1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended DECEMBER 31, 1997 --------------------------------------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------------- -------------------- Commission file number 02-26762 ------------------------------------------------- PEDIATRIX MEDICAL GROUP, INC. (Exchange name of registrant as specified in its charter) FLORIDA 65-0271219 ------- ---------- (State or other jurisdiction) (I.R.S. Employer of incorporation or organization) Identification No.) 1455 NORTH PARK DRIVE, FT. LAUDERDALE, FLORIDA 33326 (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) (954) 384-0175 Securities registered pursuant to Section 12(b) of the Act: Name of each Title of each class exchange on which registered ------------------- ---------------------------- COMMON STOCK NEW YORK STOCK EXCHANGE $.01 PAR VALUE PER SHARE Securities registered pursuant to Section 12(g) of the Act: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of shares of Common Stock held by non-affiliates of the registrant as of March 17, 1998, was approximately $373,624,525 based on a $41.38 closing sales price for the Common Stock on the New York Stock Exchange on such date. For purposes of this computation, all executive officers, directors and 5% beneficial owners of the common stock of the registrant have been deemed to be affiliates. Such determination should not be deemed to be an admission that such directors, officers or 5% beneficial owners are, in fact, affiliates of the registrant. The number of shares of Common Stock, $.01 par value, of the registrant outstanding as of March 17, 1998 were 15,175,087. DOCUMENTS INCORPORATED BY REFERENCE: Portions of the following documents have been incorporated by reference into the parts indicated: The registrant's definitive Proxy Statement to be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this report - Part III. ================================================================================ 2 INDEX TO ITEMS PART I............................................................................................................3 Item 1. Business.....................................................................................3 Item 2. Properties..................................................................................15 Item 3. Legal Proceedings...........................................................................15 Item 4. Submission of Matters to a Vote of Security Holders.........................................15 PART II..........................................................................................................15 Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters...................15 Item 6. Selected Financial Data.....................................................................17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................................................................18 Item 8. Financial Statements and Supplementary Data.................................................23 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..................................................................................43 PART III.........................................................................................................43 Item 10. Directors and Executive Officers of the Registrant..........................................43 Item 11. Executive Compensation......................................................................43 Item 12. Security Ownership of Certain Beneficial Owners and Management..............................43 Item 13. Certain Relationships and Related Transactions..............................................43 PART IV..........................................................................................................44 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................44 Schedules........................................................................................................45 Exhibits ........................................................................................................46 Signatures.......................................................................................................49 2 3 PART I ITEM 1. BUSINESS Pediatrix Medical Group, Inc. ("PMG") includes its subsidiaries and the professional associations and partnerships (the "PA Contractors") which are separate legal entities that contract with PMG to provide physician services in certain states and Puerto Rico. PMG, its subsidiaries and the PA Contractors are collectively referred to herein as the "Company" or "Pediatrix." GENERAL Pediatrix is the nation's leading provider of physician management services to hospital-based neonatal intensive care units ("NICUs"). NICUs provide medical care to newborn infants with low birth weight and other medical complications, and are staffed with specialized pediatric physicians, known as neonatologists. The Company also provides physician management services to (i) hospital-based pediatric intensive care units ("PICUs"), units which provide medical care to critically ill children and are staffed with specially-trained pediatricians, and (ii) pediatrics departments in hospitals. In addition to the above hospital based services, the Company began providing inpatient and outpatient perinatal services during 1997. Perinatology is a subspecialty of obstetrical medicine that focuses on the diagnostics, management and care of high-risk and/or complicated pregnancies. As of December 31, 1997, the Company provided services to over 100 hospital based units and one perinatology practice in 20 states and Puerto Rico and employed or contracted with approximately 260 physicians. The Company staffs and manages NICUs and PICUs in hospitals, providing the physicians, professional management and administrative support, including physician billing and reimbursement expertise and services. The Company's policy is to provide 24-hour coverage at its NICUs and PICUs with on-site or on-call physicians. As a result of this policy, physicians are available to provide continuous pediatric support to other areas of the hospital on an as-needed basis, particularly in the obstetrics, nursery and pediatrics departments, where immediate accessibility to specialized care is critical. Pediatrix established its leading position in physician management services to NICUs by developing a comprehensive care model and management and systems infrastructure that address the needs of patients, hospitals, payor groups and physicians. Pediatrix addresses the needs of (i) patients by providing continuous, comprehensive, professional quality care, (ii) hospitals by recruiting, credentialing, and retaining neonatologists and hiring related staff to operate NICUs in a cost-effective manner thereby relieving hospitals of the financial and administrative burdens of operating the NICUs, (iii) payor groups by providing cost-effective care to patients and (iv) physicians by providing administrative support, including physician billing and reimbursement expertise and services, to enable them to focus on providing care to patients, and by offering an opportunity for career advancement within Pediatrix. RECENT DEVELOPMENTS During 1997, the Company completed ten acquisitions, which added 28 NICUs. Additionally, three NICUs were added through the Company's internal marketing activities. The Company has developed regional networks in Denver, Phoenix, Southern California and Texas and intends to develop additional regional and state-wide networks. The Company believes these networks, augmented by ongoing marketing and acquisition efforts, will strengthen its position with managed care organizations and other third party payors. During the period of January 1 through March 25, 1998, the Company completed the acquisition of five neonatal and three perinatal practices. In addition, one NICU was added through internal marketing efforts. INDUSTRY OVERVIEW The evolving managed care environment has created substantial cost containment pressures for all constituents of the healthcare industry. The increasing use of fixed-payment systems that shift financial risk from payors to providers has forced hospitals, in particular, to be more cost-effective in all aspects of their operations. A 3 4 trend among hospitals is to utilize third party contract management companies to manage specialized functions in an effort to contain costs, improve utilization management, and reduce administrative burdens. Physician management organizations provide hospitals with professional management of staff, including recruiting, staffing and scheduling of physicians. Physicians are responding to cost containment pressures by joining group practices through which they have greater leverage to negotiate and contract with hospitals and managed care payors. Physician management organizations provide a physician group practice an alternative to self management that enables physicians to maintain their clinical autonomy while creating greater negotiating power with payors and hospitals, and providing administrative support to deal with the increasing complexity of billing and reimbursement. Physician group practices are becoming larger and more prevalent. The Company believes that as cost pressures continue to influence the medical industry, the trend of physicians joining group practices will continue. Although the Company continues to market its services to hospitals to obtain new contracts, the Company has shifted its strategy to growth through acquisitions as physicians become more receptive to being acquired. The Company believes that hospitals will continue to outsource certain units, such as NICUs, on a contract management basis. NICUs present significant operational challenges for hospitals, including complex billing procedures, highly variable admissions rates, and difficulties in recruiting and retaining qualified physicians. These operational challenges generally make it difficult for hospitals to operate these units profitably. Traditionally, hospitals have staffed their NICUs internally, through affiliations with small, local physician groups or with independent practitioners. These small practices typically lack the necessary expertise and support services in billing and reimbursement, recruiting and effective medical management to operate NICUs on a cost-effective basis. Hospitals are increasingly seeking to contract with physician management services organizations that have the capital resources, information and reimbursement systems and practice management expertise that NICUs require to accept and manage risk in the evolving managed care environment. Of the approximately four million babies born in the United States annually, approximately 10% to 15% require neonatal treatment. Demand for neonatal services is primarily due to premature births, and to infants having difficulty making the transition to extrauterine life. A majority of high-risk mothers whose births require neonatal treatment are not identified until the time of delivery, thus heightening the need for continuous coverage by neonatologists. Across the United States, NICUs are concentrated primarily among hospitals located in metropolitan areas with a higher volume of births. NICUs are important to hospitals since obstetrics generates one of the highest volumes of admissions and obstetricians generally prefer to perform deliveries at hospitals with NICUs. Hospitals must maintain cost-effective care and service in these units to enhance the hospital's desirability to the community, physicians and managed care payors. STRATEGY The Company's objective is to enhance its position as the nation's leading provider of physician management services to NICUs by adding new units and increasing same unit growth. The key elements of the Company's strategy are as follows: FOCUS ON NEONATOLOGY, PERINATOLOGY AND PEDIATRICS. Since its founding in 1979, the Company has focused primarily on neonatology and pediatrics. As a result of this focus, the Company believes it has (i) developed significant expertise in the complexities of billing and reimbursement for neonatology physician services and (ii) a competitive advantage in recruiting and retaining neonatologists seeking to join a group practice. The Company believes its continued focus will allow it to enhance its position as the nation's leading provider of physician management services to NICUs. In 1997, the Company began providing perinatal services in cooperation with one of its hospital customers. The Company is continuing to pursue the integration of perinatology and, in the future, will investigate obstetrics and other areas of pediatrics beyond neonatology. ACQUIRE NEONATAL AND PERINATAL PHYSICIAN GROUP PRACTICES. The Company intends to further increase the number of locations at which it provides physician management services by acquiring well-established neonatal and perinatal physician group practices. The Company believes that it will continue to benefit from 4 5 physicians joining larger practice groups in an effort to increase negotiating power with managed care organizations and eliminate administrative burdens, while maintaining clinical autonomy. The Company completed its first acquisition of a neonatology physician group practice in California in July 1995 and since has completed acquisitions of an additional 28 physician group practices. The Company is actively pursuing acquisitions of other neonatal and perinatal physician group practices. No assurance can be given that future acquisition candidates will be identified or that any future acquisitions will be consummated. See "Recent Developments" and "Factors to be Considered - Risks Relating to Acquisition Strategy." DEVELOP REGIONAL NETWORKS. The Company intends to develop regional and state-wide networks of NICUs in geographic areas with high concentrations of births. The Company operates regional networks in Colorado, Arizona, Southern California and Texas. The Company believes that the development of regional and state-wide networks will strengthen its position with third party payors, such as Medicaid and managed care organizations, since such networks will offer more choice to the patients of third party payors. INCREASE SAME UNIT GROWTH. The Company seeks to provide its services to hospitals where the Company can benefit from increased admissions and intends to increase revenues at existing units by providing support to areas of the hospital outside the NICU, particularly in the obstetrics, nursery and pediatrics departments, where immediate accessibility to specialized care is critical. These services generate incremental revenue to the Company, contribute to the Company's overall profitability, enhance the hospital's profitability, strengthen the Company's relationship with the hospital, and assist the hospital in attracting more admissions by enhancing the hospital's reputation in the community as a full-service critical care provider. ASSIST HOSPITALS TO CONTROL COSTS. The Company intends to continue assisting hospitals to control costs. The Company's comprehensive care model, which promotes early intervention by neonatologists in emergency situations, as well as the retention of qualified neonatologists, improves the overall cost effectiveness of care. The Company believes that its ability to assist hospitals to control costs will allow it to continue to be successful in adding new units at which the Company provides physician management services. ADDRESS CHALLENGES OF MANAGED CARE ENVIRONMENT. The Company intends to continue to develop new methods of doing business with managed care and third party payors, which will allow it to develop relationships among payors, hospitals and the Company. The Company is also prepared to enter into flexible arrangements with third party payors, including capitation arrangements. As the nation's leading provider of physician management services to NICUs, the Company believes that it is well-positioned to address the needs of managed care organizations and other third party payors which seek to contract with cost-effective, quality providers of medical services. PHYSICIAN MANAGEMENT SERVICES The Company provides physician management services to NICUs, providing (i) a medical director to manage the unit, (ii) recruiting, staffing and scheduling of physicians and certain other medical staff, (iii) neonatology and pediatric support to other hospital departments, (iv) pediatric subspecialty services and (v) billing and reimbursement expertise and services. These physician management services include: UNIT MANAGEMENT. The Company staffs each unit it manages with a medical director who reports to a Regional Medical Officer ("RMO") of the Company. The RMOs and all medical directors at these units are board certified or board eligible in neonatology, pediatrics, pediatric critical care or pediatric cardiology. In addition to providing medical care and physician management in the unit, the medical director is