-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PC3/jgCIAEd/7kU+jqOASTl/AAg7XOJ8sa/fdqmg9XhIZwinSKKywF++d9YHrG2Q OJ2btU/u9kpqHq+VdnDw3Q== 0000936392-98-001064.txt : 19980729 0000936392-98-001064.hdr.sgml : 19980729 ACCESSION NUMBER: 0000936392-98-001064 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19980430 FILED AS OF DATE: 19980728 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PMR CORP CENTRAL INDEX KEY: 0000829608 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SPECIALTY OUTPATIENT FACILITIES, NEC [8093] IRS NUMBER: 232491701 STATE OF INCORPORATION: DE FISCAL YEAR END: 0430 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-20488 FILM NUMBER: 98672309 BUSINESS ADDRESS: STREET 1: 501 WASHINGTON ST 5TH FL CITY: SAN DIEGO STATE: CA ZIP: 92103 BUSINESS PHONE: 6192952227 MAIL ADDRESS: STREET 1: 3990 OLD TOWN AVENUE SUITE 206A CITY: SAN DIEGO STATE: CA ZIP: 92110 FORMER COMPANY: FORMER CONFORMED NAME: ZARON CAPITAL INC DATE OF NAME CHANGE: 19891116 10-K405 1 FORM 10-K 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 APRIL 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM __________ TO ___________ COMMISSION FILE NO. 0-20488 PMR CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 23-2491707 State or other jurisdiction of I.R.S. Employer Identification No. incorporation or organization 501 WASHINGTON STREET, 5TH FLOOR 92103 SAN DIEGO, CALIFORNIA (Zip Code) (Address of principal executive offices) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (619) 610-4001 ------------------ SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $.01 PER SHARE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [X] As of July 24, 1998, the approximate aggregate market value of the Common Stock held by non-affiliates of the registrant was $44,582,569, based upon the closing price of the Common Stock reported on the Nasdaq National Stock Market of $9.3125 per share. See footnote (1) below. The number of shares of Common Stock outstanding as of July 24, 1998 was 6,959,810. DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the registrant's definitive Proxy Statement, to be filed not later than 120 days after April 30, 1998 in connection with the registrant's 1998 Annual Meeting of Stockholders, are incorporated by reference into Part III of this Form 10-K. - ----------- (1) The information provided shall in no way be construed as an admission that any person whose holdings are excluded from the figure is not an affiliate or that any person whose holdings are included is an affiliate and any such admission is hereby disclaimed. The information provided is included solely for record keeping purposes of the Securities and Exchange Commission. 2 PART I ITEM 1. BUSINESS GENERAL Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include without limitation, those discussed in the description of the Company's business below and the section entitled "Risk Factors," in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Annual Report, as well as those discussed in documents incorporated herein by reference. OVERVIEW PMR Corporation and its subsidiaries ("PMR" or the "Company") is a leading manager of specialized mental health care programs and disease management services designed to treat individuals diagnosed with a serious mental illness ("SMI"), primarily schizophrenia and bi-polar disorder (i.e., manic-depressive illness). PMR manages the delivery of a broad range of outpatient and community-based psychiatric services for SMI patients, consisting of 37 intensive outpatient programs (the "Outpatient Programs"), two case management programs (the "Case Management Programs") and four chemical dependency and substance abuse programs (the "Chemical Dependency Programs"). In June 1998, the Company announced an agreement to form a new company to be called Stadt Solutions, LLC ("Stadt Solutions") that will be jointly owned by the Company and Stadtlander Drug Distribution Co., Inc. ("Stadtlander"). Stadt Solutions will offer a specialty pharmacy program for individuals with an SMI, initially serving approximately 6,000 individuals through fourteen pharmacies in thirteen states. PMR, with Stadt Solutions, will operate in twenty-three states and is expected to employ or contract with more than 400 mental health and pharmaceutical industry professionals and currently provides services to approximately 11,000 individuals diagnosed with SMI. PMR believes it is the only private sector company focused on providing an integrated mental health disease management model to the SMI population. A four-decade old public policy trend of de-institutionalizing the mentally ill from long-term care hospitals into the community has resulted in a deterioration in SMI patient care. In response to this trend, a fragmented, community-based system of care has evolved that does not adequately provide the patient management or coordination of benefits required by the medically complex SMI patient population. SMI patients typically enter the health care system through multiple, uncoordinated points of care where services are provided in reaction to patient crises rather than proactively to manage patient care. Multiple physicians, case workers and other care providers handle patients in various sites across the spectrum of care with little or no coordination. This disjointed system of care results in low levels of patient monitoring and medication compliance among the SMI population, which increases the incidence rate of high-cost catastrophic events. Coordination and monitoring of patient services is essential to avoid the debilitating effects of fragmented care delivered by diverse outpatient providers which are reimbursed by disparate, uncoordinated funding sources. PMR's clinical philosophy focuses on improving outcomes and lowering costs by utilizing intensive, community-based treatment of the SMI population in outpatient settings. PMR's Outpatient Programs serve as a comprehensive alternative to inpatient hospitalization and include partial hospitalization and lower intensity outpatient services. The Case Management Programs provide an intensive, individualized primary care service which consists of a proprietary case management model utilizing clinical protocols for delivering care to SMI patients. The Company also provides Chemical Dependency Programs to patients affiliated with managed care organizations and government-funded programs. During fiscal 1998, the Company continued to establish the initial infrastructure and relationships for its site management and clinical information initiative. The Company believes that its access to a large SMI patient base provides it with a unique opportunity to collect, process and analyze clinical and pharmacoeconomic data on schizophrenia and bi-polar disorder. In January 1997, PMR entered into a collaborative agreement with United HealthCare Corporation and its Applied HealthCare Informatics division ("Applied Informatics") to assist in 2. 3 developing this initiative. In November 1997, the Company established a strategic relationship with InSite Clinical Trials to assist in the training and development of clinical research sites. In June 1998, PMR entered into an agreement with Stadtlander to form Stadt Solutions and to contribute the site management and clinical information initiative to the new venture. PMR's objective is to be the leader in the management of cost-effective programs which provide quality care and foster the successful recovery of individuals from the devastating effects of SMI. The Company intends to achieve this objective by (i) obtaining new contracts for its Outpatient and Case Management Programs, (ii) expanding Stadt Solutions, a new specialty pharmacy program, (iii) establishing new programs and ancillary services, and (iv) combining its outpatient, case management and chemical dependency capabilities into a fully-integrated mental health disease management model. PMR believes that its proprietary mental health disease management model will position it to accept risk for SMI benefits and directly manage the costs associated with providing care to the SMI population. PMR was incorporated in the State of Delaware in 1988. The operations of the Company include the operations of the Company's wholly owned subsidiaries, Psychiatric Management Resources, Inc., Collaborative Care Corporation, Collaborative Care, Inc., and PMR-CD, Inc. The principal executive offices of the Company are located at 501 Washington Street, 5th Floor, San Diego, California 92103. The Company's telephone number is (619) 610-4001. THE MARKET AND INDUSTRY BACKGROUND According to the National Institute of Mental Health (the "NIMH") and its National Advisory Mental Health Council (the "NAMHC"), serious mental illnesses are neurobiological disorders of the brain and include schizophrenia, schizoaffective disorder, manic-depressive illness and autism, as well as severe forms of other disorders such as major depression, panic disorder and obsessive-compulsive disorder. These diseases are chronic and represent one of the highest cost segments of the health care system. Industry sources indicate that approximately 2.8% of the adult population and 3.2% of children ages 9-17 are affected by SMI, for a total SMI population in the United States of approximately 5.6 million people. According to industry sources, in 1995, individuals diagnosed with SMI consumed $27 billion in direct medical costs relating to the provision of mental health services and consumed more than $74 billion in total costs, including estimates of lost productivity. Based on industry data, the Company estimates that the direct medical expenditures associated with SMI represent in excess of 25% of total direct mental health care costs. However, the potential costs of direct medical care may exceed these levels due to the approximately 2.2 million Americans estimated to be suffering from untreated SMI. Substantially all costs of treating and managing the SMI population are borne by federal, state and local programs, including Medicare and Medicaid. The SMI population accesses care primarily through community mental health centers ("CMHCs") and other community-based health care facilities such as psychiatric and acute care hospitals and nursing homes. CMHCs typically are not-for-profit organizations which lack access to capital, sophisticated management information and financial systems, and comprehensive programs for treating SMI patients. Since 1955, the SMI population in the United States has experienced extensive de-institutionalization resulting in the public psychiatric hospital census declining from approximately 560,000 individuals in 1955 to approximately 72,000 individuals in 1994. The effect of de-institutionalization is exacerbated by the fact that the general population grew 58% over this same period, while the SMI incidence rate remained stable. Industry sources estimate that there are approximately 763,000 individuals in the United States currently diagnosed with SMI who otherwise would have received inpatient treatment prior to de-institutionalization, of which 60%-75% are patients with schizophrenia or bi-polar disorder. The result of this trend has been increased rates of transinstitutionalism and homelessness among SMI patients. Transinstitutionalism is a term utilized to describe the mechanism by which de-institutionalized individuals receive care in one or more alternate settings such as nursing homes, general hospitals, jails and prisons. Industry estimates indicate that 23% of nursing home residents have a mental disorder and that more than 98,000 acute care hospital beds are occupied by SMI patients. Furthermore, approximately 10% of all prison and jail inmates are SMI diagnosed and 35% of the approximately 350,000 homeless individuals in the United States are currently suffering from SMI disorders. The most frequently occurring primary diagnosis of the SMI population treated by PMR is schizophrenia, an incurable biological disorder which affects approximately 1% of the general population. Approximately 70% of 3. 4 the patients treated at the Company's programs are diagnosed with schizophrenia or schizoaffective disorder. The remainder are afflicted with bi-polar disorder, major depression, or other personality disorders. Industry sources indicate that up to 50% of patients suffering from schizophrenia receive no treatment for symptoms. In addition, due to the stigma and social constraints that accompany schizophrenia, 25% of schizophrenics attempt to end their lives through suicide. In general, each year a significant percentage of individuals with schizophrenia are admitted for an inpatient hospitalization and virtually all of the diagnosed population is prescribed a chronic medication regimen. It is not uncommon that these individuals also suffer from a substance abuse or chemical dependency diagnosis. Based on industry data, the Company estimates that schizophrenia consumes approximately $20 billion in annual mental health care expenditures. The direct medical costs of schizophrenia are consumed primarily in CMHCs, nursing homes and acute care hospitals. Since the introduction of Clozaril in the United States in 1989, several pharmaceutical products have been developed for SMI patients that have resulted in significant improvements in treatment. Although the specific biological causes of SMI remain unknown, the efficacy of many treatment regimens has been found to be comparable to that in other branches of medicine. For example, with the exception of autism, medications exist which generate medical responses in 60%-90% of patients with SMI. For schizophrenia and schizoaffective disorder, research has shown that standard anti-psychotic medication will reduce psychotic symptoms in 60% of patients and in 70%-85% of those experiencing symptoms for the first time. These newer medications, with proper compliance, offer significant potential for recovery to individuals afflicted with SMI. PROGRAMS AND OPERATIONS OUTPATIENT PROGRAMS PMR's Outpatient Programs are operated under management or administrative contracts with acute care hospitals, psychiatric hospitals and CMHCs, and consist principally of intensive outpatient programs which serve as alternatives to inpatient care. These programs target patients in crisis or those recovering from crisis and thus provide more intensive clinical services than those generally available in a traditional outpatient setting. The Company currently manages 37 Outpatient Programs in Arizona, Arkansas, California, Colorado, Hawaii, Illinois, Kentucky, Michigan, North Carolina, Ohio, Tennessee, Texas and Washington. The Company contracts with 27 separate providers including Scripps Health, Sutter Health System, St. Luke's Hospital of San Francisco and the University of California, Irvine. Typically, the Company's contracts are two to five years in length. While contract expirations occur from time to time in the ordinary course of business, the Company vigorously attempts to extend and renew existing contracts and to maintain its market share through the addition of new contracts. The Outpatient Programs consist principally of psychiatric partial hospitalization programs which are ambulatory in nature and provide intensive, coordinated clinical services to patients diagnosed with SMI. In 1996, the Company introduced its structured outpatient clinic which is a lower intensity "step-down" outpatient service designed to continue the care, maintain the gains achieved and prevent the relapse of patients who have completed the partial hospitalization program. To further expand the Company's potential client population, in August 1997, the Company broadened its structured outpatient program to include clients who are at a lower level of clinical risk. Patients admitted to the Outpatient Programs undergo a complete assessment and treatment planning process that includes psychiatric, psycho-social, medical and other specialized evaluations. Each SMI individual is assigned a care coordinator responsible for managing the comprehensive treatment available to the patient, which includes specialty services for geriatric and dually diagnosed patients. All Outpatient Programs provide programming five or six days a week. Treatments include daily group psychotherapy and individual therapy conducted by therapists, nurses and mental health specialists who are supervised by the appropriate department of the hospital or CMHC and by senior clinical managers in the programs. In Outpatient Programs where the Company retains designated staffing responsibilities, the Company provides program administrators, and medical directors, and may provide nurses, community liaisons and other clinical personnel. In these cases, the program administrator generally has a degree in psychology or social work and several years of experience in health care administration. Typically, the medical director is a board-eligible or certified psychiatrist and the other professionals have various levels of training in nursing, psychology or social work. 4. 