SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A-2
(Mark One)
[X] Annual Report pursuant to section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended December 31, 1996 or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from ____________ to ____________
Commission file number 0-22019
SPECIALTY CARE NETWORK, INC.
(Exact name of registrant as specified in its charter)
Delaware 62-1623449
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
44 Union Boulevard, Suite 600 80228
Lakewood, Colorado (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (303) 716-0041
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes No X
-- --
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy statement incorporated
by reference in Part III of this annual report on Form 10-K or any amendment to
this annual report on Form 10-K. X
---
As of March 26, 1997, the aggregate market value of the Common Stock held by
non-affiliates of the registrant was $103,865,677. Such aggregate market value
was computed by reference to the closing sale price of the Common Stock as
reported on the National Market segment of The Nasdaq Stock Market on such date.
For purposes of making this calculation only, the registrant has defined
affiliates as including all directors and beneficial owners of more than five
percent of the Common Stock of the Company.
As of March 26, 1997, there were 14,662,575 shares of the registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement for the Registrant's 1997 Annual
Meeting of Stockholders to be filed within 120 days after the end of the fiscal
year covered by this annual report on Form 10-K -- Part III.
This amendment to the Company's Form 10-K for the fiscal year ended December 31,
1996 amends and modifies the Form 10-K, as amended by Form 10-K/A-1, to amend
and restate in its entirety Item 1 of Part I.
This Report contains forward-looking statements that address, among
other things, acquisition and expansion strategy, use of proceeds, projected
capital expenditures, liquidity, proposed specialties of physicians with whom
the Company intends to affiliate, possible third party payor arrangements, cost
reduction strategies, possible effects of changes in government regulation and
availability of insurance. These statements may be found under "Item 1-Business"
and "Item 1-Risk Factors" as well as in the Report generally. Actual events or
results may differ materially from those discussed in forward-looking statements
as a result of various factors, including without limitation those discussed in
"Item 1-Risk Factors" and matters set forth in the Report generally.
Unless the context indicates otherwise, the terms "SCN" and "Company"
refer to Specialty Care Network, Inc.
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PART I
Item 1. Business.
General
Specialty Care Network is a physician practice management company
focusing exclusively on musculoskeletal disease-state management. Since November
12, 1996, the Company has provided management services under long-term
agreements with five practices, encompassing 50 physicians in five states. In
addition, in March 1997, the Company began providing management services under
long-term agreements with three single physician practices in two of its
existing markets (all practices that have affiliated with the Company are
referred to as the "Affiliated Practices"). The Company also manages one
outpatient surgery center and one outpatient magnetic resonance imaging ("MRI")
center owned by two of its Affiliated Practices.
On November 12, 1996, the Company, through a series of transactions
(the "Initial Affiliation Transactions"), including an asset purchase, a share
exchange and three mergers, acquired substantially all of the assets and certain
liabilities of the predecessors (the "Predecessor Practices") of five of the
practices with which the Company has affiliated through the entry into service
agreements. In connection with the Initial Affiliation Transactions, the Company
issued an aggregate of 7,659,115 shares of Common Stock and paid $1,537,872 in
cash to physician owners of the Predecessor Practices. Following the Initial
Affiliation Transactions, the physician owners of the Predecessor Practices,
other than Greater Chesapeake Orthopaedic Associates, LLC ("GCOA") in Baltimore,
Maryland, which survived the Initial Affiliation Transactions, formed new
entities through which to practice medicine. The new entities (together with
GCOA, the "Initial Affiliated Practices") are Reconstructive Orthopaedic
Associates II, P.C. ("ROA"), in Philadelphia, Pennsylvania; Princeton
Orthopaedic Associates II, P.A. ("POA") in Princeton, New Jersey; TOC
Specialists, P.L. ("TOC") in Tallahassee, Florida and Bainbridge, Georgia; and
Vero Orthopaedics II, P.A. ("VO") in Vero Beach, Florida. In addition, in March
1997, the Company acquired, through merger, the assets and certain liabilities
of predecessors to its three single physician Affiliated Practices for an
aggregate consideration of 409,222 shares of Common Stock and $83,674 in cash.
Under the service agreements between the Company and each of the
Affiliated Practices (the "Service Agreements"), the Company provides
management, administrative and development services to the Affiliated Practices.
The Affiliated Practices were selected based on a variety of factors including,
but not limited to, physician credentials and reputation; competitive market
position; specialty and subspecialty mix of physicians; historical financial
performance and growth potential; and willingness to embrace SCN's corporate
philosophy.
The Affiliated Practices offer a broad spectrum of musculoskeletal
care, which is the treatment of conditions relating to bones, joints, muscles
and related connective tissues. The Company's affiliated physicians are trained
in a variety of musculoskeletal disciplines, including general orthopaedics,
joint replacement surgery, sports medicine, spinal care, hand and upper
extremity care, foot and ankle care, pediatric orthopaedics, physiatry, trauma
and adult neurology. In order to build networks of providers that offer access
to a full range of musculoskeletal care, the Company intends to affiliate and
otherwise contract with physicians trained in other musculoskeletal
subspecialties, including occupational medicine, neurosurgery, plastic surgery,
rehabilitation therapy and rheumatology.
The Company was incorporated in December 1995. Following its
incorporation through November 12, 1996, the date of the Initial Affiliation
Transactions, the Company hired personnel, raised funds through the private
placement of securities and conducted negotiations with potential affiliation
candidates. On November 12, 1996, the Company consummated the Initial
Affiliation Transactions and entered into service agreements with the Initial
Affiliated Practices.
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Recent Developments
On March 24, 1997, the Company entered into a definitive agreement to
affiliate with Orthopaedic and Sports Medicine Center, P.A., headquartered in
Annapolis, Maryland. The Company has agreed to acquire, through merger,
substantially all of the assets and certain liabilities of the practice for
aggregate consideration of $8,246,560, which will consist of $3,579,042 in cash
and 473,379 shares of Company Common Stock valued at $9.86 per share (the
average of the closing share price of Company Common Stock during the two weeks
preceding the execution of the agreement). In addition, based on current
estimates, it is anticipated that in the event the practice enters into a joint
venture with a specified hospital prior to July 31, 1997, the practice will
receive additional consideration from the Company of approximately $900,000 in
cash and 115,000 shares of Company Common Stock. The practice, which includes
nine physicians, has offices in Annapolis, Prosten and Severna Park, Maryland.
Consummation of the transaction is subject to certain conditions. Information in
this Annual Report on Form 10-K relating to the Affiliated Practices does not
include information about Orthopaedic and Sports Medicine Center, P.A.
Musculoskeletal Market Overview
Expenditures for musculoskeletal care in the United States are
significant, with total direct costs associated with the delivery of
musculoskeletal care exceeding $60 billion in 1988, according to the American
Academy of Orthopaedic Surgeons ("AAOS"). Of this amount, approximately $7
billion represents fees paid for physician services. Furthermore, according to
the AAOS, the 65-and-over age group accounts for approximately 25% of
musculoskeletal cases. Given the aging of the U.S. population, the Company
believes that demographic trends favor the growth of the need for
musculoskeletal care.
The spectrum of musculoskeletal care ranges from acute procedures, such
as spinal or hip surgery after trauma, to the treatment of chronic conditions,
such as arthritis and back pain. Musculoskeletal care is provided by a variety
of medical and surgical specialists. Although the orthopaedic surgeon represents
the primary musculoskeletal provider, musculoskeletal care is also provided by
neurosurgeons, neurologists, plastic surgeons, physiatrists, rheumatologists,
occupational medicine physicians, podiatrists and primary care physicians, as
well as rehabilitative therapists. Moreover, there are a number of
subspecialties of orthopaedics, including adult reconstructive (joint
replacement) surgery, spinal care, sports medicine, foot and ankle care, hand
and upper extremity care, pediatrics, oncology and trauma care. The American
Medical Association estimates that in 1995, there were approximately 23,000
orthopaedic surgeons, as well as approximately 5,500 physiatrists, 3,500
rheumatologists, 3,000 occupational medicine physicians, 11,400 neurologists and
4,900 neurosurgeons.
The payor mix for musculoskeletal care is diverse, with managed care
enrollees representing an increasing percentage of patients. According to data
from a 1994 AAOS survey, the largest percentage of patients is private pay
(28%), followed by managed care, including fee-for-service and capitation (21%),
Medicare (21%) and workers compensation (18%). Almost 80% of orthopaedic
surgeons indicated they received patients from managed care sources. While
private pay patients remain the largest category, the AAOS survey indicated that
the percentage of total private pay patients has declined from 39% in 1988 to
28% in 1994. Over the same period, patients from managed care sources increased
from 12% to 21%. The distribution of patients from other sources remained
relatively constant over this period.
Affiliated Practices
On November 12, 1996, the Company, in connection with the Initial
Affiliation Transactions, issued an aggregate of 7,659,115 shares (constituting
an aggregate of $45,954,690, based on an agreed value of $6 per share) of Common
Stock and paid $1,537,872 in cash to physicians in the Initial Affiliated
Practices. See Item 13 for details regarding the Company's affiliation with the
Initial Affiliated Practices. Subsequent to the Initial Affiliation
Transactions, the Company granted to certain physicians in the Initial
Affiliated Practices options to purchase an
4
aggregate of 382,590 shares of Common Stock at an exercise price of $6.00 per
share. In addition, the Company has affiliated with three single physician
practices in Tallahassee, Florida; Thomasville, Georgia; and Baltimore,
Maryland. In March 1997, the Company acquired, through merger, substantially all
of the assets and certain liabilities of these practices for an aggregate
consideration of 409,222 shares of Common Stock and $83,674 in cash.