responsible for (i) the overall management of the unit, including quality of care, professional discipline, utilization review, physician recruitment, staffing and scheduling, (ii) serving as a liaison to the hospital administration, (iii) maintaining professional and public relations in the hospital and the community and (iv) monitoring the Company's financial performance within the unit. RECRUITING, STAFFING AND SCHEDULING. The Company is responsible for recruiting, staffing and scheduling the neonatologists, pediatricians and advanced registered nurse practitioners ("ARNPs") within the NICU. The Company's recruiting department maintains an extensive database of neonatologists and 5 6 pediatricians nationwide from which to draw for recruiting purposes. All candidates are pre-screened and their credentials, licensure and references are checked and verified by the Company. The RMOs and the medical directors play a key role in the recruiting and interviewing process before candidates are introduced to hospital administrators. The units managed by the Company are staffed with at least one neonatologist or pediatrician on site or available on call. All of these physicians are board certified or board eligible in neonatology, pediatrics, pediatric critical care or pediatric cardiology. The Company also employs or contracts with ARNPs, who assist medical directors and other physicians in operating the units. All ARNPs have either a certificate as a neonatal nurse practitioner or pediatric nurse practitioner or a masters degree in nursing, and have previous neonatal or pediatric experience. With respect to the physicians that are employed by or under contract with the Company, the Company assumes responsibility for salaries, benefits, bonuses, group health insurance and physician malpractice insurance. See "Business -- Contractual Relationships." SUPPORT TO OTHER HOSPITAL DEPARTMENTS. As part of the Company's comprehensive care model, physicians provide pediatric support services to other areas of hospitals, particularly in the obstetrics, nursery and pediatrics departments, where immediate accessibility to specialized care is critical. The Company believes this support (i) improves its relations with hospital staff and referring physicians, (ii) enhances the hospital's reputation in the community as a full-service critical care provider, (iii) increases admissions from referring obstetricians and pediatricians, (iv) integrates the physicians into a hospital's medical community, (v) generates incremental revenue which contributes to the Company's overall profitability and (vi) increases the likelihood of renewing and adding new hospital contracts. PEDIATRIC SUBSPECIALTIES. The Company has developed a pediatric cardiology program consisting of several pediatric cardiologists to complement and enhance its comprehensive care model. These physicians provide out-patient services in offices outside contracting hospitals and assist attending physicians at certain hospitals. The Company is exploring the possibility of expanding the existing program in pediatric cardiology in line with the Company's other strategic objectives in neonatology and pediatric intensive care. Expansion of the program will depend in part on the demand for such critical care services at hospitals and by payor groups. PERINATOLOGY. The Company has developed, in conjunction with a hospital customer, a perinatal practice to manage the care of high-risk and/or complicated pregnancies. The services provided include highly technical invasive and non-invasive diagnostic procedures, sophisticated medical consultations and hands-on patient management or co-management, including deliveries. Since a significant portion of the pregnancies managed by perinatologists result in admissions in the NICU, it is expected that the addition of these services will result in better patient care. The Company is continuing to pursue the development of perinatal programs in other locations where it currently provides services to NICUs. See "Business - Recent Developments." BILLING AND REIMBURSEMENT. The Company assumes responsibility for all aspects of the billing, reimbursement and collection process relating to physician services. Patients and/or third party payors receive a bill from the Company for physician services, and the hospital bills and collects separately for all other services. To address the increasingly complex and time-consuming processing for obtaining reimbursement for medical services, the Company has invested in both the technical and human resources necessary to create an efficient billing and reimbursement process, including specific claim forms and software systems. The Company begins this process by providing training to physicians that emphasizes a detailed review of and proper coding protocol for all procedures performed and services provided to achieve appropriate collection of revenues for physician services. The Company's billing and collection operations are conducted from its corporate headquarters in Ft. Lauderdale, Florida, as well as regional business offices in Orange, California and Dallas, Texas. MARKETING Historically, most of the Company's growth was generated internally through marketing efforts and referrals. Beginning in the latter part of 1995, the Company significantly increased its acquisition activities to capitalize on the opportunities created by the trend toward consolidation in the healthcare industry. The Company's marketing program to physician groups consists of (i) market research to identify established physician groups, (ii) telemarketing to identify and contact acquisition candidates, as well as hospitals with high demand for NICU 6 7 services, and (iii) other sales and business development personnel that conduct on-site visits along with senior management. The Company also advertises its services in hospital and healthcare trade journals, participates at hospital and physician trade conferences, and markets its services directly to hospital administrators and medical staff. In addition, the Company intends to focus on developing additional regional networks and state-wide networks to strengthen its position with managed care organizations and other third party payors. MANAGEMENT INFORMATION SYSTEMS The Company maintains several systems to support day-to-day operations, business development and ongoing clinical and business analysis, including (i) a Company-wide electronic mail system to assist intracompany communications and conferencing, (ii) an intranet site to facilitate clinical research and interaction among physicians regarding clinical matters on a real-time basis, (iii) electronic interchange with payors utilizing electronic benefits verification and claims submission, (iv) a database used by the business development and marketing departments in recruiting individual physicians and identifying potential neonatal and perinatal physician group acquisition candidates, which is updated through telemarketing activities, personal contacts, professional journals and mail solicitation, (v) electronic imaging to streamline accessibility to operational documents, and (vi) a clinical tracking system used by the physicians to assist in the creation of their respective paperwork and establish the basis for the consolidated clinical information database used to support the Company's education, research and quality assurance programs. Ongoing development will provide even greater streamlining of information from the clinical systems through the reimbursement process, allowing the overall process to be expedited further. The Company's management information system is an integral component of the billing and reimbursement process. The Company's system enables it to track numerous and diverse third party payor relationships and payment methods and provides for electronic interchange in support of insurance benefits verification and claims processing to payors accepting electronic submission. The Company's system was designed to meet its requirements by providing maximum flexibility as payor groups upgrade their payment and reimbursement systems. CONTRACTUAL RELATIONSHIPS HOSPITAL RELATIONSHIPS. Many of the Company's contracts with hospitals grant the Company the exclusive right and responsibility to manage the provision of physician management services to the NICUs. The contracts typically have terms of three to five years and renew automatically for additional terms of one to five years unless otherwise terminated by either party. The contracts typically provide that either party may terminate the agreement prior to the expiration of the initial term in the event of material breach by the other party and failure to cure after the notice and cure period has expired. The Company bills for the physicians' services on a fee-for-service basis separately from other charges billed by the hospital. Certain contracting hospitals that do not generate sufficient patient volume agree to pay the Company administrative fees to assure a minimum revenue level. Administrative fees include guaranteed payments to the Company, as well as fees paid to the Company by certain hospitals for administrative services performed by the Company's medical directors at such hospitals. Administrative fees accounted for 12%, 8% and 5% of the Company's net patient service revenue during 1995, 1996 and 1997, respectively. The hospital contracts typically require that the Company and the physicians performing services maintain minimum levels of professional and general liability insurance. The Company contracts for and pays the premiums for such insurance on behalf of the physicians. See "Business -- Professional Liability and Insurance." PAYOR RELATIONSHIPS. While virtually all of the Company's contracts with third party payors are discounted fee-for-service contracts, as of December 31, 1997, the Company had eight contracts that provide for capitated payments, with payors located in California, Arizona, Texas and Florida. The Company is prepared to enter into capitation arrangements with other third party payors. In the event the Company enters into relationships with third party payors with respect to regional and state-wide networks, such relationships may be on a capitated basis. See "Factors to be Considered - Impact of Payor Discounts and Capitation Arrangements." 7 8 PA CONTRACTOR RELATIONSHIPS. PMG has entered into management agreements ("PA Management Agreements") with PA Contractors in all states in which it operates, other than Florida. There is at least one PA Contractor in each state in which the Company operates. Each PA Contractor is owned by a physician licensed in the jurisdiction in which the PA Contractor operates, who is also an officer of the PA Contractor. Under the PA Management Agreements, the PA Contractors delegate to PMG the administrative, management and support functions (but not any functions constituting the practice of medicine) that the PA Contractors have agreed to provide to the hospital. In consideration of such services, each PA Contractor pays PMG a percentage of the PA Contractor's gross revenue (but in no event greater than the net profits of such PA Contractor), or a flat fee. PMG has the discretion to determine whether the fee shall be paid on a monthly, quarterly or annual basis. The management fee may be adjusted from time to time to reflect industry standards and the range of services provided by the PA Contractor. The agreements provide that the term of the arrangements are permanent, subject only to termination by PMG, and that the PA Contractor shall not terminate the agreement without PMG's prior written consent. Also, the agreements provide that PMG or its assigns has the right, but not the obligation, to purchase the stock of the PA Contractor. See Note 2 to the Consolidated Financial Statements and "Factors to be Considered - State Laws Regarding Prohibition of Corporate Practice of Medicine." PHYSICIAN RELATIONSHIPS. The Company contracts with the PA Contractors to provide the medical services required to fulfill its obligations to hospitals. The physician employment agreements typically have terms of three to five years and can be terminated by either party at any time upon 90 days prior written notice. The physicians generally receive a base salary plus a productivity bonus. The physician is required to hold a valid license to practice medicine in the appropriate jurisdiction in which the physician practices and to become a member of the medical staff, with appropriate privileges at the hospital. The Company is responsible for billing patients and third party payors for services rendered by the physician, and the Company has the exclusive right to establish the schedule of fees to be charged for such services. Substantially all of the physicians employed by PMG or the PA Contractors have agreed not to compete with PMG or the PA Contractor within a specified radius of any hospital for which the physician is rendering medical services for a period of one to two years after termination of employment. The Company contracts for and pays the premiums for professional liability insurance on behalf of the physicians. See "Business -- Professional Liability and Insurance." ACQUISITIONS. The Company structures acquisitions of physician practice groups as asset purchases, stock purchases and stock mergers. Generally, these structures provide for: (i) the assignment to the Company of the contracts between the physician practice group and the hospital at which the physician practice group provides medical services; (ii) physician "tail insurance" coverage under which the Company is an insured party to cover malpractice liabilities that may arise after the date of the acquisition which relate to events prior to the acquisition; and (iii) indemnification to the Company by the previous owners of the acquired entity. Generally, in acquisitions structured as asset purchases, the Company does not acquire the physician practice group's receivables or liabilities, including professional liability claims, arising from the physician practice group's activities prior to the date of the acquisition. Generally, in acquisitions structured as stock purchases or stock mergers, the physician practice group's receivables (net of any liabilities accruing prior to the acquisition and permitted indemnification claims) are assigned to the former owners of the physician practice group. GOVERNMENT REGULATION The Company's operations and relationships are subject to a variety of governmental and regulatory requirements relating to the conduct of its business. The Company is also subject to laws and regulations which relate to business corporations in general. The Company believes that it exercises care in an effort to structure its practices and arrangements with hospitals and physicians to comply with relevant federal and state law and believes that such arrangements and practices comply in all material respects with all applicable statutes and regulations. Approximately 23% and 22% of the Company's net patient service revenue in 1996 and 1997, respectively, was derived from payments made by government-sponsored healthcare programs (principally Medicaid). These programs are subject to substantial regulation by the federal and state governments. Any change in reimbursement regulations, policies, practices, interpretations or statutes that places material limitations on reimbursement amounts or practices could adversely affect the operations of the Company. Medicaid and other government reimbursement programs are increasingly shifting to managed care, which could result in reduced 8 9 payments to the Company for Medicaid patients. In addition, funds received under these programs are subject to audit with respect to the proper billing for physician services and, accordingly, retroactive adjustments of revenue from these programs may occur. See "Factors to be Considered -- Reliance upon Government Programs; Possible Reduction in Reimbursement." The Company is also subject to (i) certain provisions of the Social Security Act, commonly referred to as the "Anti-kickback Statute," which prohibits entities, such as the Company, from offering, paying, soliciting, or receiving any form of remuneration in return for the referral of Medicare or state health program patients or patient care opportunities, or in return for the recommendation, arrangement, purchase, lease, or order of items or services that are covered by Medicare or state health programs, (ii) prohibitions against physician referrals, commonly known as "Stark II," which prohibit, subject to certain exemptions, a physician or a member of his immediate family from referring Medicare or Medicaid patients to an entity providing "designated health services" (which include inpatient and outpatient hospital services) in which the physician has an ownership or investment interest, or with which the physician has entered into a compensation arrangement including the physician's own group practice, (iii) state and federal