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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT: OCTOBER 28, 1998
DATE OF EARLIEST EVENT
REPORTED: OCTOBER 28, 1998
MAGELLAN HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter).
DELAWARE 1-6639 58-1076937
(State of incorporation) (Commission File Number) (IRS Employer Identification
No.)
3414 PEACHTREE ROAD, N.E., SUITE 1400, ATLANTA, 30326
GEORGIA
(Address of principal executive offices) (Zip Code)
(404) 841-9200
(Registrant's telephone number, including area code)
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ITEM 5. OTHER EVENTS
The Registrant (the "Company" or "Magellan") is filing this Form 8-K to
include the unaudited pro forma financial information required by Article 11 of
Regulation S-X for inclusion, via incorporation by reference, in each of its
Registration Statements filed under the Securities Act of 1933, as amended.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma consolidated financial information for the
Company is included herein:
1) Unaudited Pro Forma Consolidated Statement of Operations for the year ended
September 30, 1997;
2) Unaudited Pro Forma Consolidated Statement of Operations for the nine months
ended June 30, 1998.
2
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
The Unaudited Pro Forma Consolidated Financial Information set forth below
is based on the historical presentation of the consolidated financial statements
of Magellan, and the historical operating results of Human Affairs
International, Incorporated ("HAI"), Allied Health Services, Inc. and certain of
its affiliates ("Allied"), Merit Behavioral Care Corporation ("Merit") and CMG
Health, Inc. ("CMG"). The Unaudited Pro Forma Consolidated Statements of
Operations for the year ended September 30, 1997 and the nine months ended June
30, 1998 give effect to the Crescent Transactions (as defined), the HAI
acquisition, the Allied acquisition, the Green Spring Minority Stockholder
Conversion (as defined), Merit's acquisition of CMG and the Transactions (as
defined) as if they had been consummated on October 1, 1996.
The Unaudited Pro Forma Consolidated Statements of Operations do not give
effect to hospital acquisitions and closures during the year ended September 30,
1997 as such transactions and events are not considered material to the pro
forma presentation. The Unaudited Pro Forma Consolidated Statements of
Operations presentation assumes that the net proceeds from the Crescent
Transactions, after debt repayment of approximately $200 million, were fully
utilized to fund the HAI acquisition and the Allied acquisition. The Unaudited
Pro Forma Consolidated Statement of Operations for the year ended September 30,
1997 excludes the non-recurring losses incurred by the Company as a result of
the Crescent Transactions.
The Unaudited Pro Forma Consolidated Financial Information does not purport
to be indicative of the results that actually would have been obtained if the
operations had been conducted as presented and they are not necessarily
indicative of operating results to be expected in future periods. The business
of the Company's 50% owned hospital business, Charter Behavioral Health Systems,
LLC ("CBHS"), is seasonal in nature with a reduced demand for certain services
generally occurring in the first fiscal quarter around major holidays, such as
Thanksgiving and Christmas, and during the summer months comprising the fourth
fiscal quarter. Accordingly, the Unaudited Pro Forma Statement of Operations for
the nine months ended June 30, 1998 is not necessarily indicative of the pro
forma results expected for a full year. The Unaudited Pro Forma Statements of
Operations excludes approximately $60.0 million of cost savings on an annual
basis that the Company expects to achieve within eighteen months following
consummation of the Merit acquisition. The Unaudited Pro Forma Consolidated
Statement of Operations for the nine months ended June 30, 1998 also excludes
managed care integration costs of $12.3 million that were directly attributable
to the acquisitions described herein. The Unaudited Pro Forma Consolidated
Financial Information and notes thereto should be read in conjunction with the
historical consolidated financial statements and notes thereto of Magellan, and
Management's Discussion and Analysis of Financial Condition and Results of
Operations that appear in the Company's Annual Report on Form 10-K for the year
ended September 30, 1997, filed on December 23, 1997, and in the Company's Form
10-Q for the quarterly period ended June 30, 1998, filed on August 12, 1998,
which are incorporated herein by reference, the historical consolidated
financial statements and notes thereto of Merit, which appear in the Company's
current report on Form 8-K/A, filed on October 28, 1998, which are incorporated
herein by reference and the historical consolidated financial statements and
notes thereto of HAI, which appear in the Company's Current Report on Form 8-K,
filed on December 17, 1997, which are incorporated herein by reference.
The following is a description of each of the transactions that are
reflected in the pro forma presentation:
CRESCENT TRANSACTIONS. The Crescent Transactions, which were consummated on
June 17, 1997, resulted in, among other things: (i) the sale of substantially
all of its domestic acute-care psychiatric hospitals and residential treatment
facilities (the "Psychiatric Hospital Facilities") to Crescent Real Estate
Equities Limited Partnership ("Crescent") for $417.2 million (before costs of
approximately $16.0 million); (ii) the creation of CBHS; (iii) the Company
entering into the Franchise Agreements (as defined);
3
and (iv) the issuance by Magellan of 2,566,622 warrants to Crescent and Crescent
Operating, Inc. ("COI") (1,283,311 warrants each) with an exercise price of $30
per share. CBHS leases the Psychiatric Hospital Facilities from Crescent under a
twelve-year operating lease (the "Facilities Lease") (subject to renewal) for
$41.7 million annually, subject to adjustment, with a 5% escalator, compounded
annually plus certain additional rent. The Company entered into a master
franchise agreement (the "Master Franchise Agreement") with CBHS and a franchise
agreement with each of the Psychiatric Hospital Facilities and the other
facilities operated by CBHS (collectively, the "Franchise Agreements"). Pursuant
to the Franchise Agreements, the Company franchises the "CHARTER" System of
behavioral healthcare to each of the Psychiatric Hospital Facilities and other
facilities operated by CBHS. In exchange, CBHS agreed to pay the Company,
pursuant to the Master Franchise Agreement, annual franchise fees (the
"Franchise Fees") of approximately $78.3 million. However, CBHS's obligation to
pay the Franchise Fees is subordinate to its obligation to pay rent for the
Psychiatric Hospital Facilities to Crescent. The warrants issued to Crescent and
COI have been valued at $25.0 million in the Company's balance sheet. The
Company accounts for its 50% investment in CBHS under the equity method of
accounting, which significantly reduces the revenues and related operating
expenses presented in the Unaudited Pro Forma Consolidated Statements of
Operations. "Divested Operations--Crescent Transactions" in the Unaudited Pro
Forma Consolidated Statement of Operations represents the results of operations
of the businesses that are operated by CBHS.