The table below sets forth certain information regarding the Initial
Affiliated Practices, all of whose physicians are board certified or board
eligible:
Musculoskeletal
Initial Affiliated Practices Location(s) Physicians Subspecialties Ancillary Services
- ---------------------------- ----------- ---------- -------------- ------------------
Reconstructive Orthopaedic Philadelphia, PA 11 3 None
Associates II, P.C.
Princeton Orthopaedic Associates II, Princeton, NJ 12 7 Outpatient Surgery,
P.A. Physical Therapy
TOC Specialists, P.L. Tallahassee, FL 14 7 MRI
Bainbridge, GA
Greater Chesapeake Orthopaedic Baltimore, MD 8 5 None
Associates, LLC
Vero Orthopaedics II, P.A. Vero Beach, FL 5 5 None
---
Sebastian, FL
Total 50
===
Reconstructive Orthopaedic Associates II, P.C.
ROA, operating under the name The Rothman Institute, was founded in
Philadelphia, Pennsylvania in 1970 and currently has ten orthopaedic surgeons
and one anesthesiologist. ROA has its own research department and has compiled
an orthopaedic database for more than 25 years.
ROA physicians (and their specialties) are Todd J. Albert, M.D. (spine
surgery); Richard A. Balderston, M.D. (spine surgery); Arthur R. Bartolozzi,
M.D. (sports medicine); Robert E. Booth, Jr., M.D. (joint replacement surgery);
Michael G. Ciccotti, M.D. (sports medicine); William J. Hozack, M.D. (joint
replacement surgery); H.N. Karanjia, M.D., D.P.M. (foot and ankle surgery);
Philip M. Maurer, M.D. (anesthesiologist); Richard H. Rothman, M.D., Ph.D.
(joint replacement surgery); Peter F. Sharkey, M.D. (joint replacement surgery);
and Alexander R. Vaccaro, M.D. (spine surgery). All of these physicians, other
than Dr. Maurer, are physician owners of ROA.
Dr. Balderston serves as Clinical Professor, Vice Chairman of the
Department of Orthopaedics and Chief of Orthopaedic Surgery at Thomas Jefferson
University Hospital ("Jefferson"). Dr. Bartolozzi is a team physician for
several sports teams, including the Philadelphia Flyers hockey team and the
Philadelphia Eagles football team. Dr. Booth serves as Co-Chief of Orthopaedic
Surgery at Pennsylvania Hospital, and is Professor and Vice Chairman of
Orthopaedic Surgery at Jefferson. Dr. Rothman serves as the Chairman of the
Department of Orthopaedics at Jefferson and Co-Chairman of the Department of
Orthopaedics at Pennsylvania Hospital and is the Editor-in-Chief of the Journal
of Arthroplasty, a journal of joint replacement surgery.
Drs. Booth and Bartolozzi have entered into an agreement with the
Company and ROA that contemplates that Drs. Booth and Bartolozzi will form and
own an independent practice. The agreement provides that this practice will
enter into a separate service agreement with the Company. See "Contractual
Agreements with Affiliated Practices" in this Item.
5
See Item 13 for additional information regarding the Company's
affiliation with ROA.
Princeton Orthopaedic Associates II, P.A. and Princeton SportsMedicine
POA was founded in 1974 in Princeton, New Jersey and currently has 10
orthopaedic surgeons, one podiatric surgeon, one physiatrist and 16 physical
therapists. POA operates three facilities, each of which provides physical
therapy. One of these facilities, operating under the name SportsMedicine
Princeton, provides multi-disciplinary diagnostic and rehabilitative care for
sports-related injuries. The other two facilities provide comprehensive
diagnostic and rehabilitative care for the neck and back. POA also operates its
own outpatient surgery center, for which SCN provides management services for a
fee.
POA physicians (and their specialties) are Jeffrey S. Abrams, M.D.
(shoulder surgery); Jon W. Ark, M.D. (hand and foot surgery); Robert N. Dunn,
M.D. (spine surgery); Richard E. Fleming, Jr., M.D. (sports medicine); Steven R.
Gecha, M.D. (sports medicine); W. Thomas Gutowski, M.D. (sports medicine);
Michael N. Jolley, M.D. (joint replacement surgery); C. Alexander Moskwa, Jr.,
M.D. (sports medicine); Michael A. Palmer, M.D. (physiatry); Harvey E. Smires,
M.D. (joint replacement surgery); David M. Smith, M.D. (general orthopaedics);
and John S. Smith, DPM (podiatry). All of these physicians, other than Drs. Ark,
Palmer and John S. Smith, are physician owners of POA.
See Item 13 for additional information regarding the Company's
affiliation with POA.
TOC Specialists, P.L.
TOC was founded in 1972 and currently has nine orthopaedic surgeons,
two non-surgical musculoskeletal specialists and three neurologists. In its main
facility in Tallahassee, Florida, TOC has an MRI center, for which SCN provides
management services for a fee. TOC physicians also practice at a satellite
facility in Bainbridge, Georgia operating under the name Southern Orthopedic
Specialists, Inc. TOC has a non-contractual capitated arrangement with Capital
Health Plans covering approximately 75,000 lives and a capitated contract with
Health Plan Southeast covering approximately 55,000 lives.
TOC physicians (and their specialties) are Gregg A. Alexander, M.D.
(musculoskeletal medicine, disorders of the spine); D. Christian Berg, M.D.
(hand and upper extremities); Richard E. Blackburn, M.D. (adult neurology);
Donald M. Dewey, M.D., C.P.O. (foot and ankle surgery, pediatric orthopaedics);
Mark E. Fahey, M.D. (general orthopaedic surgery); Thomas C. Haney, M.D. (knee
surgery, sports medicine); William D. Henderson, Jr., M.D. (knee surgery, sports
medicine); Steve E. Jordan, M.D. (general orthopaedic surgery, sports medicine);
J. Rick Lyon, M.D. (general orthopaedic surgery); Kris D. Stowers, M.D.
(musculoskeletal and sports medicine); Robert L. Thornberry, M.D. (hip and knee
surgery, sports medicine); Billy C. Weinstein, M.D. (adult neurology); Stanley
Whitney, M.D. (adult neurology); and Charles H. Wingo, M.D. (spine surgery). All
of these physicians, other than Dr. Whitney, are physician owners of TOC.
TOC physicians have served as team physicians for a number of local
high schools and colleges. Dr. Haney serves as the team physician for the
Florida State University football team. Dr. Henderson currently serves as the
president of the Herodicus Society, a national sports medicine society, and is
one of the sports medicine physicians for the U.S. National Soccer Team. Dr.
Wingo currently serves as Chairman of the Orthopaedic Section/Surgery at the
Tallahassee Memorial Regional Medical Center.
See Item 13 for additional information regarding the Company's
affiliation with TOC.
Greater Chesapeake Orthopaedic Associates, LLC
GCOA was founded in Baltimore, Maryland in 1994 and currently has eight
orthopaedic surgeons. The two main focus areas of GCOA are sports medicine and
foot and ankle services. The practice is located adjacent to Union
6
Memorial Hospital and is actively involved in the orthopaedic residency and
fellowship teaching programs at that institution. In addition, three of its
physicians are active in such programs at the Johns Hopkins University School of
Medicine ("Johns Hopkins").
GCOA physicians (and their specialties) are Paul L. Asdourian, M.D.
(spine surgery); Frank R. Ebert, M.D. (joint replacement surgery); Leslie S.
Matthews, M.D. (sports medicine); Stuart D. Miller, M.D. (foot and ankle); Mark
S. Myerson, M.D. (foot and ankle); John B. O'Donnell, M.D. (sports medicine);
Lew C. Schon, M.D. (foot and ankle); and Martin A. Yahiro, M.D. (general
orthopaedics). All of these physicians, other than Dr. Yahiro, are physician
owners of GCOA.
Dr. Asdourian serves as Chief of Orthopaedic Spinal Surgery at Union
Memorial Hospital and is a clinical instructor in orthopaedic surgery at Johns
Hopkins. Dr. Ebert currently serves as Assistant Chief of Orthopaedic Surgery at
Union Memorial Hospital. Dr. Matthews currently serves as Chief of Orthopaedic
Surgery at Union Memorial Hospital and is Program Director for the Orthopaedic
Surgery Residency training program. Dr. Matthews also is an Assistant Professor
of orthopaedic surgery at Johns Hopkins. Dr. Myerson serves as the director of
Foot and Ankle Services at Union Memorial Hospital. Dr. O'Donnell is assistant
director of Union Memorial Hospital's Sports Medicine Fellowship Program and is
a clinical instructor in orthopaedic surgery at Johns Hopkins. Dr. Schon serves
as Associate Director of the Foot & Ankle Fellowship program at Union Memorial
Hospital. Dr. Yahiro joined the group in July 1995. He currently serves as an
orthopaedic surgeon advisor to the federal Food and Drug Administration.