5 Through its Outpatient Programs, the Company brings management expertise to the health care provider with respect to the establishment, development and operation of an outpatient program for SMI patients that is not usually available on an in-house basis. Services provided under Outpatient Program management contracts include complete program design and administration from start-up through ongoing program operation. These programs are intended to enhance the delivery of outpatient mental health services by introducing proprietary clinical protocols and procedures, conducting quality assurance and utilization reviews, advising on compliance with government regulations and licensure requirements, supplying highly trained personnel, and expanding the range of services provided. In addition, the programs also enhance the management of financial and administrative services by providing support to the providers and performing budget, financial and statistical analyses designed to monitor facility performance. The Company believes these comprehensive features enhance the efficiency and quality of care provided by its Outpatient Programs. CASE MANAGEMENT PROGRAMS PMR's Case Management Programs were created in 1993 to treat the SMI population in a managed care environment. The case management model was developed in part from proprietary clinical protocols and assessment tools which were purchased in 1993 from leading researchers in the field of psychiatric rehabilitation. Specifically, the Company's programs provide SMI individuals with personalized, one-on-one services designed to stabilize their daily lives and provide early intervention in crisis situations, thereby limiting the catastrophic events which lead to inpatient hospitalizations. The Case Management Programs utilize comprehensive protocols based upon a specific model of intensive service coordination in conjunction with a case manager whose responsibilities include consumer education, the development of crisis plans, responding to crisis events, linking patients to emergency services, assessing patient needs, reviewing patient treatment plans, and authorizing and reviewing services. Case management services vary by market and need of the population and may include 24-hour case management, crisis intervention, respite services, housing assistance, medication management and routine health screening. PMR believes that its Case Management Programs represent the core clinical tool for managing the SMI population in either a capitated or fee-for-service environment and enable its patients to live more healthy, independent, productive and satisfying lives in the community. PMR offers its case management services through long-term exclusive management agreements with leading independent case management agencies or CMHCs. Pursuant to those agreements, the Company contributes its proprietary protocols and management expertise and, when necessary, negotiates case management rates and contracts on behalf of the providers. The Company also provides training, management information systems support, and accounting and financial services. Presently, the Company has management agreements with two case management agencies in Tennessee. PMR provides its Case Management services principally in Davidson County, Tennessee, presently serving approximately 2,200 consumers located primarily in Nashville, Tennessee. The Company is in the process of terminating or substantially restructuring its relationship with a case management agency in Memphis due to contractual disputes and differences in operating philosophy. During fiscal 1998, the Company reached agreement with its CMHC providers in Arkansas to terminate Case Management services due to the repeated delays in transitioning the Arkansas Medicaid program to a managed care environment. In 1998, the Company introduced an additional service in Tennessee, known as Urgent Care. Urgent Care is a high acuity, crisis intervention service designed for triage and stabilization of a patient at the time of highest clinical need. The service involves a physician intervention and thus combines a medical model at crises and assessment with the case management model for on-going maintenance. The Company anticipates introducing this service into additional markets in Tennessee in fiscal 1999. CHEMICAL DEPENDENCY PROGRAMS Through a wholly-owned subsidiary, the Company operates and manages programs devoted exclusively to substance abuse and rehabilitation in ambulatory settings, primarily to patients of managed care organizations in Southern California. The Company's chemical dependency and substance abuse programs are operated both as free-standing treatment services or as part of a Management Services Agreement with health care providers. All programs have received accreditation by the Joint Commission of American Health Organizations ("JCAHO"). 5. 6 The Company also offers chemical dependency programs that have been specially developed with application to public sector clients. Public sector clients with chemical dependency problems often are also dually diagnosed with a mental illness. Bridging the gap between the two systems (i.e. chemical abuse and mental health) is often difficult due to different funding streams, treatment philosophies and regulations pertaining to Medicaid and other public sector payors. Meeting the needs of the public sector dually diagnosed client requires cross training of staff and development of linkage between traditional chemical dependency providers and providers of behavioral health services. The Company operates four outpatient programs in southern California under the name of Twin Town Treatment. SITE MANAGEMENT AND CLINICAL INFORMATION In January 1997, the Company began the development of a site management and clinical information division. This division seeks to participate in clinical trials and collect clinical information related to pharmaceutical and non-pharmaceutical clinical practice. The Company's objective is to build a business model that contributes to the Company's revenues and earnings and to develop an information asset that can improve and define "best practices" for the SMI patient population. On January 24, 1997, the Company signed an agreement with the Applied Healthcare Informatics division of United Healthcare with respect to developing this business. The Company believes that its expanding service base is an excellent platform for the development of research and clinical information business lines. Key to that assumption is the Company's direct access to a large number of individuals with SMI. Presently, the Company believes that it has access, through programs it manages and through contracts providers, to more than 20,000 individuals diagnosed with SMI. In November 1997 the Company signed an agreement with Insite Clinical Trials, Inc. for the specific development and training of Company sites for participation in clinical trials, as well as the marketing of those sites to sponsors of clinical trials. InSite Clinical Trials is now a wholly owned subsidiary of United Healthcare, Inc. The genetic and neurobiological bases of severe mental disorders will continue to be the focus of intensive research attention in the field. Presently, numerous pharmaceutical companies and drug development companies have compounds in various stages of development which are targeted for the treatment of these disorders. The development of these compounds requires extensive pre-clinical and clinical testing phases, many aspects of which are outsourced to global contract research organizations ("CROs"). The Company's current research network includes six locations with qualified investigators and study coordinators. The Company plans to expand the network to between ten and twelve locations by the end of fiscal 1999. The Company anticipates that the site management and clinical information initiative will be contributed to Stadt Solutions as part of the venture between the Company and Stadtlander. STADT SOLUTIONS The Company and Stadtlander have entered into a binding subscription agreement to form Stadt Solutions, a Delaware limited liability company. Stadt Solutions will offer specialty pharmaceutical services to individuals with SMI. The joint venture will also offer site management and clinical information services to pharmaceutical companies, health care providers and public sector purchasers. It is expected that ownership of Stadt Solutions will be held 50.1% by PMR and 49.9% by Stadtlander. Following formation, Stadtlander will be entitled to receive a priority distribution approximately equivalent to the operating income Stadtlander expected to be generated by Stadtlander's existing base of approximately 6,000 clients whom the parties expect will choose to receive services from the venture. The incremental operating income in excess of this base, if any, will be distributed equally to the Company and Stadtlander. The venture will commence business with operations serving clients through fourteen pharmacies in thirteen states serving approximately 6,000 clients. These individuals are presently receiving the drug clozaril, an anti-psychotic for schizophrenia, as well as blood monitoring services. Stadt Solutions will seek to offer patients expanded services, including dispensing of all of the pharmaceuticals needed by these individuals and providing disease management services to improve compliance and education for the patient, the physician and family 6. 7 members. The Company believes that Stadt Solutions will be the first specialty pharmacy company devoted to serving the needs of individuals with an SMI. PROGRAM LOCATIONS
LOCATION (STATE, CITY) SERVICE PROVIDED - ------------------------------------- ---------------- California San Diego Outpatient, Clinical Research Culver City Outpatient Santee Outpatient San Francisco Outpatient Los Angeles Outpatient Studio City Outpatient Oakland Outpatient Santa Ana Outpatient Vista Outpatient Union City Outpatient Riverside Outpatient San Bernardino Outpatient Rosemead Outpatient Sacramento Outpatient, Clinical Research Orange Outpatient, Chemical Dependency San Jose Outpatient La Jolla Outpatient Burbank Chemical Dependency Los Alamitos Chemical Dependency Torrance Chemical Dependency Encinitas Clinical Research Alabama Birmingham Pharmacy* Arizona Phoenix Outpatient Tempe Outpatient Arkansas Little Rock Outpatient (2), Clinical Research Colorado Denver Outpatient (2) Georgia Atlanta Pharmacy* Hawaii Honolulu Outpatient, Pharmacy* Illinois Chicago Outpatient, Pharmacy* Kentucky Frankfort Outpatient Bowling Green Outpatient Mayfield Outpatient Maine Portland Pharmacy* Massachusetts Boston Pharmacy* Michigan Detroit Outpatient (2), Clinical Research Minnesota Minneapolis Pharmacy* Missouri St. Louis Pharmacy* New York Long Island Pharmacy* North Carolina Charlotte Outpatient Ohio Cleveland Outpatient Pennsylvania Pittsburgh Pharmacy* Philadelphia Pharmacy* South Carolina Columbia Pharmacy* Tennessee Kingsport Outpatient Madison Outpatient Nashville Outpatient, Case Management, Clinical Research Memphis Case Management Texas Austin Outpatient Utah Salt Lake City Pharmacy* Washington Bellevue Outpatient
7. 8
LOCATION (STATE, CITY) SERVICE PROVIDED - ------------------------------------- ---------------- Seattle Pharmacy*
- ---------- * Anticipated service and location upon formation of Stadt Solutions. CONTRACTS OUTPATIENT PROGRAMS Each Outpatient Program is generally administered and operated pursuant to the terms of written management or administrative contracts with providers. These contracts generally govern the term of the program, the method by which the program is to be managed by the Company, the responsibility of the provider for licensure, billing, insurance and the provision of health care services, and the methods by which the Company will be compensated. The contracts are generally for a stated term between two and five years. Generally, contracts may only be terminated with cause or upon the occurrence of certain material events including changes in applicable laws, rules or regulations. Revenues derived by the Company under these contracts generally fit within three types of arrangements: (i) an all-inclusive fee arrangement based on fee-for-service rates which provides that the Company is responsible for substantially all program costs; (ii) a fee-for-service arrangement whereby substantially all program costs are the responsibility of the provider; and (iii) a fixed fee arrangement. The all-inclusive arrangements were in effect at 34 of the 39 Outpatient Programs operated during fiscal 1998 and constituted approximately 62.4% of the Company's revenues for the year ended April 30, 1998. Typical contractual agreements with these providers, primarily acute care hospitals or CMHCs, require the Company to provide, at its own expense, specific management personnel for each program site. Regardless of the type of arrangement with the provider, all medical services rendered in the programs are provided by the provider. A significant number of the Company's contracts require the Company to indemnify the provider for some or all of the management fee paid to the Company if either third-party reimbursement for mental health services provided to patients of the programs is denied or if the management fee paid to the Company is not reimbursable by Medicare. See "Risk Factors -- Dependence Upon Medicare Reimbursement," "-- Sufficiency of Existing Reserves to Cover Reimbursement Risks," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Regulatory Matters." In February 1998, the Company announced that Scripps Health had received a letter from an official at Region IX of HCFA, informing Scripps Health that its partial hospitalization programs managed by the Company could no longer be considered "provider based" for Medicare reimbursement purposes. In July 1998, HCFA notified Scripps Health that certain of the programs are approved as "provider based" and that certain other program locations are not "provider based" because they did not meet HCFA's service area requirements. As a result of HCFA's notice, the Company and Scripps Health amended their contract, Scripps Health reconfigured certain of its partial hospitalization programs and one of the locations was acquired by another provider who engaged the Company to manage the program. While to the Company's knowledge, no other Company programs have received provider based challenges to date, it is possible that these challenges will emerge with other providers and that the Company may not be able to amend its contracts to satisfy HCFA or its provider customers. As the Outpatient Programs mature and increase in number, the Company anticipates that as a matter of normal business development, contract terminations may occur on a periodic basis. In the past, if a contract was terminated, the Company has been successful in contracting with another provider in the program's geographic area. There can be no assurance that the Company will be able to successfully replace such terminated contracts or programs in the future. The Company's Outpatient Program contracts covering sites operated by hospitals operating under Scripps Health, a San Diego provider, accounted for approximately 13.9% and 12.6% of the Company's revenues for fiscal 8. 9 1998 and fiscal 1997, respectively. No other provider accounted for more than 10% of the Company's revenues for fiscal 1998. CASE MANAGEMENT PROGRAMS Each Case Management Program is generally administered pursuant to a management and affiliation agreement with a contracting provider and operates through a wholly owned subsidiary of the Company. The Company is responsible for developing and implementing detailed operating protocols relating to training procedures, management information systems, utilization review, coordination of quality assurance, contract development and other management and administrative services, and, under certain contracts, the provision of mental health services. Pursuant to the terms of the management and affiliation agreements, the Company manages and operates, on behalf of each case management provider, the delivery of case management and other covered psychiatric services. The case management provider is responsible for staff personnel and program facilities, and retains final discretionary authority to approve the related policy manual, staffing issues and overall program operations. The terms of the management and affiliation agreements are six years and may only be terminated for cause upon the occurrence of such events as (i) a loss of accreditation or other required licensing or regulatory qualifications, (ii) material breach by either party, (iii) certain legislative or administrative changes that may adversely affect the continued operation of the program and (iv) failure to achieve certain performance targets after designated notice and cure periods. In the Fall of 1995, the Company commenced the operation of its Case Management Programs with two case management agencies in Nashville, Tennessee and Memphis, Tennessee. In March and April of 1996, the Company also executed management and affiliation agreements with three CMHCs in Arkansas, which became operational in 1996. In September 1997 and in May 1998 the Company reached agreement with its CMHC providers to close its Case Management Programs in Arkansas. The Company is engaged in arbitration with a case management agency in Memphis regarding disputes involving the management and affiliation agreement. The Company cannot predict the outcome of the arbitration. The Company expects to terminate or substantially restructure the relationship with the case management agency in fiscal 1999. See "Risk Factors - --Concentration of Revenues" and "-- Limited Operating History of Case Management Programs." Commencing in July 1996, two managed care consortiums became the payors for mental health care services under the Tennessee Tenncare Partners State Medicaid Managed Care Program ("TennCare"). These consortiums, known as Tennessee Behavioral Health ("TBH") and Premier Behavioral Health ("Premier"), were fully at-risk for the approximately 1.2 million individuals who qualified for coverage based on Medicaid eligibility or other indigency standards. The Company has a contract for a Case Management Program with Premier. The Company received notice of termination of its contract with TBH effective December 10, 1997. The parties were unable to negotiate a new contract, however, the Company has continued to provide services to, and receive payments from, TBH at reduced rates. In February 1998, Magellan Health Services, Inc. acquired Merit Behavioral Health Care, Inc. and thus became the managing shareholder of TBH. Magellan, through its Green Spring subsidiary, is also the managing shareholder of Premier. The Company is presently renegotiating its rates with Premier and anticipates that Premier will take over TBH's business, which may result in the Company's contract with Premier applying to all the Company's case management services in Tennessee. Some uncertainty exists as to the future structure of TennCare. See "Risk Factors -- Potential Changes in TennCare." Case management contracts in Tennessee accounted for 21.6% and 23.7% of the Company's revenues for fiscal 1998 and fiscal 1997, respectively. MARKETING AND DEVELOPMENT PMR's principal marketing efforts with respect to its Outpatient and Case Management Programs are concentrated in the identification of prospective hospitals, CMHCs and case management agencies which may be suitable providers. Providers that may contract for the Company's services are identified through an analysis of market need, discussions with key individuals in the prospective area, and an assessment of the financial and clinical profile of the provider. The Company also markets the benefits of its Outpatient, Case Management and Urgent Care Programs to managed care organizations and their provider networks as public sector contracts are awarded. The development of the Chemical Dependency Programs focuses on expanding current contractual relationships, 9. 