The Company incurred a loss before income taxes, minority interest and
extraordinary items of approximately $59.9 million as a result of the Crescent
Transactions, which was recorded during fiscal 1997.
HAI ACQUISITION. On December 4, 1997, the Company consummated the purchase
of HAI, formerly a unit of Aetna, for approximately $122.1 million. HAI manages
the care of approximately 16.3 million covered lives, primarily through employee
assistance programs and other managed behavioral healthcare plans. The Company
funded the acquisition of HAI with cash on hand and accounted for the
acquisition of HAI using the purchase method of accounting. The Company may be
required to make additional contingent payments of up to $60.0 million annually
to Aetna over the five-year period subsequent to closing. The maximum contingent
payments are $300.0 million. The amount and timing of the payments will be
contingent upon net increases in the number of HAI's covered lives in specified
products. The Company is obligated to make contingent payments under two
separate calculations. Under the first calculation, the amount and timing of the
contingent payments will be based on growth in the number of lives covered by
certain HAI products during the next five years. The Company may be required to
make contingent payments of up to $25.0 million per year for each of the five
years following the HAI acquisition depending on the net annual growth in the
number of lives covered by such products. The amount to be paid per incremental
covered life decreases during the five-year term of the Company's contingent
payment obligation. Under the second calculation, the Company may be required to
make contingent payments of up to $35.0 million per year for each of five years
based on the net cumulative growth in the number of lives covered by certain
other HAI products. Aetna will receive a specified amount per net incremental
life covered by such products. The amount to be paid per incremental covered
life increases with the number of incremental covered lives. The Company will
account for the additions to the purchase price for HAI under the purchase
method.
ALLIED ACQUISITION. On December 5, 1997, the Company purchased the assets
of Allied for approximately $70.0 million, of which $50.0 million was paid to
the seller at closing with the remaining $20.0 million placed in escrow. Allied
provides specialty risk-based products and administrative services to a variety
of insurance companies and other customers, including Blue Cross of New Jersey,
CIGNA and NYLCare, covering approximately 3.8 million aggregate lives. Allied
has over 80 physician networks across the eastern United States. Allied's
networks include physicians specializing in cardiology, oncology and diabetes.
The Company funded the Allied acquisition with cash on hand. The Company
accounted for the Allied acquisition using the purchase method of accounting.
The escrowed amount of
4
the purchase price is payable in one-third increments if Allied achieves
specified earnings targets during each of the three years following the closing.
Additionally, the purchase price may be increased during the three-year period
by up to $40.0 million, if Allied's performance exceeds specified earnings
targets, or decreased by up to $20.0 million, if Allied's performance does not
meet specified earnings targets. The purchase price adjustments will be computed
based on the amount of "EBITDA" (as defined in the Allied Purchase Agreement)
earned by Allied during each of the three 12-month periods ending on November
30, 1998, 1999 and 2000. The seller will be paid an amount that is a specified
multiple of the excess of Allied's "EBITDA" during such periods over specified
"EBITDA" targets for such periods. The maximum purchase price payable is $110.0
million. The Company will account for the additions to the purchase price for
Allied under the purchase method. The Company will be paid an amount that is a
specified multiple of the amount by which Allied's "EBITDA" during such periods
is less than the specified "EBITDA" targets for such periods.
GREEN SPRING MINORITY STOCKHOLDER CONVERSION. The minority stockholders of
Green Spring Health Services, Inc. ("Green Spring") converted their interests in
Green Spring into an aggregate of 2,831,516 shares of the Company's common stock
during January 1998 (the "Green Spring Minority Stockholder Conversion"). As a
result of the Green Spring Minority Stockholder Conversion, the Company owns
100% of Green Spring. The Company accounted for the Green Spring Minority
Stockholder Conversion as a purchase of minority interest at the fair value of
the consideration paid.
MERIT ACQUISITION OF CMG. On September 12, 1997, Merit acquired all of the
outstanding capital stock of CMG for approximately $48.7 million in cash and
approximately 739,000 shares of Merit common stock. In connection with Merit's
acquisition of CMG, the Company may be required to make contingent payments to
the former shareholders of CMG if the financial results of certain contracts
exceed specified base-line amounts. Such contingent payments are subject to an
aggregate maximum of $23.5 million.
THE TRANSACTIONS. On February 12, 1998, the Company acquired all of the
outstanding stock of Merit for approximately $448.9 million in cash plus the
repayment of Merit's debt. The Company accounted for the Merit acquisition using
the purchase method of accounting. Merit manages behavioral healthcare programs
for approximately 21.6 million covered lives across all segments of the
healthcare industry, including HMOs, Blue Cross/Blue Shield organizations and
other insurance companies, employers and labor unions, federal, state and local
government agencies, and various state Medicaid programs.