civil and criminal statutes imposing substantial penalties, including civil and criminal fines and imprisonment, on healthcare providers which fraudulently or wrongfully bill governmental or other third party payors for healthcare services and (iv) state laws similar to the Anti-Kickback statute and Stark II which, in many cases, apply to privately paid or insured services as well as services covered under governmentally sponsored health care programs. Although the Company believes that it is not in violation of these provisions, there can be no assurance that the Company's current or future practices will not be found to be in violation of these provisions, and any such finding could have a material adverse effect on the Company. See "Factors to be Considered -- Risk of Applicability of Anti-Kickback and Self-Referral Laws." In addition, business corporations such as PMG are generally not permitted under state law to practice medicine, exercise control over the medical judgments or decisions of physicians, or engage in certain practices such as fee-splitting with physicians. In states where PMG is not permitted to practice medicine, the Company performs only nonmedical administrative services, does not represent to the public or its clients that it offers medical services and does not exercise influence or control over the practice of medicine by the PA Contractors or the physicians employed by the PA Contractors. Accordingly, the Company believes it is not in violation of applicable state laws relating to the practice of medicine. In most states, PMG contracts with the PA Contractors (which are owned by a licensed physician employed by the respective PA Contractor), which in turn employ or contract with physicians to provide necessary physician services. There can be no assurance that regulatory authorities or other parties will not assert that PMG is engaged in the corporate practice of medicine or that the percentage fee arrangements between PMG and the PA Contractors constitute fee-splitting or the corporate practice of medicine. If such a claim were successfully asserted in any jurisdiction, PMG could be subject to civil and criminal penalties under such jurisdiction's laws and could be required to restructure its contractual arrangements, which could have a material adverse effect on the Company's financial condition and results of operations. See "Factors to be Considered -- State Laws Regarding Prohibition of Corporate Practice of Medicine." In addition to current regulation, the public and state and federal governments have recently focused significant attention on reforming the healthcare system in the United States. Although the Company cannot predict whether these or other reductions in the Medicare or Medicaid programs will be adopted, the adoption of such proposals could have a material adverse effect on the Company's business. Concern about such proposals has been reflected in volatility of the stock prices of companies in healthcare and related industries. See "Factors to be Considered -- Healthcare Regulatory Environment Could Increase Restrictions on the Company." PROFESSIONAL LIABILITY AND INSURANCE The Company's business entails an inherent risk of claims of physician professional liability. The Company maintains professional liability insurance and general liability insurance on a claims-made basis in accordance with standard industry practice. The Company believes that its coverage is appropriate based upon claims experience and the nature and risks of its business. There can be no assurance that a pending or future claim or claims will not be successful or if successful will not exceed the limits of available insurance coverage or that such coverage will continue to be available at acceptable costs and on favorable terms. See "Factors to be Considered -- Professional Liability and Insurance" and "Legal Proceedings." 9 10 The physicians that are employed by or under contract with the Company are required to obtain professional liability insurance coverage, and the Company contracts for and pays the premiums with respect to such insurance for the physicians. The current professional liability insurance policy expires May 1, 1998 and the Company expects to be able to renew such policy upon expiration. COMPETITION The healthcare industry is highly competitive and has been subject to continual changes in the method in which healthcare services are provided and the manner in which healthcare providers are selected and compensated. The Company believes that private and public reforms in the healthcare industry emphasizing cost containment and accountability will result in an increasing shift of NICU and related pediatric care from highly fragmented, individual or small practice neonatology providers to physician management companies. Companies in other healthcare industry segments, such as managers of other hospital-based specialties or large physician group practices, some of which have financial and other resources greater than those of the Company, may become competitors in providing management of neonatal and pediatric services to hospitals. See "Factors to be Considered -- Competition." SERVICE MARKS The Company has registered the service mark "Pediatrix Medical Group" and its design with the United States Patent and Trademark Office, and has applied for registration of a baby design logo. The United States Patent and Trademark Office has issued a Notice of Allowance and registration should follow in due course. EMPLOYEES AND PROFESSIONALS UNDER CONTRACT In addition to the approximately 260 physicians employed or under contract with the Company as of December 31, 1997, Pediatrix employed or contracted with approximately 60 other clinical professionals and 310 other full-time and part-time employees. The Company's employees are not subject to any collective bargaining agreements. FACTORS TO BE CONSIDERED The parts of this Annual Report on Form 10-K titled "Item 1. Business," "Item 3. Legal Proceedings" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" contain certain forward-looking statements which involve risks and uncertainties. In addition, officers of the Company may from time to time make certain forward-looking statements which also involve risks and uncertainties. Set forth below is a discussion of certain factors that could cause the Company's actual results to differ materially from the results projected in such forward-looking statements. In addition, to the other information contained in this Annual Report on Form 10-K or incorporated by reference herein, such factors should be considered when evaluating the Company and its business. HEALTHCARE REGULATORY ENVIRONMENT COULD INCREASE RESTRICTIONS ON THE COMPANY. The healthcare industry and physicians' medical practices are highly regulated. Neonatal and other healthcare services that the Company offers and proposes to offer are subject to extensive federal and state laws and regulations governing state matters such as licensure and certification of facilities and personnel, conduct of operations, audit and retroactive reimbursement policies, adjustment of prior government billings and prohibitions on payments for the referral of business and self referrals. Failure to comply with these laws, or a determination that in the past the Company has failed to comply with these laws, could have a material adverse effect on the Company's financial condition and results of operations. There can be no assurance that the healthcare regulatory environment will not change so as to restrict the Company's existing operations or limit the expansion of its business. Changes in government regulation could also impose new requirements, involving compliance costs which cannot be recovered through price increases. Finally, under the Health Insurance Portability and Accountability Act of 1996, Congress expanded the powers of and increased funding to the Office of Inspector General of the Department of Health and Human Services to investigate violations of healthcare laws. See "Business -- Government Regulations." 10 11 RELIANCE UPON GOVERNMENT PROGRAMS; POSSIBLE REDUCTION IN REIMBURSEMENT. A significant portion of the Company's net patient service revenue is derived from payments made by government-sponsored healthcare programs (principally Medicaid). Increasing budgetary pressures may lead to reimbursement reductions or limits, reductions in these programs or elimination of coverage for certain individuals or treatments under these programs. Federal legislation could result in a reduction of Medicaid funding or an increase in state discretionary funding through block grants, or a combination thereof. State Medicaid waiver requests if granted by the federal government could increase discretion, or reduce coverage of or funding for certain individuals or treatments under the Medicaid program, in the absence of new federal legislation. Increased state discretion in Medicaid, coupled with the fact that Medicaid expenditures compromised a substantial and growing share of state budgets, could lead to significant reductions in reimbursement. In addition, these programs generally reimburse on a fee schedule basis, rather than a charge-related basis. Therefore, the Company generally cannot increase its revenues by increasing the amount it charges for services provided. To the extent the Company's costs increase, the Company may not be able to recover such cost increases from government reimbursement programs. In various states, Medicaid managed care is encouraged and may become mandated. In such systems, health maintenance organizations ("HMO's") bargain for reimbursement with competing providers and contract with the state to provide benefits to Medicaid enrollees. Such systems are intended and expected to reduce Medicaid reimbursement of providers. Legislation enacted in states could result in reduced payments to the Company for Medicaid patients. Additionally, Proposition 187, which was adopted by referendum in California, but has been enjoined by a California court, may limit the access by illegal aliens to Medicaid funds in California. In the event similar legislation is passed in other states with large illegal alien populations, such as Arizona and Florida, the Company's ability to collect for medical services rendered to such patients could be adversely affected. Changes in government-sponsored healthcare programs which result in the Company being unable to recover cost increases through price increases or otherwise could have a material adverse effect on the Company's financial condition and results of operations. Because of cost containment measures and market changes in non-governmental insurance plans, the Company may not be able to shift cost increases to, or recover them from, non-governmental payors. Also, state and federal statutes impose substantial penalties, including civil and criminal fines and imprisonment, on healthcare providers that fraudulently or wrongfully bill governmental or other third party payors for healthcare services. The federal law prohibiting false billings allows a private person to bring a civil action in the name of the United States government for violations of its provisions. The Company believes it is in material compliance with such laws, but there can be no assurances that the Company's activities will not be challenged or scrutinized by governmental authorities. Noncompliance with such regulations may adversely affect the operations of the Company and subject it to penalties and additional costs. In addition, funds received under government programs are subject to audit with respect to the proper billing for physician services and, accordingly, retroactive adjustments of revenue from these programs may occur. See "Business--Government Regulation." STATE LAWS REGARDING PROHIBITION OF CORPORATE PRACTICE OF MEDICINE. Business corporations, such as PMG, are generally not permitted under state law to practice medicine, exercise control over the medical judgments or decisions of physicians or engage in certain practices, such as fee-splitting with physicians. In the states in which the Company operates, other than Florida, there exist potential judicial or governmental interpretations which may extend the scope of the corporate practice of medicine and/or medical practices acts principles. For such reasons, or for business reasons, PMG contracts with the PA Contractors (which are owned by a licensed physician in the state) in such states, which in turn employ or contract with physicians to provide necessary physician management services. There can be no assurance that the regulatory authorities or other parties will not assert that PMG is engaged in the corporate practice of medicine or that the percentage fee arrangements between PMG and the PA Contractors constitute fee-splitting or the corporate practice of medicine. For example, an order by the Florida Board of Medicine, which has been stayed pending its appeal to the Florida courts, concludes that percentage-based management arrangements violate applicable fee-splitting statutes. If such order was upheld and adopted in other jurisdictions, or similar claim was successfully asserted in any jurisdiction, PMG could be subject to civil and criminal penalties under such jurisdiction's laws and could be required to restructure its contractual arrangements. Such results or the inability to successfully restructure contractual arrangements could have a material adverse effect on the Company's financial condition and results of operations. In states where PMG is not permitted to practice medicine, PMG performs only non-medical administrative services, does not represent to the public or its clients that it offers medical services and does not exercise influence or control over the practice of medicine by the physicians employed by the PA Contractors. Accordingly, the Company believes it is not in violation of applicable state laws in relation to the corporate practice of medicine. See "Business-Contractual Relationships." 11 12 RISK OF APPLICABILITY OF ANTI-KICKBACK AND SELF-REFERRAL LAWS. Federal anti-kickback laws and regulations prohibit any knowing and willful offer, payment, solicitation, or receipt of any form of remuneration, either directly or indirectly, in return for, or to induce (i) referral of an individual for a service for which payment may be made by Medicaid or another government-sponsored healthcare program or (ii) purchasing, leasing, ordering or arranging for, or recommending the purchase, lease or order of, any service or item for which payment may be made by a government sponsored healthcare program. Violations of anti-kickback rules are punishable by monetary fines, civil and criminal penalties and exclusion from participation in Medicare and Medicaid programs. Effective January 1, 1995, federal physician self-referral laws became applicable to inpatient and outpatient hospital services. Subject to certain exceptions, these laws, such as "Stark I" and "Stark II," prohibit Medicare or Medicaid payments for services furnished by a physician who has a financial relationship with the entity through ownership, investment, or compensation agreement. Possible sanctions for violation of these laws include civil monetary penalties, exclusion from Medicare and Medicaid programs and forfeiture of amounts collected in violation of such prohibitions. Certain states in which the Company does business have similar anti-kickback, anti-fee-splitting and self-referral laws, imposing substantial penalties for violations. In many cases, such state laws apply to privately insured or paid services as well as services covered under governmentally sponsored plans. The Company's relationships, including fee payments, among PA Contractors, hospital clients and physicians have not been examined by federal or state authorities under these laws and regulations. Although the Company believes it is in compliance with these laws and regulations, there can be no assurance that federal or state regulatory authorities will not challenge the Company's current or future activities under these laws. See "Business-Strategy" and "Business-Government Regulation." RISKS RELATING TO ACQUISITION STRATEGY. The Company has expanded and intends to continue to expand its geographic and market penetration primarily through acquisitions of physician group practices. In implementing this acquisition strategy, the Company will compete with other potential acquirers, some of which may have greater financial or operational resources than the Company. Competition for acquisitions may intensify due to the ongoing consolidation in the healthcare industry, which may increase the costs of capitalizing on such opportunities. While the Company has recently completed several acquisitions, there can be no assurance that future acquisition candidates will be identified or that any future acquisition will be consummated or, if consummated, that any acquisition, including the recent acquisitions, will be integrated successfully