10 obtaining new provider contracts and marketing primarily to at-risk payors where ambulatory chemical dependency services are of significant value. The Company's marketing efforts with providers are undertaken by its own marketing and development personnel who focus upon the dissemination of information about the benefits of the Company's programs. The Company believes that its ability to secure new contracts with providers is based on its reputation for quality and the uniqueness of its services in its market areas. REGULATORY MATTERS COMPLIANCE WITH MEDICARE GUIDELINES; REIMBURSEMENT FOR PARTIAL HOSPITALIZATION PROGRAMS A significant component of the Company's revenues are derived from payments made by providers to the Company for the management and administration by the Company of Outpatient Programs managed for providers. The Company bills its management fee to the provider as a purchased management and administrative support service. Substantially all of the patients admitted to these programs are eligible for Medicare coverage and thus, the providers rely upon payment from Medicare. The providers are reimbursed their costs on an interim basis by Medicare fiscal intermediaries and the providers submit annual cost reimbursement reports to the fiscal intermediaries for audit and payment reconciliation. The providers seek reimbursement of the Company's management fees from these fiscal intermediaries as part of their overall payments from Medicare. Under certain of the Company's contracts the Company is obligated to indemnify the provider for all or some portion of the Company's management fees that may be disallowed to the provider. In the event a significant amount of such fees are disallowed for providers, there could be a material adverse effect upon the Company's financial condition and results of operations. In addition, to the extent that providers who contract with the Company for management services suffer material losses in Medicare payments, there is a greater risk of non-payment by the providers, and a risk that the providers will terminate or not renew their contracts with the Company. Thus, even though the Company is not paid by Medicare, it may be adversely affected by reductions in Medicare payments or other Medicare policies. See "Risk Factors-Dependence Upon Third Party Reimbursement" below and "Item 7. Management's Discussion And Analysis Of Financial Condition And Results Of Operations." The Medicare Program is part of a federal health program created in 1965 as part of the federal social security system. It is administered by the U.S. Department of Health and Human Services which has established Health Care Financing Administration ("HCFA") to promulgate rules and regulations governing the Medicare program and the benefits associated therewith. Medicare guidelines indicate that, subject to certain regulatory requirements relating to reasonable costs imposed upon a Provider, contract management services may be used in lieu of or in support of in-house staff of the provider and are reimbursable by Medicare. As a general rule, Medicare guidelines indicate that contract management services costs related to furnishing services covered by Medicare are reasonable if the costs incurred are comparable with marketplace prices for similar services. Management of the Company believes that the value of the Company's services is comparable with marketplace prices for similar services. HCFA has published criteria which partial hospitalization services must meet in order to qualify for Medicare funding. In transmittal number 1303 (effective January 2, 1997) and in subsequent criteria published in Section 230.50 of the Medicare Coverage Manual, HCFA requires partial hospitalization services to be: (i) incident to a physician's service; (ii) reasonable and necessary for the diagnosis or treatment of the patient's conditions; and (iii) provided by a physician with a reasonable expectation of improvement of the patient from the treatment. The Medicare criteria for coverage, specifically what is "reasonable and necessary" in particular cases is a subjective determination on which health care professionals may disagree. Moreover, the fiscal intermediaries which administer the Medicare program and evaluate and process claims for payment, establish local medical review policies which may have a material adverse effect on the Company's results of operations. How Medicare applies its "reasonable and necessary" standard is not always consistent, and that standard may be interpreted in the future in a manner which is more restrictive than currently prevailing interpretations. The Company and its providers have quality assurance and utilization review programs to monitor partial hospitalization programs managed by the Company to ensure that such programs operate in compliance with the Company's understanding of all Medicare coverage requirements. 10. 11 All of the partial hospitalization programs managed by the Company are required to be "provider based" programs by HCFA, which administers the Medicare program. This designation is important since partial hospitalization services are covered only when furnished by or "under arrangement" with, a "provider", i.e., a hospital or a CMHC. To the extent that partial hospitalization programs are not operated in a manner which is deemed by HCFA to satisfy its "provider based" criteria, there would not be Medicare coverage for the services furnished at that site under Medicare's partial hospitalization benefit. In August 1996, HCFA published (and in 1998 substantially reissued) criteria for determining when programs operated in facilities separate from a hospital's or CMHC's main premises may be deemed to be "provider based" programs. The proper interpretation and application of these criteria are not entirely clear, and are applied on a case by case basis, thereby creating a risk that some of the sites managed by the Company will be found not to be "provider based." If such a determination is made, HCFA may cease reimbursing for the services of the provider and has not ruled out, in some situations, the possibility that it would seek retrospective recoveries from providers. Any such cessation of reimbursement for services or retrospective recoveries could result in non-payment by providers and have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors - Dependence Upon Third Party Reimbursement." In February 1998, the Company announced that Scripps Health had received a letter from an official at Region IX of HCFA, informing Scripps Health that its partial hospitalization programs managed by the Company could no longer be considered "provider based" for Medicare reimbursement purposes. In July 1998, HCFA notified Scripps Health that certain of the programs were approved as "provider based" and that certain other program locations are not "provider based" because they did not meet HCFA's service area requirements. As a result of HCFA's notice, the Company and Scripps Health amended their contract, Scripps Health reconfigured certain of its partial hospitalization programs and one of the locations was acquired by another provider who engaged the Company to manage the program. While to the Company's knowledge, no other Company programs have received provider based challenges to date, it is possible that these challenges will emerge with other providers and that the Company may not be able to amend its contracts to satisfy HCFA or its provider customers. See "Business - Contracts - Outpatient Programs." Historically, CMHCs, unlike hospitals, were not surveyed by a Medicare contractor before being permitted to participate in the Medicare program. However, HCFA is now in the process of surveying all CMHCs to confirm that they meet all applicable Medicare conditions for furnishing partial hospitalization programs. Management believes that all the CMHCs which contract with the Company should be found to be in compliance with the applicable requirements, but it is possible that some CMHCs contracting with the Company will be terminated from the Medicare program. It is also possible that the government will attempt to recover payments made to such CMHCs for services which had been furnished by the Company and paid for by Medicare. CHANGES IN MEDICARE'S COST BASED REIMBURSEMENT FOR PARTIAL HOSPITALIZATION SERVICES The Balanced Budget Act of 1997 requires the implementation of a prospective payment system ("PPS") for all outpatient hospital services, including partial hospitalization, for the calendar year beginning January 1, 1999. Under such a system, a predetermined rate would be paid to providers regardless of the provider's reasonable costs. While the actual reimbursement rates have not been determined and thus their effect, positive or negative, is unknown, the Company anticipates that it may need to negotiate modifications to its contracts with providers if the system is implemented. The initial date for publishing the proposed PPS rates was May 1998. Recent concerns over HCFA's compliance with year 2000 computer issues have raised the possibility of significant delays in such implementation. The uncertainty regarding PPS has negatively effected the Company's marketing of new programs due to provider's uncertainty regarding the economic impact of the new rates. While the Company cannot predict the impact of continued delays on the Company's marketing program, it could have a material adverse effect on the Company's ability to sign new contracts and retain existing contracts. The Medicare partial hospitalization benefit has a coinsurance feature, which means that the amount paid by Medicare is the provider's reasonable cost less "coinsurance" which is ordinarily to be paid by the patient. The coinsurance amount is 20% of the charges for the services and must be charged to the patient by the provider unless the patient is indigent. If the patient is indigent or if the patient does not pay the provider the billed coinsurance amounts after reasonable collection efforts, the Medicare program has historically paid those amounts as "allowable Medicare bad debts." The allowability of Medicare bad debts to providers for whom the Company manages partial 11. 12 hospitalization programs is significant since most of the patients in programs managed by the Company are indigent or have very limited resources. The Balanced Budget Act of 1997 reduces the amount of Medicare allowable bad debts payable to hospital providers, as follows: 25% for provider fiscal years beginning on or after October 1, 1997; 40% for provider fiscal years beginning on or after October 1, 1998; and 45% for provider fiscal years beginning on or after October 1, 1999. The reduction in "allowable Medicare bad debts" could have a materially adverse effect on Medicare reimbursement to the Company's hospital providers and could further result in the restructuring or loss of Provider contracts with the Company. It is also possible that the reduction in reimbursable allowable bad debt by Medicare could be extended to CMHC providers. COMPLIANCE WITH MEDICAID REGULATIONS AND POTENTIAL CHANGES Since the Company is involved with state Medicaid agencies and with providers whose clients are covered by Medicaid, the Company must comply with the laws and regulations governing such reimbursement. Medicaid is a joint state and federally funded program established as part of the Social Security Act in the mid-1960s to provide certain defined health care benefits to poor, indigent or otherwise eligible general welfare recipients. As states consider methods to control the cost of health care services generally, and behavioral health services specifically, to Medicaid recipients, and because such recipients are, as a group, heavy users of the type of services which the Company offers, the effect of Medicaid reimbursement and regulatory compliance with its rules could be material to the Company's financial condition and results of operations. Medicaid funding and the methods by which services are supplied to recipients are changing rapidly. Many states have "carved out" behavioral health services from the delivery of other health services to Medicaid recipients and are separately procuring such services on a capitated basis requiring the contractor, and permitting subcontracted providers, to assume risk. The Company cannot predict the extent or scope of changes which may occur in the ways in which state Medicaid programs contract for and deliver services to Medicaid recipients. All Medicaid funding is generally conditioned upon financial appropriations to state Medicaid agencies by the state legislatures and there are ever-increasing uncertain political pressures on such legislatures in terms of controlling and reducing such appropriations. The overall trend is generally to impose lower reimbursement rates and to negotiate reduced contract rates with providers, including incentives to assume risk not only by licensed managed care organizations with whom state Medicaid agencies contract, but by subcontracted providers, such as the Company. Part of the Company's strategy for growth depends upon obtaining continued and increased contracts with managed care organizations to provide behavioral health managed care services to Medicaid recipients. Consequently, any significant reduction in funding for Medicaid programs could have a material adverse effect on the Company's business, financial condition and results of operations. The United States Congress continues to consider legislation to substantially alter the overall Medicaid program, to give states greater flexibility in the design and operation of their individual Medicaid program, and to stabilize federal spending for such benefits. Various states are also considering substantial health care reform measures which could modify the manner in which all health services are delivered and reimbursed, especially with respect to Medicaid recipients and with respect to other individuals funded by public resources. The reduction in other public resources could have an impact upon the delivery of services to Medicaid recipients. Many of the patients served in the Outpatient Programs managed by the Company are indigent or have very limited resources. Accordingly, many of those patients have Medicaid coverage in addition to Medicare coverage. In some of the states where the Company furnishes services, the state Medicaid plans have paid the Medicare coinsurance amount. However, under the Balanced Budget Act of 1997, states will no longer have to pay such amounts if the amount paid by Medicare for the service equals or exceeds what Medicaid would have paid had it been the primary insurer. To the extent that states take advantage of this new legislation and refuse to pay the Medicare coinsurance amounts on behalf of the Outpatient Program patients to the extent that they had in the past, it will have an adverse effect on the providers with whom the Company contracts, and thus, may have a material adverse effect on the Company's business, financial condition and results of operations. 12. 13 COMPLIANCE WITH OTHER STATE REGULATORY CONSIDERATIONS The Company is also sensitive to the particular nature of the delivery of behavioral health services and various state and federal requirements with respect to confidentiality and patient privacy. Indeed, federal and state laws require providers of certain behavioral health services to maintain strict confidentiality as to treatment records and, the fact of treatment. There are specific requirements permitting disclosure, but inadvertent or negligent disclosure can trigger substantial criminal and other penalties. SPECIFIC LICENSING OF PROGRAMS The Company's Outpatient Programs are operated as outpatient departments of hospitals or CMHCs, thus subjecting such programs to regulation by federal, state and local agencies. These regulations govern licensure and conduct of operations at the facilities, review of construction plans, addition of services and facilities and audit of cost allocations, cost reporting and capital expenditures. The facilities occupied by the programs must comply with the requirements of municipal building, health and fire codes. Inclusion of hospital space where the Outpatient Programs are furnished within the hospitals' license, when required under applicable state laws, is a prerequisite to participation in the Medicare programs. Additionally, the Provider's premises and programs are subject to periodic inspection and recertification. FALSE CLAIMS INVESTIGATIONS AND ENFORCEMENT OF HEALTH CARE FRAUD LAWS The Office of the Inspector General within the U.S. Department of Health and Human Services, as well as other federal, state, and private organizations, are aggressively enforcing their interpretation of Medicare and Medicaid laws and policies, and other applicable standards. Often in such enforcement efforts, the government has relied on the Federal False Claims Act. Under that law, if the government prevails in a case, it is entitled to treble damages plus not less than $5,000 nor more than $10,000 per claim, plus reasonable attorney fees and costs. In addition, a person found to have submitted false claims can be excluded from governmental health care programs including Medicare and Medicaid. If a provider contracting with the Company were excluded from governmental health programs, no services furnished by that provider would be covered by any governmental health program. Some of the providers contracting with the Company are reported to be under active investigation for health care fraud, although the Company is not aware of those investigations relating to programs with which the Company is involved. If the Company were excluded from governmental health programs, providers contracting with the Company could not be reimbursed for amounts paid to the Company. To prevail in a False Claims Act case, the government need show only that incorrect claims were submitted with "reckless disregard" or in "deliberate ignorance" of the applicable Medicare law. The government does not have to prove that the claims were submitted with the intent to defraud a governmental or private health care payor. The qui tam provisions of the Federal False Claims Act permit individuals also to bring suits under the False Claims Act. The incentive for an individual to do so is that he or she will usually be entitled to approximately 15% to 30% of any ultimate recovery. Under the Federal False Claims Act, the Office of the Inspector General, in conjunction with the Department of Justice, have successfully made demands on thousands of providers to settle alleged improper billing disputes at double damages or more. Although the Company does not bill governmental programs directly, it could possibly be liable under the False Claims Act to the extent that it is found to have "caused" false claims to have been presented. In February 1998, the Company announced that an Outpatient Program that it formerly managed in Dallas, Texas was the subject of a civil investigation conducted by the U.S. Department of Health and Human Services' Office of Inspector General and the U.S. Attorney's office in Dallas, Texas. See "Item 3. Legal Proceedings." In addition, the Company was informed on July 20, 1998 that a qui tam suit had been filed by a former employee of the Company against a subsidiary of the Company. See "Item 3. Legal Proceedings." There are many other civil and criminal statutes at the federal and state levels that may penalize conduct related to submitting false claims for health care services or for offering or receiving anything of value in exchange for the referral of patients. The penalties under many of those statutes are severe, and the government often need not 13. 