In connection with the consummation of the Merit acquisition, the Company
consummated certain related transactions (together with the Merit acquisition,
collectively, the "Transactions"), as follows: (i) the Company terminated its
existing credit agreement (the "Magellan Existing Credit Agreement"); (ii) the
Company repaid all loans outstanding pursuant to and terminated Merit's existing
credit agreement (the "Merit Existing Credit Agreement"); (iii) the Company
completed a tender offer for its 11 1/4% Series A Senior Subordinated Notes due
2004 (the "Magellan Outstanding Notes"); (iv) Merit completed a tender offer for
its 11 1/2% Senior Subordinated Notes due 2005 (the "Merit Oustanding Notes");
(v) the Company entered into a new senior secured bank credit agreements (the
"New Credit Agreement") with The Chase Manhattan Bank and a syndicate of
financial institutions, providing for credit facilities of $700.0 million; and
(vi) the Company issued its 9% Senior Subordinated Notes due 2008 (the "Old
Notes") pursuant to an indenture, dated February 12, 1998, between the Company
and Marine Midland Bank, as Trustee (the "Indenture"). The Company has initiated
an exchange offer, expiring on November 9, 1998, in which it is offering to
exchange its 9% Series A Senior Subordinated Notes (the "New Notes") for the Old
Notes. The Old Notes and the New Notes are collectively referred to hereinafter
as the "Notes."
The New Credit Agreement provides for (a) a term loan facility in an
aggregate principal amount of $550 million (the "Term Loan Facility"),
consisting of an approximately $183.3 million Tranche A Term
5
Loan (the "Tranche A Term Loan"), an approximately $183.3 million Tranche B Term
Loan (the "Tranche B Term Loan") and an approximately $183.3 million Tranche C
Term Loan (the "Tranche C Term Loan") and (b) a revolving credit facility
providing for revolving loans to the Company and the "Subsidiary Borrowers" (as
defined therein) and the issuance of letters of credit for the account of the
Company and the Subsidiary Borrowers in an aggregate principal amount (including
the aggregate stated amount of letters of credit) of $150 million (the
"Revolving Facility").
The following table sets forth the sources and uses of funds for the
Transactions (in thousands):
Sources:
Cash and cash equivalents...................................... $ 59,290
New Credit Agreement:
Revolving Facility (1)....................................... 20,000
Term Loan Facility........................................... 550,000
The Old Notes.................................................. 625,000
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Total sources.............................................. $1,254,290
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Uses:
Cash paid to Merit Shareholders................................ $ 448,867
Repayment of Merit Existing Credit Agreement (2)............... 196,357
Purchase of the Magellan Outstanding Notes (3)................. 432,102
Purchase of Merit Outstanding Notes (4)........................ 121,651
Transaction costs (5).......................................... 55,313
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Total uses................................................. $1,254,290
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(1) The Revolving Facility provides for borrowings of up to $150.0 million. At
February 12, 1998, the Company had approximately $112.5 million available
for borrowing pursuant to the Revolving Facility, excluding approximately
$17.5 million of availability reserved for certain letters of credit.
(2) Includes principal amount of $193.6 million and accrued interest of $2.7
million.
(3) Includes principal amount of $375.0 million, tender premium of $43.4 million
and accrued interest of $13.7 million.
(4) Includes principal amount of $100.0 million, tender premium of $18.9 million
and accrued interest of $2.8 million.
(5) Transaction costs include, among other things, expenses associated with the
tender offers for the Magellan Outstanding Notes and the Merit Outstanding
Notes, the Old Notes offering, the Merit acquisition and the New Credit
Agreement.
6
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT RATIOS AND PER SHARE DATA)
DIVESTED
OPERATIONS-- MERIT/CMG MERIT/CMG
MAGELLAN CRESCENT PRO FORMA PRO FORMA PRO FORMA PRO FORMA
AS REPORTED TRANSACTIONS HAI ALLIED ADJUSTMENTS COMBINED MERIT CMG ADJUSTMENTS COMBINED
----------- ------------ -------- -------- ----------- --------- -------- -------- ----------- ----------
Net
revenue... $1,210,696 $(555,324) $116,736 $143,889 $41,578(1) $957,575 $555,717 $101,356 $(13,042)(9) $644,031
----------- ------------ -------- -------- ----------- --------- -------- -------- ----------- ----------
Salaries,
cost of
care and
other
operating
expenses... 978,513 (426,862) 88,002 137,873 (7,797)(2) 769,729 504,510 99,434 (18,075)(10) 585,869
Bad debt
expense... 46,211 (42,720) 0 0 0 3,491 0 0 0 0
Depreciation
and
amortization... 44,861 (20,073) 312 362 6,164(3) 31,626 39,400 1,987 2,365(11) 43,752
Interest,
net..... 45,377 (3,233) (1,604) (725) (6,833)(4) 32,982 21,566 (516) 4,390(12) 25,440
Stock
option
expense... 4,292 0 0 0 0 4,292 0 0 0 0
Equity in
loss of
CBHS.... 8,122 0 0 0 12,028(5) 20,150 0 0 0 0
Loss on
Crescent
Transactions... 59,868 0 0 0 (59,868)(6) 0 0 0 0 0
Unusual
items... 357 (2,500) 0 0 5,388(7) 3,245 8,239 1,200 (6,925)(13) 2,514
----------- ------------ -------- -------- ----------- --------- -------- -------- ----------- ----------
1,187,601 (495,388) 86,710 137,510 (50,918) 865,515 573,715 102,105 (18,245) 657,575
----------- ------------ -------- -------- ----------- --------- -------- -------- ----------- ----------
Income
(loss)
before
income
taxes
and
minority
interest... 23,095 (59,936) 30,026 6,379 92,496 92,060 (17,998) (749) 5,203 (13,544)
Provision
for
(benefit
from)
income
taxes... 9,238 (23,974) 11,480 0 39,550(8) 36,294 (4,126) (443) 2,095(14) (2,474)
----------- ------------ -------- -------- ----------- --------- -------- -------- ----------- ----------
Income
(loss)