into the Company's operations or that the Company will be successful in achieving its objectives. The recent acquisitions also involve numerous short and long term risks, including diversion of management's attention, failure to retain key personnel and amortization of acquired intangible assets. The Company may also incur one-time acquisition expenses in connection with acquisitions. Consummation of acquisitions could result in the incurrence or assumption by the Company of additional indebtedness and the issuance of additional equity. The issuance of shares of common stock for an acquisition may result in dilution to shareholders. Also, as the Company enters into new geographic markets, the Company will be required to comply with laws and regulations of states that differ from those in which the Company's operations are currently conducted. There can be no assurance that the Company will be able to effectively establish a presence in these new markets. While many of the expenses arising from the Company's efforts in these areas may have a negative effect on operating results until such time, if at all, as these expenses are offset by increased revenues, there can be no assurance that the Company will be able to implement its acquisition strategy, or that this strategy will be successful. See "Business-Strategy," "Business-Marketing" and "Business-Government Regulation." GROWTH STRATEGY; RAPID GROWTH. Since the Initial Public Offering ("IPO") the Company has experienced rapid growth in its business and number of employees. Continued rapid growth may impair the Company's ability to efficiently provide its physician management services and to adequately manage its employees. While the Company is taking steps to manage rapid growth, future results of operations could be materially adversely affected if it is unable to do so effectively. QUARTERLY FLUCTUATIONS IN OPERATING RESULTS; POTENTIAL VOLATILITY. The Company has historically experienced and expects to continue to experience quarterly fluctuations in net patient service revenue and associated net income due to unit specific volume and cost fluctuations. The Company has a high level of fixed operating costs, including physician costs, and, as a result, is highly dependent on the volume of births and capacity utilization of NICUs and PICUs to sustain profitability. Results of operations for any quarter are not necessarily 12 13 indicative of results of operations for any future period or full year. As a result, there can be no assurance that the results of operations will not fluctuate significantly from period to period. There has been significant volatility in the market price of securities of healthcare companies that often has been unrelated to the operating performance of such companies. The Company believes that certain factors, such as legislative and regulatory developments, quarterly fluctuations in the actual or anticipated results of operations of the Company, lower revenues or earnings in the financial results of the Company than those anticipated by securities analysts, the overall economy and the financial markets, could cause the price of Common Stock to fluctuate substantially. IMPACT OF PAYOR DISCOUNTS AND CAPITATION ARRANGEMENTS. The evolving managed care environment has created substantial cost containment pressures for the healthcare industry. The Company's business could be adversely affected by reductions in reimbursement amounts or rates, changes in services covered and similar measures which may be implemented by government sponsored healthcare programs or by other third party payors. The Company contracts with payors and managed care organizations traditionally have been fee-for-service arrangements. At December 31, 1997, the Company had eight shared-risk capitated arrangements with payors in California, Arizona, Texas and Florida. These arrangements and many future arrangements may adversely affect the Company's financial condition and results of operations if the Company is unable to limit the risks associated with such arrangements. See "Business-Contractual Relationships," "Business-Government Regulation" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." PROFESSIONAL LIABILITY AND INSURANCE. The Company's business entails an inherent risk of claims of physician professional liability. The Company periodically becomes involved as a defendant in medical malpractice lawsuits, some of which are currently ongoing, and is subject to the attendant risk of substantial damage awards. See "Legal Proceedings." The Company's contracts with hospitals generally require the Company to indemnify certain parties for losses resulting from the negligence of physicians who are managed by or affiliated with the Company. While the Company believes it has adequate professional liability insurance coverage, there can be no assurance that a pending or future claim or claims will not be successful or if successful, will not exceed the limits of available insurance coverage or that such coverage will continue to be available at acceptable costs and on favorable terms. See "Business-Professional Liability and Insurance." COLLECTION AND REIMBURSEMENT RISK. The Company assumes the financial risk related to collection, including the potential uncollectibility of accounts and delays attendant to reimbursement by third party payors, such as government programs, private insurance plans and managed care plans. Failure to manage adequately the collection risks and working capital demands could have a material adverse effect on the Company's financial condition and results of operations. See "Business-Contractual Relationships" and "Business-Government Regulation." CANCELLATION OR NON-RENEWAL OF CONTRACTS. The Company's net patient service revenue is derived primarily from fee-for-service billings for patient care provided by its physicians and from administrative fees. Certain contracting hospitals that do not generate sufficient patient volume pay the Company administrative fees to assure the Company a minimum revenue level. If, at the time of renewal of the contracts with the hospitals currently paying administrative fees to the Company, such hospitals continue to generate insufficient patient volume but elect not to pay administrative fees to assure the Company a minimum revenue level, then the Company could either choose not to renew the contract or renew the contract with lower gross profit margins at such hospitals. The Company's contracts provide for terms of three to five years and are generally terminable by the hospital upon 90 days written notice. While the Company has in most cases been able to negotiate renewal of its contracts in the past, no assurance can be given that the Company's contracts with hospitals will not be canceled or will be renewed in the future or that the administrative fees will be continued. To the extent that the Company's contracts with hospitals are canceled or are not renewed or replaced with other contracts with at least as favorable terms, the Company's financial position and results of operations could be adversely affected. See "Business-Contractual Relationships." COMPETITION. The healthcare industry is highly competitive and subject to continual changes in the method in which services are provided and the manner in which healthcare providers are selected and compensated. The Company believes that private and public reforms in the healthcare industry emphasizing cost containment and accountability will result in an increasing shift of NICU and related pediatric care from highly fragmented, 13 14 individual or small practice neonatology providers to physician practice management companies. Companies in other healthcare industry segments, such as managers of other hospital-based specialties or currently expanding large physician group practices, some of which have financial and other resources greater than those of the Company, may become competitors in providing management of neonatal and pediatric services to hospitals. Increased competition could have a material adverse effect on the Company's financial condition and results of operations. See "Business-Competition." DEPENDENCE ON QUALIFIED NEONATALOGISTS. The Company's business strategy is dependent upon its ability to recruit and retain qualified neonatologists. The Company has been able to compete with many types of healthcare providers, as well as teaching, research, and government institutions, for the services of such physicians. No assurance can be given that the Company will be able to continue to recruit and retain a sufficient number of qualified neonatologists who provide services in markets served by the Company on terms similar to its current arrangements. The inability to successfully recruit and retain physicians could adversely affect the Company's ability to service existing or new units at hospitals, or expand its business. DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a significant extent on the continued contributions of its key management, business development, sales and marketing personnel, including one of the Company's principal shareholders, President, Chief Executive Officer and co-founder, Dr. Roger Medel, for management of the Company and successful implementation of its growth strategy. The loss of Dr. Medel or other key personnel could have a material adverse effect on the Company's financial condition, results of operations and plans for future development. DEPENDENCE ON PA CONTRACTORS. The Company has a management agreement with a PA Contractor in each state in which it operates except Florida. The agreements provide that the terms of the arrangements are permanent, subject only to termination by PMG and that the PA Contractor shall not terminate the agreement without PMG's prior written consent. Any disruption of the Company's or the PA Contractors' relationships with contracting hospitals (including the determination that the PA Contractors arrangements with PMG constitute the corporate practice of medicine) or any other event adverse to the PA Contractors could have a material adverse effect on the Company's financial condition and results of operations. See "Business-Government Regulation" and "Business-Contractual Relationships." ANTI-TAKEOVER PROVISIONS; ISSUANCE OF PREFERRED STOCK. The Company's Articles of Incorporation and Bylaws contain provisions that could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire control of, the Company. These provisions establish certain advance notice procedures for nomination of candidates for election as directors and for shareholder proposals to be considered at shareholders' meetings and provide that only the Board of Directors may call special meetings of the shareholders. In addition, the Company's Articles of Incorporation authorize the Board of Directors to issue preferred stock ("Preferred Stock") without shareholder approval and upon such terms as the Board of Directors may determine. While no shares of Preferred Stock are outstanding and the Company has no present plans to issue any shares of Preferred Stock, the rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of any holders of Preferred Stock that may be issued in the future. YEAR 2000. The Company has conducted a comprehensive review of its computer systems to identify the systems that could be affected by the transition to the year 2000 and has developed an implementation plan to resolve any related issues. The Year 2000 problem is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations. The Company presently believes that, by modifying and upgrading its existing software the transition to the year 2000 will not pose significant operational problems. The Company has not had any discussion with its payors to determine the status of their systems. However, if the Company or its vendors or payors do not make the modifications and conversions required on a timely basis it could have a material adverse effect on the Company's financial condition and results of operations. 14 15 ITEM 2. PROPERTIES The Company owns its executive offices located in Ft. Lauderdale, Florida (approximately 30,000 square feet) including a new building that was completed in the third quarter of 1996. The Company also leases space in other facilities in various states for its business offices, pediatric cardiology offices, storage space, and temporary housing of medical staff, with aggregate annual rents of approximately $395,000. To facilitate its acquisition and business integration programs, in September 1996, the Company entered into a contract to lease an aircraft. See Note 10 to the Consolidated Financial Statements. ITEM 3. LEGAL PROCEEDINGS During the ordinary course of business, the Company has become a party to pending and threatened legal actions and proceedings, most of which involve claims of medical malpractice and are generally covered by insurance. The Company believes, based upon the investigations conducted by the Company to date, that the outcome of such legal actions and proceedings, individually or in the aggregate, will not have a material adverse effect on the Company's financial condition, results of operations or liquidity, notwithstanding any possible insurance recovery. If liability results from the medical malpractice claims, there can be no assurance that the Company's medical malpractice insurance coverage will be adequate to cover liabilities arising out of such proceedings. See "Factors to be Considered--Professional Liability and Insurance." The Company is currently under examination by the Internal Revenue Service (the "IRS") for the tax years ended December 31, 1992, 1993, and 1994. The IRS has challenged certain deductions that, if ultimately disallowed, would result in additional taxes of approximately $4.5 million, plus interest. The Company and its tax advisors believe that the ultimate resolution of the examination will not have a material effect on the Company's consolidated financial position or results of operations and cash flows. In 1997, the Company was notified by a hospital customer of a dispute regarding the interpretation of the customer's contract with the Company. In December 1997, this dispute was resolved amicably and the Company continues to provide services to this hospital customer. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fiscal quarter ended December 31, 1997. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock commenced trading on the NASDAQ National Market (the "NASDAQ") under the symbol "PEDX" on September 20, 1995. The Company's stock began trading on the New York Stock Exchange (the "NYSE") under the symbol "PDX" on September 11, 1996 and ceased trading on the NASDAQ on September 10, 1996. The following table sets forth, for the periods indicated, the high and low sales prices for the Common Stock as reported on the NASDAQ and the NYSE. HIGH LOW ---- --- 1996 ---- First Quarter 40 3/4 22 1/2 Second Quarter 64 3/4 35 1/4 Third Quarter 53 31 1/4 Fourth Quarter 50 3/8 32 1997 ---- First Quarter 44 1/2 30 1/2 Second Quarter 46 28 5/8 Third Quarter 50 7/16 39 7/8 Fourth Quarter 46 15/16 38 5/8 As of March 17, 1998 there were approximately 112 holders of record of the 15,175,087 outstanding shares of Common Stock. The closing sales price for the Common Stock on March 17, 1998 was $41.38. The Company did not declare or pay in 1995, 1996 or 1997, nor does it currently intend to declare or pay in the future, any dividends on its Common Stock, but intends to retain all earnings for the operation and expansion 15 16 of its business. The payment of any future dividends will be at the discretion of the Board of Directors and will depend upon, among other things, future earnings, results of operations, capital requirements, the general financial condition of the Company, general business conditions and contractual restrictions on payment of dividends, if any, as well as such other factors as the Board of Directors may deem relevant. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." 