14 prove intent to defraud in order to prevail. Management believes that the Company is in material compliance with applicable regulatory and industry standards. However, in light of the complexity of the policies governing governmental health care programs together with changing and uncertain interpretations of those policies, it is impossible to be absolutely assured that the government (or a qui tam relator in the name of the government) will not assert that some conduct by the Company has given rise to potentially a large liability. In the past, there have been occasions when Medicare fiscal intermediaries have denied coverage for all or substantially all of the claims submitted by the providers where the Company had a management contract. Such denials have occurred even though a physician has certified that the Outpatient Program services were medically necessary. Notwithstanding the Company's ongoing efforts to assure that the Outpatient Program services furnished by it under contract are consistent with its understanding of the Medicare coverage criteria, it is possible that there will be future occasions when a substantial number of services furnished at a site managed by the Company will be denied coverage. The Health Insurance Portability and Accountability Act of 1996 grants the U.S. Department of Health and Human Services broad authority to impose civil monetary penalties on providers for certain activities. Among those activities are the repeated submission of claims for services which are not medically necessary. If there were again to be occasions when a Medicare fiscal intermediary denied a large number of claims for a site managed by the Company, it is possible that the government would seek sanctions from the provider and possibly from the Company. While the Company believes that it would be inappropriate for the government to seek such sanctions for services for which the coverage criteria are interpreted differently at different times and which have been ordered by a physician, it is not clear at this time how the government will apply this new authority. COMPETITION In general, the operation of psychiatric programs is characterized by intense competition. General, community and specialty hospitals, including national companies and their subsidiaries, provide many different health care programs and services. The Company anticipates that competition will become more intense as pressure to contain the rising costs of health care continues to intensify, particularly as programs such as those operated by the Company are perceived to help contain mental health care costs. Many other companies engaged in the management of outpatient psychiatric programs compete with the Company for the establishment of affiliations with acute care hospitals. Furthermore, while the Company's existing competitors in the case management business are predominantly not-for-profit CMHCs and case management agencies, the Company anticipates that other health care management companies will eventually compete for this business. Many of these present and future competitors are substantially more established and have greater financial and other resources than the Company. In addition, the Company's current and potential providers may choose to operate mental health programs themselves rather than contract with the Company. There can be no assurance that the Company will be able to compete effectively with its present or future competitors, and any such inability could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that the proprietary nature of its policy and procedures manuals as well as the level of service it provides and the expertise of its management and field personnel provides it with a leading position in the development and management of Outpatient Programs. The Company believes that the Case Management Programs provide the means to effectively control costs in a managed, public-sector mental health system by reducing the costs for the population that consumes the largest portion of the treatment dollars, the SMI population. In addition, the Company believes that the Company's case management model provides state-of-the-art treatment and rehabilitation services which serve to upgrade the existing provider network in a community. The Company believes the benefits of its case management model are recognized as a distinguishing feature for public-sector managed care efforts. The Company's primary existing competitors in the case management business are predominantly not for profit CMHCs and case management agencies. The Company anticipates that mental health managed care companies will eventually compete for this business. There can be no assurances that the Company will be able to compete successfully with its present or future competitors. The specialty pharmacy business is intensely competitive. There are numerous local, regional and national companies which can dispense pharmaceuticals locally or through the mail. There are also numerous companies which provide lab work and analysis services necessary for blood monitoring. Many of these companies have 14. 15 substantially greater resources than Stadt Solutions. While the Company believes that Stadt Solutions will be the first specialty pharmacy company to focus on SMI and further believes that Stadt Solutions will offer value added disease management services not typically provided by competitors, there can be no assurance that Stadt Solutions will be able to compete successfully with its present or future competitors. EMPLOYEES As of July 15, 1998, PMR employed approximately 818 employees, of which 397 are full-time employees. Approximately 713 employees staff clinical programs and approximately 105 are in corporate management including finance, accounting, development, utilization review, training and education, information systems, human resources and legal areas. None of the Company's employees are subject to a collective bargaining agreement and the Company believes that its employee relations are good. RISK FACTORS The Company's business is subject to a number of risks, including the risks described in this section and elsewhere in this Annual Report on Form 10-K. The Company's actual results could differ materially from the results projected in this Report or in any other forward-looking statements presented by management from time to time, due to some or all of such risks. Dependence Upon Medicare Reimbursement. A significant component of the Company's revenues is derived from payments made by providers to the Company for managing and administering Outpatient Programs for providers. Substantially all of the patients admitted to the Outpatient Programs are eligible for Medicare coverage. A provider's Medicare payments can be adversely affected by actions of HCFA or fiscal intermediaries in several ways including: (i) denials of coverage on claims for services furnished to Medicare eligible patients; (ii) disallowances of costs claimed on the annual cost report on the grounds that such costs are unreasonable, relate to uncovered services or are otherwise non-allowable; or (iii) changes in the law or interpretation of the law governing Medicare coverage and payment. Providers generally seek reimbursement of the Company's management fees from the fiscal intermediaries as part of their overall payments from Medicare, and payment of the Company's management fee may be directly affected by the reimbursement experience of the provider. In certain instances, providers are not obligated to pay the Company's management fee if coverage for claims submitted by the provider related to services furnished by the Company are denied by Medicare's fiscal intermediary. In other instances, the Company may be obligated to indemnify a provider to the extent the Company's management fee charged to the provider is disallowed by Medicare's fiscal intermediary for reimbursement. The occurrence of either of these events with respect to a significant number of providers or a significant amount of fees could have a material adverse effect upon the Company's business, financial condition and results of operations. See "Business -- Regulatory Matters -- Compliance With Medicare Guidelines; Reimbursement For Partial Hospitalization Programs." The Company's programs have in the past, and may in the future, from time to time, be subject to Focused Medical Reviews. A "Focused Medical Review" consists of an intensive review by fiscal intermediaries of HCFA, on an industry-wide basis, of certain targeted claims. Focused Medical Reviews may occur for a number of reasons including, without limitation, an intermediary's concern about coverage for claims at a specific site or because HCFA has identified certain services as being at risk of inappropriate program payment. This generally occurs when HCFA identifies significant industry-wide increases in payments for certain types of services, as had been the case with partial hospitalization benefits. During 1997 and 1998, HCFA has increased its scrutiny of outpatient psychiatric services due to a significant increase in charges to Medicare for outpatient partial hospitalization and other mental health services. The Company believes that Focused Medical Reviews and related denials are increasing throughout the industry, including at programs managed by the Company. Any denied claims resulting from future Focused Medical Reviews could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business --Regulatory Matters -- Compliance With Medicare Guidelines; Reimbursement For Partial Hospitalization Programs." 15. 16 All of the partial hospitalization programs managed by the Company are required under HCFA's current interpretation of the Medicare regulations, to be "provider based" programs by HCFA. This designation is important since partial hospitalization services are covered only when furnished by or "under arrangement" with, a "provider", i.e., a hospital or a CMHC. To the extent that partial hospitalization programs are not deemed by HCFA to be "provider based" under HCFA's current interpretation of the Medicare regulations, there would not be Medicare coverage for the services furnished at that site under Medicare's partial hospitalization benefit. HCFA has published criteria for determining when programs operated in facilities separate from a hospital's or CMHC's main premises may be deemed to be "provider based" programs. The proper interpretation and application of these criteria are not entirely clear, and there is a risk that some of the sites managed by the Company will be found not to be "provider based". If such a determination is made, HCFA may cease reimbursing for the services at the provider, and HCFA has not ruled out the possibility that, in some situations, it would seek retrospective recoveries from providers. Any such cessation of reimbursement for services or retrospective recoveries could result in non-payment by providers and have a material adverse effect on the Company's business, financial condition and results of operations. In February 1998, the Company announced that Scripps Health had received a letter from an official at Region IX of HCFA, informing Scripps Health that its partial hospitalization programs managed by the Company could no longer be considered "provider based" for Medicare reimbursement purposes. In July 1998, HCFA notified Scripps Health that certain of the programs are approved as "provider based" and that certain other program locations were not "provider based" because they did not meet HCFA's service area requirements. As a result of HCFA's notice, the Company and Scripps Health amended their contract, Scripps Health reconfigured certain of its partial hospitalization programs and one of the locations was acquired by another provider who engaged the Company to manage the program. While to the Company's knowledge, no other Company programs have received provider based challenges to date, it is possible that these challenges will emerge with other providers and that the Company may not be able to amend its contracts to satisfy HCFA or its provider customers. In addition, there can be no assurance that HCFA will not challenge the "provider based" status of the Scripps Health program in the future. If the Company is unable to amend its contracts to satisfy any "provider based" challenge in the future, the potential termination of any such contracts could have a material adverse effect upon the Company's business, financial condition and results of operations. See "Business -- Contracts -- Outpatient Programs," "-- Regulatory Matters -- Compliance with Medicare Guidelines; Reimbursement for Partial Hospitalization Programs." Impact of Health Care Reform and the Balanced Budget Act of 1997. Political, economic and regulatory influences are subjecting the health care industry in the United States to fundamental change. Changes in the law, new interpretations of existing laws, or changes in payment methodology or amounts may have a dramatic effect on the relative costs associated with doing business and the amount of reimbursement provided by government or other third-party payors. In addition to specific health care legislation, both the Clinton Administration and various federal legislators have considered health care reform proposals intended to control health care costs and to improve access to medical services for uninsured individuals. These proposals have included cutbacks to the Medicare and Medicaid programs and steps to permit greater flexibility in the administration of the Medicaid program. In addition, some states in which the Company operates are considering various health care reform proposals. The Company anticipates that federal and state governments will continue to review and assess alternative health care delivery systems and payment methodologies, and that public debate on these issues will likely continue in the future. Due to uncertainties regarding the ultimate features of reform initiatives and their enactment, implementation and interpretation, the Company cannot predict which, if any, of such reform proposals will be adopted, when they may be adopted or what impact they may have on the Company. Accordingly, there can be no assurance that future health care legislation or other changes in the administration or interpretation of governmental health care programs will not have a material adverse effect on the Company's business, financial condition and results of operations. The Balanced Budget Act of 1997 could adversely affect reimbursements to certain providers and payments to the Company. The Medicare partial hospitalization benefit has a coinsurance feature, which means that the amount paid by Medicare is the provider's reasonable cost less "coinsurance" which is ordinarily to be paid by the patient. The Medicare program has historically paid amounts designated as the patient's coinsurance obligation where the patient is indigent or if the patient does not pay the provider the billed coinsurance amounts after reasonable collection efforts. Those amounts are characterized as "allowable Medicare bad debts." The allowability of bad debts to providers is significant because most of the patients in programs managed by the Company are 16. 17 indigent or have very limited resources. The Balanced Budget Act of 1997 reduces the amount of allowable Medicare bad debts payable to hospital providers, as follows: 25% for provider fiscal years beginning on or after October 1, 1997; 40% for provider fiscal years beginning on or after October 1, 1998; and 45% for provider fiscal years beginning on or after October 1, 1999. The reduction in "allowable Medicare bad debts" could have a material adverse impact on Medicare reimbursement to the Company's hospital Providers and could further result in the restructuring or loss of provider contracts with the Company. It is also possible that the reduction in reimbursable allowable bad debt by Medicare could be expanded to CMHC providers. An adverse effect on Medicare reimbursement to the Company's hospital providers, and if so expanded, on reimbursement to CMHC providers, could have a material adverse effect upon the Company's business, financial condition and results of operations. See "Business -- Regulatory Matters -- Compliance With Medicare Guidelines; Reimbursement For Partial Hospitalization Programs." In addition, under the Balanced Budget Act of 1997, state Medicaid plans that have historically paid the Medicare coinsurance amount will no longer have to pay such amounts if the amount paid by Medicare for the service equals or exceeds what Medicaid would have paid had it been the primary insurer. To the extent that states take advantage of this new legislation and refuse to pay the Medicare coinsurance amounts on behalf of the Outpatient Program patients to the degree that they had in the past, it will have an adverse impact on the providers with whom the Company contracts, and thus may have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Regulatory Matters -- Changes In Medicare's Cost Based Reimbursement For Partial Hospitalization Services" and "-- Compliance With Medicaid Regulations and Potential Changes." The PPS to be implemented under the Balanced Budget Act of 1997 could have an adverse effect on the business of certain providers and the Company. While the actual reimbursement rates and methodology for the PPS have not been determined and thus their effect is unknown, the Company may need to negotiate modifications to its contracts with providers, which could have a material adverse effect on the Company's business, financial condition and results of operations. Recent concerns over HCFA's compliance with year 2000 computer issues have raised the possibility of significant delays in the implementation of PPS. The uncertainty regarding PPS has negatively effected the Company's marketing of new programs due to provider's uncertainty regarding the economic impact of the new rates. While, the Company cannot predict the impact of continued delays on the Company's marketing program, it could have a material adverse impact on the Company's ability to sign new contracts and retain existing contracts. See "Business -- Regulatory Matters -- Changes in Medicare's Cost Based Reimbursement For Partial Hospitalization Services." Sufficiency of Existing Reserves to Cover Reimbursement Risks. The Company maintains significant reserves to cover the potential impact of two primary uncertainties: (i) the Company may have an obligation to indemnify certain providers for some portions of its management fee which may be subject to disallowance upon audit of a provider's cost report by fiscal intermediaries; and (ii) the Company may not receive full payment of the management fees owed to it by a provider during the periodic review of the provider's claims by the fiscal intermediaries. The Company has been advised by HCFA that certain program-related costs are not allowable for reimbursement. The Company may be responsible for reimbursement of the amounts previously paid to the Company that are disallowed pursuant to obligations that exist with certain providers. Although the Company believes that its potential liability to satisfy such requirements has been adequately reserved in its financial statements, there can be no assurance that such reserves will be adequate. The obligation to pay the amounts estimated within the Company's financial statements (or such greater amounts as are due), if and when they become due, could have a material adverse effect upon the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business - Regulatory Matters - Compliance with Medicare Guidelines; Reimbursement for Partial Hospitalization Programs. Continuity of Management Contracts. Substantially all of the revenues of the Company are derived from contracts with providers, behavioral health organizations and case management agencies. The continued success of the Company is subject to its ability to maintain, renew, extend or replace existing management contracts and obtain new management contracts. These contracts generally have defined terms of duration and many have automatic renewal provisions. The contracts often provide for early termination either by the provider if specified performance criteria are not satisfied or by the Company under various other circumstances. 17. 