before
minority
interest... 13,857 (35,962) 18,546 6,379 52,946 55,766 (13,872) (306) 3,108 (11,070)
Minority
interest... 9,102 0 0 0 0 9,102 0 0 0 0
----------- ------------ -------- -------- ----------- --------- -------- -------- ----------- ----------
Net income
(loss)... $ 4,755 $ (35,962) $ 18,546 $ 6,379 $52,946 $ 46,664 $(13,872) $ (306) $ 3,108 $(11,070)
----------- ------------ -------- -------- ----------- --------- -------- -------- ----------- ----------
----------- ------------ -------- -------- ----------- --------- -------- -------- ----------- ----------
Average
number
of
common
shares
outstanding--basic... 28,781 28,781
----------- ---------
----------- ---------
Average
number
of
common
shares
outstanding--diluted... 29,474 29,474
----------- ---------
----------- ---------
Net income
(loss)
per
common
share--basic... $ 0.17 $ 1.62
----------- ---------
----------- ---------
Net income
(loss)
per
common
share--diluted... $ 0.16 $ 1.58
----------- ---------
----------- ---------
THE
TRANSACTIONS
PRO FORMA PRO FORMA
ADJUSTMENTS CONSOLIDATED
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Net
revenue... $ 0 $1,601,606
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Salaries,
cost of
care and
other
operating
expenses. 5,567(15) 1,361,165
Bad debt
expense... 0 3,491
Depreciati
and
amortiza (7,262)(16) 68,116
Interest,
net..... 36,670(17) 95,092
Stock
option
expense... 0 4,292
Equity in
loss of
CBHS.... 0 20,150
Loss on
Crescent
Transact 0 0
Unusual
items... (1,314)(19) 4,445
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33,661 1,556,751
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Income
(loss)
before
income
taxes
and
minority
interest (33,661) $ 44,855
Provision
for
(benefit
from)
income
taxes... (9,699)(20) 24,121
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Income
(loss)
before
minority
interest (23,962) 20,734
Minority
interest.. (6,835)(21) 2,267
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Net income
(loss)... $(17,127) $ 18,467
------------ ------------
------------ ------------
Average
number
of
common
shares
outstand 2,832(21) 31,613
------------ ------------
------------ ------------
Average
number
of
common
shares
outstand 2,832(21) 32,306
------------ ------------
------------ ------------
Net income
(loss)
per
common
share--b $ 0.58
------------
------------
Net income
(loss)
per
common
share--d $ 0.57
------------
------------
See Notes to Unaudited Pro Forma Consolidated Statements of Operations
7
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED JUNE 30, 1998
(IN THOUSANDS, EXCEPT RATIOS AND PER SHARE DATA)
THE TRANSACTIONS
MAGELLAN PRO FORMA PRO FORMA PRO FORMA PRO FORMA
AS REPORTED HAI ALLIED ADJUSTMENTS COMBINED MERIT ADJUSTMENTS CONSOLIDATED
------------- ------- ------- ----------- ----------- -------- ---------------- --------------
Net revenue............. $1,063,099 $19,528 $30,945 $(2,143)(1) $1,111,429 $262,630 $ 0 $1,374,059
------------- ------- ------- ----------- ----------- -------- ------- --------------
Salaries, cost of care
and other operating
expenses.............. 909,353 15,031 31,068 (1,392)(2) 954,060 241,084 (1,893)(15) 1,193,251
Bad debt expense........ 2,972 0 0 0 2,972 0 0 2,972
Depreciation and
amortization.......... 37,649 34 100 1,075(3) 38,858 16,159 (2,506)(16) 52,511
Interest, net........... 49,336 (256) (92) 1,816(4) 50,804 8,870 14,312(17) 73,986
Stock option expense.... (3,527) 0 0 0 (3,527) 0 0 (3,527)
Managed Care integration
costs................. 12,314 0 0 (2,729)(18) 9,585 0 (9,585)(18) 0
Equity in loss of
CBHS.................. 24,221 0 0 0 24,221 0 0 24,221
Unusual items........... (3,000) 0 0 3,000(7) 0 1,318 (1,318)(19) 0
------------- ------- ------- ----------- ----------- -------- ------- --------------
1,029,318 14,809 31,076 1,770 1,076,973 267,431 (990) 1,343,414
------------- ------- ------- ----------- ----------- -------- ------- --------------
Income (loss) before
income taxes and
minority interest..... 33,781 4,719 (131) (3,913) 34,456 (4,801) 990 30,645
Provision for (benefit
from) income taxes.... 15,972 1,879 0 (1,617)(8) 16,234 (786) 1,765(20) 17,213
------------- ------- ------- ----------- ----------- -------- ------- --------------
Income (loss) before
minority interest..... 17,809 2,840 (131) (2,296) 18,222 (4,015) (775) 13,432
Minority interest....... 5,063 0 0 0 5,063 0 (2,606)(21) 2,457
------------- ------- ------- ----------- ----------- -------- ------- --------------
Net income (loss)....... $ 12,746 $ 2,840 $ (131) $(2,296) $ 13,159 $ (4,015) $ 1,831 $ 10,975
------------- ------- ------- ----------- ----------- -------- ------- --------------
------------- ------- ------- ----------- ----------- -------- ------- --------------
Average number of common
shares
outstanding--basic.... 30,505 30,505 1,090(21) 31,595
------------- ----------- ------- --------------
------------- ----------- ------- --------------
Average number of common
shares
outstanding--diluted... 31,099 31,099 1,090(21) 32,189
------------- ----------- ------- --------------
------------- ----------- ------- --------------
Net income per common
share--basic.......... $ 0.42 $ 0.43 $ 0.35
------------- ----------- --------------
------------- ----------- --------------
Net income per common
share--diluted........ $ 0.41 $ 0.42 $ 0.34
------------- ----------- --------------
------------- ----------- --------------
See Notes to Unaudited Pro Forma Consolidated Statements of Operations
8
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
(1) Adjustments to net revenue for the year ended September 30, 1997 represent
Franchise Fees of $55.5 million for the 259 days ended June 16, 1997 (prior
to consummation of the Crescent Transactions) less a $13.9 million decrease
in HAI revenue resulting from renegotiated contractual rates with Aetna as a
direct result of the acquisition of HAI by the Company. Adjustment to net
revenue for the nine months ended June 30, 1998 represents the effect of
renegotiated contractual rates with Aetna for the two months prior to
consummation of the HAI acquisition.