16 17 ITEM 6. SELECTED FINANCIAL DATA (in thousands, except per share and other operating data) The selected consolidated financial data set forth as of and for each of the five years in the period ended December 31, 1997, have been derived from the Consolidated Financial Statements, which statements have been audited by Coopers & Lybrand L.L.P., independent accountants. The following data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the Consolidated Financial Statements and the notes thereto included elsewhere herein. ------------------------------------------------------------ YEARS ENDED DECEMBER 31, ------------------------------------------------------------ 1993 1994 1995 1996 1997 -------- --------- --------- --------- --------- CONSOLIDATED INCOME STATEMENT DATA: Net patient service revenue $ 23,570 $ 32,779 $ 43,860 $ 80,833 $ 128,850 Operating expenses: Salaries and benefits 14,852 20,723 29,545 52,732 81,486 Supplies and other operating expenses 2,230 2,774 3,451 6,262 9,765 Depreciation and amortization 95 244 363 1,770 4,522 --------- --------- --------- --------- --------- Total operating expenses 17,177 23,741 33,359 60,764 95,773 --------- --------- --------- --------- --------- Income from operations 6,393 9,038 10,501 20,069 33,077 Investment income 45 208 804 2,096 2,102 Interest expense (105) (90) (117) (192) (324) Other expense, net (17) -- -- -- -- --------- --------- --------- --------- --------- Income before income taxes 6,316 9,156 11,188 21,973 34,855 Income tax provision 2,166 3,749 4,475 8,853 13,942 --------- --------- --------- --------- --------- Net income (1) $ 4,150 $ 5,407 $ 6,713 $ 13,120 $ 20,913 ========= ========= ========= ========= ========= PER SHARE DATA: Net income per common share Basic $ 0.66 $ 0.70 $ 0.95 $ 1.39 ========= ========= ========= ========= Diluted $ 0.49 $ 0.57 $ 0.90 $ 1.33 ========= ========= ========= ========= Weighted average shares outstanding Basic 6,272 8,092 13,806 15,021 ========= ========= ========= ========= Diluted 10,945 11,855 14,535 15,743 ========= ========= ========= ========= OTHER OPERATING DATA: Number of physicians at end of period 52 75 114 195 260 Number of births 32,532 39,541 59,186 132,796 200,616 NICU admissions 4,777 5,823 7,611 14,250 21,203 NICU patient days 59,024 64,615 87,672 185,702 325,199 CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents $ 2,469 $ 7,384 $ 18,499 $ 18,435 $ 18,562 Working capital 8,052 13,772 53,448 81,187 53,908 Total assets 14,239 20,295 69,881 159,026 196,812 Total liabilities 3,762 4,203 7,071 22,705 33,103 Long-term debt, including current maturities 965 879 815 2,950 2,750 Convertible preferred stock(2) 14,401 15,697 -- -- -- Stockholders' equity (deficit) (3,924) 395 62,810 136,321 163,709 - ---------------- (1) The net income amounts do not include accrued and unpaid dividends with respect to the Convertible Preferred Stock. See footnote 2 below. (2) Immediately prior to the consummation of the Company's IPO in September 1995, the Convertible Preferred Stock was converted into 4,571,063 shares of Common Stock and unpaid dividends of approximately $3.7 million were forgiven pursuant to the terms of the Series A Preferred Stock Purchase Agreement, dated as of October 26, 1992. Upon conversion, such amounts were credited to the common stock and additional paid-in capital accounts. 17 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Pediatrix is the nation's leading provider of physician management services to hospital-based NICUs. The Company also provides physician management services to hospital-based PICUs and pediatric departments in hospitals. Pediatrix was founded in 1979 by Drs. Roger Medel and Gregory Melnick. Since obtaining its first hospital contract in 1980, the Company has grown by increasing revenues at existing units ("same unit growth") and by adding new units. In July 1995, the Company completed its first acquisition of a neonatal physician group practice. Since its initial public offering in September 1995, the Company has enhanced its management infrastructure, thereby strengthening its ability to identify acquisition candidates, consummate transactions and integrate acquired physician group practices into the Company's operations. During 1997, the Company completed ten acquisitions, which added 28 NICUs. Additionally, three NICUs were added through the Company's internal marketing activities. The Company has developed networks in Colorado, Arizona, Southern California and Texas and intends to develop additional regional and state-wide networks. The Company believes these networks, augmented by ongoing marketing and acquisition efforts, will strengthen its position with third party payors, such as Medicaid and managed care organizations. The Company bills payors for services provided by physicians based upon rates for the specific services provided. The rates are substantially the same for all patients in a particular geographic area regardless of the party responsible for paying the bill. The Company determines its net patient service revenue based upon the difference between the gross fees for services and the ultimate collections from payors which differ from the gross fees due to (i) Medicaid reimbursements at government-established rates, (ii) managed care payments at contracted rates, (iii) various reimbursement plans and negotiated reimbursements from other third parties and (iv) discounted and uncollectible accounts of private pay patients. The Company seeks to increase revenue at existing units in hospitals by providing support to areas of the hospital outside the NICU and PICU, particularly in the obstetrics, nursery and pediatric departments, where immediate accessibility to specialized care is critical. The following table indicates the point at which services originate, expressed as a percentage of net patient service revenue, exclusive of administrative fees, for the periods indicated. YEARS ENDED DECEMBER 31, -------------------------------------- 1995 1996 1997 ----------- ----------- ----------- NICU 74.7% 81.4% 85.4% PICU and PEDS 6.0 3.4 2.2 Other(1) 19.3 15.2 12.4 --------- --------- -------- 100.0% 100.0% 100.0% ========= ========= ======== - ----------------- (1) Represents principally the percentage of net patient service revenue generated by physicians providing support to areas of hospitals outside the NICU and PICU. PAYOR MIX The Company's payor mix is comprised of government (principally Medicaid), managed care, other third parties and private pay patients. The Company benefits when more patients are covered by Medicaid, despite Medicaid's lower reimbursement rates as compared with other payors, because typically these patients would not otherwise be able to pay for services due to lack of insurance coverage. In addition, the Company benefits from the fact that most of the medical services provided at the NICU or PICU are classified as emergency services, a category typically classified as a covered service by managed care payors. A significant increase in the managed 18 19 care or capitated components of the Company's payor mix, however, could result in reduced reimbursement rates and, in the absence of increased patient volume, could have a material adverse effect on the Company's financial condition and results of operations. The following is a summary of the Company's payor mix, expressed as a percentage of net patient service revenue, exclusive of administrative fees, for the periods indicated (the amounts reported for 1995 and 1996 have been restated to reflect revised classifications in certain payor relationships). YEARS ENDED DECEMBER 31, ---------------------------------------------- 1995 1996 1997 ----------------- ------------ ------------ Government 24% 23% 22% Managed Care 24 34 31 Other third parties 50 42 44 Private pay 2 1 3 ----------- --------- -------- 100% 100% 100% =========== ========= ======== The payor mix shown above is not necessarily representative of the amount of services provided to patients covered under these plans. For example, services provided to patients covered under government programs represented approximately 44% of the Company's total gross patient service revenue during 1997. RESULTS OF OPERATIONS The following discussion provides an analysis of the Company's results of operations and should be read in conjunction with the Consolidated Financial Statements and related notes thereto appearing elsewhere in this Annual Report. The operating results for the periods presented were not significantly affected by inflation. The following table sets forth, for the periods indicated, certain information related to the Company's operations expressed as a percentage of the Company's net patient service revenue (patient billings net of contractual adjustments and uncollectibles, and including administrative fees): YEARS ENDED DECEMBER 31, -------------------------------------------------------- 1995 1996 1997 ----------------- ----------------- ----------------- Net patient service revenue 100.0% 100.0% 100.0% Operating expenses: Salaries and benefits 67.4 65.2 63.2 Supplies and other operating expenses 7.9 7.8 7.6 Depreciation and amortization .8 2.2 3.5 ----------- ---------- ---------- Total operating expenses 76.1 75.2 74.3 ----------- ---------- ---------- Income from operations 23.9 24.8 25.7 Other income, net 1.6 2.4 1.3 ----------- ---------- ---------- Income before income taxes 25.5 27.2 27.0 Income tax provision 10.2 11.0 10.8 ----------- ---------- ---------- Net income 15.3% 16.2% 16.2% =========== ========== ========== YEAR ENDED DECEMBER 31, 1997 AS COMPARED TO YEAR ENDED DECEMBER 31, 1996 The Company reported net patient service revenue of $128.9 million for the year ended December 31, 1997, as compared with $80.8 million in 1996, a growth rate of 59.4%. Of this $48.1 million increase, approximately $47.5 million, or 98.8%, was attributable to new units, including units at which the Company provides services as a result of acquisitions. Same unit patient service revenue increased approximately $603,000, or 1.2%, for the year ended December 31, 1997, compared to the year ended December 31, 1996. Same units are those units at which the Company provided services for the entire period for which the percentage is calculated and the entire prior comparable period. The same unit growth resulted primarily from volume increases. 19 20 Salaries and benefits increased $28.8 million, or 54.5%, to $81.5 million for the year ended December 31, 1997, as compared with $52.7 million for the same period in 1996. Of this increase, $21.4 million, or 74.3%, was attributable to hiring new physicians, primarily to support new unit growth, and the remaining $7.4 million was primarily attributable to increased support staff and resources added in the areas of nursing, management and billing and reimbursement. Supplies and other operating expenses increased $3.5 million, or 55.9%, to $9.8 million for the year ended December 31, 1997, as compared with $6.3 million for the year ended December 31, 1996, primarily as a result of new units. Depreciation and amortization expense increased by $2.7 million, or 155.5%, to $4.5 million for the year ended December 31, 1997, as compared with $1.8 million for the year ended December 31, 1996, primarily as a result of amortization of goodwill in connection with acquisitions. Income from operations increased $13.0 million, or 64.8%, to $33.1 million for the year ended December 31, 1997, as compared with $20.1 million for the year ended December 31, 1996, representing an increase in the operating margin from 24.8% to 25.7%. The increase in operating margin was primarily due to increased volume, principally from acquisitions, without comparable increases in corporate overhead. The Company earned net interest income of approximately $1.8 million for the year ended December 31, 1997, as compared with $1.9 million for the year ended December 31, 1996. The effective income tax rate was approximately 40.0% for the year ended December 31, 1997 as compared with 40.3% for the year ended December 31, 1996. Net income increased 59.4% to $20.9 million for the year ended December 31, 1997, as compared with $13.1 million for the year ended December 31, 1996. Net income as a percentage of net patient service revenue remained consistent at 16.2% for the years ended December 31, 1996 and 1997. YEAR ENDED DECEMBER 31, 1996 AS COMPARED TO YEAR ENDED DECEMBER 31, 1995 The Company reported net patient service revenue of $80.8 million for the year ended December 31, 1996, as compared with $43.9 million in 1995, a growth rate of 84.3%. Of this $36.9 million increase, $34.7 million, or 94.0%, was attributable to new units, including units at which the Company provides services as a result of acquisitions. Same unit patient service revenue increased $2.2 million, or 6.2%, for the year ended December 31, 1996, compared to the year ended December 31, 1995. The same unit growth resulted from volume increases as there were no general price increases during the periods. Salaries and benefits increased $23.2 million, or 78.5%, to $52.7 million for the year ended December 31, 1996, as compared with $29.5 million for the same period in 1995. Of this $23.2 million increase, $18.0 million, or 77.6%, was attributable to hiring new physicians, primarily to support new unit growth, and the remaining $5.2 million was primarily attributable to increased support staff and resources added in the areas of nursing, management and billing and reimbursement. Supplies and other operating expenses increased $2.8 million, or 81.5%, to $6.3 million for the year ended December 31, 1996, as compared with $3.5 million for the year ended December 31, 1995, primarily as a result of new units. Depreciation and amortization expense increased by $1.4 million, or 387.6%, to $1.8 million for the year ended December 31, 1996, as compared with $363,000 for the year ended December 31, 1995, primarily as a result of amortization of goodwill in connection with acquisitions. Income from operations increased approximately $9.6 million, or 91.1%, to $20.1 million for the year ended December 31, 1996, as compared with $10.5 million for the year ended December 31, 1995, representing an increase in the operating margin from 23.9% to 24.8%. The increase in operating margin was primarily due to increased volume, principally from acquisitions, without comparable increases in corporate overhead. The Company earned net interest income of approximately $1.9 million for the year ended December 31, 1996, as compared with $687,000 for the year ended December 31, 1995. The increase in net interest income resulted primarily from additional funds available for investment due to proceeds from the initial and secondary public stock offerings, as well as cash flow from operations. 20 21 The effective income tax rate was approximately 40.3% for the year ended December 31, 1996 compared with 40.0% for the year ended December 31, 1995. Net income increased 95.4% to $13.1 million for the year ended December 31, 1996, as compared with $6.7 million for the year ended December 31, 1995. Net income as a percentage of net patient service revenue increased to 16.2% for the year ended December 31, 1996, compared to 15.3% for the year ended December 31, 1995. QUARTERLY RESULTS The following table presents certain unaudited quarterly financial data for each of the quarters in the years ended December 31, 1996 and 1997. This information has been prepared on the same basis as the Consolidated Financial Statements appearing elsewhere in this Annual Report and include, in the opinion of the Company, all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the quarterly results when read in conjunction with the Consolidated Financial Statements and the notes thereto. The Company has historically experienced and expects to continue to experience quarterly fluctuations in net patient service revenue and net income. As a result, the operating results for any quarter are not necessarily indicative of results for any future period or for the full year. 1996 CALENDAR QUARTERS 1997 CALENDAR QUARTERS ------------------------------------------- ------------------------------------------- FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH ---------- --------- --------- --------- --------- ---------- ---------- --------- (In thousands, except for per share data) Net patient service revenue $16,127 $17,808 $22,404 $24,494 $27,013 $30,599 $34,444 $36,794 Operating expenses: Salaries and benefits 10,796 11,541 14,526 15,869 17,609 19,774 21,874 22,229 Supplies and other operating expenses 1,213 1,269 1,740 2,040 2,102 2,358 2,467 2,838 Depreciation and amortization 233 335 543 659 783 1,008 1,278 1,453 --------- -------- -------- -------- -------- --------- --------- -------- Total operating expenses 12,242 13,145 16,809 18,568 20,494 23,140 25,619 26,520 --------- -------- -------- -------- -------- --------- --------- -------- Income from operations 3,885 4,663 5,595 5,926 6,519 7,459 8,825 10,274 Other income, net 464 396 455 589 661 488 346 283 --------- -------- -------- -------- -------- --------- --------- -------- Income before income taxes 4,349 5,059 6,050 6,515 7,180 7,947 9,171 10,557 Income tax provision 1,737 2,024 2,485 2,607 2,872 3,179 3,668 4,223 --------- -------- -------- -------- -------- --------- --------- -------- Net income $2,612 $3,035 $3,565 $3,908 $4,308 $4,768 $5,503 $6,334 ========= ======== ======== ======== ======== ========= ========= ======== Per share data: Net income per common and common equivalent share: Basic $.20 $.23 $.25 $.26 $.29 $.32 $.37 $.42 ========= ======== ======== ======== ======== ========= ========= ======== Diluted $.19 $.22 $.24 $.25 $.28 $.30 $.35 $.40 ========= ======== ======== ======== ======== ========= ========= ======== LIQUIDITY AND CAPITAL RESOURCES During 1997, the Company completed the acquisition of ten physician group practices, utilizing approximately $59.0 million in cash. These acquisitions were funded principally by the net proceeds