18 Contract renewals and extensions are likely to be subject to competing proposals from other contract management companies as well as consideration by certain providers to terminate their mental health programs or convert their mental health programs from independently managed programs to programs operated internally. There can be no assurance that any provider or case management agency will continue to do business with the Company following expiration of its management contract or that such management contracts will not be terminated prior to expiration. In addition, any changes in the Medicare or Medicaid program which have the effect of limiting or reducing reimbursement levels for mental health services provided by programs managed by the Company could result in the early termination of existing management contracts and could adversely affect the ability of the Company to renew or extend existing management contracts and to obtain new management contracts. The termination or non-renewal of a significant number of management contracts could result in a significant decrease in the Company's net revenues and could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Contracts." Potential Changes in TennCare. The Company has a contract for a Case Management Program with Premier. In addition, the Company is presently renegotiating its rates with Premier. The Company previously received a notice of termination of its contract with TBH. The Company anticipates that Premier may take over TBH's business, possibly resulting in the Company's contract with Premier applying to all of the Company's case management services in Tennessee. However, there can be no assurance that the Company's relationship with Premier and TBH will be resolved as currently anticipated by the Company, and there can be no assurance that the ultimate resolution of such matters will not have a material adverse effect on the Company's business, financial condition and results of operations. The TennCare program has been subjected to substantial criticism which could result in structural changes which the Company cannot predict with any degree of certainty, and which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company is in the process of arbitrating its agreement with a case management agency in Memphis and anticipates terminating or substantially restructuring the agreement. See "Business -- Contracts -- Case Management Programs." While the Company does not anticipate that the outcome of this arbitration will have a material adverse effect on the Company's business, the Company cannot predict the outcome of this matter or other potential related changes or outcomes, with any degree of certainty, and such results could individually or in the aggregate have a material adverse effect on the Company's business, financial condition and results of operations. Concentration of Revenues. For fiscal 1998, only one provider accounted for more than 10% of the Company's revenue. In addition, although not attributed to a particular "customer," the Case Management Programs accounted for 22.4% of the Company's revenue for fiscal 1998. These programs were largely operated under contracts with two managed care consortiums in the State of Tennessee and management agreements with two case management agencies. A termination or non-renewal of any of these contracts could have a material adverse effect on the Company's business, financial condition and results of operations. See " -- Potential Changes in TennCare," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business --Programs and Operations" -- Case Management Programs" and "Contracts -- Case Management Programs." Limited Operating History of Case Management Programs. The operations of the Company's Case Management Programs are subject to limited operating history. Thus, the success of these programs will be dependent upon the Company's ability to manage and expand operations effectively, control costs and recognize operating efficiencies. By virtue of the lack of operating history, there can be no assurance that the Company will be able to maintain these operations at their current level or expand these programs in the future. See "Risk Factors -- Potential Changes in TennCare," "-- Concentration of Revenues" and "Business -- Programs and Operations" "-- Case Management Programs" and "Contracts -- Case Management Programs." Government Regulation. Mental health care is an area subject to extensive regulation and frequent changes in those regulations. Changes in the laws or new interpretations of existing laws can have a significant effect on the methods of doing business, costs of doing business and amounts of reimbursement available from governmental and other payors. In addition, a number of factors, including changes in the healthcare industry and the availability of investigatory resources, have resulted in increased scrutiny, inquiry and investigations by various federal and state regulatory agencies relating to the operation of healthcare companies, including the Company. The Company is and will continue to be subject to varying degrees of regulation, licensing, inquiry and investigation by 18. 19 health or social service agencies and other regulatory and enforcement authorities in the various states and localities in which it operates or intends to operate. The Company's business is subject to a broad range of federal, state and local requirements including, but not limited to, fraud and abuse laws, licensing and certification standards, and regulations governing the scope and quality of care. Violations of these requirements may result in civil and criminal penalties and exclusions from participation in federal and state-funded programs. The Company at all times attempts to comply with all such laws including applicable Medicare and Medicaid regulations; however, there can be no assurance that the expansion or interpretation of existing laws or regulations, or the imposition of new laws or regulations, will not have a material adverse effect on the Company's provider relationships or the Company's business, financial condition and results of operations. The U.S. Department of Health and Human Services has established HCFA to administer and interpret the rules and regulations governing the Medicare program and the benefits associated therewith. Applicable Medicare guidelines permit the reimbursement of contracted management services provided that, among other things, the associated fees are "reasonable." As a general rule, Medicare guidelines indicate that the costs incurred by a provider for contract management services relating to furnishing Medicare-covered services are deemed "reasonable" if the costs incurred are comparable with marketplace prices for similar services. Although management believes that the Company's charges for its services are comparable with marketplace prices for similar services, the determination of reasonableness may be interpreted by HCFA or a fiscal intermediary in a manner inconsistent with the Company's belief. Notwithstanding the Company's belief, a determination that the Company's management fees may not be "reasonable" may have a material adverse effect on the Company's business, financial condition and results of operations. HCFA requires that partial hospitalization programs must meet certain published criteria to qualify for Medicare funding, including that the partial hospitalization services be reasonable and necessary for the diagnosis or treatment of the patient's condition. The Medicare criteria for coverage, specifically what is "reasonable and necessary" in particular cases, is a subjective determination on which health care professionals may disagree. Moreover, the fiscal intermediaries which administer the Medicare program and evaluate and process claims for payment, establish local medical review policies which may have a material adverse effect on the Company's results of operations. Medicare does not always apply its "reasonable and necessary" standard consistently, and that standard may be interpreted in the future in a manner which is more restrictive than currently prevailing interpretations. Although the Company and its providers have quality assurance and utilization review programs to ensure that the partial hospitalization programs managed by the Company are operating in compliance with the Company's understanding of all Medicare coverage requirements, there can be no assurance that in the future certain aspects of the Company's programs will not be found to have failed to satisfy all applicable criteria for Medicare eligibility. See "Business -- Regulatory Matters -- Compliance With Medicare Guidelines; Reimbursement For Partial Hospitalization Programs." In February 1998, the Company announced that an Outpatient Program that it formerly managed in Dallas, Texas was the subject of a civil investigation conducted by the U.S. Department of Health and Human Services' Office of Inspector General and the U.S. Attorney's office in Dallas, Texas. The investigation resulted from a HCFA review of certain partial hospitalization services rendered by the program. As of July 27, 1998, no formal complaint, demand, or additional request for information has been made by the investigating agencies. The Company is unable to predict the impact, if any, on the Company's business, financial condition or results of operations, which may result from the investigation or any claim or demand which may arise therefrom. See "Business -- Regulatory Matters -- False Claims Investigations And Enforcement Of Health Care Fraud Laws." The Company was informed that a qui tam suit had been filed by a former employee of the Company against a subsidiary of the Company. The Company is unable to predict the impact, if any, that the claim and ultimate resolution thereof may have on the Company's business, financial condition or results of operations. See "Item 3. Legal Proceedings." Historically, CMHCs, unlike hospitals, were not surveyed by a Medicare contractor before being permitted to participate in the Medicare program. However, HCFA is now in the process of surveying all CMHCs to confirm that they meet all applicable Medicare conditions for furnishing partial hospitalization programs. Management believes that all the CMHCs that contract with the Company should be found in compliance with the applicable requirements. However, there can be no assurance that some CMHCs contracting with the Company will not be 19. 20 terminated from the Medicare program or that the government will not attempt to recover payments made to such CMHCs for services, including payments relating to the Company's services, which had been furnished and paid for by Medicare. See "Business -- Regulatory Matters." Risks Associated with Acquisitions. The Company currently intends as part of its business strategy to pursue acquisitions of complementary businesses as it seeks to compete in the rapidly changing healthcare industry. Acquisitions involve numerous risks, including difficulties in assimilation of the operations and personnel of the acquired business, the integration of management information and accounting systems of the acquired business, the diversion of management's attention from other business concerns, risks of entering markets in which the Company has no direct prior experience, and the potential loss of key employees of the acquired business. The Company's management will be required to devote substantial time and attention to the integration of any such businesses and to any material operational or financial problems arising as a result of any such acquisitions. There can be no assurance that operation or financial problems will not occur as a result of any such acquisitions. Failure to effectively integrate acquired businesses could have a material adverse effect on the Company's business, financial condition and results of operations. The Company intends to continue to evaluate potential acquisitions of, or investments in, companies which the Company believes will complement or enhance its existing business. Future acquisitions by the Company may result in potentially dilutive issuances of equity securities, the incurrence of additional debt and amortization expenses related to goodwill and other intangible assets which could adversely affect the Company's business, financial condition and results of operations. There can be no assurance that the Company will consummate any acquisition in the future or if consummated, that any such acquisition will ultimately be beneficial to the Company. Management of Rapid Growth. The Company expects that its outpatient psychiatric management services business and the number of its Outpatient, Case Management and Chemical Dependency Programs may increase significantly as it pursues its growth strategy. If it materializes, this rapid growth will place significant demands on the Company's management resources. The Company's ability to manage its growth effectively will require it to continue to expand its operational, financial and management information systems, and to continue to attract, train, motivate, manage and retain key employees. If the Company is unable to manage its growth effectively, its business, financial condition and results of operations could be adversely affected. Dependence on Key Personnel. The Company depends, and will continue to depend, upon the services of its current senior management for the management of the Company's operations and the implementation of its business strategy. In addition, the Company's success is also dependent upon its ability to attract and retain additional qualified management personnel to support the Company's growth. The loss of the services of any or all such individuals or the Company's inability to attract additional management personnel in the future may have a material adverse effect on the Company's business, financial condition and results of operations. The Company presently has no employment agreements with any of its senior executive officers. The Company's success and growth strategy also will depend on its ability to attract and retain qualified clinical, marketing and other personnel. The Company competes with general acute care hospitals and other health care providers for the services of psychiatrists, psychologists, social workers, therapists and other clinical personnel. Demand for such clinical personnel is high and they are often subject to competing offers. There can be no assurance that the Company will be able to attract and retain the qualified personnel necessary to support its business in the future. Any such inability may have a material adverse effect on the Company's business, financial condition and results of operations. Competition. In general, the operation of psychiatric programs is characterized by intense competition. General, community and specialty hospitals, including national companies and their subsidiaries, provide many different health care programs and services. The Company anticipates that competition will become more intense as pressure to contain the rising costs of health care continues to intensify, particularly as programs such as those operated by the Company are perceived to help contain mental health care costs. Many other companies engaged in the management of outpatient psychiatric programs compete with the Company for the establishment of affiliations with acute care hospitals. Furthermore, while the Company's existing competitors in the case management business are predominantly not-for-profit CMHCs and case management agencies, the Company anticipates that other health care management companies will eventually compete for this business. Many of these present and future 20. 21 competitors are substantially more established and have greater financial and other resources than the Company. In addition, the Company's current and potential providers may choose to operate mental health programs themselves rather than contract with the Company. There can be no assurance that the Company will be able to compete effectively with its present or future competitors, and any such inability could have a material adverse effect on the Company's business, financial condition and results of operations. The specialty pharmacy business is intensely competitive. There are numerous local, regional and national companies which can dispense pharmaceuticals locally or through the mail. There are also numerous companies which provide lab work and analysis services necessary for blood monitoring. Many of these companies have substantially greater resources than Stadt Solutions. While the Company believes that Stadt Solutions will be the first specialty pharmacy company to focus on SMI and further believes that Stadt Solutions will offer value added disease management services not typically provided by competitors, there can be no assurance that Stadt Solutions will be able to compete successfully with its present or future competitors. Availability and Adequacy of Insurance. The provision of mental health care services entails an inherent risk of liability. In recent years, participants in the industry have become subject to an increasing number of lawsuits alleging malpractice or related legal theories, many of which involve large claims and significant defense costs. The Company currently maintains annually renewable liability insurance intended to cover such claims and the Company believes that its insurance is in conformity with industry standards. There can be no assurance, however, that claims in excess of the Company's insurance coverage or claims not covered by the Company's insurance coverage (e.g., claims for punitive damages) will not arise. A successful claim against the Company not covered by, or in excess of, the Company's insurance coverage could have a material adverse effect upon the Company's business, financial condition and results of operations. In addition, claims asserted against the Company, regardless of their merit or eventual outcome, could have a material adverse effect upon the Company's reputation and ability to expand its business, and could require management to devote time to matters unrelated to the operation of the Company's business. There can be no assurance that the Company will be able to obtain liability insurance coverage on commercially reasonable terms in the future or that such insurance will provide adequate coverage against potential claims. Shares Eligible For Sale. Sales by holders of substantial amounts of Common Stock could adversely affect the prevailing market price of the Common Stock. The number of shares of Common Stock available for sale in the public market is limited by restrictions under the Securities Act of 1933, as amended (the "Securities Act"), including Rule 144 ("Rule 144") under the Securities Act. As of July 24, 1998, the Company had 6,959,810 shares of Common Stock outstanding. Of these shares, the officers and directors of the Company and their affiliates own 2,172,420 shares and may acquire up to 768,175 shares that may be issued upon the exercise of outstanding stock options and warrants. These outstanding shares and shares issued upon the exercise of the options and warrants are considered "restricted securities" and may be sold, subject to the volume limitations under Rule 144. Possible Volatility of Stock Price. The market price of the Common Stock could be subject to significant fluctuations in response to various factors and events, including, but not limited to, the liquidity of the market for the Common Stock, variations in the Company's quarterly results of operations, revisions to existing earnings estimates by research analysts and new statutes or regulations or changes in the interpretation of existing statutes or regulations affecting the health care industry generally or mental health services in particular, some of which are unrelated to the Company's operating performance. In addition, the stock market in recent years has generally experienced significant price and volume fluctuations that often have been unrelated to the operating performance of particular companies. These market fluctuations also may adversely affect the market price of the Common Stock. Concentration of Ownership, Anti-Takeover Provisions. The officers and directors of the Company and their affiliates own over 20% of the Company's issued and outstanding Common Stock (and over 30% including shares issuable upon currently exercisable stock options and warrants). Although the officers and directors do not have any arrangements or understandings among themselves with respect to the voting of the shares of Common Stock beneficially owned by such persons, such persons acting together could elect a majority of the Company's Board of Directors and control the Company's policies and day-to-day management. The Company's Board of Directors has the authority, without action by the stockholders, to issue shares of preferred stock and to fix the rights and preferences of such shares. The ability to issue shares of preferred stock, together with certain provisions of Delaware law and certain provisions of the Company's Restated Certificate of Incorporation, such as staggered 21. 