See Item 13 for additional information regarding the Company's
affiliation with GCOA.
Vero Orthopaedics II, P.A.
VO was founded in Vero Beach, Florida in 1976 and currently has four
orthopaedic surgeons and one physiatrist. The practice is located near Indian
River Memorial Hospital. VO operates one satellite office in Sebastian, Florida.
VO's physicians (and their specialties) are James L. Cain, M.D. (foot and
ankle); David W. Griffin, M.D. (knee surgery); George K. Nichols, M.D. (hip
surgery); Peter G. Wernicki, M.D. (sports medicine); and Charlene Wilson, M.D.
(physiatry). All of these physicians, other than Dr. Wilson, are physician
owners of VO.
Dr. James L. Cain, founder of Vero Orthopaedics, has served as Chairman
of the Department of Orthopaedics, Chief of the Medical Staff, and as a member
of the Board of Directors of Indian River Memorial Hospital. Dr. David W.
Griffin is Director of the Joint Implant Center of the Treasure Coast at Indian
River Memorial Hospital.
See Item 13 for additional information regarding the Company's
affiliation with VO.
Single Physician Practices
In addition to the Initial Affiliated Practices, the Company is
affiliated with the following single physician practices:
Riyaz H. Jinnah, M.D., P.A. - This practice is located in Baltimore,
Maryland. Dr. Jinnah is a board certified surgeon engaged in general
orthopaedics.
Medical Rehabilitation Specialists, P.A. - This practice is located in
Tallahassee, Florida. The physician owner is Kirk J. Mauro, M.D. Dr. Mauro is a
physiatrist.
Floyd Jaggears, M.D., P.C. - This practice is located in Thomasville,
Georgia. Dr. Jaggears is a board certified surgeon engaged in general
orthopaedics.
7
SCN Operations
Upon affiliation with SCN, physician practices enter into a long-term
service agreement with the Company. Under the terms of a service agreement, the
Company generally employs most of a practice's non-physician personnel, provides
facilities for the practice and provides services in the areas of practice
management, information systems and negotiation of payor contracts, all as more
specifically described below. The governance structure provided with respect to
the service agreements facilitates close cooperation between the Company and the
practices, while ensuring that the practices maintain clinical autonomy. See
"Contractual Agreements with Affiliated Practices" in this Item.
Management Services
Pursuant to the terms of the Service Agreements, the Company assists
the Affiliated Practices in strategic planning, preparation of operating budgets
and capital project analysis. The Company intends to coordinate group purchasing
of supplies, inventory and insurance for the practices. In addition, the Company
will assist the Affiliated Practices in physician recruitment by introducing
physician candidates to the practices and advising the practices in structuring
employment arrangements.
The Company also provides or arranges for a variety of additional
services relating to the day-to-day non-medical operations of the practices,
including (i) management and monitoring each practice's billing levels,
invoicing and accounts receivable collection by payor type, (ii) accounting,
payroll and legal services and records and (iii) cash management and centralized
disbursements.
These services are designed to reduce the amount of time physicians
must spend on administrative matters, thereby enabling the physicians to
dedicate more of their efforts toward the delivery of health care. The Company's
anticipated capital resources and assistance in preparation of budgets and
capital project analyses are intended to facilitate the establishment of
ancillary musculoskeletal facilities, such as outpatient occupational medicine,
physical therapy and surgery centers and MRI centers. Comprehensive
administrative support should facilitate more effective billings and collections
and, as the Company grows, economies of scale in effecting purchases. The
Company's proprietary accounts payable system should allow SCN to control
disbursements and identify economies in purchasing.
Practice Services
As a result of its affiliation with the Affiliated Practices, SCN
employs most of the Affiliated Practices' non-physician personnel. These
non-physician personnel, along with additional personnel at the Company's
headquarters, manage the day-to-day non-medical operations of each of the
Affiliated Practices, including, among other things, provision of secretarial,
bookkeeping, scheduling and other routine services. Under the Service
Agreements, the Company must provide facilities and equipment to the Affiliated
Practices, and to this end, the Company entered into lease agreements for the
facilities and purchased the assets utilized by each of the Affiliated
Practices.
Management Information Systems
The Company believes that a key element in the implementation of its
business strategy is the development and utilization of its proprietary
management information systems. The Company is designing its information systems
to integrate and analyze financial and clinical data, improve operating
efficiency at the practice level and enhance the ability of the Company to
negotiate managed care contracts on behalf of its Affiliated Practices.
The Company has developed proprietary financial systems that have been
installed at the Company's headquarters and at each of the Affiliated Practices.
These systems include an internally developed purchase order application and
electronic interfaces between payroll, general ledger, banking, accounts payable
and accounts receivable applications. These systems permit each Affiliated
Practice to separately designate purchase requirements and transfer
8
purchase information on a daily basis. Such information allows the Company to
monitor purchases from order to receipt, to centrally control the disbursement
of funds and to identify economies in purchasing. In addition, the Company's
systems permit the Company to capture, analyze and report centrally financial
data from the various Affiliated Practice locations and provide analyses of
financial data on a fully integrated basis.
The Company has established standards at the Affiliated Practices for
gathering clinical and financial information such as personal patient data,
physician and procedure identifier codes, payor class and amounts charged and
reimbursed. The Company intends to develop a proprietary clinical outcomes
database to enable the Affiliated Practices to analyze clinical outcomes at the
practitioner and practice levels on a standardized basis. Information will be
gathered in areas such as incidents rates (the number of specified procedural,
diagnostic and medical events during a specified period with respect to a
specified patient population), utilization (frequency of patient care and
activity relating to the patient) and quality of care (monitoring and evaluation
of patient outcomes). This information should assist physicians in developing
clinical protocols, measuring outcomes, ensuring that standards of quality are
met and determining the most cost-effective course for treating patients. The
Company intends to use this data, together with data derived from its financial
information systems, to produce comprehensive financial and clinical reports to
be used in connection with the negotiation, structuring and pricing of managed
care contracts.
Payor Contracting
An increasing portion of the net revenue of the Affiliated Practices is
derived from managed care payors. Although rates paid by managed care payors are
generally lower than commercial rates, managed care payors can provide access to
large patient volumes.
The Company seeks to negotiate both fee-for-service and capitated
contracts on behalf of the Affiliated Practices. Under capitated arrangements,
providers deliver health care services to managed care enrollees and would bear
all or a portion of the risk that the cost of such services may exceed capitated
payments. Capitated contracts involve various forms of risk sharing. Providers
may accept risk only with respect to the costs of physician services required by
a patient (professional component) or for all of the medical costs required by a
patient including professional, institutional and ancillary services (global
capitation). Managed care companies' arrangements with providers can be further
segmented into episode of care and per member per month capitation. Under
specified episode of care capitation, providers deliver care for covered
enrollees with a specified medical condition or who require a particular
treatment on a fixed fee basis per episode. Under per member per month
capitation, the providers receive fixed monthly fees per covered enrollee and
assume the additional risk for the incidence of medical conditions requiring
procedures specified in the contract.
Currently, the Company performs analyses of the Affiliated Practices'
markets to develop managed care contracting strategies and meets with principal
payors in each of these markets to enhance and establish relationships between
the Affiliated Practices and such payors. In addition, the Company is currently
in the process of negotiating a capitated, episode of care managed care contract
on behalf of one of the Initial Affiliated Practices, fee for service contracts
for physician services for several of the Initial Affiliated Practices and a fee
for service contract for the surgery center at POA. TOC has a non-contractual
capitated arrangement covering approximately 75,000 lives and a capitated
contract covering approximately 55,000 lives, and POA has a capitated contract
covering approximately 20,000 lives. These arrangements existed at the time of
the Initial Affiliation Transactions. No other Affiliated Practice has a
capitated arrangement.
Governance and Quality Assurance
The Company's current governance structure promotes physician
participation in the management of the Company. At least one physician from each
Initial Affiliated Practice serves on the Company's Board of Directors. In
addition, each Affiliated Practice has a Joint Policy Board whose membership
includes an equal number of representatives from each of the Company and the
Affiliated Practice. The Joint Policy Board will have responsibilities
9
that include developing long-term strategic objectives, developing practice
expansion and payor contracting guidelines, promoting practice efficiencies,
recommending significant capital expenditures and facilitating communication and
information exchange between the Company and each of the Affiliated Practices.
The Company intends to create an Outcomes Management and Standards
Board that will focus on the identification and communication of the best
practices and clinical protocols in the business and administrative areas. The
Company also intends to create a Medical Provider Board that will identify and
communicate the best practices and protocols in the medical area. Both of these
boards, which will consist solely of physicians from Affiliated Practices, will
receive managerial and information systems support from the Company.
Contractual Agreements with Affiliated Practices
The Company has entered into the Service Agreements with each of the
Affiliated Practices, and intends to enter into long-term service agreements
with each additional practice that affiliates with the Company, to provide
management, administrative and development services. Under the Service
Agreements, the Affiliated Practices are solely responsible for all aspects of
the practice of medicine and the Company has the primary responsibility for the
business and administrative aspects of the Affiliated Practices. The Company
employs most of the Affiliated Practice's non-physician personnel. Pursuant to
the Service Agreements, the Company provides or arranges for various management,
administrative and development services to the Affiliated Practices relating to
the day-to-day non-medical operations of the Affiliated Practices.