The pro forma presentation assumes that all Franchise Fees due from CBHS are
collectible. Based on operational projections prepared by CBHS management
for the quarter ended September 30, 1998, and for the fiscal year ended
September 30, 1999, and on CBHS' results of operations through June 30,
1998, the Company believes that CBHS will be unable to pay the full amount
of the Franchise Fees it is contractually obligated to pay the Company
during fiscal 1998 and fiscal 1999. CBHS has paid $30.6 million of Franchise
Fees to the Company during the nine months ended June 30, 1998. As of June
30, 1998, the Company had Franchise Fees receivable from CBHS, net of equity
in loss of CBHS in excess of the Company's investment in CBHS, of
approximately $13.2 million reflected in the consolidated balance sheet. The
Company expects to receive additional Franchise Fee payments from CBHS of
$9.4 million to $14.4 million during the quarter ended September 30, 1998,
in the form of cash payments and settlements of other amounts due to CBHS.
The Company also estimates that CBHS will be able to pay $15.0 million to
$25.0 million of Franchise Fees in fiscal 1999. Accordingly, the Company
believes the Franchise Fees receivable from CBHS, net of equity in loss of
CBHS in excess of the Company's investment in CBHS, at June 30, 1998, is
fully collectible. However, the Company may reflect Franchise Fee revenue in
its statements of operations for future periods which is lower in amount
than that specified in the Master Franchise Agreement if CBHS does not
generate sufficient cash flows to allow for payment of future Franchise
Fees. Based on the amount of unpaid Franchise Fees to date, the Company
exercised, in the fourth quarter of fiscal 1998, certain rights available to
it under the Master Franchise Agreement and assisted CBHS management in
formulating and enacting a plan designed to improve profitability.
(2) Adjustments to salaries, cost of care and other operating expenses represent
the following (in thousands):
NINE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, JUNE 30,
TRANSACTION DESCRIPTION 1997 1998
- ----------- --------------------------------------------- -------------------- -----------
Crescent Fees payable to CBHS by the Company for the
management of less than wholly-owned
hospital-based joint ventures controlled by
the Company for the 259 days ended June 16,
1997......................................... $ 7,564 $ --
Crescent Reduction of corporate overhead that was
transferred to CBHS for the 259 days ended
June 16, 1997................................ (2,845) --
HAI Elimination of Aetna overhead allocations.... (17,162) (2,044)
HAI Bonus expense previously reflected in Aetna's
financial statements......................... 1,138 200
HAI Costs absorbed by HAI previously incurred by
Aetna including information technology, human
resources and legal.......................... 5,110 852
9
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
NINE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, JUNE 30,
TRANSACTION DESCRIPTION 1997 1998
- ----------- --------------------------------------------- -------------------- -----------
Allied Reduction of shareholders'/executives'
compensation to revised contractual level
pursuant to the Allied purchase agreement.... (648) (197)
Allied Reduction of certain consulting agreement
costs to revised contractual level pursuant
to the Allied purchase agreement............. (954) (203)
---------- -----------
$ (7,797) $ (1,392)
---------- -----------
---------- -----------
10
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
(3) Adjustments to depreciation and amortization represent the following (in
thousands):
NINE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, JUNE 30,
TRANSACTION DESCRIPTION 1997 1998
- ------------- --------------------------------------------- -------------------- -----------
Crescent Elimination of amortization related to
impaired intangible assets................... $ (177) $ --
HAI Purchase price allocation (i)................ 3,948 676
Allied Purchase price allocation (ii)............... 2,393 399
------- -----------
$ 6,164 $ 1,075
------- -----------
------- -----------
---------------------------------
(i) Represents $4.0 million estimated fair value of property and
equipment depreciated over an estimated useful life of 5 years, $83.3
million of goodwill amortized over an estimated useful life of 40
years and $20.7 million estimated fair value of other intangible
assets (primarily client lists) amortized over an estimated useful
life of 15 years less historical depreciation and amortization.