22 terms for directors, limitations on the stockholders' ability to call a meeting or remove directors and the requirement of a two-thirds vote of stockholders for amendment of certain provisions of the Restated Certificate of Incorporation or approval of certain business combinations, may delay, deter or prevent a change in control of the Company, may discourage bids for the Common Stock at a premium over the market price of the Common Stock and may adversely affect the market price of, and the voting and other rights of the holders of, the Common Stock. Year 2000 Compliance. The year 2000 issue is the result of computer applications being written using two digits rather than four to define the applicable year. Computer applications may recognize a date using "00" as the year 1900 rather than the year 2000, resulting in system failures or miscalculations causing disruption of operations. The Company has reviewed its material computer applications for year 2000 compliance and is working with vendors and suppliers to make its computer applications year 2000 compliant. However, if any such corrections cannot be completed on a timely basis, the year 2000 issue could have a material adverse impact on the Company's business, financial condition and results of operations. Because of the many uncertainties associated with year 2000 compliance issues, and because the Company's assessment is necessarily based on information from third party vendors and suppliers, there can be no assurance that the Company's assessment is correct or as to the materiality or effect of any failure of such assessment to be correct. The Company has not determined whether and to what extent computer applications of contract providers and Medicare and other payors will be year 2000 compliant. In addition, the Company has not determined the extent to which any disruption in the billing practices of providers or the payment practices of Medicare or other payors caused by the year 2000 issues will affect the Company's operations. However, any such disruption in the billing or reimbursement process could have a substantial adverse impact on Medicare or Medicaid payments to providers and, in turn, payments to the Company. Any such disruption could have a material adverse effect upon the Company's business, financial condition and results of operations. See "Management's Discussion And Analysis of Financial Condition And Results of Operations -- Impact of Year 2000 Computer Issues." ITEM 2. PROPERTIES The Company owns no real property, but currently leases and subleases approximately 205,000 square feet comprised of (i) a lease for the Company's corporate headquarters expiring on April 3, 2002, (ii) two leases for regional administration offices expiring in July 2001 and September 2001, respectively, and (iii) thirty (30) leases for program sites, averaging three years duration, none of which extend beyond 2002. The Company carries property and liability insurance where required by lessors and sublessors. The Company believes that its facilities are adequate for its short term needs. Leases and sub-leases, other than the short-term and month-to-month leases, generally provide for annual rental adjustments which are either indexed to inflation or have been agreed upon, and typically provide for termination on not less than ninety (90) days' written notice. ITEM 3. LEGAL PROCEEDINGS In February 1998, the Company announced that it had been informed that the Outpatient Program that it formerly managed in Dallas, Texas is the subject of a civil investigation being conducted by the U.S. Department of Health and Human Services' Office of inspector General and the U.S. Attorney's office in Dallas, Texas (collectively the "Agencies"). The investigation resulted from a HCFA review of the eligibility for payment under Medicare's coverage guidelines of certain partial hospitalization services rendered by the program. As of July 27, 1998, no formal complaint, demand, or additional request for information has been made by the investigating agencies. A representative of the Agencies has indicated that the investigation is civil in nature and focuses on eligibility of patients for partial hospitalization services. The eligibility determinations for participation at the Dallas program were made by board certified or board eligible psychiatrists. The Company is cooperating fully with the Agencies. Due to the preliminary nature of the investigation, the Company is unable to predict the ultimate outcome of the investigation, or the material impact, if any, on the Company's business, financial condition or results of operations. See "Risk Factors -- Government Regulation." 22. 23 The Company is engaged in disputes with TBH regarding certain payments made to the Company for case management services provided by the case management agencies. TBH has made a claim based on a sample audit, for approximately $4.2 million relating to payments made to the Company for case management services. The Company believes that the claim is without merit and is in the process of discussing the issue with TBH. The matter may be referred to arbitration if the parties do not resolve the dispute. The Company is engaged in arbitration with a case management agency in Memphis regarding disputes involving the management and affiliation agreement. The Company cannot predict the outcome of the arbitration. The Company expects to terminate or restructure substantially the relationship with the case management agency in fiscal 1999. See "Risk Factors -- Potential Changes in TennCare." A qui tam suit has been filed by Anastasios Giorgiadis, a former employee of the Company, against a subsidiary of the Company in Federal District Court in the Southern District of California. This suit was filed under seal and the Company was first informed of it on July 20, 1998. The suit alleges a broad range of improper conduct relating to the quality of services furnished by the Company, the medical necessity of the services furnished by the Company, and the accuracy of billing for services furnished by the Company and by physicians who admit patients to the programs managed by the Company, and other matters. The suit was filed by a former employee who previously had filed a separate action for wrongful termination. The Company prevailed in that wrongful termination case when the court dismissed the case by granting the Company's motion for summary judgment. The allegations in the wrongful termination case were very similar to the allegations in the pending qui tam case. Notwithstanding the similarity between the allegations in the wrongful termination case and the qui tam case, the Company cannot give any assurances with respect to the ultimate outcome of the qui tam case or its effect on the Company's business, financial condition or results of operations. Under the False Claims Act, the Department of Justice must inform the court whether it will intervene and take control of the qui tam suit. In this case, the Department of Justice has not yet made that decision, but rather is conducting an investigation. The Company has met with the Assistant United States Attorney who is coordinating the government's investigation of this case, and the Company has agreed to furnish certain documentation to the government. The Company is unable to predict the impact, if any, on the Company's business, financial condition, or results of operations which may result from the investigation, or any claims which may arise therefrom. See "Risk Factors -- Government Regulation." The Company is not a party to any other material legal proceedings required to be reported hereunder. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS The Company held a special meeting of the stockholders on March 5, 1998 to approve an amendment to the Company's Restated Certificate of Incorporation (the "Restated Certificate") to increase the authorized number of shares of Common Stock and to clarify certain provisions of the Restated Certificate relating to the Board of Directors' authority to issue preferred stock, the limitation of directors' personal liability under the Delaware General Corporation Law and indemnification of officers, directors, employees and agents of the Company (collectively the "Amendment"). The Amendment was approved with 4,927,085 votes in favor, 93,335 votes against and 32,448 abstentions. 23. 24 ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY The executive officers of the Company and their ages and positions at April 30, 1998, are as follows:
NAME AGE POSITION - ---- --- -------- Allen Tepper.................... 50 Chief Executive Officer Fred D. Furman.................. 50 President Mark P. Clein................... 39 Executive Vice President and Chief Financial Officer Susan D. Erskine................ 46 Executive Vice President- Development, Secretary and Director Daniel L. Frank................. 41 President of Disease Management Division Charles E. Galetto.............. 47 Senior Vice President - Finance and Treasurer
- ------------ Allen Tepper co-founded the Company in 1988, has served as Chairman and Chief Executive Officer of the Company since October 1989 and previously served as President from October 1989 to April 1997. Mr. Tepper co-founded Consolidated Medical Corp., which was engaged in out-patient clinic management for acute care hospitals in the Philadelphia area. The company was subsequently sold to the Berwind Corporation in 1984 and Mr. Tepper remained with the company until December 1986 as Senior Vice President. Mr. Tepper holds a Masters of Business Administration degree from Northwestern University and a Bachelors degree from Temple University. Fred D. Furman has served as President of the Company since April 1997. Previously, he held the position of Executive Vice President -- Administration and General Counsel from March 1995 to April 1997. Prior to joining the Company, Mr. Furman was a partner at Kleinbard, Bell and Brecker, a Philadelphia law firm from 1980 to March 1995. Mr. Furman is a member of the National Health Lawyers Association. He holds a Juris Doctor degree and a Bachelors degree from Temple University. Mark P. Clein has served as Executive Vice President and Chief Financial Officer of the Company since May 1996. Prior to joining the Company, Mr. Clein was a Managing Director of Health Care Investment Banking for Jefferies & Co., an investment banking firm, from August 1995 to May 1996, a Managing Director of Rodman & Renshaw, Inc., an investment banking firm, from March 1995 to August 1995, a Managing Director of Mabon Securities Corp., an investment banking firm, from March 1993 to March 1995, a Vice President with Sprout Group, an affiliate of Donaldson, Lufkin and Jenrette, Inc., from May 1991 to March 1993, and a Vice President and partner with Merrill Lynch Venture Capital, Inc. from 1982 to February 1990 and from August 1990 to February 1991. Mr. Clein holds a Masters of Business Administration degree from Columbia University and a Bachelors degree from the University of North Carolina. Susan D. Erskine co-founded the Company in 1988 and has served as Executive Vice President, Secretary and a director of the Company since October 1989. Ms. Erskine previously served in several operational and marketing management positions with acute care hospitals and health care management organizations. Ms. Erskine holds a Masters in Health Science degree and completed post-graduate work at Stanford University in Education and Psychology, and she holds a Bachelors degree from the University of Miami. Daniel L. Frank has served as President of the Disease Management division of the Company since April 1998. This division is responsible for the development of Stadt Solutions and its integrated managed care initiative. Mr. Frank has also served as a director of the Company since 1992. Previously, Mr. Frank was President of Coram Healthcare's Lithotripsy division from 1996 until its sale in 1997. Prior to that, Mr. Frank was Chief Executive Officer of Western Medical Center - Anaheim and Santa Ana Health, Inc. from 1993 to 1996. From 1991 to 1993, he was President of Summit Ambulatory Network. 24. 25 Charles E. Galetto has served as Senior Vice President-Finance and Treasurer of the Company since August 1997. Prior to joining the Company, Mr. Galetto was Vice President-Corporate Controller of Medtrans, a medical transportation company, from June 1996 to July 1997 and Vice President, Chief Financial Officer, Treasurer and Secretary of Data/Ware Development, Inc., a computer hardware and software developer, from 1989 to May 1996. Mr. Galetto holds a Bachelors degree from Wayne State University. PART II ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (a) MARKET INFORMATION The Company's Common Stock (NASDAQ symbol "PMRP") is traded publicly through the NASDAQ National Market System. The following table represents quarterly information on the price range of the Company's Common Stock. This information indicates the high and low sale prices reported by the NASDAQ National Market System. These prices do not include retail markups, markdowns or commissions:
QUARTERS FOR THE YEAR ENDED APRIL 30, 1998 HIGH LOW ---- --- FIRST QUARTER $24.13 $16.88 SECOND QUARTER $24.50 $19.13 THIRD QUARTER $23.63 $17.00 FOURTH QUARTER $19.50 $10.50 QUARTERS FOR THE YEAR ENDED APRIL 30, 1997 FIRST QUARTER $15.50 $8.50 SECOND QUARTER $35.25 $14.13 THIRD QUARTER $31.44 $20.25 FOURTH QUARTER $29.75 $16.75
(b) HOLDERS As of July 23, 1998 there were 89 holders of record of the Company's Common Stock. (c) DIVIDENDS It is the policy of the Company's Board of Directors to retain earnings to support operations and to finance continued growth of the Company rather than to pay dividends. The Company has never paid or declared any cash dividends on its Common Stock and does not anticipate paying any cash dividends in the foreseeable future. The Company's credit facility contains certain restrictions and limitations, including the prohibition against payment of dividends on Common Stock. (d) RECENT SALES OF UNREGISTERED SECURITIES From May 1, 1997 to April 30, 1998, the Company has sold and issued (without payment of any selling commission to any person) the following unregistered securities: On May 1, 1997, the Company issued a Warrant to purchase up to 5,000 shares of Common Stock to each of Case Management, Inc. and Mental Health Cooperative, Inc. in connection with Management and Affiliation Agreements with each of them. The Warrants were issued in connection with services provided under Management and Affiliation Agreements, based on the program's satisfaction of certain revenue-based threshold requirements. Each Warrant is exercisable for 5 years at an exercise price equal to the average closing price of the Company's common 25. 26 stock on the Nasdaq National Market for the 10 trading days prior to April 30, 1997 (subject to adjustment upon certain events as described in the Warrants.) The proceeds to be received, if any, upon exercise of the warrant are anticipated to be used for operating capital. The issuance of the Warrants were deemed to be exempt from registration under the Securities Act by virtue of Section 4(2) thereunder. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with the Company's consolidated financial statements and the accompanying notes included elsewhere herein.
YEARS ENDED APRIL 30 ---------------------------------------------------------------- 1998 1997 1996 1995 1994 ------- -------- ------- -------- -------- (in thousands, except per share amounts) INCOME STATEMENT INFORMATION Revenues $ 67,524 $ 56,637 $ 36,315 $ 21,747 $ 22,786 Net Income (loss) 1,458 3,107 918 (2,352) 825 Net Income (loss) per share Basic .24 .66 .26 (.71) .25 Diluted .22 .55 .23 (.71) .25 WEIGHTED SHARES OUTSTANDING Basic 6,053 4,727 3,484 3,336 3,228 Diluted 6,695 5,646 4,471 3,336 3,347
AS OF APRIL 30 ---------------------------------------------------------------- 1998 1997 1996 1995 1994 ------- -------- ------- -------- -------- BALANCE SHEET INFORMATION Working Capital $ 51,820 $ 17,036 $ 10,911 $ 8,790 $ 7,705 Total Assets 70,449 32,450 21,182 14,811 13,671 Long Term Debt 392 0 0 126 320 Total Liabilities 16,903 16,202 12,070 7,749 5,972 Stockholders' Equity 53,546 16,248 9,112 7,062 7,699
QUARTERS FOR THE YEARS ENDED ------------------------------------------------------------------------------------------------------ APRIL 30, 1998 APRIL 30, 1997 ------------------------------------------------ ----------------------------------------------- 7/31/97 10/31/97 1/31/98 4/30/98 7/31/96 10/31/96 1/31/97 4/30/97 --------- -------- ------- ------- ------- -------- ------- ------- (in thousands, except per share amounts) REVENUES 16,177 17,561 16,522 17,264 13,028 14,293 14,190 15,126 NET INCOME (LOSS) 970 1,162 1,327 (2,001) 583 799 831 894 NET INCOME (LOSS) PER SHARE Basic .19 .22 .19 (.29) .14 .16 .17 .19 Diluted .17 .19 .18 (.29) .12 .14 .14 .15