from the Company's initial public stock offering in September 1995, and a secondary public stock offering in August 1996. As of December 31, 1997, the Company had approximately $45.7 million of cash, cash equivalents and marketable securities on hand. As of December 31, 1997, the Company had working capital of approximately $53.9 million, a decrease of $27.3 million from the working capital of $81.2 million available at December 31, 1996. The net decrease is principally the result of expenditures related to the acquisition of physician group practices and additions to property and equipment offset by funds generated from operations. On June 27, 1996, the Company entered into an unsecured revolving credit facility (the "Credit Facility") with BankBoston and SunTrust Bank. During 1997, the Company increased the amount available under the Credit Facility to $75.0 million, which includes a $2.0 million amount reserved to cover deductibles under the Company's professional liability insurance policies. The Company intends to use the amount available under the Credit Facility primarily for acquisitions. The Credit Facility matures on September 30, 2000. At the Company's option, the 21 22 Credit Facility bears interest at either LIBOR plus .875%, or the prime rate announced by BankBoston. There is no balance currently outstanding under the Credit Facility. The Company's annual capital expenditures have typically been for computer hardware and software and for furniture, equipment and improvements at the corporate headquarters. During the year ended December 31, 1997, capital expenditures amounted to approximately $2.2 million. The Company anticipates that funds generated from operations, together with cash and marketable securities on hand, and funds available under the Credit Facility will be sufficient to meet its working capital requirements and finance required capital expenditures and acquisitions for at least the next twelve months. STATUS OF YEAR 2000 COMPLIANCE The Company has completed a review of its computer systems to identify any software that could be affected by the transition to the year 2000. Currently, all the Company's systems are year 2000 compliant or are upgradeable to commercially available versions that are compliant. In addition, all of the vendors that the Company uses for the transmission of electronic claims information are expected to complete the transition to year 2000 compliant systems by the end of September 1998. The Company has not had any discussions with its payors to determine the status of their systems. However, if a substantial number of payors do not make the modifications and conversions required on a timely basis it could have a material adverse effect on the Company's financial condition and results of operations. CHANGE IN ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which must be implemented by the Company in 1998. This statement establishes standards for the reporting and display of comprehensive income and its components. The Company expects that the implementation of SFAS No. 130 will not have a material impact on its consolidated financial statements. 22 23 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following Consolidated Financial Statements of the Company are included in this Annual Report on Form 10-K on the pages set forth below: PAGE ---- Report of Independent Accountants.....................................................................24 Consolidated Balance Sheets as of December 31, 1996 and 1997..........................................25 Consolidated Statements of Income for the Years Ended December 31, 1995, 1996 and 1997................26 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1995, 1996 and 1997................................................................................27 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1996 and 1997.....................................................................................28 Notes to Consolidated Financial Statements............................................................29 23 24 REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors of Pediatrix Medical Group, Inc. Ft. Lauderdale, Florida We have audited the consolidated financial statements and the financial statement schedule of Pediatrix Medical Group, Inc. listed in Item 14(a) of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pediatrix Medical Group, Inc. as of December 31, 1996 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included herein. COOPERS & LYBRAND L.L.P. Ft. Lauderdale, Florida January 26, 1998, except as to information presented in Note 14, for which the date is March 23, 1998 24 25 PEDIATRIX MEDICAL GROUP, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) DECEMBER 31, ----------------------------------------------- ASSETS 1996 1997 --------------------- --------------------- Current assets: Cash and cash equivalents $18,435 $18,562 Investments in marketable securities 57,218 27,132 Accounts receivable, net 23,396 34,866 Prepaid expenses 1,283 873 Other assets 375 586 Income taxes receivable 202 -- --------------------- --------------------- Total current assets 100,909 82,019 Property and equipment, net 8,676 9,898 Other assets, net 49,441 104,895 --------------------- --------------------- Total assets $159,026 $196,812 ===================== ===================== LIABILITIES & STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $13,423 $16,170 Income taxes payable -- 1,348 Current portion of note payable 200 200 Deferred income taxes 6,099 10,393 --------------------- --------------------- Total current liabilities 19,722 28,111 Note payable 2,750 2,550 Deferred income taxes 233 2,442 --------------------- --------------------- Total liabilities 22,705 33,103 --------------------- --------------------- Commitments and contingencies Stockholders' equity: Preferred stock; $.01 par value, 1,000,000 shares authorized, none issued and outstanding at December 31, 1996 and 1997 -- -- Common stock; $.01 par value, 50,000,000 shares authorized at December 31, 1996 and 1997, 14,864,694 and 15,141,418 shares issued and outstanding at December 31, 1996 and 1997, respectively 149 151 Additional paid-in capital 116,037 122,391 Retained earnings 20,165 41,078 Unrealized gain (loss) on investments (30) 89 --------------------- --------------------- Total stockholders' equity 136,321 163,709 --------------------- --------------------- Total liabilities and stockholders' equity $159,026 $196,812 ===================== ===================== THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. 25 26 PEDIATRIX MEDICAL GROUP, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT FOR PER SHARE DATA) YEARS ENDED DECEMBER 31, ---------------------------------------------- 1995 1996 1997 ------------ ------------ ------------ Net patient service revenue $43,860 $80,833 $128,850 ------------ ------------ ------------ Operating expenses: Salaries and benefits 29,545 52,732 81,486 Supplies and other operating expenses 3,451 6,262 9,765 Depreciation and amortization 363 1,770 4,522 ------------ ------------ ------------ Total operating expenses 33,359 60,764 95,773 ------------ ------------ ------------ Income from operations 10,501 20,069 33,077 Investment income 804 2,096 2,102 Interest expense (117) (192) (324) ------------ ------------ ------------ Income before income taxes 11,188 21,973 34,855 Income tax provision 4,475 8,853 13,942 ------------ ------------ ------------ Net income $6,713 $13,120 $20,913 ============ ============ ============ Per share data: Net income per common and common equivalent share: Basic $.70 $.95 $1.39 ============ ============ ============ Diluted $.57 $.90 $1.33 ============ ============ ============ Weighted average shares used in computing net income per common and common equivalent share: Basic 8,092 13,806 15,021 ============ ============ ============ Diluted 11,855 14,535 15,743 ============ ============ ============ THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. 26 27 PEDIATRIX MEDICAL GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands) COMMON STOCK ----------------------- ADDITIONAL NUMBER OF PAID-IN RETAINED SHARES AMOUNT CAPITAL EARNINGS ------------ ---------- --------- ------------- Balance at December 31, 1994 6,266 $ 63 $ -- $ 332 Net income -- -- -- 6,713 Accrued and unpaid preferred stock dividends through conversion date, September 25, 1995 -- -- (1,040) -- Conversion of preferred stock 4,571 46 16,691 -- Common stock issued 2,240 22 39,848 -- Common stock retired (26) -- (131) -- Tax benefit related to employee stock options -- -- 252 -- --------- --------- --------- --------- Balance at December 31, 1995 13,051 131 55,620 7,045 Net income -- -- -- 13,120 Common stock issued 1,815 18 59,757 -- Common stock retired (1) -- (45) -- Tax benefit related to employee stock options -- -- 705 -- --------- --------- --------- --------- Balance at December 31, 1996 14,865 149 116,037 20,165 Net income -- -- -- 20,913 Common stock issued 276 2 3,480 -- Tax benefit related to employee stock options and stock purchase plans -- -- 2,874 -- --------- --------- --------- --------- Balance at December 31, 1997 15,141 $ 151 $ 122,391 $ 41,078 ========= ========= ========= ========= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. 27 28 PEDIATRIX MEDICAL GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) YEARS ENDED DECEMBER 31, ----------------------------------- 1995 1996 1997 ----------- ---------- ---------- Cash flows from operating activities: Net income $ 6,713 $ 13,120 $ 20,913 Adjustments to reconcile net income to net cash provided from operating activities: Depreciation and amortization 363 1,770 4,522 Deferred income taxes 1,456 4,423 6,503 Other (2) -- -- Changes in assets and liabilities: Accounts receivable (3,131) (11,300) (11,470) Prepaid expenses and other assets (493) (533) 199 Income taxes receivable/payable 101 833 4,424 Other assets 62 7 (232) Accounts payable and accrued expenses 871 6,470 4,140 -------- -------- -------- Net cash provided from operating activities 5,940 14,790 28,999 -------- -------- -------- Cash flows used in investing activities: Physician group acquisition payments (4,938) (42,487) (60,158) Purchase of investments (34,382) (57,394) (14,003) Proceeds from sale of investments 6,681 27,850 44,207 Purchase of property and equipment (1,861) (4,688) (2,200) -------- -------- -------- Net cash used in investing activities (34,500) (76,719) (32,154) -------- -------- -------- Cash flows from financing activities: Borrowings on notes payable -- 3,000 -- Payments on notes payable (64) (865) (200) Proceeds from issuance of common stock 39,870 59,775 3,482 Payments made to retire common stock (131) (45) -- -------- -------- -------- Net cash provided from financing activities 39,675 61,865 3,282 -------- -------- -------- Net increase (decrease) in cash and cash equivalents 11,115 (64) 127 Cash and cash equivalents at beginning of year 7,384 18,499 18,435 -------- -------- -------- Cash and cash equivalents at end of year $ 18,499 $ 18,435 $ 18,562 ======== ======== ======== Supplemental disclosure of cash flow information: Cash paid for: Interest $ 117 $ 164 $ 310 Income taxes $ 2,943 $ 2,950 $ 2,651 Non-cash investing and financing activities: Accrued and unpaid preferred stock dividends $ 1,040 $-- $-- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. 28 29 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. GENERAL: The principal business activity of Pediatrix Medical Group, Inc. ("Pediatrix" or the "Company") is to provide physician management services to hospital-based neonatal units in 20 states and Puerto Rico. Contractual arrangements with hospitals include a) fee-for-service contracts whereby hospitals agree, in exchange for the Company's services, to authorize the Company and its healthcare professionals to bill and collect the professional component of the charges for medical services rendered by the Company's healthcare professionals; and b) administrative fees whereby the Company is assured a minimum revenue level. In September 1995, the Company completed its initial public offering whereby it issued 2,200,000 shares of common stock, resulting in net cash proceeds to the Company of approximately $39.7 million. In addition, in connection with the initial public offering, the Company authorized 50,000,000 shares of common stock and 1,000,000 shares of preferred stock. In August 1996, the Company completed a secondary public offering whereby it issued 1,755,000 shares of common stock, resulting in net cash proceeds to the Company of approximately $59.1 million. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: PRINCIPLES OF PRESENTATION The financial statements (the "consolidated financial statements") include all the accounts of Pediatrix and its wholly owned subsidiaries combined with the accounts of the professional associations (the "PA Contractors") with which the Company currently has specific management billing arrangements. All significant intercompany and interaffiliate accounts and transactions have been eliminated. The financial statements of the PA Contractors are consolidated with Pediatrix because Pediatrix, as opposed to affiliates of Pediatrix, has unilateral control over the assets and operations of the PA Contractors. Notwithstanding the lack of technical majority ownership, consolidation of the PA Contractors is necessary to present fairly the financial position and results of operations of Pediatrix because of the existence of a parent-subsidiary relationship by means other than record ownership of the PA Contractors' voting common stock. Control of the assets and operations of the PA Contractors by Pediatrix is permanent and other than temporary because the PA Contractor's agreements with Pediatrix provide that the term of the arrangements are permanent, subject only to termination by Pediatrix and that the PA Contractors shall not terminate the agreements without the prior written consent of Pediatrix. Also, the agreements provide that Pediatrix or its assigns has the right, but not the obligation, to purchase the stock of the PA Contractors. In November 1997, the Emerging Issues Task Force of the FASB (the "EITF") reached a consensus relating to the conditions under which a physician practice management company would consolidate the accounts of an affiliated physician practice. The Company believes that its accounting policies conform to the EITF consensus. 29 30 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: ACCOUNTING ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. ACCOUNTS RECEIVABLE AND REVENUES Accounts receivable are primarily amounts due under fee-for-service contracts from third party payors, such as insurance companies, self-insured employers and patients and government-sponsored healthcare programs geographically dispersed throughout the United States and its territories. These receivables are presented net of an estimated allowance for contractual adjustments and uncollectibles which is charged to operations based on the Company's evaluation of expected collections resulting from an analysis of current and past due accounts, past collection experience in relation to amounts billed and other relevant information. Contractual adjustments result from the difference between the physician rates for services performed and reimbursements by government-sponsored healthcare programs and insurance companies for such services. Bad debts are included in contractual allowances and uncollectibles because they are not considered material. Concentration of credit risk relating to accounts receivable is limited by number, diversity and geographic dispersion of the neonatology units managed by the Company, as well as by the large number of patients and payors, including the various governmental agencies in the states in which the Company provides services. Receivables from government agencies made up approximately 41% and 37% of accounts receivable at December 31, 1996 and 1997, respectively. CASH EQUIVALENTS Cash equivalents are defined as all highly liquid financial instruments with maturities of 90 days or less from the date of purchase. The Company maintains its cash and cash equivalents which consist principally of demand deposits, short-term government securities and amounts on deposit in money market accounts with principally three financial institutions. INVESTMENTS The Company determines the appropriate classification of its investments in debt securities at the time of purchase and re-evaluates such determination at each balance sheet date. Investments are classified as available for sale and are carried at fair value, with unrealized gains and losses, net of tax, reported as a separate component of stockholders' equity. Fair value is determined by the most recently traded price of the security at the balance sheet date. 30 31 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: INVESTMENTS, CONTINUED The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and