(ii) Represents $50.7 million of goodwill amortized over an estimated
useful life of 40 years and $16.9 million estimated fair value of
other intangible assets (primarily client lists and treatment
protocols) amortized over an estimated useful life of 15 years.
The allocation of the HAI and Allied purchase prices to goodwill and
identifiable intangible assets and estimated useful lives are based on the
Company's preliminary valuations, which are subject to change upon receiving
independent appraisals for such assets.
Subsequent to the consummation of the HAI acquisition, the Company may be
required to make additional contingent payments of up to $60 million
annually during the five years following the consummation of the HAI
acquisition to Aetna for aggregate potential contingent payments of $300
million. These contingent payments, if any, would be recorded as goodwill
and identifiable intangible assets, which would result in estimated
additional annual amortization of $11 million to $13 million in future
periods if all the contingent payments are made.
The Company may also be required to make contingent payments to the former
owners of Allied of up to $60 million during the three years subsequent to
consummation of the Allied acquisition, of which $20 million is in escrow.
These contingent payments, if any, would be recorded as goodwill, which
would result in estimated additional annual amortization of $1.5 million.
(4) Adjustments to interest, net, represent reductions in interest expense as a
result of the repayment of outstanding borrowings under the Magellan
Existing Credit Agreement with the proceeds from the Crescent Transactions
offset by forgone interest income as a result of using cash on hand to fund
the HAI and Allied acquisitions. The Magellan Existing Credit Agreement had
an outstanding balance of approximately $131.0 million at May 31, 1997
(prior to consummation of the Crescent Transactions). The pro forma interest
expense reduction in fiscal 1997 of approximately $6.8 million represents
actual interest expense related to Magellan's Credit Agreements in effect
during fiscal 1997, or an effective interest rate of 7.3%
(5) Adjustment to equity in loss of CBHS represents the Company's 50% interest
in CBHS' pro forma loss for the 259 day period ended June 16, 1997. The
Company's investment in CBHS is accounted for under the equity method of
accounting. The Condensed Pro Forma Statement of Operations of CBHS for the
year ended September 30, 1997 is as follows (in thousands):
11
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
CBHS
OPERATIONS--
DIVESTED 106 DAYS ENDED PRO FORMA PRO FORMA
OPERATIONS SEPTEMBER 30, 1997 ADJUSTMENTS CONSOLIDATED
----------- -------------------- ------------ -------------
Net revenue.............. $ 555,324 $ 213,730 $ 2,565(i) $ 771,619
----------- ---------- ------------ -------------
Salaries, supplies and
other operating
expenses............... 426,862 210,277 103,723 (ii 740,862
Bad debt expense......... 42,720 17,437 0 60,157
Depreciation and
amortization........... 20,073 668 (17,333) ii) 3,408
Interest, net............ 3,233 1,592 167 (iv 4,992
Unusual items............ 2,500 0 0 2,500
----------- ---------- ------------ -------------
495,388 229,974 86,557 811,919
----------- ---------- ------------ -------------
Income (loss) before
income taxes........... 59,936 (16,244) (83,992) (40,300)
Provision for income
taxes.................. 23,974 0 (23,974)(v) 0
----------- ---------- ------------ -------------
Net income (loss)...... $ 35,962 $ (16,244) $ (60,018) $ (40,300)
----------- ---------- ------------ -------------
----------- ---------- ------------ -------------
----------------------------------------
(i) Fees from the Company for the management of less than
wholly-owned hospital-based joint ventures controlled by the
Company (see note 2) less non-recurring accounts receivable
collection fees receivable from the Company (see note 6) of
approximately $5.0 million during the 106 days ended September
30, 1997.
(ii) Adjustments to salaries, supplies and other operating
expenses represent the following (in thousands):
259 DAYS
ENDED
JUNE 16, 1997
--------------
Franchise Fees (see note 1)................................................ $ 55,463
Rent expense under the Facilities Lease.................................... 44,665
Additional corporate overhead.............................................. 3,595
--------------
$ 103,723
--------------
--------------
(iii) Adjustment to depreciation and amortization represents the
decrease in depreciation expense as a result of the sale of
property and equipment to Crescent by the Company and the
elimination of amortization expense related to impaired
intangible assets.
(iv) Adjustment to interest, net, represents the following (in
thousands):
259 DAYS
ENDED
JUNE 16, 1997
--------------
Interest expense on debt repaid by the Company............................. $ (3,233)
Interest expense for the 259 days ended June 16, 1997 for estimated average
borrowings of $60 million at an assumed interest rate of 8% per annum...... 3,400
--------------
$ 167
--------------
--------------
(v) CBHS is a limited liability company. Accordingly, provision
for income taxes is eliminated as the tax consequences of CBHS
ownership will pass through to the Company and COI.
12
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
(6) Adjustment to loss on Crescent Transactions represents the elimination of
the non-recurring losses incurred by the Company as a result of the Crescent
Transactions as follows (in thousands):
Accounts receivable collection fees(i).................................... $ 21,400
Impairment losses on intangible assets(ii)................................ 14,408
Exit costs and construction obligation(iii)............................... 12,549
Loss on the sale of property and equipment................................ 11,511
---------
$ 59,868
---------
---------
----------------------------------------
(i) Accounts receivable collection fees represent the reduction
in the net realizable value of accounts receivable for
estimated collection fees on hospital-based receivables
retained by the Company. The Company paid CBHS a fee equal to
5% of collections for the first 120 days after consummation of
the Crescent Transactions and estimated bad debt agency fees of
40% for receivables collected subsequent to 120 days after the
consummation of the Crescent Transactions.