26. 27 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the more detailed information and consolidated financial statements and accompanying notes, as well as the other financial information appearing elsewhere in this document. Except for historical information, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Risk Factors," as well as those discussed elsewhere in this document. OVERVIEW PMR is a leading manager of specialized mental health care programs and disease management services designed to treat individuals diagnosed with SMI. PMR manages the delivery of a broad range of outpatient and community-based psychiatric services for SMI patients, consisting of 37 Outpatient Programs, two Case Management Programs and four Chemical Dependency Programs. Stadt Solutions, upon formation, will offer a specialty pharmacy program for individuals with SMI, initially serving approximately 6,000 individuals through fourteen pharmacies in thirteen states. Stadt Solutions will also receive the Company's clinical research and information business upon formation. Including Stadt Solutions, PMR will operate in approximately twenty-three states and is expected to employ or contract with more than 400 mental health and pharmaceutical professionals and provide services to approximately 11,000 individuals diagnosed with SMI. PMR believes it is the only private sector company focused on providing an integrated mental health disease management model to the SMI population. PMR's Outpatient Programs serve as a comprehensive alternative to inpatient hospitalization and include partial hospitalization and lower intensity outpatient services. The Case Management Programs provide an intensive, individualized primary care service which consists of a proprietary case management model utilizing clinical protocols for delivering care to SMI patients. The Company also provides Chemical Dependency Programs to patients affiliated with managed care organizations and government-funded programs. SOURCES OF REVENUE Outpatient Programs. Outpatient Programs operated by PMR are the Company's primary source of revenue. Revenue under these programs is derived primarily from services provided under three types of agreements: (i) an all-inclusive fee arrangement based on fee-for-service rates which provides that the Company is responsible for substantially all program costs; (ii) a fee-for-service arrangement under which substantially all program costs are the responsibility of the provider; and (iii) a fixed fee arrangement. The all-inclusive arrangements are in effect at 34 of the 39 Outpatient Programs operated during fiscal 1998 and constituted 62.4% of the Company's revenue for the year ended April 30, 1998. Typical contractual agreements with these providers, primarily acute care hospitals or CMHCs, require the Company to provide, at its own expense, specific management personnel for each program site. Patients served by the Outpatient Programs typically are covered by Medicare. Revenue under the Outpatient Program is recognized at estimated net realizable amounts when services are rendered based upon contractual arrangements with providers. Under certain of the Company's contracts, the Company is obligated to indemnify the provider for all or some portion of the Company's management fees that may not be deemed reimbursable to the provider by Medicare's fiscal intermediaries. As of April 30, 1998, the Company had recorded $7.5 million in contract settlement reserves to provide for possible amounts ultimately owed to its provider customers resulting from disallowance of costs by Medicare and Medicare cost report settlement adjustments. Such reserves are classified as non-current liabilities because ultimate determination of substantially all of the potential contract disallowances is not anticipated to occur during fiscal 1998. See "Risk Factors -- Dependence Upon Medicare Reimbursement" and "-- Sufficiency of Existing Reserves to Cover Reimbursement Risks." Case Management Programs. For its Case Management Programs in Tennessee, the Company receives a monthly case rate payment from the managed care consortiums responsible for managing the TennCare program and is responsible for planning, coordinating and managing psychiatric case management services for its consumers who are eligible to participate in the TennCare program. The Company also is responsible for providing a portion of the 27. 28 related outpatient clinical care under certain of the agreements. Revenue under the TennCare program is recognized in the period in which the related service is to be provided. These revenues represent substantially all of the Company's case management revenues. The urgent care program receives interim payments which are adjusted based on inpatient utilization statistics which are compared to a baseline. Revenues are recognized based on the quarterly calculation of the statistical trends. See "Risk Factors -- Potential Changes in TennCare," "-- Concentration of Revenues" and "-- Limited Operating History of Case Management Programs." Chemical Dependency Programs. In Southern California, the Company contracts primarily with managed care companies and commercial insurers to provide its outpatient chemical dependency services. The contracts are structured as fee-for-service or case rate reimbursement and revenue is recognized in the period in which the related service is delivered. In Arkansas, the Company managed detoxification and dual diagnosis programs for individuals eligible for public sector reimbursement. The Company generated revenue based on a combination of state-funded grants and Medicaid fee-for-service reimbursement. Revenue was recognized in the period in which the related service was delivered. The Arkansas programs were terminated as of June 30, 1998. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage of revenue represented by the respective financial items:
YEAR ENDED APRIL 30, ------------------------------- 1998 1997 1996 ---- ---- ----- Revenue..................................... 100.0% 100.0% 100.0% Operating expenses.......................... 71.5 73.7 78.4 Marketing, general and administrative....... 13.6 10.7 11.1 Provision for bad debts..................... 7.6 5.4 4.0 Depreciation and amortization............... 1.6 1.2 1.6 Special Charge 3.8 - - Interest (income), expense.................. (1.8) (0.4) 0.0 ---- ---- ---- Total expenses.............................. 96.3 90.6 95.1 ----- ---- ---- Income before income taxes 3.7% 9.4% 4.9% ===== ==== ====
YEAR ENDED APRIL 30, 1998 COMPARED TO YEAR ENDED APRIL 30, 1997 REVENUE. Revenue increased from $56.6 million for the year ended April 30, 1997 to $67.5 million for the year ended April 30, 1998, an increase of $10.9 million, or 19.2%. The Outpatient Programs recorded revenue of $49.4 million, an increase of 23.5% as compared to fiscal 1997. The growth in Outpatient Programs was the result of the addition of nine new programs in fiscal 1998 and increases in "same-site" revenues of 11.7% compared to fiscal 1997. The remainder of the increase in revenue came from the growth in Case Management Programs in Tennessee and Arkansas, which recorded revenue of $15.1 million, an increase of $1.4 million or 10.4% as compared to fiscal 1997. Revenue from the Chemical Dependency Programs was $3.0 million, an increase of 1.0% as compared to fiscal 1997. The Company is currently in the process of terminating or restructuring its relationship with a Tennessee case management agency and during fiscal 1998 terminated its Arkansas Case Management Programs. See "Business -- Programs and Operations -- Case Management Programs." OPERATING EXPENSES. Operating expenses consist of costs incurred at the program sites and costs associated with the field management responsible for the administering the programs. Operating expenses increased from $41.7 million for the year ended April 30, 1997 to $48.2 million for the year ended April 30, 1998, an increase of $6.5 million, or 15.6%. As a percentage of revenue, operating expenses were 71.5%, down from 73.7% for the year ended April 30, 1997. The improvement in the operating expense ratio was due to reductions in certain 28. 29 expenses as well as operating leverage realized as a result of revenue growth in the Outpatient and Case Management Programs which was spread across existing fixed and semi-variable cost structures. MARKETING, GENERAL AND ADMINISTRATIVE. Marketing, general and administrative expenses increased from $6.0 million for the year ended April 30, 1997 to $9.2 million for the year ended April 30, 1998, an increase of $3.2 million, or 53.3%. The increase was due to investment in both the regional and home offices to support existing and anticipated programs. As a percentage of revenue, marketing, general and administrative expenses were 13.6% for the year ended April 30, 1998, as compared to 10.7% for the year ended April 30, 1997. PROVISION FOR BAD DEBTS. Provision for bad debt expense increased from $3.1 million for the year ended April 30, 1997 to $5.1 million for the year ended April 30, 1998, an increase of $2.0 million, or 64.5%. The increase was due to anticipated difficulties associated with collection of receivables relating to program locations closed in the fourth quarter of fiscal 1998. As part of a special charge in the fourth quarter of fiscal 1998, the Company recorded approximately $2.4 million in additional bad debt expenses associated with the closed programs. SPECIAL CHARGE. A Special Charge of $5.0 million was recorded in the fourth quarter to provide for costs associated with closing several programs, resolving the provider based status associated with the Scripps Health programs and resolving other regulatory matters. Included in this charge is a $2.4 million bad debt expense which was recorded in provision for bad debts. The remaining $2.6 million was allocated to program closing costs which were $1.4 million and costs associated with noncancelable contract obligations which were $1.2 million. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense increased from $701,000 for the year ended April 30, 1997 to $1,065,000 for the year ended April 30, 1998, an increase of $364,000 or 51.9%. The increase was due to additional capital expenditures associated with the start-up of new programs during fiscal 1998 and as well as equipment and leasehold improvements associated with the Company's corporate office. INTEREST (INCOME), EXPENSE. Interest income increased from $217,000 for the year ended April 30, 1997 to $1,187,000 for the year ended April 30, 1998, an increase of $970,000 or 447.0%. This increase resulted from higher cash and cash equivalent and short-term investment balances resulting from the completion of the Company's common stock offering in October 1997. INCOME BEFORE INCOME TAXES. Income before income taxes decreased from $5.3 million for the year ended April 30, 1997 to $2.5 million for the year ended April 30, 1998, a decrease of $2.8 million, or 52.8%. Income before income taxes as a percentage of revenue decreased from 9.4% to 3.7% over this period of time. YEAR ENDED APRIL 30, 1997 COMPARED TO YEAR ENDED APRIL 30, 1996 REVENUE. Revenue increased from $36.3 million for the year ended April 30, 1996 to $56.6 million for the year ended April 30, 1997, an increase of $20.3 million, or 56.0%. The Outpatient Programs recorded revenue of $40.0 million, an increase of 49.3% as compared to fiscal 1996. This increase was the result of same-site increases in revenue of 40.0% compared to fiscal 1996 and the gross addition of eight new programs in fiscal 1997. The remainder of the increase in revenue came predominantly from the growth in Case Management Programs in Tennessee and the introduction of Case Management Programs in Arkansas, which recorded revenue of $13.7 million, an increase of 80.3% as compared to fiscal 1996. Revenue from the Chemical Dependency Programs was $2.9 million, an increase of 54.4% as compared to fiscal 1996. This increase was attributable to a full year of operation of the Little Rock public sector program in Arkansas and to growth in the managed care business in California. OPERATING EXPENSES. Operating expenses increased from $28.5 million for the year ended April 30, 1996 to $41.7 million for the year ended April 30, 1997, an increase of $13.2 million, or 46.3%. Of this increase, $5.4 million, or 40.9%, resulted from the effect of a full year of operations of the Case Management Programs in Tennessee and the launch of the Case Management Programs in Arkansas. The remainder of the increase in operating expenses was associated primarily with increased costs to support the revenue growth at existing Outpatient Programs and the net addition of six Outpatient Programs during fiscal 1997. 29. 30 MARKETING, GENERAL AND ADMINISTRATIVE. Marketing, general and administrative expenses increased from $4.0 million for the year ended April 30, 1996 to $6.0 million for the year ended April 30, 1997, an increase of $2.0 million, or 50.0%. The increase was related to the following factors: (i) the reorganization of the Company into three regions; (ii) the significant investment in the Mid-America region to prepare for anticipated growth associated with an enabling agreement with Columbia/HCA Healthcare Corporation; (iii) the start-up of the site management and clinical information initiative; and (iv) increases in personnel associated with information systems, development and utilization review. PROVISION FOR BAD DEBTS. Provision for bad debt expense increased from $1.4 million for the year ended April 30, 1996 to $3.1 million for the year ended April 30, 1997, an increase of $1.7 million, or 121.4%. This increase was due to an increase in the percentage for bad debt from 4.0% in fiscal 1996 to 5.4% in fiscal 1997, which resulted in part from higher rates of indigent clients in the Case Management Programs, limited collection experience in the Case Management Programs and in the Chemical Dependency Programs in Arkansas, and a more conservative percentage for denials by third-party payors. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense increased from $596,000 for the year ended April 30, 1996 to $701,000 for the year ended April 30, 1997, an increase of $105,000, or 17.6%. The increase was due to additional capital expenditures associated with the start-up of eight new Outpatient Programs and increased capital expenditures for information systems. INTEREST (INCOME), EXPENSE. Interest expense decreased from $2,000 for the year ended April 30, 1996 to interest income of $217,000 for the year ended April 30, 1997, an increase of $219,000. The improvement was due to higher cash and cash equivalent balances and the absence of bank debt in fiscal 1997. INCOME BEFORE INCOME TAXES. Income before income taxes increased from $1.8 million for the year ended April 30, 1996 to $5.3 million for the year ended April 30, 1997, an increase of $3.5 million, or 194.4%. Income before income taxes as a percentage of revenue increased from 4.9% to 9.4% over this period of time. LIQUIDITY AND CAPITAL RESOURCES For the year ended April 30, 1998, net cash used in operating activities was $3.0 million. Working capital at April 30, 1998 was $51.8 million, an increase of $34.8 million, or 204.2%, as compared to working capital at April 30, 1997. Cash and cash equivalents and short-term investments at April 30, 1998 were $38.8 million, an increase of $28.7 million, or 286.0% as compared to April 30, 1997. The increase in working capital, cash and cash equivalents and short-term investments was due to the completion of a public offering of shares of common stock of the Company during October 1997, which resulted in net proceeds of $33.1 million, which was offset by cash used to finance operating activities. The use of cash for operating activities during the year ended April 30, 1998 was due to delayed collections of accounts receivable. Accounts receivable growth was a result of significant revenue increases combined with an increase in days revenue outstanding to 88 at April 30, 1998 (versus 67 at April 30, 1997). The increase in days revenue outstanding was due to focused reviews of claims by fiscal intermediaries at several Outpatient Programs. The other significant use of cash was the purchase of equipment and leasehold improvements associated with recently opened sites and investment in information technology. During fiscal 1999, working capital is expected to be realized principally from operations, as well as from a $10 million line of credit from Sanwa Bank which became effective November 1, 1996. Interest is payable under this line of credit at a rate of either the bank's reference rate or the Eurodollar rate plus 2%. As of April 30, 1998 no balance was outstanding under the line of credit. Working capital is anticipated to be utilized during fiscal 1999, to continue expansion of the Company's Outpatient and Case Management Programs, for expansion of Stadt Solutions and the site management and clinical information business, and for the development of a risk based managed care project. The Company also anticipates using working capital and, if necessary, incurring indebtedness in connection with, selective acquisitions. The opening of a new Outpatient Program site typically requires $45,000 to $150,000 for office equipment, supplies, lease deposits, leasehold improvements and the hiring and training of personnel prior to opening. These 30. 31 programs generally experience operating losses through an average of the first four months of operation. The Company expects to provide cash for the start up of the site management and clinical information business as part of the formation of Stadt Solutions. The Company also is in the process of refining the specifications for the purchase and development of a new care management information system which will be a state of the art data collection and repository system for the Company's clinical information. The Company anticipates investing approximately $1,000,000 in this system during fiscal 1999. From time to time, the Company recognizes charges to operations as a result of particular uncertainties associated with the health care reimbursement rules as they apply to the Outpatient Programs. During fiscal 1997 and fiscal 1998, a substantial majority of the Company's revenue was derived from the management of the Outpatient Programs. Since substantially all of the patients of the Outpatient Programs are eligible for Medicare, collection of a significant component of the Company's management fees is dependent upon reimbursement of claims submitted to fiscal intermediaries by the hospitals or Community Mental Health Centers on whose behalf these programs are managed. Under the Company's contracts with its providers, the Company may be responsible to indemnify providers for the portion of the Company's management fee disallowed for reimbursement pursuant to warranty obligations that exist with certain providers. Although the Company believes that its potential liability to satisfy such requirements has been adequately reserved in its financial statements, the obligation to pay such amounts, if and when they become due, could have a material adverse effect on the Company's short term liquidity. Certain factors are, in management's view, likely to lessen the impact of any such effect, including the expectation that, if claims arise, they will arise on a periodic basis over several years and that any disallowance will merely be offset against obligations already owed by the provider to the Company. The Company maintains significant reserves to cover the potential impact of two primary uncertainties: (i) the Company may have an obligation to indemnify certain providers for some portions of its management fee which may be subject to disallowance upon audit of a provider's cost report by fiscal intermediaries; and (ii) the Company may not receive full payment of the management fees owed to it by a provider during the periodic review of the provider's claims by the fiscal intermediaries. The Company has been advised by HCFA that certain program-related costs are not allowable for reimbursement. The Company may be responsible for reimbursement of the amounts previously paid to the Company that are disallowed pursuant to obligations that exist with certain providers. Although the Company believes that its potential liability to satisfy such requirements has been adequately reserved in its financial statements, there can be no assurance that such reserves will be adequate. The obligation to pay the amounts estimated within the Company's financial statements (or such greater amounts as are due), if and when they become due, could have a material adverse effect upon the Company's business, financial condition and results of operations. See "Risk Factors -- Sufficiency of Existing Reserves to Cover Reimbursement Risks," "Business -- Contracts" and "-- Regulatory Matters." IMPACT OF INFLATION A substantial portion of the Company's revenue is subject to reimbursement rates that are regulated by the federal and state governments and that do not automatically adjust for inflation. As a result, increased operating costs due to inflation, such as labor and supply costs, without a corresponding increase in reimbursement rates, may adversely affect the Company's earnings in the future. IMPACT OF YEAR 2000 COMPUTER ISSUES The year 2000 issue is the result of computer applications being written using two digits rather than four to define the applicable year. The Company's computer applications (and computer applications used by any of the Company's customers, vendors, payors or other business partners) may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations causing disruption of operations. The Company has completed a thorough review of its material computer applications and has identified and scheduled necessary corrections for its computer applications. Corrections are currently being made and are expected to be substantially implemented by the third quarter of fiscal 1999. The Company expects that the total cost associated with these revisions will not be material. These costs will be primarily incurred during fiscal 1999 31. 