanding — basic | 34,670 | 34,763 | 34,897 | 35,085 | |||||||||
| Weighted average number of common shares outstanding — diluted | 42,075 | 35,416 | 35,473 | 35,085 | |||||||||
| Income (loss) per common share available to common stockholders — basic: | |||||||||||||
| Income (loss) from continuing operations | $ | 0.22 | $ | 0.11 | $ | 0.06 | $ | (15.99 | ) | ||||
| Income from discontinued operations | $ | 0.03 | $ | 0.03 | $ | 0.03 | $ | 0.05 | |||||
| Cumulative effect of change in accounting principle | $ | (5.53 | ) | $ | — | $ | — | $ | — | ||||
| Net income (loss) | $ | (5.28 | ) | $ | 0.14 | $ | 0.09 | $ | (15.94 | ) | |||
| Income (loss) per common share available to common stockholders — diluted: | |||||||||||||
| Income (loss) from continuing operations | $ | 0.21 | $ | 0.11 | $ | 0.06 | $ | (15.99 | ) | ||||
| Income from discontinued operations | $ | 0.02 | $ | 0.03 | $ | 0.02 | $ | 0.05 | |||||
| Cumulative effect of change in accounting principle | $ | (4.55 | ) | $ | — | $ | — | $ | — | ||||
| Net income (loss) | $ | (4.32 | ) | $ | 0.14 | $ | 0.08 | $ | (15.94 | ) | |||
F-68
MAGELLAN HEALTH SERVICES, INC.
SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
| Classification | Classification | Balance at Beginning of Period | Charged to Costs and Expenses | Charged to Other Accounts | Addition | Deduction | Balance at End of Period |
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| Predecessor Company: | Predecessor Company: | Predecessor Company: |
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| Fiscal year ended September 30, 2001: | $ | 6,458 | (2) | |||||||||||||||||||||||||||||||||||||||||||||||||
Fiscal year ended September 30, 2002: | Fiscal year ended September 30, 2002: |
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Allowance for doubtful accounts | Allowance for doubtful accounts |
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| $ | 6,357 |
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| $ | 5,293 | (4) |
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| $ | (1,041 | )(1) |
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| $ | — |
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| $ | (7,553 | )(2) |
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| $ | 3,056 |
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Three months ended December 31, 2002: | Three months ended December 31, 2002: |
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Allowance for doubtful accounts | Allowance for doubtful accounts |
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| 3,056 |
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| 925 | (4) |
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| (75 | )(1) |
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| — |
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| (157 | )(2) |
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| 3,749 |
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Fiscal year ended December 31, 2003: | Fiscal year ended December 31, 2003: |
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Allowance for doubtful accounts | Allowance for doubtful accounts |
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| 3,749 |
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| 2,366 | (4) |
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| (768 | )(1) |
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| — |
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| (552 | )(2) |
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| 4,795 |
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Reorganized Company: | Reorganized Company: |
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December 31, 2003: | December 31, 2003: |
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Allowance for doubtful accounts | Allowance for doubtful accounts |
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| — |
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| 5,178 |
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| 5,178 | (5) |
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Fiscal year ended December 31, 2004: | Fiscal year ended December 31, 2004: |
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Allowance for doubtful accounts | Allowance for doubtful accounts |
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| 5,178 |
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| 491 | (4) |
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| (1,952 | )(1) |
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| (1,610 | )(2) |
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| 2,107 |
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| Allowance for doubtful accounts | $ | 11,592 | $ | 8,012 | (4) | $ | (1,649 | )(1) | — | 5,140 | (3) | $ | 6,357 | |||||||||||||||||||||||||||||||||||||||
| Fiscal year ended September 30, 2002: | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for doubtful accounts | 6,357 | 5,293 | (4) | (1,041 | )(1) | — | 7,553 | (2) | 3,056 | |||||||||||||||||||||||||||||||||||||||||||
| Three months ended December 31, 2002: | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for doubtful accounts | 3,056 | 925 | (4) | (75 | )(1) | — | 157 | (2) | 3,749 | |||||||||||||||||||||||||||||||||||||||||||
| Fiscal year ended December 31, 2003: | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for doubtful accounts | 3,749 | 2,366 | (4) | (768 | )(1) | — | (552 | )(2) | 4,795 | |||||||||||||||||||||||||||||||||||||||||||
| Reorganized Company: | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| December 31, 2003 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for doubtful accounts | — | — | — | 5,178 | — | 5,178 | (5) | |||||||||||||||||||||||||||||||||||||||||||||
(1)
(2)
(3)
(4)
(5)
S-1S-1