The following summary of the Service Agreements is intended to be a
general summary of the form of Service Agreement. The Company expects to enter
into similar agreements with other practices with which it may affiliate in the
future. The actual terms of the individual Service Agreements may vary in
certain respects from the description below as a result of negotiations with the
individual practices and the requirements of local regulations. Agreements that
the Company may enter into in the future are also expected to vary in certain
respects. Each of the Service Agreements with the Initial Affiliated Practices
and certain related agreements are exhibits to this filing. The following
summary is qualified in its entirety by reference to such exhibits. For a
discussion of circumstances under which a service agreement may be rendered
unenforceable. See "Risk Factors -- Government Regulation" in this Item.
Pursuant to the Service Agreements, the Company, among other things,
(i) acts as the exclusive manager and administrator of non-physician services
relating to the operation of the Affiliated Practices, subject to matters for
which the Affiliated Practices maintain responsibility or which are referred to
the Joint Policy Boards of the Affiliated Practices, (ii) bills patients,
insurance companies and other third party payors and collects, on behalf of the
Affiliated Practices, the fees for professional medical and other services
rendered, including goods and supplies sold by the Affiliated Practices, (iii)
provides or arranges for, as necessary, clerical, accounting, purchasing,
payroll, legal, bookkeeping and computer services and personnel, information
management, preparation of certain tax returns, printing, postage and
duplication services and medical transcribing services, (iv) supervises and
maintains custody of substantially all files and records (medical records of the
Affiliated Practices remain the property of the Affiliated Practices), (v)
provides facilities for the Affiliated Practices, (vi) prepares, in consultation
with the Joint Policy Boards and the Affiliated Practices, all annual and
capital operating budgets, (vii) orders and purchases inventory and supplies as
reasonably requested by the Affiliated Practices, (viii) implements, in
consultation with the Joint Policy Boards and the Affiliated Practices, national
and local public relations or advertising programs and (ix) provides financial
and business assistance in the negotiation, establishment, supervision and
maintenance of contracts and relationships with managed care and other similar
providers and payors. Most of the services described above are provided by
employees previously employed by the Predecessor Practices.
Under the Service Agreements, the Affiliated Practices retain the
responsibility for, among other things, (i) hiring and compensating physician
employees and other medical professionals, (ii) ensuring that physicians have
the required licenses, credentials, approvals and other certifications needed to
perform their duties and (iii) complying with
10
certain federal and state laws and regulations applicable to the practice of
medicine. In addition, the Affiliated Practices maintain exclusive control of
all aspects of the practice of medicine and the delivery of medical services.
Under the Service Agreements, the Company collects fees from the
Affiliated Practices on a monthly basis. The fees consist of the following: (i)
service fees based on a percentage (the "Service Fee Percentage") ranging from
20%-33% of the Adjusted Pre-Tax Income of the Affiliated Practices (defined
generally as revenue of the Affiliated Practices related to professional
services less amounts equal to certain clinic expenses of the Affiliated
Practices ("Clinic Expenses," as defined more fully in the Service Agreements),
not including physician owner compensation or most benefits to physician owners)
and (ii) amounts equal to Clinic Expenses. For the first three years following
the affiliation, however, the portion of the service fees described under clause
(i) above is specified to be the greater of the amount payable as described
under clause (i) above or a fixed dollar amount (the "Base Service Fee"), which
was generally calculated by applying the respective Service Fee Percentage of
Adjusted Pre-Tax Income of the predecessors to the Affiliated Practices for the
twelve months prior to affiliation. In addition, with respect to its management
of certain facilities and ancillary services associated with certain of the
Initial Affiliated Practices, the Company receives fees ranging from 2%-8% of
net revenue related to such facilities and services.
Pursuant to the Service Agreements, each Affiliated Practice agrees to
sell and assign to the Company, and the Company agrees to buy, all of the
Affiliated Practice's accounts receivable each month during the existence of the
Service Agreement. The purchase price for such accounts receivable will equal
the face amounts of the accounts receivable recorded each month less adjustments
for contractual allowances, allowances for doubtful accounts and other
potentially uncollectible amounts based on the practice's historical collection
rate, as determined by the Company.
However, the Company and the Affiliated Practices have discussed making
periodic adjustments so that amounts paid by the Company for the accounts
receivable will be adjusted upwards or downwards based on the Company's actual
collection experience. While the Company believes, based on its discussions with
the Affiliated Practices, that this arrangement is acceptable to them, the
Company cannot assure that this arrangement will be effected.
The Service Agreements have initial terms of forty years, with
automatic extensions (unless specified notice is given) of additional five-year
terms. The Service Agreement may be terminated by either party if the other
party (i) files a petition in bankruptcy or other similar events occur or (ii)
defaults on the performance of a material duty or obligation, which default
continues for a specified term after notice. In addition, the Company may
terminate the agreement if the Affiliated Practice's Medicare or Medicaid number
is terminated or suspended as a result of some act or omission of the Affiliated
Practice or the physicians, and the Affiliated Practice may terminate the
agreement if the Company misapplies funds or assets or violates certain laws.
Upon termination of a Service Agreement by the Company for one of the
reasons set forth above, the Company has the option to require the Affiliated
Practice to purchase and assume the assets and liabilities related to the
Affiliated Practice at the fair market value thereof. In addition, upon
termination of a Service Agreement by the Company during the first five years of
the term, the physician owners of the Affiliated Practice are required to pay
the Company or return to the Company an amount of cash or stock of the Company
equal to one-third of the total consideration received by such physicians in
connection with the Company's affiliation with the practice.
Under the Service Agreements, each physician owner must give the
Company twelve months notice of an intent to retire from the Affiliated
Practice. If a physician gives such notice during the first five years of the
agreement, the physician must also locate a replacement physician or physicians
acceptable to the Joint Policy Board and pay an amount based on a formula
relating to any loss of service fee for the first five years of the term. In
addition, a physician leaving a practice during the first five years of the term
is required to pay the Company or return to the Company an amount of cash or
stock equal to one-third of the total consideration received by such physician
in connection with the Company's affiliation with the practice. The agreement
also provides that after the fifth year, no more than 20% of the physician
owners at the Affiliated Practice may retire within a one-year period.
11
The Affiliated Practices and the physician owners of the Affiliated
Practices generally agree with the Company not to compete with the Company in
providing services similar to those provided by the Company under the Service
Agreements, and the physician owners also generally agree with the Company not
to compete with an Affiliated Practice, within a specified geographic area.
Non-competition restrictions generally apply to physicians during their
affiliation with Affiliated Practices and for three years thereafter. In
addition, the Service Agreement requires the Affiliated Practice to enter into
non-competition agreements with all physicians in the Affiliated Practice, of
which agreements the Company will be a third party beneficiary. After the fifth
year of the term of the Service Agreement, physician owners of the Affiliated
Practices may be released from the non-competition provisions upon payment of
certain amounts to the Company, which may be paid in the form of Common Stock.
The Service Agreements generally require the Affiliated Practices to pursue
enforcement of the non-competition agreement with physicians or assign to the
Company the right to pursue enforcement.
The Company has entered into an agreement with ROA and Drs. Booth and
Bartolozzi pursuant to which there will be a division of ROA and Drs. Booth and
Bartolozzi will establish an independent practice ("BB One"). The agreement
provides that the Company will enter into a service agreement with BB One, and
amend the service agreement with ROA so that the aggregate Base Service Fee for
ROA and BB One will be equal to ROA's current Base Service Fee. In addition,
unless BB One exercises the right described below, in the event that the Base
Service Fee of either (but not both) of the practices is more than the service
fee (the "Percentage-Based Service Fee") that would result from the application
of the Service Fee Percentage to the practice's Adjusted Pre-Tax Income (a "Base
Fee Deficit"), the other practice will offset against the deficit the amount, if
any, by which its Percentage-Based Service Fee exceeds its Base Service Fee.
Thereafter, if any deficit remains, (i) the Company will forgive one-third of
the remaining Base Fee Deficit, up to $120,000, (ii) the practice that did not
have the Base Fee Deficit will pay to the Company one-third of the remaining
Base Fee Deficit, up to $120,000 and (iii) the practice with the Base Fee
Deficit will pay to the Company all additional remaining Base Fee Deficit. If
both practices have a Base Fee Deficit, (i) BB One will pay to SCN one-third of
ROA's Base Fee Deficit, up to $120,000, (ii) the Company will forgive one-third
of ROA's Base Fee Deficit, up to $120,000, (iii) ROA will pay the remainder of
the Base Fee Deficit and (iv) BB One will pay to the Company the entire amount
of its Base Fee Deficit.
The agreement provides that BB One has the right, prior to July 15,
1997, to increase its Service Fee Percentage by a stipulated amount. In the
event that the right is exercised, BB One's Base Service Fee will be increased
by a stipulated amount, and Dr. Booth will receive options from the Company to
purchase shares of Common Stock, based on a specified multiple of the increase
in the Base Service Fee, the product of which will be divided by the greater of
$10.00 or the closing bid price of Company Common Stock on the Nasdaq National
Market on the date the right is exercised. If the right is exercised, the
Company will have no obligation to forgive any Base Fee Deficit of either ROA or
BB One.