interest income and declines in value judged to be other than temporary are included in investment income. Realized gains and losses are included in earnings using the specific identification method for determining the cost of securities sold. Investments are stated at fair market value which approximates amortized cost and consist principally of tax exempt municipal obligations (fair value of $48.6 million and $26.6 million at December 31, 1996 and 1997, respectively), U.S. government and government agency securities (fair value of $6.8 million and $511,000 at December 31, 1996 and 1997, respectively) and commercial paper (fair value of $1.5 million at December 31, 1996). The Company's investments in marketable securities represent amounts available for current operations and are accordingly classified as current assets. PROPERTY AND EQUIPMENT Property and equipment is recorded at cost. Depreciation of property and equipment is computed on the straight-line method over the estimated useful lives which range from five to forty years. Upon sale or retirement of property and equipment, the cost and related accumulated depreciation are eliminated from the respective accounts and the resulting gain or loss is included in earnings. OTHER ASSETS Other assets consists principally of the excess of cost over the fair value of net assets acquired which is being amortized on a straight-line basis over twenty-five years. In 1996, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement requires companies to review certain assets for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable, in which case the asset generally would be written down to fair value. The adoption of SFAS No. 121 did not affect the Company's financial position, results of operations or liquidity. At each balance sheet date following the acquisition of a business, the Company reviews the carrying value of the goodwill to determine if facts and circumstances suggest that it may be impaired or that the amortization period may need to be changed. The Company considers external factors relating to each acquired business, including hospital and physician contract changes, local market developments, changes in third party payments, national healthcare trends, and other publicly available information. If these external factors indicate the goodwill will not be recoverable, as determined based upon undiscounted cash flows before interest charges of the business acquired over the remaining amortization period, the carrying value of the goodwill will be reduced. The Company does not believe there currently are any indicators that would require an adjustment to the carrying value of the goodwill or its estimated periods of recovery at December 31, 1997. 31 32 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: PROFESSIONAL LIABILITY COVERAGE The Company maintains professional liability coverage which indemnifies the Company and its healthcare professionals on a claims made basis with a portion of self insurance retention. The Company records an estimate of its liabilities for claims incurred but not reported based on an actuarial valuation. Such liabilities are not discounted. INCOME TAXES The Company utilizes the liability method of accounting for deferred income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. STOCK OPTIONS SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options and other equity instruments to employees based on new fair value accounting rules. The Company has chosen the SFAS No. 123 alternative to disclose pro forma net income and earnings per share under the new method but not to apply the fair value accounting rules in the statements of income. No charge has been reflected in the consolidated statements of income as a result of the grant of stock options, as the market value of the Company's stock equals the exercise price on the date the options are granted. To the extent that the Company realizes an income tax benefit from the exercise or early disposition of certain stock options, this benefit results in a decrease in current income taxes payable and an increase in additional paid-in capital. NET INCOME PER SHARE During 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which requires the presentation of both basic and diluted earnings per share. Net income per share information for all periods has been restated to conform with the requirements of the standard. Basic net income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is calculated by dividing net income by the weighted average number of common and potential common shares outstanding during the period. Potential common shares consist of the dilutive effect of outstanding options calculated using the treasury stock method. 32 33 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of cash and cash equivalents, accounts receivable, investments in marketable securities, and accounts payable and accrued expenses approximate fair value due to the short maturities of these items. The carrying amount of the note payable approximates fair value because the interest rates on this instrument change with market interest rates. CHANGE IN ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income," which must be implemented by the Company in 1998. This statement establishes standards for the reporting and display of comprehensive income and its components. The Company expects that the implementation of SFAS No. 130 will not have a material impact on its consolidated financial statements. 3. ACCOUNTS RECEIVABLE AND NET PATIENT SERVICE REVENUE Accounts receivable consists of the following: DECEMBER 31, --------------------------------------- 1996 1997 ----------------- ----------------- (IN THOUSANDS) Gross accounts receivable $53,991 $80,237 Less allowance for contractual adjustments and uncollectibles (30,595) (45,371) ----------------- ----------------- $23,396 $34,866 ================= ================= Net patient service revenue consists of the following: YEARS ENDED DECEMBER 31, ---------------------------------------------------- 1995 1996 1997 -------------- -------------- -------------- (IN THOUSANDS) Gross patient service revenue $79,360 $156,594 $260,112 Less contractual adjustments and uncollectibles (40,843) (82,759) (137,385) Hospital contract administrative fees 5,343 6,998 6,123 -------------- -------------- -------------- $43,860 $80,833 $128,850 ============== ============== ============== 33 34 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 4. PROPERTY AND EQUIPMENT: Property and equipment consists of the following: DECEMBER 31, ------------------------------------- 1996 1997 ------------- ------------- (IN THOUSANDS) Land and land improvements $1,374 $1,493 Building 4,000 4,290 Equipment and furniture 4,312 6,351 ------------- ------------- 9,686 12,134 Less accumulated depreciation (1,275) (2,236) Construction in progress 265 -- ------------- ------------- $8,676 $9,898 ============= ============= 5. OTHER ASSETS: Other assets consists of the following: DECEMBER 31, ------------------------------------- 1996 1997 ------------- ------------- (IN THOUSANDS) Excess of cost over net assets acquired $48,963 $107,972 Physician agreements 1,692 1,692 Other 572 1,023 ------------- ------------- 51,227 110,687 Less accumulated amortization (1,786) (5,792) ------------- ------------- $49,441 $104,895 ============= ============= During 1996, the Company completed the acquisition of ten physician group practices. Total consideration and related costs for these acquisitions approximated $43.7 million. In connection with these transactions, the Company recorded assets totaling $43.7 million, including $43.0 million of goodwill, and liabilities of $3.4 million. In 1997, the Company paid an aggregate of $1.3 million to the prior shareholders of two physician group practices acquired in 1996. The payments were earned based upon the achievement of certain targets as outlined in the acquisition agreements. During 1997, the Company completed the acquisition of ten physician group practices. Total consideration and related costs for these acquisitions approximated $59.0 million. In connection with these transactions, the Company recorded assets totaling approximately $59.0 million, principally goodwill, and liabilities of $1.9 million. 34 35 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 5. OTHER ASSETS, CONTINUED: The Company has accounted for the transactions using the purchase method of accounting and the excess of cost over fair value of net assets acquired is being amortized on a straight-line basis over 25 years. The results of operations of the acquired companies have been included in the consolidated financial statements from the dates of acquisition. The following unaudited pro forma information combines the consolidated results of operations of the Company and the companies acquired during 1996 and 1997 as if the acquisitions had occurred on January 1, 1996: YEARS ENDED DECEMBER 31, ------------------------------------ 1996 1997 ------------ -------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net patient service revenue $113,303 $136,519 Net income 14,603 21,143 Net income per share: Basic $1.06 $1.41 Diluted $1.00 $1.34 The pro forma results do not necessarily represent results which would have occurred if the acquisition had taken place at the beginning of the period, nor are they indicative of the results of future combined operations. 6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES: Accounts payable and accrued expenses consists of the following: DECEMBER 31, ------------------------------------- 1996 1997 ------------- -------------- (IN THOUSANDS) Accounts payable $2,489 $2,988 Accrued salaries and bonuses 3,508 5,340 Accrued payroll taxes and benefits 2,009 3,013 Accrued professional liability coverage 2,413 3,747 Other accrued expenses 3,004 1,082 ------------- -------------- $13,423 $16,170 ============= ============== 35 36 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 7. NOTE PAYABLE: Note payable consists of the following: DECEMBER 31, ------------------------------------- 1996 1997 ------------- -------------- (IN THOUSANDS) Mortgage payable to bank $2,950 $2,750 Less current portion (200) (200) ------------- -------------- $2,750 $2,550 ============= ============== During 1996, the Company negotiated a new mortgage loan agreement, increasing the principal balance to $3.0 million and adjusting the terms of the original mortgage. The new loan agreement requires quarterly payments totaling $200,400 per year plus interest through the maturity date of the loan, June 30, 2003, at which time the unpaid principal balance of $1,647,300 is due, bears interest at prime (8.5% at December 31, 1997), and is collateralized by the Company's two buildings. In June 1996, the Company entered into an unsecured revolving credit facility. During 1997, the amounts available under the credit facility were increased to $75 million, which includes a $2 million amount reserved to cover deductibles under the Company's professional liability insurance policies. The credit facility matures on September 30, 2000. At the Company's option, the credit facility bears interest at either LIBOR plus .875% or prime. The Company had no outstanding balance at December 31, 1996 or 1997. The Company is required to maintain certain financial covenants including a requirement that the Company maintain a minimum level of net worth, as defined under the terms of the mortgage and credit facility agreement. 8. PREFERRED STOCK: In October 1992, the Company issued 4,571,063 shares of 9% voting, redeemable, cumulative convertible Preferred Stock for $13,000,103. In connection with the Company's initial public offering, the Preferred Stock was converted into common stock of the Company and the unpaid dividends of $3,736,589 were forgiven. As a result, the redemption value of the Preferred Stock was credited to common stock and additional paid-in capital accounts. 36 37 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 9. INCOME TAXES: The components of the income tax provision are as follows: DECEMBER 31, --------------------------------------------------------------- 1995 1996 1997 -------------- ------------- ------------- (IN THOUSANDS) Federal: Current $2,573 $3,072 $6,004 Deferred 1,184 3,667 5,913 -------------- ------------- ------------- 3,757 6,739 11,917 -------------- ------------- ------------- State: Current 454 1,358 1,054 Deferred 264 756 971 -------------- ------------- ------------- 718 2,114 2,025 -------------- ------------- ------------- Total $4,475 $8,853 $13,942 ============== ============= ============= The Company files its tax return on a consolidated basis with its subsidiaries. The PA Contractors file tax returns on an individual basis. The effective tax rate on income was 40% for the years ended December 31, 1995, 1996 and 1997. The differences between the effective rate and the U.S. federal income tax statutory rate are as follows: DECEMBER 31, --------------------------------------------------------------- 1995 1996 1997 -------------- ------------- ------------- (IN THOUSANDS) Tax at statutory rate $3,804 $7,472 $12,199 State income tax, net of federal benefit 451 1,374 1,316 Permanent differences 16 (391) 43 Other, net 204 398 384 -------------- ------------- ------------- Income tax provision $4,475 $8,853 $13,942 ============== ============= ============= 37 38 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 9. INCOME TAXES, CONTINUED: The significant components of deferred income tax assets and liabilities are as follows: DECEMBER 31, 1996 DECEMBER 31, 1997 --------------------------------- ---------------------------------- NON NON TOTAL CURRENT CURRENT TOTAL CURRENT CURRENT --------- --------- --------- --------- ---------- ---------- (IN THOUSANDS) Allowance for uncollectible accounts $ 150 $ 150 $ -- $ 766 $ 766 $ -- Net operating loss carryforward 1,112 1,112 -- 398 398 -- Other -- -- -- 304 304 -- -------- -------- -------- -------- -------- -------- Total deferred tax assets 1,262 1,262 -- 1,468 1,468 -- -------- -------- -------- -------- -------- -------- Accrual to cash adjustment (7,416) (7,355) (61) (8,878) (8,878) -- Property and equipment -- -- -- (1,251) -- (1,251) Receivable discounts -- -- -- (2,966) (2,966) -- Other (178) (6) (172) (1,208) (17) (1,191) -------- -------- -------- -------- -------- -------- Total deferred tax liabilities (7,594) (7,361) (233) (14,303) (11,861) (2,442) -------- -------- -------- -------- -------- -------- Net deferred tax liability $ (6,332) $ (6,099) $ (233) $(12,835) $(10,393) $ (2,442) ======== ======== ======== ======== ======== ======== The income tax benefit related to the exercise of stock options and the purchase of shares under the Company's non-qualified employee stock purchase plan, reduces taxes currently payable and is credited to additional paid-in capital. Such amounts totaled $252,180, $704,630 and $2,873,649 for the years ended December 31, 1995, 1996 and 1997, respectively. The Company's PA Contractors have net operating loss carryforwards for federal and state tax purposes of approximately $1,377,000, $2,762,000 and $978,000 at December 31, 1995, 1996 and 1997, respectively, expiring at various times commencing in 1999. The Company is currently under examination by the Internal Revenue Service for the tax years ended December 31, 1992, 1993 and 1994. The IRS has challenged certain deductions that, if ultimately disallowed, would result in additional taxes of approximately $4.5 million, plus interest. The Company and its tax advisors believe that the ultimate resolution of the examination will not have a material effect on the Company's consolidated financial position or results of operations and cash flows. 10. COMMITMENTS AND CONTINGENCIES: During the ordinary course of business, the Company has become a party to pending and threatened legal actions and proceedings, most of which involve claims of medical malpractice and are generally covered by insurance. These lawsuits are not expected to result in judgments which would exceed professional liability insurance coverage, and therefore, will not have a material impact on the Company's consolidated results of operations, financial position or liquidity, notwithstanding any possible insurance recovery. 38 39 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 10. COMMITMENTS AND CONTINGENCIES, CONTINUED: Rent expense for the years ended December 31, 1995, 1996 and 1997 was $189,408, $1,118,594 and $1,721,964, respectively. At December 31, 1997, the future minimum lease payments are as follows: (IN THOUSANDS) -------------- 1998 $1,565 1999 1,472 2000 1,367 2001 1,315 2002 1,177 Thereafter 5,495 ----------- $12,391 =========== 11. RETIREMENT PLAN: The Company has a qualified contributory savings plan (the "Plan") as allowed under Section 401(k) of the Internal Revenue Code. The Plan permits participant contributions and allows elective Company contributions based on each participant's contribution. Participants may defer up to 15% of their annual compensation by contributing amounts to the Plan. The Company approved contributions of $559,125, $1,107,092 and $1,731,829 to the Plan during the years ended December 31, 1995, 1996 and 1997, respectively. 