(ii) The impairment loss on intangible assets resulted from
reducing the book value of the Company's investment in CBHS to
its approximate fair value at the consummation date of the
Crescent Transactions. The impairment losses represent the
reductions in the carrying amount of goodwill and other
intangible assets related to the divested or contributed CBHS
operations.
(iii) Represents approximately $5.0 million of incremental costs
to perform finance and accounting functions transferred to CBHS
and approximately $7.5 million for the Company's obligation to
replace CBHS' Philadelphia hospital.
(7) Adjustments to unusual items represent the elimination of non-recurring
gains on the sale of psychiatric hospitals.
(8) Adjustments to provision for income taxes represent the tax expense related
to the pro forma adjustments at the Company's historic effective tax rate of
40% and the imputed income tax expense on the operating results of Allied,
which was an S-corporation for income tax purposes and historically did not
provide for income taxes.
(9) Adjustment to net revenue represents the elimination of the fiscal 1997
revenues of Choate Health Management, Inc. ("Choate"), which was sold by
Merit in fiscal 1997.
(10) Adjustment to salaries, cost of care and other operating expenses
represents the elimination of salaries, benefits and other costs of $5.5
million for duplicate CMG personnel and facilities that were eliminated as a
direct result of Merit's acquisition of CMG and the elimination of fiscal
1997 expenses of $12.6 million for Choate, which was sold by Merit in fiscal
1997.
(11) Adjustment to depreciation and amortization represents the effect of
Merit's purchase price allocation related to the CMG acquisition.
(12) Adjustment to interest, net, represents the effect of increased borrowing
by Merit related to the CMG acquisition.
(13) Adjustments to unusual items, net, represents the elimination of
non-recurring losses on Merit's sale of Choate.
(14) Adjustment to provision for income taxes represents the tax effect of the
Merit/CMG pro forma adjustments.
(15) Adjustment to salaries, cost of care and other operating expenses
represents (i) the elimination of fees paid by Merit to its former owner,
(ii) the presentation of Merit's capitalized start-up costs of $6.1 million
and $0.5 million for the fiscal year ended September 30, 1997 and the nine
months ended June 30, 1998, respectively, as other operating expenses to
conform to the Company's accounting policies and (iii) the elimination of
salaries, benefits and other costs of $2.2 million for the nine
13
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
months ended June 30, 1998 for duplicate CMG personnel and facilities that
have been announced as a direct result of Merit's acquisition of CMG. The
adjustment excludes approximately $60.0 million of cost savings on an annual
basis that the Company expects to achieve within eighteen months following
consummation of the Merit acquisition.
(16) Adjustments to depreciation and amortization represent the effect of the
Merit purchase price allocation and the Green Spring Minority Stockholder
Conversion as follows (in thousands):
NINE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, JUNE 30,
1997 1998
-------------- -----------
Estimated fair value of property and equipment of $51.9 million
depreciated over an estimated useful life of 5 years........... $ 10,384 $ 3,894
Estimated goodwill of $641.2 million amortized over an estimated
useful life of 40 years........................................ 16,029 6,011
Estimated fair value of other intangible assets (primarily client
lists and provider networks) of $140.0 million amortized over
an estimated useful life of 15 years........................... 9,333 3,500
-------------- -----------
Total estimated depreciation and amortization.................... 35,746 13,405
Elimination of Merit and CMG historical and pro forma
depreciation and amortization.................................. (43,752) (16,157)
Effect of Green Spring Minority Stockholder Conversion(i)........ 744 246
-------------- -----------
$ (7,262) $ (2,506)
-------------- -----------
-------------- -----------
----------------------------------------
(i) The Green Spring Minority Stockholder Conversion resulted in
approximately $20.5 million of additional intangible assets
(Goodwill of $6.9 million; Client lists of $13.6 million) with
a weighted average useful life of 27.5 years. The additional
intangible assets resulted from the excess of the fair value of
the consideration paid for the Green Spring Minority
Stockholder Conversion ($63.5 million) over the book value of
minority interests purchased.
The allocation of the Merit purchase price to property and
equipment, goodwill and identifiable intangible assets and estimated
useful lives was based on the Company's preliminary valuations,
which are subject to change upon receiving independent appraisals
for such assets.