The agreement also provides that in the event Dr. Bartolozzi does not
join with Dr. Booth in forming BB One, then ROA and the Company will enter into
arrangements with Dr. Booth on terms proportionately consistent with the
economic principles underlying the above described arrangement. In the event Dr.
Bartolozzi remains with ROA or leaves BB One, BB One's Base Service Fee and
Service Fee Percentage and the amount of the increase in the Base Service Fee in
the event the right is exercised will be modified.
The parties have agreed that in the event additional issues arise in
the process of completing definitive agreements, or amendments to existing
agreements, and such issues are not resolved, then such issues will be submitted
to binding arbitration.
In addition, the Company has entered into an agreement with Dr.
Bartolozzi pursuant to which the Company has agreed to support the development
of a sports medicine center. If the Company and Dr. Bartolozzi have not agreed
to a plan for the development of the center by November 1997, Dr. Bartolozzi may
terminate the service agreement as it pertains to him, with three months written
notice to the Company. Upon such a termination, Dr. Bartolozzi must return to
the Company an amount equal to (i) the after-tax amount of the consideration
received by Dr. Bartolozzi in the merger
12
transaction between ROA and the Company less (ii) the after-tax amount of Dr.
Bartolozzi's pro rata portion of service fees paid to SCN during the term of the
service agreement. In the event of such termination, the Base Service Fee to be
paid by BB One (or ROA, if Dr. Bartolozzi elects to remain with ROA) to SCN will
be proportionally reduced by the pro rata portion of the consideration paid to
Dr. Bartolozzi at the closing of the merger between SCN and ROA.
The Affiliated Practices are responsible for obtaining professional
liability and worker's compensation insurance for the physicians and other
medical employees of the Affiliated Practices, as well as general liability
umbrella coverage. The Company is responsible for obtaining professional
liability and worker's compensation insurance for employees of the Company and
general liability and property insurance for the Affiliated Practices.
The Service Agreements contain indemnification provisions, pursuant to
which the Company indemnifies the Affiliated Practices for damages resulting
from negligent acts or omissions by the Company or its agents, employees or
shareholders. In addition, the Affiliated Practices indemnify the Company for
any damages resulting from any negligent act or omissions by any affiliated
physicians, agents or employees of the Affiliated Practice, other than damages
resulting from claims arising from the performance or nonperformance of medical
services.
Government Regulation and Supervision
The delivery of health care services has become one of the most highly
regulated of professional and business endeavors in the United States. Both the
federal government and the individual state governments are responsible for
overseeing the activities of individuals and businesses engaged in the delivery
of health care services. Federal law and regulations are based primarily upon
the Medicare program and the Medicaid program, each of which is financed, at
least in part, with federal funds. State jurisdiction is based upon the state's
interest in regulating the quality of health care in the state, regardless of
the source of payment.
The Company believes its operations are in material compliance with
applicable laws; however, the Company has not received or applied for a legal
opinion from counsel or from any federal or state judicial or regulatory
authority to this effect, and many aspects of the Company's business operations
have not been the subject of state or federal regulatory interpretation. The
laws applicable to the Company are subject to evolving interpretations, and
therefore, there can be no assurance that a review of the Company or the
Affiliated Practices by a court or law enforcement or regulatory authority will
not result in a determination that could have a material adverse effect on the
Company or the Affiliated Practices. Furthermore, there can be no assurance that
the laws applicable to the Company will not be amended in a manner that could
have a material adverse effect on the Company.
Federal Law
The federal health care laws apply in any case in which an Affiliated
Practice is providing an item or service that is reimbursable under Medicare or
Medicaid or in which the Company is claiming reimbursement from Medicare or
Medicaid on behalf of physicians with whom the Company has a service agreement.
The principal federal laws include those that prohibit the filing of false or
improper claims with the Medicare or Medicaid programs, those that prohibit
unlawful inducements for the referral of business reimbursable under Medicare or
Medicaid and those that prohibit the provision of certain services by a provider
to a patient if the patient was referred by a physician with which the provider
has certain types of financial relationships.
False and Other Improper Claims. The federal government is authorized
to impose criminal, civil and administrative penalties on any health care
provider that files a false claim for reimbursement from Medicare or Medicaid.
Criminal penalties are also available in the case of claims filed with private
insurers if the government can show that the claims constitute mail fraud or
wire fraud. While the criminal statutes are generally reserved for instances
evincing an obviously fraudulent intent, the criminal and administrative penalty
statutes are being applied by the government in an increasingly broad range of
circumstances. The government has taken the position, for example, that a
pattern of claiming reimbursement for unnecessary services violates these
statutes if the claimant should have known
13
that the services were unnecessary. The government has also taken the position
that claiming reimbursement for services that are substandard is a violation of
these statutes if the claimant should have known that the care was substandard.
The Company believes that its billing activities on behalf of the
Affiliated Practices are in material compliance with such laws, but there can be
no assurance that the Company's activities will not be challenged or scrutinized
by governmental authorities. A determination that the Company had violated such
laws could have a material adverse impact on the Company.
Anti-Kickback Law. A federal law commonly known as the "Anti-kickback
Amendments" prohibits the offer, solicitation, payment or receipt of anything of
value (direct or indirect, overt or covert, in cash or in kind) which is
intended to induce the referral of Medicare or Medicaid patients, or the
ordering of items or services reimbursable under those programs. The law also
prohibits remuneration that is intended to induce the recommendation of, or the
arranging for, the provision of items or services reimbursable under Medicare
and Medicaid. The law has been broadly interpreted by a number of courts to
prohibit remuneration that is offered or paid for otherwise legitimate purposes
if the circumstances show that one purpose of the arrangement is to induce
referrals. Even bona fide investment interests in a health care provider may be
questioned under the Anti-kickback Amendments if the government concludes that
the opportunity to invest was offered as an inducement for referrals. The
penalties for violations of this law include criminal sanctions and exclusion
from the federal health care program.
In part to address concerns regarding the implementation of the
Anti-kickback Amendments, the federal government in 1991 published regulations
that provide exceptions or "safe harbors," for certain transactions that will
not be deemed to violate the Anti-kickback Amendments. Among the safe harbors
included in the regulations were provisions relating to the sale of physician
practices, management and personal services agreements and employee
relationships. Subsequently, regulations were published offering safe harbor
protection to additional activities, including referrals within group practices
consisting of active investors. Proposed amendments clarifying the existing safe
harbor regulations were published in 1994. If any of the proposed regulations
are ultimately adopted, they would result in substantive changes to existing
regulations. The failure of an activity to qualify under a safe harbor
provision, while potentially leading to greater regulatory scrutiny, does not
render the activity illegal.
There are several aspects of the Company's relationships with
physicians to which the anti-kickback law may be relevant. In some instances,
for example, the government may construe some of the marketing and managed care
contracting activities of the Company as arranging for the referral of patients
to the physicians with whom the Company has a Service Agreement.
Although neither the investments in the Company by physicians nor the
Service Agreements between the Company and the Affiliated Practices qualify for
protection under the safe harbor regulations, the Company does not believe that
these activities fall within the type of activities the Anti-kickback Amendments
were intended to prohibit. A determination that the Company has violated the
Anti-kickback Amendments would have a material adverse effect on the Company.
The Stark Self-Referral Law. The Stark Self-Referral Law (the "Stark
Law") prohibits a physician from referring a patient to a health care provider
for certain designated health services reimbursable by Medicare or Medicaid if
the physician has a financial relationship with that provider, including an
investment interest, a loan or debt relationship or a compensation relationship.
In addition to the conduct directly prohibited by the law, the statute also
prohibits schemes that are designed to obtain referrals indirectly that cannot
be made directly. The penalties for violating the law include (i) a refund of
any Medicare or Medicaid payments for services that resulted from an unlawful
referral, (ii) civil fines and (iii) exclusion from the Medicare and Medicaid
programs.
The Company does not currently provide any designated health service
under the Stark Law. However, because the Company will provide management
services related to those designated health services provided by physicians
affiliated with the Affiliated Practices, there can be no assurance that the
Company will not be deemed the provider for
14
those services for purposes of the Stark Law and, accordingly, the recipient of
referrals from physicians affiliated with the Affiliated Practices. In that
event, such referrals will be permissible only if (i) the financial arrangements
under the service agreements with the Affiliated Practices meet certain
exceptions in the Stark Law and (ii) the ownership of stock in the Company by
the referring physicians meets certain investment exceptions under the Stark
Law. The Company believes that the financial arrangements under the Service
Agreements qualify for applicable exceptions under the Stark Law; however, there
can be no assurance that a review by courts or regulatory authorities would not
result in a contrary determination. In addition, the Company will not meet the
Stark Law exception related to investment interest until the Company's
stockholders' equity exceeds $75 million.
State Law
State Anti-Kickback Laws. Many states have laws that prohibit payment
of kickbacks in return for the referral of patients. Some of these laws apply
only to services reimbursable under state Medicaid programs. However, a number
of these laws apply to all health care services in the state, regardless of the
source of payment for the service. Based on court and administrative
interpretation of federal anti-kickback laws, the Company believes that these
laws prohibit payments to referral sources where a purpose for payment is for
the referral. However, the laws in most states regarding kickbacks have been
subjected to limited judicial and regulatory interpretation and therefore, no
assurances can be given that the Company's activities will be found to be in
compliance. Noncompliance with such laws could have an adverse effect upon the
Company and subject it and physicians affiliated with the Affiliated Practices
to penalties and sanctions.