39 40 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 12. NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE: The calculation of basic and diluted net income per share for the years ended December 31, 1995, 1996 and 1997 are as follows: YEARS ENDED DECEMBER 31, ----------------------------------------- 1995 1996 1997 -------------- ---------- ------------- (IN THOUSANDS, EXCEPT FOR PER SHARE DATA) Basic net income per share: Net income $ 6,713 $ 13,120 $ 20,913 Preferred stock dividends (1,040) -- -- -------- -------- -------- Income applicable to common shareholders $ 5,673 $ 13,120 $ 20,913 ======== ======== ======== Weighted average common shares outstanding 8,092 13,806 15,021 ======== ======== ======== Basic net income per share $ 0.70 $ 0.95 $ 1.39 ======== ======== ======== Diluted net income per share: Weighted average common shares outstanding 8,092 13,806 15,021 Preferred stock 3,354 -- -- Stock options 409 729 722 -------- -------- -------- Weighted average common and potential common shares outstanding 11,855 14,535 15,743 ======== ======== ======== Net income $ 6,713 $ 13,120 $ 20,913 ======== ======== ======== Diluted net income per share $ 0.57 $ 0.90 $ 1.33 ======== ======== ======== 13. STOCK OPTION PLAN AND EMPLOYEE STOCK PURCHASE PLANS: In 1993, the Company's Board of Directors authorized a stock option plan. Under the plan, options to purchase shares of common stock may be granted to certain employees at a price not less than the fair market value of the shares on the date of grant. The options must be exercised within ten years from the date of grant. The stock options become exercisable on a pro rata basis over a three year period from the date of grant. In 1997, the Company's shareholders approved an amendment to increase the number of shares authorized to be issued under the plan from 2,500,000 to 3,250,000. At December 31, 1997, 220,164 shares were available for future grants. 40 41 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 13. STOCK OPTION PLAN AND EMPLOYEE STOCK PURCHASE PLANS, CONTINUED: Pertinent information covering the stock option plan is as follows: WEIGHTED AVERAGE NUMBER OF OPTION PRICE EXERCISE EXPIRATION SHARES PER SHARE PRICE DATE -------------- --------------- -------------- -------------- Outstanding at December 31, 1994 1,231,700 $2.84-$10.00 $5.82 2003-2004 Granted 841,500 $10.00-$21.50 $17.95 Canceled (324,583) $3.12-$12.50 $5.33 Exercised (39,709) $3.12-$10.00 $3.46 -------------- ------------------------------- Outstanding at December 31, 1995 1,708,908 $2.84-$21.50 $12.03 2003-2005 Granted 600,400 $12.50-$36.75 $35.27 Canceled (34,660) $3.12-$36.00 $16.46 Exercised (47,187) $5.00-$20.50 $5.64 -------------- --------------- -------------- Outstanding at December 31, 1996 2,227,461 $2.84-$36.75 $18.27 2003-2006 Granted 783,500 $29.00-$41.38 $33.38 Canceled (68,021) $5.00-$36.00 $21.55 Exercised (229,710) $5.00-$36.00 $9.69 -------------- --------------- -------------- Outstanding at December 31, 1997 2,713,230 $2.84-$41.38 $23.28 2003-2007 ============== =============== ============== Exercisable at: December 31, 1995 306,872 $2.84-$10.00 $6.15 December 31, 1996 828,631 $2.84-$21.50 $10.20 December 31, 1997 1,315,850 $2.84-$36.75 $14.74 Significant option groups outstanding at December 31, 1997 and related price and life information follows: OPTIONS OUTSTANDING OPTIONS EXERCISABLE -------------------------------------------- --------------------------- WEIGHTED WEIGHTED AVERAGE WEIGHTED AVERAGE REMAINING AVERAGE RANGE OF EXERCISE CONTRACTUAL EXERCISE EXERCISE PRICES OUTSTANDING PRICE LIFE EXERCISABLE PRICE ----------------------- -------------- ------------ ------------- ------------- ------------ $2.84 50,000 $2.84 5.5 50,000 $2.84 $5.00 278,770 $5.00 6.1 278,770 $5.00 $7.50 200,000 $7.50 6.8 200,000 $7.50 $10.00-$12.50 266,667 $10.80 7.0 226,249 $10.60 $19.25-$21.50 567,243 $19.59 7.2 369,074 $19.59 $24.00-$32.88 644,000 $29.71 9.2 51,788 $31.71 $36.00-$41.38 706,550 $38.22 8.7 139,969 $36.36 -------------- ------------ ------------- ------------- ------------ 2,713,230 $23.28 7.9 1,315,850 $14.74 ============== ============ ============= ============= ============ Under the Company's stock purchase plans, employees may purchase the Company's common stock at 85% of the average high and low sales price of the stock as reported as of commencement of the purchase period or as of the purchase date, whichever is lower. Under these plans, 12,786 and 47,302 shares were issued during 1996 and 1997, respectively. At December 31, 1997, the Company has an additional 939,912 shares reserved under the stock purchase plans. 41 42 PEDIATRIX MEDICAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 13. STOCK OPTION PLAN AND EMPLOYEE STOCK PURCHASE PLANS, CONTINUED: The Company has adopted the disclosure-only provisions of SFAS No. 123. Accordingly, no compensation expense has been recognized for stock options granted under the stock option plan or stock issued under the employee stock purchase plans. Had compensation expense been determined based on the fair value consistent with the provisions of SFAS No. 123, the Company's net income and net income per share would have been reduced to the pro forma amounts below: YEARS ENDED DECEMBER 31, ------------------------------------------------------------- 1995 1996 1997 ----------------- ----------------- ----------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net income $6,381 $11,002 $16,272 Net income per share: Basic $.66 $ .80 $1.08 Diluted $.55 $ .77 $1.05 The fair value of each option or share to be issued is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 1995, 1996 and 1997, respectively: dividend yield of 0% for all years; expected volatility of 42%, 42% and 41%; and risk-free interest rates of 6.1%, 6.3% and 6.6% for options with expected lives of five years (certain management and physicians of the Company) and 6.1%, 6.1% and 6.6% for options with expected lives of three years (all other employees of the Company). The pro forma effect on net income is not representative of the pro forma effect on net income in future periods because it does not take into consideration pro forma compensation expense related to grants made in prior periods. 14. SUBSEQUENT EVENTS: Subsequent to December 31, 1997, the Company completed the acquisitions of eight physician group practices. Total consideration for these acquisitions approximated $48.6 million in cash and 2,951,327 shares of stock in a subsidiary of the Company. The acquisitions will be accounted for using the purchase method of accounting. 42 43 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The Company has had no changes in or disagreements with its independent certified public accountants on accounting and financial disclosure. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information with respect to directors and executive officers of the Company is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. ITEM 11. EXECUTIVE COMPENSATION The information required in response to this item is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required in response to this item is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required in response to this item is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. 43 44 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (A) DOCUMENTS FILED AS PART OF THIS REPORT: (1) FINANCIAL STATEMENTS. An index to financial statements included in this annual report on Form 10-K appears on page 23. (2) FINANCIAL STATEMENT SCHEDULES. The following financial statement schedules for the years ended December 31, 1995, 1996 and 1997 are included in this Annual Report on Form 10-K on the pages set forth below. ITEM PAGE Financial Statement Schedules Report of Independent Accountants............................. 24 Schedule II: Valuation and Qualifying Accounts............... 45 Any required information not included in the above described schedules is included in the consolidated financial statements and notes thereto incorporated herein by reference. All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable and therefore have been omitted. 44 45 PEDIATRIX MEDICAL GROUP, INC. SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 1995 1996 1997 ----------------- ----------------- ------------------ Allowance for contractual adjustments and uncollectibles: Balance at beginning of year $13,246,580 $13,087,899 $30,594,906 Portion charged against operating revenue 40,843,431 82,759,087 137,385,310 Accounts receivable written- off (net of recoveries) (41,002,112) (65,252,080) (122,608,986) ---------------- ---------------- ----------------- Balance at end of year $13,087,899 $30,594,906 $45,371,230 ================ ================ ================= 45 46 (3) EXHIBITS 3.1 Pediatrix's Amended and Restated Articles of Incorporation (3.1)(1) 3.2 Pediatrix's Amended and Restated Bylaws (3.2)(12) 4.1 Registration Rights Agreement, dated as of September 13, 1995 between Pediatrix and certain shareholders (4.1)(1) 10.1 Pediatrix's Amended and Restated Stock Option Plan (10.1)(10) 10.2 Form of Indemnification Agreement between Pediatrix and each of its directors and certain executive officers (10.2)(1) 10.3 Employment Agreement, dated as of January 1, 1995, as amended, between Pediatrix and Roger J. Medel, M.D. (10.3)(1) 10.4 Employment Agreement, dated as of February 1, 1995, as amended, between Pediatrix and Richard J. Stull, II (10.4)(1) 10.5 Employment Agreement, dated as of May 1, 1995, as amended, between Pediatrix and Larry M. Mullen (10.5)(1) 10.6 Employment Agreement, dated as of February 1, 1995, as amended, between Pediatrix and Brian D. Udell, M.D., as amended (10.7)(1) 10.7 Employment Agreement, dated November 6, 1995, between Kristen Bratberg and Pediatrix (10.9)(4) 10.8 Employment Agreement, dated June 1, 1996, between Pediatrix and M. Douglas Cunningham, M.D. (10.21)(3) 10.9 Mortgage, Security Agreement and Assignment of Leases and Rents, dated as of September 30, 1993, made by Pediatrix in favor of The First National Bank of Boston (10.22)(1) 10.10 The Company's Profit Sharing Plan (10.23)(1) 10.11 Form of Non-competition and Nondisclosure Agreement (10.24)(1) 10.12 Form of Exclusive Management and Administrative Services Agreement between Pediatrix and each of the PA Contractors (10.25)(1) 10.13 Agreement for Purchase and Sale of Stock, dated July 27, 1995, between Pediatrix Medical Group of California and Neonatal and Pediatric Intensive Care Medical Group, Inc. and the individual physicians set forth in Exhibit A therein (10.26)(1) 10.14 Stock Purchase Agreement, effective January 16, 1996, between Jack C. Christensen, M.D., Cristina Carballo-Perelman, M.D., Michael C. McQueen, M.D., Neonatal Specialists, Ltd. and Brian Udell, M.D. (2.1)(4) 10.15 Asset Purchase Agreement, effective January 16, 1996, between Med-Support, L.P. and Neonatal Specialists, Ltd.(2.2)(4) 10.16 Asset Purchase Agreement, effective January 16, 1996, between CMJ Leasing, L.P. and Neonatal Specialists, Ltd. (2.3)(4) 10.17 Asset Purchase Agreement, dated January 29, 1996, among Pediatrix Medical Group of Colorado, P.C., Pediatrix and Newborn Consultants, P.C., and the shareholders of PNC (2.1)(5) 10.18 Agreement and Plan of Merger, dated January 29, 1996, among Pediatrix Medical Group of Colorado, P.C., Colorado Neonatal Associates, P.C. and the shareholders of CNA (2.1)(5) 10.19 Amendment No. 4 to Credit Agreement dated as of December 30, 1995, between Pediatrix, certain PA Contractors and The First National Bank of Boston (10.24)(2) 10.20 1996 Qualified Employee Stock Purchase Plan (10.25)(2) 10.21 1996 Non-Qualified Employee Stock Purchase Plan (10.26)(2) 10.22 Agreement and Plan of Merger, dated May 1, 1996, among Pediatrix Acquisition Corp., Rocky Mountain Neonatology, P.C. and the shareholders of RMN (2.1)(7) 46 47 10.23 Asset Purchase Agreement, dated as of May 30, 1996, by and among Pediatrix Medical Group of Texas, P.A., West Texas Neonatal Associates and the individual physicians set forth in Exhibit A therein (2.1)(8) 10.24 Agreement for Purchase and Sale of Assets, dated as of June 5, 1996, by and among Pediatrix Medical Group of California, P.C., Infant Care Specialists Medical Group, Inc. and the individual physicians set forth in Exhibit A therein (2.1)(9) 10.25 Airplane Purchase Agreement, dated March 22, 1996, between Pediatrix and Learjet Inc. (10.22)(3) 10.26 First Amended and Restated Credit Agreement, dated as of June 27, 1996, between Pediatrix, certain PA Contractors, The First National Bank of Boston and Sun Trust Bank (10.25)(3) 10.27 Modification of Mortgage, dated as of June 27, 1996, between PMG and The First National Bank of Boston (10.26)(3) 10.28 Amendment No. 2 to the employment agreement between Pediatrix and Roger J. Medel, M.D. (10.34)(10) 10.29 Amendment No. 1 to the employment agreement between Pediatrix and Kristen Bratberg (10.35)(10) 10.30 Amendment No. 2 to First Amended and Restated Credit Agreement, dated October 21, 1997, between Pediatrix, certain PA Contractors, BankBoston and SunTrust Bank (10.36)(11) 10.31 Regional Vice President of Medical Operations appointment, dated as of June 1, 1997, between Pediatrix and M. Douglas Cunningham, M.D. (12) 10.32 Employment Agreement, dated as of April 7, 1997, between Pediatrix and Bruce A. Jordan (12) 21.1 Subsidiaries of Pediatrix (12) 23.1 Consent of Coopers & Lybrand L.L.P. (12) 27.1 Financial Data Schedule for current period and restated Financial Data Schedules for other periods. (12) - ---------------------- (1) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Form S-1 (File No. 33-95086). (2) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Form 10-Q for the quarterly period ended March 31, 1996. (3) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Form S-1 (File No. 333-07125). (4) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Form 8-K, dated January 31, 1996. (5) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Form 8-K, dated February 8, 1996. (6) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Annual Report on Form 10-K for the year ended December 31, 1995. (7) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Form 8-K, dated May 9, 1996. (8) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Form 8-K, dated May 30, 1996. (9) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Form 8-K, dated June 5, 1996. (10) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Form 10-Q for the quarterly period ended June 30, 1997. (11) Incorporated by reference to the exhibit shown in parentheses and filed with the Pediatrix Form 10-Q for the quarterly period ended September 30, 1997. (12) Filed herewith. 47 48 (B) REPORTS ON FORM 8-K No reports on Form 8-K were filed by the Registrant during the last quarter of the period covered by this Report. (C) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K The index to exhibits that are listed in Item 14(a)(3) of this report and not incorporated by reference follows the "Signatures" section hereof and is incorporated herein by reference. (D) FINANCIAL STATEMENT SCHEDULES REQUIRED BY REGULATION S-X The financial statement schedules required by Regulation S-X which are excluded from the Registrant's Annual Report to Shareholders for the Year ended December 31, 1997, by Rule 14a-3(b)(1) are included above. See Item 14(a)(2) for index. 48 49 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. PEDIATRIX MEDICAL GROUP, INC. Date: March 30, 1998 By: /s/ Roger J. Medel, M.D., M.B.A. --------------------------------------- ROGER J. MEDEL, M.D., M.B.A., President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. SIGNATURE TITLE DATE --------- ----- ---- President, Chief Executive /s/ ROGER J. MEDEL, M.D., M.B.A. Officer and Director (principal March 30, 1998 - ------------------------------------------------ executive officer) Roger J. Medel, M.D., M.B.A. Vice President and Chief Financial /s/ LAWRENCE M. MULLEN Officer (principal financial officer March 30, 1998 - ------------------------------------------------ and principal accounting officer) Lawrence M. Mullen /s/ E. ROE STAMPS, IV Director March 30, 1998 - ------------------------------------------------ E. Roe Stamps, IV /s/ BRUCE R. EVANS Director March 30, 1998 - ------------------------------------------------ Bruce R. Evans /s/ M. DOUGLAS CUNNINGHAM, M.D. Director March 30, 1998 - ------------------------------------------------ M. Douglas Cunningham, M.D. /s/ MICHAEL FERNANDEZ Director March 30, 1998 - ------------------------------------------------ Michael Fernandez /s/ ALBERT H. NAHMAD Director March 30, 1998 - ------------------------------------------------ Albert H. Nahmad /S/ CESAR L. ALVAREZ Director March 30, 1998 - ------------------------------------------------ CESAR L. ALVAREZ 49