(17) Adjustments to interest, net, represent the following (in thousands):
NINE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, JUNE 30,
DESCRIPTION 1997 1998
- ------------------------------------------------------- -------------------- ---------------
Elimination of Merit and CMG historical and pro forma
interest expense..................................... $ (29,959) $ (10,536)
Elimination of historical interest expense for the
Magellan Outstanding Notes........................... (42,188) (15,820)
Elimination of the Company's historical deferred
financing cost amortization.......................... (1,214) (914)
Tranche A Term Loan interest expense (i)............... 14,393 5,500
Tranche B Term Loan interest expense (i)............... 14,850 5,672
Tranche C Term Loan interest expense (i)............... 15,308 5,844
Revolving Facility interest expense (i)................ 1,570 600
Foregone interest income--cash proceeds utilized in the
Merit acquisition at 5.5% per annum.................. 3,261 1,223
The Notes at an interest rate of 9.0%.................. 56,250 21,094
14
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
NINE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, JUNE 30,
DESCRIPTION 1997 1998
- ------------------------------------------------------- -------------------- ---------------
Amortization of deferred financing costs of $35.6
million over a weighted average life of approximately
8.1 years............................................ 4,399 1,649
---------- ---------------
$ 36,670 $ 14,312
---------- ---------------
---------- ---------------
----------------------------------------
(i) Assumes borrowings are one-month LIBOR-based, which is
consistent with the Company's past borrowing practices. Average
one-month LIBOR was approximately 5.60% and 5.75% during the
year ended September 30, 1997 and the six months ended March
31, 1998, respectively. Each tranche of the Term Loan Facility
is approximately $183.3 million and the Revolving Facility
borrowing is $20.0 million. Interest rates utilized to compute
pro forma adjustments are as follows:
YEAR ENDED SIX MONTHS ENDED
SEPTEMBER 30, MARCH 31,
1997 1998
----------------------- -------------------
Tranche A Term Loan and Revolving Facility
(LIBOR plus 2.25%).......................... 7.85% 8.00%
Tranche B Term Loan (LIBOR plus 2.50%)........ 8.10% 8.25%
Tranche C Term Loan (LIBOR plus 2.75%)........ 8.35% 8.50%
(18) Adjustments to managed care integration costs represent the elimination of
the expenses incurred by the Company as a direct result of the Merit
acquisition and the Allied acquisition. The Company owns three behavioral
managed care organizations ("BMCOs"), Green Spring, HAI and Merit, as a
result of acquisitions consummated in fiscal 1996 (Green Spring) and fiscal
1996 (HAI and Merit). The Company also owns two other specialty managed care
organizations, Allied and Care Management Resources, Inc. ("CMR").
Management has approved and committed the Company to a plan to combine and
integrate the operations of its BMCOs and other specialty managed care
organizations (the "Integration Plan") that will result in the elimination
of duplicative functions and will standardize business practices and
information technology platforms. The Company expects to achieve
approximately $60 million of cost savings on an annual basis by August 1999
at its BMCOS and approximately $3 million of cost savings on an annual basis
at CMR as a result of integration Plan.
The Integration Plan will result in the elimination of approximately 1,000
positions during fiscal 1998 and fiscal 1999. Approximately 200 employees
had been involuntarily terminated pursuant to the Integration Plan as of
June 30, 1998 and approximately 250 positions have been eliminated by normal
attrition through June 30, 1998. The remaining positions to be eliminated
have been identified, and will be eliminated through a combination of normal
attrition and involuntary termination.
The employee groups of the BMCOs that are primarily affected include
executive management, finance, human resources, information systems and
legal personnel at the various BMCOs corporate headquarters and regional
offices and credentialing, claims processing, contracting and marketing
personnel at various operating locations. The Company expects to complete
the specific identification of all personnel who will be involuntarily
terminated by December 31, 1998 and will complete its involuntary
terminations by April 1999.
The Integration Plan will also result in the closure of approximately 40 to
45 leased facilities at the BMCOs during fiscal 1998 and fiscal 1999. As of
June 30, 1998, 20 offices had been specifically identified for closure and
20 to 25 additional offices are under consideration for closure. The
15
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
Company expects to complete the specific identification of remaining office
closures by December 31, 1998.
The Company has recorded approximately $18.3 million of liabilities related
to the Integration Plan, as of June 30, 1998 of which $11.7 million was
recorded as part of the Merit purchase price allocation and $6.6 million was
recorded in the statement of operations under "Managed Care Integration
costs". These amounts represent those portions of the Integration Plan
obligations that were measurable as of June 30, 1998. The Company expects to
record additional liabilities as a result of the Integration Plan in fiscal
1998 and fiscal 1999 as final decisions regarding office closures and other
contractual obligation terminations are made. The Integration Plan will
result in additional incremental costs that must be expensed as incurred in
accordance with Emerging Issues Task Force Consensus 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to
Exit an Activity (Including Certain Costs Incurred in a Restructuring)" that
are not described above and certain other charges. Other integration costs
include, but are not limited to, outside consultants, costs to relocate
closed officer contents and long-lived asset impairments. Other integration
costs are reflected in the statement of operations under "Managed Care
Integration costs."
During the nine months ended June 30, 1998, the Company incurred
approximately $5.7 million in other integration costs, including long-lived
asset impairments of approximately $2.2 million and outside consulting costs
of approximately $3.1 million. The asset impairments relate primarily to
identifiable intangible assets that no longer have value and have been
written as a result of the Integration Plan.
(19) Adjustments to unusual items represent the following (in thousands):
NINE MONTHS
YEAR ENDED ENDED
DESCRIPTION SEPTEMBER 30, 1997 JUNE 30, 1998
- ------------------------------------------------------- -------------------- ---------------
Elimination of Merit's transaction costs related to
Merit's attempt to acquire HAI....................... $ (733) $ --
Elimination of non-recurring employee benefit costs
related to stock options which were eliminated upon
the consummation of the Transactions................. (581) (57)
Elimination of Merit's transaction costs related
primarily to the Transactions........................ -- (1,261)
-------- ---------------
$ (1,314) $ (1,318)
-------- ---------------
-------- ---------------
(20) Adjustment to provision for income taxes represents the tax benefit related
to Merit/CMG combined and the pro forma adjustments, excluding annual
non-deductible goodwill amortization of $16.1 million related to the Merit
acquisition, at the Company's historic effective tax rate of 40%.
(21) Adjustments to minority interest and average number of common shares
outstanding (basic and diluted) represents the effect of the Green Spring
Minority Stockholder Conversion.
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Dated: October 26, 1998 Magellan Health Services, Inc.
By: /s/ JEFFREY T. HUDKINS
----------------------------------------------------------------------
Jeffrey T. Hudkins
Vice President and Controller
(Principal Accounting Officer)
16