State Self-Referral Laws. A number of states have enacted self-referral
laws that are similar in purpose to the Stark Law but which impose different
restrictions. Some states, for example, only prohibit referrals when the
physician's financial relationship with a health care provider is based upon an
investment interest. Other state laws apply only to a limited number of
designated health services. Some states do not prohibit referrals, but require
only that a patient be informed of the financial relationship before the
referral is made. The Company believes that its operations are in material
compliance with the self-referral law of the states in which the Affiliated
Practices are located.
Fee-Splitting Laws. Many states prohibit a physician from splitting
with a referral source the fees generated from physician services. Other states
have a broader prohibition against any splitting of a physician's fees,
regardless of whether the other party is a referral source. In most states, it
is not considered to be fee-splitting when the payment made by the physician is
reasonable reimbursement for services rendered on the physician's behalf.
The Company will be reimbursed by physicians on whose behalf the
Company provides management services. The compensation provisions of the Service
Agreements have been designed to comply with applicable state laws relating to
fee-splitting. There can be no certainty, however, that, if challenged, the
Company and its Affiliated Practices will be found to be in compliance with each
state's fee-splitting laws. A determination in any state that the Company is
engaged in any unlawful fee-splitting arrangement could render any service
agreement between the Company and an Affiliated Practice located in such state
unenforceable or subject to modification in a manner adverse to the Company.
Corporate Practice of Medicine. Most states prohibit corporations from
engaging in the practice of medicine. Many of these state doctrines prohibit a
business corporation from employing a physician. States differ, however, with
respect to the extent to which a licensed physician can affiliate with corporate
entities for the delivery of medical services. Some states interpret the
"practice of medicine" broadly to include activities of corporations such as the
Company that have an indirect impact on the practice of medicine, even where the
physician rendering the medical services is not an employee of the corporation
and the corporation exercises no discretion with respect to the diagnosis or
treatment of a particular patient.
The Company intends that, pursuant to its service agreements, it will
not exercise any responsibility on behalf of affiliated physicians that could be
construed as affecting the practice of medicine. Accordingly, the Company
believes that its operations do not violate applicable state laws relating to
the corporate practice of medicine. Such laws and legal
15
doctrines have been subjected to only limited judicial and regulatory
interpretation and there can be no assurance that, if challenged, the Company
would be considered to be in compliance with all such laws and doctrines. A
determination in any state that the Company is engaged in the corporate practice
of medicine could render any service agreement between the Company and an
Affiliated Practice located in such state unenforceable or subject to
modification in a manner adverse to the Company.
Insurance Laws. Laws in all states regulate the business of insurance
and the operation of HMOs. Many states also regulate the establishment and
operation of networks of health care providers. While these laws do not
generally apply to companies that provide management services to networks of
physicians, there can be no assurance that regulatory authorities of the states
in which the Company operates would not apply these laws to require licensure of
the Company's operations as an insurer, as an HMO or as a provider network. The
Company believes that its proposed operations are in compliance with these laws
in the states in which it currently does business, but there can be no assurance
that future interpretations of insurance and health care network laws by
regulatory authorities in these states or in the states into which the Company
may expand will not require licensure or a restructuring of some or all of the
Company's operations.
The National Association of Insurance Commissioners ("NAIC") in 1995
endorsed a policy proposing the state regulation of risk assumption by
physicians. The policy proposes prohibiting physicians from entering into
capitated payment or other risk sharing contracts except through HMOs or
insurance companies. Several states have adopted regulations implementing the
NAIC policy in some form. In states where such regulations have been adopted,
practices affiliated with the Company will be precluded from entering into
capitated contracts directly with employers, individuals and benefit plans
unless they qualify to do business as HMOs or insurance companies. Currently,
the Company does not intend, on its own behalf, or on behalf of the Affiliated
Practices, to enter into capitated payment or other risk-sharing arrangements
other than with HMOs or insurance companies. In addition, in December 1996, the
NAIC issued a white paper entitled "Regulation of Health Risk Bearing Entities,"
which sets forth issues to be considered by state insurance regulators when
considering new regulations and encourages that a uniform body of regulation be
adopted by the states. The Company believes that additional regulation at the
state level will be forthcoming in response to the NAIC initiatives. Other
states have enacted statutes or adopted regulations affecting risk assumption in
the health care industry, including statutes and regulations that subject any
physician or physician network engaged in risk-based contracting to applicable
insurance laws and regulations, which may include, among other things, laws and
regulations providing for minimum capital requirements and other safety and
soundness requirements.
Competition
The Company competes with many other entities to affiliate with
musculoskeletal practices. Several companies that have established operating
histories and greater resources than the Company are pursuing the acquisition of
the assets of general and specialty practices and the management of such
practices. Physician practice management companies and some hospitals, clinics
and HMOs engage in activities similar to the activities of the Company. There
can be no assurance that the Company will be able to compete effectively with
such competitors, that additional competitors will not enter the market, or that
such competition will not make it more difficult to affiliate with, and to enter
into agreements to provide management services to, practices on terms beneficial
to the Company.
Affiliated Practices compete with local musculoskeletal care service
providers as well as some managed care organizations. The Company believes that
changes in governmental and private reimbursement policies and other factors
have resulted in increased competition for consumers of medical services. The
Company believes that the cost, accessibility and quality of services provided
are the principal factors that affect competition. There can be no assurance
that the Affiliated Practices will be able to compete effectively in the markets
that they serve. The inability of the Affiliated Practices to compete
effectively would materially adversely affect the Company.
Further, the Affiliated Practices compete with other providers for
managed musculoskeletal care contracts. The Company believes that trends toward
managed care have resulted in increased competition for such contracts. Other
16
practices and management service organizations may have more experience than the
Affiliated Practices and the Company in obtaining such contracts. There can be
no assurance that the Company and the Affiliated Practices will be able to
successfully acquire sufficient managed care contracts to compete effectively in
the markets they serve. The inability of the Affiliated Practices to compete
effectively for such contracts could materially adversely affect the Company.
Employees
As of March 21, 1997, the Company has approximately 319 employees, of
whom 30 are located at the Company's corporate offices and 289 are located at
the Affiliated Practices. The Company believes that its relationship with its
employees is good.
Corporate Liability and Insurance
The provision of medical services entails an inherent risk of
professional malpractice and other similar claims. However, the Company does not
influence or control the practice of medicine by physicians or have
responsibility for compliance with certain regulatory and other requirements
directly applicable to physicians and physician groups. As a result of the
relationship between the Company and the Affiliated Practices, the Company may
become subject to some medical malpractice actions under various theories,
including successor liability. There can be no assurance that claims, suits or
complaints relating to services and products provided by Affiliated Practices
will not be asserted against the Company in the future. The Company's medical
professional liability insurance provides coverage of up to $1 million per
incident, with maximum coverage of $3 million per year. The Company's general
liability insurance provides coverage of up to $5 million per incident, with
maximum coverage of $5 million per year. The Company believes that such
insurance will extend to professional liability claims that may be asserted
against employees of the Company that work on site at Affiliated Practice
locations. In addition, pursuant to the Service Agreements, the Affiliated
Practices are required (and the other practices with which the Company
affiliates in the future will be required) to maintain comprehensive
professional liability insurance. The availability and cost of such insurance
has been affected by various factors, many of which are beyond the control of
the Company and Affiliated Practices. The cost of such insurance to the Company
and Affiliated Practices may have a material adverse effect on the Company. In
addition, successful malpractice or other claims asserted against Affiliated
Practices or the Company that exceed applicable policy limits would have a
material adverse effect on the Company.
Risk Factors
Limited Operating History; Risks Related to Integration of Assets
and Personnel
The Company was incorporated in December 1995 and, prior to its
affiliation with the Initial Affiliated Practices in November 1996, had no
history of operations or earnings. As a result of acquiring certain assets of
the Predecessor Practices, and the practices that were predecessors to the
single physician practices acquired by the Company, and entering into the
Service Agreements with the Affiliated Practices, the Company is now responsible
for most non-medical aspects of the operations, and manages most non-physician
employees, of the Initial Affiliated Practices. Prior to their affiliation with
the Company, the Predecessor Practices and the practices that were predecessors
to the single physician practices acquired by the Company operated as separate
independent entities, and there can be no assurance that the Company will be
able to integrate and manage successfully the assets and personnel of, or
provide services profitably to, the Affiliated Practices or other practices with
which it may affiliate in the future. In addition, there can be no assurance
that the Company's affiliation with the Affiliated Practices or other practices
with which it may affiliate in the future will not result in a loss of patients
by any of those practices or other unanticipated adverse consequences. Any of
these events could have a material adverse effect on the Company. There can be
no assurance that the Company's personnel, systems and infrastructure will be
sufficient to permit effective and profitable management of the Affiliated
Practices under the Service Agreements or to implement effectively the Company's
strategies.
17
Risks Associated with Affiliation and Expansion Strategy
A primary element of the Company's strategy is to acquire certain
assets of, and affiliate through service agreements with, selected
musculoskeletal practices in targeted markets. The Company's strategy also
involves assisting Affiliated Practices in recruiting physicians and, to the
extent permitted by applicable law, contracting with ancillary musculoskeletal
facilities, such as outpatient occupational medicine, physical therapy and
surgery centers and MRI centers, and with associated providers. Identifying
appropriate physician group practices, individual physicians and ancillary
providers and facilities and proposing, negotiating and implementing
economically attractive affiliations with such practices, physicians and
providers can be a lengthy, complex and costly process. In addition, the Company
is a party to a credit facility that places certain limitations upon the number
of affiliations the Company can enter into in any quarter or year and the terms
of any future affiliations. The failure of the Company to identify and effect
additional affiliations would have a material adverse effect on the Company.
Moreover, there can be no assurance that future affiliations, if any, will
contribute to the Company's profitability or otherwise facilitate the successful
implementation of the Company's overall strategy.
The Company's ability to expand is also dependent upon factors such as
the ability of the Company and any practice with which it may seek to affiliate
to (i) adapt the Company's arrangements with such practices to comply with
current or future legal requirements, including state prohibitions on
fee-splitting, corporate practice of medicine and referrals to facilities in
which physicians have a financial interest and state anti-kickback provisions,
(ii) obtain regulatory approval and certificates of need, where necessary, and
(iii) comply with licensing requirements applicable to physicians and to
facilities operated, and services offered, by physicians. There can be no
assurance that application of current laws or changes in legal requirements will
not adversely affect the Company or that the Company and the practices with
which it is affiliated will be able to obtain and maintain all necessary
regulatory approvals and comply with applicable laws, regulations and licensing
requirements.
Dependence on Affiliated Practices and Physicians; Risk of Termination
of Service Agreements
The Company's operations are entirely dependent on its continued
affiliation through service agreements with the Affiliated Practices and on the
success of the Affiliated Practices. There can be no assurance that the
Affiliated Practices will maintain successful practices, that service agreements
will not be terminated or that any of the key physicians in a particular
Affiliated Practice will continue affiliation with such practice. Two of the
Affiliated Practices, ROA and POA, contributed approximately 34% and 27%,
respectively, of the fees (including fees relating to the reimbursement of
clinic expenses) paid to the Company by all of the Initial Affiliated Practices.
The termination of any of the Service Agreements with the Initial Affiliated
Practices would, and termination of service agreements with any other Affiliated
Practices could, have a material adverse effect on the Company. For a
description of the Service Agreements, including a description of their
termination provisions and non-competition arrangements with affiliated
physicians, and an agreement regarding a contemplated division of ROA into two
Affiliated Practices, see "Contractual Agreements with Affiliated Practices" in
this Item. For a discussion of circumstances under which a service agreement may
be rendered unenforceable, see "Government Regulation" in this Item.
Some of the Affiliated Practices derive, and other practices with which
the Company may affiliate may derive, a significant portion of their revenue
from a limited number of physicians. Particularly because none of the physicians
at any Affiliated Practices has previously entered into service arrangements
similar to those embodied in the Service Agreements, there can be no assurance
that the Company or the Affiliated Practices will maintain cooperative
relationships with key members of a particular Affiliated Practice. In addition,
there can be no assurance that key members of an Affiliated Practice will not
retire, become disabled or otherwise become unable or unwilling to continue
practicing their profession with an Affiliated Practice. The loss by an
Affiliated Practice of one or more key members would have a material adverse
effect on the revenue of such Affiliated Practice and possibly on the Company.
Neither the Company nor the Affiliated Practices maintains insurance on the
lives of any affiliated physicians for the benefit of the Company. The loss of
revenue by any Affiliated Practice could have a material adverse effect on the
Company.
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Risk of Changes in Payment for Medical Services
The health care industry is experiencing a trend toward cost
containment as government and private third party payors seek to impose lower
reimbursement and utilization rates and negotiate reduced capitated payment
schedules with service providers. Further reductions in payments to health care
providers or other changes in reimbursement for health care services could have
a material adverse effect on the Affiliated Practices and, as a result, on the
Company. These reductions could result from changes in current reimbursement
rates or from a shift in clinical protocols to non-surgical solutions to
orthopaedic conditions. There can be no assurance that the Company will be able
to offset successfully any or all of the payment reductions that may occur.
The federal government has implemented, in annual increments through
December 31, 1996, through the Medicare program, a resource-based relative value
scale ("RBRVS") payment methodology for health care provider services. RBRVS is
a fee schedule that, except for certain geographical and other adjustments, pays
similarly situated health care providers the same amount for the same services.
The RBRVS is adjusted each year and is subject to increases or decreases at the
discretion of Congress. To date, the implementation of RBRVS has reduced payment
rates for certain of the procedures historically provided by the Affiliated
Practices. Further reductions could significantly affect the Affiliated
Practices, each of which derives a significant portion of its revenue from
Medicare. RBRVS types of payment systems have also been adopted by certain
private third party payors and may become a predominant payment methodology.
Wider-spread implementation of such programs would reduce payments from private
third party payors, and could indirectly reduce revenue to the Company.
Rates paid by private third party payors, including those that provide
Medicare supplemental insurance, are based on established health care provider
and hospital charges and are generally higher than Medicare payment rates. A
change in the patient mix of any of the Affiliated Practices that results in a
decrease in patients covered by private insurance could have a material adverse
effect on the Affiliated Practices and, as a result, on the Company.
Government Regulation
The delivery of health care, including the relationships among health
care providers such as physicians and other clinicians, is subject to extensive
federal and state regulation. The Company believes that its operations are
conducted in material compliance with applicable laws; however, the Company has
not received or applied for a legal opinion from counsel or from any federal or
state judicial or regulatory authority to this effect, and many aspects of the
Company's business operations have not been the subject of state or federal
regulatory interpretation. There can be no assurance that a review of the
Company's operations by federal or state judicial or regulatory authorities will
not result in a determination that the Company or one of its Affiliated
Practices has violated one or more provisions of federal or state law. Any such
determination could have a material adverse effect on the Company.
The fraud and abuse provisions of the Social Security Act and
anti-kickback laws and regulations adopted by many states, including Florida, a
state in which three Affiliated Practices are located, prohibit the
solicitation, payment, receipt or offering of any direct or indirect
remuneration in return for, or as an inducement to, certain referrals of
patients, items or services. Provisions of the Social Security Act also impose
significant penalties for false or improper billings. In addition, the Stark Law
imposes restrictions on physicians' referrals for designated health services
reimbursable by Medicare or Medicaid to entities with which the physicians have
financial relationships. Many states, including the states in which the
Affiliated Practices are located, have adopted similar self-referral laws which
are not limited to Medicare or Medicaid reimbursed services. Accordingly, the
Company is prohibited from owning facilities for the provision of, or otherwise
providing, certain ancillary services for patients of its Affiliated Practices.
Violations of any of these laws may result in substantial civil or criminal
penalties, including large civil monetary penalties, and, in the case of
violations of federal laws, exclusion from participation in the Medicare and
Medicaid programs. Such exclusion and penalties, if applied to the Company or
its Affiliated Practices, would have a material adverse effect on the Company.
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The laws of many states, including the states in which the Affiliated
Practices are located, prohibit business corporations such as the Company from
practicing medicine or exercising control over the medical judgments or
decisions of physicians and from engaging in certain financial arrangements,
such as splitting fees with physicians. These laws and their interpretations
vary from state to state and are enforced by both the courts and regulatory
authorities, each with broad discretion. Violations of these laws could result
in censure or delicensing of affiliated physicians, civil or criminal penalties,
including large civil monetary penalties, or other sanctions. In addition, a
determination in any state that the Company is engaged in the corporate practice
of medicine or any unlawful fee-splitting arrangement could render any service
agreement between the Company and an Affiliated Practice located in such state
unenforceable or subject to modification, which could have a material adverse
effect on the Company.
Expansion of the operations of the Company to certain jurisdictions may
require modification of the Company's form of relationship with a practice,
which could have a material adverse effect on the Company. Furthermore, the
Company's ability to expand into, or to continue to operate within certain
jurisdictions may depend on the Company's ability to modify its operational
structure to conform to such jurisdictions' regulatory framework or to obtain
necessary approvals, licenses and permits. Any limitation on the Company's
ability to expand could have a material adverse effect on the Company. See
"Government Regulation and Supervision" in this Item.
In addition to extensive existing government health care regulation,
there are numerous initiatives on the federal and state levels for comprehensive
reforms affecting the payment for and availability of health care services.
These initiatives include reductions in Medicare and Medicaid payments, trends
in adopting managed care for Medicare and Medicaid patients and regulation of
entities that provide managed care and additional prohibitions on ownership by
health care providers, directly or indirectly, of facilities to which they refer
patients. Aspects of certain of these health care proposals, if adopted, could
have a material adverse effect on the Company. See "Risk Factors-- Risks
Associated with Affiliation and Expansion Strategy," "Risk Factors-- Risk of
Changes in Payment for Medical Services" and "Government Regulation and
Supervision" in this Item.
Dependence on Information Systems
The Company's success is largely dependent on its ability to implement
new information systems and to integrate these systems into the Affiliated
Practice's existing, operational, financial and clinical information systems. In
addition to their integral role in helping the Affiliated Practices realize
operating efficiencies, such systems are critical to negotiating, pricing and
managing capitated managed care contracts. See "Risk Factors--Risks Associated
with Managed Care Contracts." The Company will need to continue to invest in,
and administer, sophisticated management information systems to support these
activities. The Company may experience unanticipated delays, complications and
expenses in implementing, integrating and operating such systems. Furthermore,
such systems may require modifications, improvements or replacements as the
Company expands or if new technologies become available. Such modifications,
improvements or replacements may require substantial expenditures and may
require interruptions in operations during periods of implementation. The
failure to implement successfully and maintain operational, financial and
clinical information systems would have a material adverse effect on the
Company. See "SCN Operations" in this Item.
Risks Associated with Managed Care Contracts
As an increasing percentage of patients enter into health care coverage
arrangements with managed care payors, the Company believes that its success
will be, in part, dependent upon the Company's ability to negotiate contracts
with HMOs, employer groups and other private third party payors on behalf of
practices affiliated with the Company. The inability of the Company to enter
into such arrangements in the future on behalf of practices affiliated with the
Company could have a material adverse effect on the Company.
In certain instances, the Company may seek to negotiate on behalf of
regional musculoskeletal care networks consisting of practices affiliated with
the Company and other physicians or group practices willing to permit the
20
Company to negotiate on their behalf with respect to a particular third party
payor. The Company anticipates that, in the future, the payor contracts that may
be entered into on behalf of practices affiliated with the Company and any
related network physicians will include contracts based on capitated fee
arrangements. Under some of these types of contracts, a health care provider
agrees either to accept a predetermined dollar amount per member per month in
exchange for undertaking to provide all covered services to patients or to
provide treatment on an episode of care basis. Such health care providers bear
the risk, generally subject to certain loss limits, that the aggregate costs of
providing medical services will exceed the premiums received. Some agreements
may also contain "shared risk" provisions under which affiliated physicians may
earn additional compensation based on utilization control of institutional,
ancillary and other services by patients, and the practices may be required to
bear a portion of any loss in connection with such "shared risk" provisions. To
the extent that patients or enrollees covered by such contracts require more
frequent or, in certain instances, more extensive care than anticipated, there
could be a material adverse effect on a practice affiliated with the Company
and, therefore, on the Company. In the worst case, revenue negotiated under
risk-sharing or capitated contracts would be insufficient to cover the costs of
the care provided. Any such reduction or elimination of earnings to the
practices affiliated with the Company under such fee arrangements could have a
material adverse effect on the Company.
TOC has a non-contractual capitated arrangement covering approximately
75,000 lives and a capitated contract covering approximately 55,000 lives, and
POA has a capitated contract covering approximately 20,000 lives. These
arrangements existed at the time of the Initial Affiliation Transactions. No
other Affiliated Practice has a capitated arrangement.
The NAIC in 1995 endorsed a policy proposing the state regulation of
risk assumption by physicians. The policy proposes prohibiting physicians from
entering into capitated payment or other risk sharing contracts except through
HMOs or insurance companies. Several states have adopted regulations
implementing the NAIC policy in some form. In states where such regulations have
been adopted, practices affiliated with the Company will be precluded from
entering into capitated contracts directly with employers, individuals and
benefit plans unless they qualify to do business as HMOs or insurance companies.
Currently, the Company does not intend, on its own behalf, or on behalf of the
Initial Affiliated Practices, to enter into capitated payment or other
risk-sharing arrangements other than with HMOs or insurance companies. In
addition, in December 1996, the NAIC issued a white paper entitled "Regulation
of Health Risk Bearing Entities," which sets forth issues to be considered by
state insurance regulators when considering new regulations, and encourages that
a uniform body of regulation be adopted by the states. The Company believes that
additional regulation at the state level will be forthcoming in response to the
NAIC initiatives. Other states have enacted statutes or adopted regulations
affecting risk assumption in the health care industry, including statutes and
regulations that subject any physician or physician network engaged in
risk-based contracting to applicable insurance laws and regulations, which may
include, among other things, laws and regulations providing for minimum capital
requirements and other safety and soundness requirements. The Company and
practices affiliated with the Company may not satisfy such insurance laws or
regulations. Full compliance with such laws and regulations could result in
substantial costs to the Company and the practices affiliated with the Company.
The inability to enter into capitated arrangements or the cost of complying with
certain applicable laws that would permit expansion of risk-based contracting
activities would have a material adverse effect on the Company.
Generally, there is no certainty that the Company and practices
affiliated with the Company will be able to establish or maintain satisfactory
relationships with managed care and other third party payors, many of which
already have existing provider structures in place and may not be able or
willing to change their provider networks. In addition, any significant loss of
revenue by the practices affiliated with the Company as a result of the
termination of third party payor contracts or otherwise would have a material
adverse effect on the Company.
Need for Additional Funds
The Company's acquisition and expansion strategy will require
substantial capital, and the Company anticipates that it will, in the future,
seek to raise additional funds through debt financing or the issuance of equity
or debt securities.
21
There can be no assurance that sufficient funds will be available on terms
acceptable to the Company, if at all. If equity securities are issued, either to
raise funds or in connection with future affiliations, dilution to the Company's
stockholders may result, and if additional funds are raised through the
incurrence of debt, the Company may become subject to restrictions on its
operation and finances. Such restrictions may have an adverse effect on, among
other things, the Company's ability to pursue its acquisition strategy. See
"Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
Competition
Competition for affiliation with additional musculoskeletal practices
is intense and may limit the availability of suitable practices with which the
Company may be able to affiliate. Several companies with established operating
histories and greater resources than the Company, including physician practice
management companies and some hospitals, clinics and HMOs, are pursuing
activities similar to those of the Company. There can be no assurance that the
Company will be able to compete effectively with such competitors, that
additional competitors will not enter the market or that such competition will
not make it more difficult and costly to acquire the assets of, and provide
management services to, musculoskeletal medical practices on terms beneficial to
the Company. The Company also believes that changes in governmental and private
reimbursement policies, among other factors, have resulted in increased
competition among providers of medical services to consumers. There can be no
assurance that the Company's Affiliated Practices will be able to compete
effectively in the markets they serve. See "Business -- Competition."
Dependence Upon Key Personnel
The Company is dependent upon the ability and experience of its
executive officers and key personnel for the management of the Company and the
implementation of its business strategy. The Company currently has employment
contracts with its ten executive officers. Because of the difficulty in finding
adequate replacements for such personnel, the loss of the services of any such
personnel or the Company's inability in the future to attract and retain
management and other key personnel could have a material adverse effect on the
Company.
Potential Liability and Insurance; Legal Proceedings
The provision of medical services entails an inherent risk of
professional malpractice and other similar claims. While the Affiliated
Practices maintain malpractice insurance, there can be no assurance that any
claim asserted against any of the Affiliated Practices or any other practice
that may affiliate with the Company in the future will be covered by, or will
not exceed the coverage limits, of applicable insurance. A successful
malpractice claim against any practice affiliated with the Company, even if
covered by insurance, could have a material adverse effect on such practice and,
as a result, on the Company.
The Company does not engage in the practice of medicine; however, the
Company could be implicated in such claims, and there can be no assurance that
claims, suits or complaints relating to services delivered by practices
affiliated with the Company (including claims with regard to services rendered
by a practice prior to its affiliation with the Company) will not be asserted
against the Company in the future. Although the Company has attempted to address
this risk by maintaining insurance, there can be no assurance that any claim
asserted against the Company for professional or other liability will be covered
by, or will not exceed the coverage limits of, such insurance. The Company's
medical professional liability insurance provides coverage of up to $1 million
per incident, with maximum coverage of $3 million per year. The Company's
general liability insurance provides coverage of up to $5 million per incident,
with maximum coverage of $5 million per year.
The availability and cost of professional liability insurance have been
affected by various factors, many of which are beyond the control of the
Company. There can be no assurance that the Company will be able to maintain
insurance in the future at a cost that is acceptable to the Company, or at all.
Any claim made against the Company not fully covered by insurance could have a
material adverse effect on the Company.
22
Risks Related to Purchase of Receivables
The Service Agreements provide that the Company will acquire each
Affiliated Practice's accounts receivable each month. The purchase price for
such accounts receivable equals the gross amounts of the accounts receivable
recorded each month, less adjustments for contractual allowances, allowances for
doubtful accounts and other potentially uncollectible amounts based on the
practice's historical collection rate, as determined by the Company. To the
extent that the Company's actual collections are less than the amounts paid for
the receivables, or if payment of receivables is not made on a timely basis, the
Company could be materially adversely affected. See "Business -- Contractual
Agreements with Affiliated Practices." The Company also bears the collection
risk with respect to outstanding receivables acquired in connection with an
affiliation.
Quarterly Results Fluctuation
The Company's quarterly operating results may fluctuate significantly
as the result of the timing of affiliations and as a result of timing of
musculoskeletal procedures. Such fluctuation could adversely affect the price of
the Company's Common Stock.
23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SPECIALTY CARE NETWORK, INC.
Date: July 7, 1997 By /s/ D. Paul Davis
-------------------------------------
D. Paul Davis
Vice President of Finance/Controller
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