32 and be charged to expense as incurred. For externally maintained systems, the Company has begun working with vendors to ensure that each system is currently year 2000 compliant or will be made year 2000 compliant during 1998 or 1999. The cost to be incurred by the Company related to externally maintained systems is expected to be minimal. The Company believes that by completing its planned corrections to its computer applications, the year 2000 issue with respect to the Company's systems can be mitigated. However, if such corrections cannot be completed on a timely basis, the year 2000 issue could have a material adverse impact on the Company's business, financial condition and results of operations. Because of the many uncertainties associated with year 2000 compliance issues, and because the Company's assessment is necessarily based on information from third party vendors and suppliers, there can be no assurance that the Company's assessment is correct or as to the materiality or effect of any failure of such assessment to be correct. The Company has initiated a program to determine whether the computer applications of its significant payors and contract providers will be upgraded in a timely manner. The Company has not completed this review and it is unknown whether computer applications of contract providers and Medicare and other payors will be year 2000 compliant. The Company has not determined the extent to which any disruption in the billing practices of providers or the payment practices of Medicare or other payors caused by the year 2000 issues will affect the Company's operations. However, any such disruption in the billing or reimbursement process could have a substantial adverse impact on Medicare or Medicaid payments to providers and, in turn, payments to the Company. Any such disruption could have a material adverse effect upon the Company's business, financial condition and results of operations. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Financial Statements and supplementary data of the Company are provided at the pages indicated in Item 14(a). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There has not been any change of accountants or any disagreements with the Company's accountants on any matter of accounting practice or financial disclosure during the reporting periods. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The information required by this item with respect to Directors is incorporated by reference from the information under the caption "Election of Directors" contained in the Company's definitive proxy statement in connection with the solicitation of proxies for the Company's 1998 Annual Meeting of Stockholders to be held on October 15, 1998 (the "Proxy Statement"). See "Item 4A. Executive Officers of the Company" with regard to Executive Officers. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference from the information under the caption "Executive Compensation" contained in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference from the information under the caption "Security Ownership of Certain Beneficial Owners and Management" contained in the Proxy Statement. 32. 33 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference from the information under the caption "Certain Relationships and Related Transactions" contained in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Annual Report on Form 10-K: 1. Financial Statements: The financial statements of PMR are included as Appendix F of this report. See Table of Contents to Financial Statements in Appendix F. 2. Financial Statement Schedules: Schedule II - PMR Corporation Valuation and Qualifying Accounts is included in Appendix F of this report. See Table of Contents to Financial Statements in Appendix F. 3. The exhibits which are filed with this Report or which are incorporated herein by reference are set forth in the Exhibit Index on page 33. (b) Reports on Form 8-K: During the fourth quarter of fiscal 1998, the Company filed the following report on Form 8-K: 1. Report on Form 8-K dated February 19, 1998, and filed on or about February 25, 1998, announcing the third quarter results, regulatory challenges and the signing of a letter of intent to acquire the provider division of American Psych Systems. 2. Report on Form 8-K dated May 12, 1998, and filed on or about May 13, 1998, announcing the Company's plan to take a special change and preliminary estimates of fourth quarter results. 3. Report on Form 8-K dated June 9, 1998 and filed on or about June 11, 1998 announcing a preliminary resolution of the provider-based challenge and a proposed joint venture with Stadtlander. (c) Exhibits:
EXHIBIT NUMBER DESCRIPTION ------ --------------------------------------------------------- 3.1 The Company's Restated Certificate of Incorporation, filed with the Delaware Secretary of State on March 9, 1998. 3.2 The Company's Amended and Restated Bylaws.* 4.1 Common Stock Specimen Certificate.** 10.1 The Company's 1997 Equity Incentive Plan (filed as Exhibit 10.1).* 10.2 Form of Incentive Stock Option Agreement under the 1997 Plan (filed as Exhibit 10.2).* 10.3 Form of Nonstatutory Stock Option Agreement under the 1997 Plan (filed as Exhibit 10.).* 10.4 Outside Directors' Non-Qualified Stock Option Plan of 1992 (the "1992 Plan") (filed as Exhibit 10.4).* 10.5 Form of Outside Directors' Non-Qualified Stock Option Agreement (filed as Exhibit 10.5).* 10.6 Amended and Restated Stock Option Agreement dated April 30, 1996, evidencing award to Allen Tepper (filed as Exhibit 10.6).*
33. 34
EXHIBIT NUMBER DESCRIPTION ------ --------------------------------------------------------- 10.7 Amended and Restated Stock Option Agreement dated April 30, 1996, evidencing award to Susan Erskine (filed as Exhibit 10.7).* 10.8 Amended and Restated Stock Option Agreement dated February 1, 1996, evidencing award to Mark Clein (filed as Exhibit 10.8).* 10.9 Amended and Restated Stock Option Agreement dated February 1, 1996, evidencing award to Mark Clein (filed as Exhibit 10.9).* 10.10 Amended and Restated Warrant dated July 9, 1997, evidencing award to Fred Furman (filed as Exhibit 10.11).* 10.11 Restated Management Agreement dated April 11, 1997 with Scripps Health (filed as Exhibit 10.12).* 10.12 Amendment to Restated Management Agreement dated July 15, 1998 with Scripps Health. 10.13 Sublease dated April 1, 1997 with CMS Development and Management Company, Inc. (filed as Exhibit 10.13).* 10.14 Management and Affiliation Agreement dated April 13, 1995, between Mental Health Cooperative, Inc. and Tennessee Mental Health Cooperative, Inc. with Addendum (filed as Exhibit 10.14). (Tennessee Mental Health Cooperative, Inc. subsequently changed its name to Collaborative Care Corporation.)* 10.15 Second Addendum to Management and Affiliation Agreement dated November 1, 1996 between Mental Health Cooperative, Inc. and Collaborative Care Corporation (filed as Exhibit 10.15).*** 10.16 Provider Services Agreement dated April 13, 1995, between Tennessee Mental Health Cooperative, Inc. and Mental Health Cooperative, Inc. (filed as Exhibit 10.15). (Tennessee Mental Health Cooperative, Inc. subsequently changed its name to Collaborative Care Corporation.)* 10.17 Management and Affiliation Agreement dated April 13, 1995, between Case Management, Inc. and Tennessee Mental Health Cooperative, Inc. with Addendum (filed as Exhibit 10.16). (Tennessee Mental Health Cooperative, Inc. subsequently changed its name to Collaborative Care Corporation.)* 10.18 Provider Services Agreement dated April 13, 1995, between Tennessee Mental Health Cooperative, Inc. and Case Management, Inc. (filed as Exhibit 10.17). (Tennessee Mental Health, Cooperative, Inc. subsequently changed its name to Collaborative Care Corporation.)* 10.19 Provider Agreement dated December 4, 1995, between Tennessee Behavioral Health, Inc. and Tennessee Mental Health Corporations, Inc. 10.20 Addendum No. 1 to Provider Agreement dated December 4, 1995, between Tennessee Behavioral Health, Inc. and Tennessee Mental Health Cooperative, Inc. 10.21 Addendum No. 2 to Provider Agreement dated February 4, 1996, between Tennessee Behavioral Health, Inc. and Tennessee Mental Health Cooperative, Inc. 10.22 Provider Participation Agreement dated December 1, 1995, among Green Spring Health Services, Inc., AdvoCare, Inc. and Tennessee Mental Health Cooperative, Inc. 10.23 Amendment to Provider Participation Agreement dated February 13, 1996, among Green Spring Health Services, Inc., AdvoCare of Tennessee, Inc. and Tennessee Mental Health Cooperative, Inc.
34. 35 10.24 Subscription Agreement dated June 8, 1998, between the Company and Stadtlander Drug Distribution Co., Inc. 10.25 Sanwa Bank California Credit Agreement dated February 2, 1996, as amended on October 31, 1996.*** 21.1 List of Subsidiaries. 23.1 Consent of Ernst & Young LLP. 27.1 Financial Data Schedule.
- ------------- * Incorporated by reference to exhibits filed with the SEC in the Company's Annual Report on Form 10-K for the year ended April 30, 1997. ** Incorporated by reference to the Company's Registration Statement on Form S-18 (Reg. No. 23-20095-A). *** Incorporated by reference to exhibits filed with the SEC in the Company's Registration Statement on Form S-2 (Reg. No. 333-36313). SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on July 27, 1998. PMR CORPORATION By: /s/ Allen Tepper ------------------------------------------- Allen Tepper Chief Executive Officer (Principal Executive Officer) Pursuant to the requirements of the Securities Act of 1934, this Form 10-K has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - --------- ----- ---- /s/ Allen Tepper Chairman, Chief Executive July 27, 1998 - ------------------------- Officer and Director Allen Tepper /s/ Susan D. Erskine Secretary, Treasurer and July 27, 1998 - ------------------------- Director Susan D. Erskine /s/ Daniel L. Frank President of Disease Management July 27, 1998 - ------------------------- Division and Director Daniel L. Frank /s/ Charles McGettigan Director July 27, 1998 - ------------------------- Charles C. McGettigan /s/ Richard A. Niglio Director July 27, 1998 - ------------------------- Richard A. Niglio /s/ Eugene D. Hill Director July 27, 1998 - ------------------------- Eugene D. Hill
35. 36 PMR Corporation Consolidated Financial Statements and Schedules Years ended April 30, 1998 and 1997
CONTENTS Report of Independent Auditors..........................................................................F-1 Consolidated Financial Statements Consolidated Balance Sheets.............................................................................F-2 Consolidated Income Statements..........................................................................F-3 Consolidated Statements of Shareholders' Equity.........................................................F-4 Consolidated Statements of Cash Flows...................................................................F-5 Notes to Financial Statements...........................................................................F-6 Schedules Schedule II - Valuation and Qualifying Accounts........................................................S-1
36. 37 Report of Ernst & Young LLP, Independent Auditors The Board of Directors and Stockholders PMR Corporation We have audited the accompanying consolidated balance sheets of PMR Corporation as of April 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended April 30, 1998. Our audits also included the financial statement schedule listed in the index at item 14(a). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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 PMR Corporation at April 30, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended April 30, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. San Diego, California June 12, 1998 except for paragraph four of Note 13, as to which the date is July 24, 1998 F-1 38 PMR Corporation Consolidated Balance Sheets
APRIL 30, 1998 1997 ----------- ----------- ASSETS Current assets: Cash and cash equivalents $18,522,859 $10,048,203 Short-term investments, available for sale 20,257,045 -- Accounts receivable, net of allowance for uncollectible amounts of $9,081,610 in 1998 and $5,081,177 in 1997 16,655,759 11,268,962 Prepaid expenses and other current assets 1,192,144 572,136 Deferred income tax benefits 4,136,000 2,464,000 ----------- ----------- Total current assets 60,763,807 24,353,301 Furniture and office equipment, net of accumulated depreciation of $1,727,040 in 1998 and $1,175,980 in 1997 3,492,449 1,263,743 Long-term receivables 2,976,918 2,360,872 Deferred income tax benefit 2,080,000 2,970,000 Other assets 1,135,880 1,501,622 ----------- ----------- Total assets $70,449,054 $32,449,538 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 469,462 $ 753,660 Accrued expenses 3,534,400 981,998 Accrued compensation and employee benefits 2,178,693 2,951,867 Advances from case management agencies 1,686,477 926,712 Income taxes payable 1,074,360 1,703,000 ----------- ----------- Total current liabilities 8,943,392 7,317,237 Note payable 392,024 -- Deferred rent expense 87,566 92,822 Contract settlement reserve 7,479,993 8,791,928 Commitments Stockholders' equity: Convertible preferred stock, $.01 par value, authorized shares - 1,000,000; Series C - issued and outstanding shares - none in 1998 and 1997 Common Stock, $.01 par value, authorized shares - 19,000,000; issued and outstanding shares - 6,949,650 in 1998 and 5,033,507 in 1997 69,496 50,334 Additional paid-in capital 47,959,557 12,138,569 Retained earnings 5,517,026 4,058,648 ----------- ----------- Total stockholders' equity 53,546,079 16,247,551 ----------- ----------- $70,449,054 $32,449,538 =========== ===========
See accompanying notes. F-2 39 PMR Corporation Consolidated Statements of Income
YEAR ENDED APRIL 30, 1998 1997 1996 ------------ ------------ ------------ Revenue $ 67,523,950 $ 56,636,902 $ 36,315,921 Expenses: Operating expenses 48,255,459 41,738,298 28,471,644 Marketing, general and administrative 9,186,401 6,034,960 4,018,685 Provision for bad debts 5,148,580 3,084,166 1,447,983 Depreciation and amortization 1,064,873 700,734 595,896 Special charge 2,582,896 -- -- Interest (income) expense (1,186,637) (217,297) 2,174 Minority interest in loss of subsidiary -- -- (524) ------------ ------------ ------------ 65,051,572 51,340,861 34,535,858 ------------ ------------ ------------ Income before income taxes 2,472,378 5,296,041 1,780,063 Income tax expense 1,014,000 2,172,000 730,000 ------------ ------------ ------------ Net income 1,458,378 3,124,041 1,050,063 Less dividends on: Series C Convertible Preferred Stock -- 17,342 131,686 ------------ ------------ ------------ Net income available to common stockholders $ 1,458,378 $ 3,106,699 $ 918,377 ============ ============ ============ Earnings per common share Basic $ .24 $ .66 $ .26 ============ ============ ============ Diluted $ .22 $ .55 $ .23 ============ ============ ============ Shares used in computing earnings per share Basic 6,053,243 4,727,124 3,484,172 ============ ============ ============ Diluted 6,695,321 5,645,947 4,470,980 ============ ============ ============
See accompanying notes. F-3 40 4 PMR Corporation Consolidated Statements of Stockholders' Equity
SERIES C CONVERTIBLE PREFERRED STOCK COMMON STOCK --------------------------------------------------------- PAID-IN SHARES AMOUNT SHARES AMOUNT CAPITAL ------------ ------------ ------------ ------------ ------------ Balance at April 30, 1995 700,000 $ 7,000 3,338,656 $ 33,385 $ 7,050,262 Issuance of common stock under stock option plans -- -- 17,174 172 61,202 Issuance of common stock for non-compete agreements and acquisition of minority interest -- -- 197,087 1,971 1,029,279 Issuance of common stock for a note receivable -- -- 25,000 250 118,500 Accrued interest on stockholder notes -- -- -- -- -- Dividend payable on Series C preferred stock -- -- -- -- -- Proceeds from payment of stockholder notes -- -- -- -- -- Net income -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ Balance at April 30, 1996 700,000 7,000 3,577,917 35,778 8,259,243 Issuance of common stock under stock option plans including realization of income tax benefit of $369,000 -- -- 96,016 960 729,189 Dividend payable on Series C preferred stock -- -- -- -- -- Proceeds from payment of stockholder notes -- -- -- -- -- Exercise of warrants to purchase common stock -- -- 657,524 6,575 3,104,801 Issuance of common stock for consulting services -- -- 2,050 21 45,336 Conversion of Series C convertible preferred stock (700,000) (7,000) 700,000 7,000 -- Net income -- -- -- ------------ ------------ ------------ ------------ ------------ Balance at April 30, 1997 -- -- 5,033,507 50,334 12,138,569 Issuance of common stock under stock option plans including realization of income tax benefit of $1,687,355 -- -- 226,143 2,262 2,717,694 Issuance of common stock in secondary offering, net of offering costs of $637,556 -- -- 1,690,000 16,900 33,103,294 Net income -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ Balance at April 30, 1998 -- $ -- 6,949,650 $ 69,496 $ 47,959,557 ============ ============ ============ ============ ============
NOTES RECEIVABLE TOTAL FROM RETAINED STOCKHOLDERS' STOCKHOLDERS EARNINGS EQUITY ------------ ------------ ------------ Balance at April 30, 1995 $ (62,626) $ 33,572 $ 7,061,593 Issuance of common stock under stock option plans 1,184 -- 62,558 Issuance of common stock for non-compete agreements and acquisition of minority interest -- -- 1,031,250 Issuance of common stock for a note receivable (118,750) -- -- Accrued interest on stockholder notes (4,507) -- (4,507) Dividend payable on Series C preferred stock -- (131,686) (131,686) Proceeds from payment of stockholder notes 43,152 -- 43,152 Net income -- 1,050,063 1,050,063 ------------ ------------ ------------ Balance at April 30, 1996 (141,547) 951,949 9,112,423 Issuance of common stock under stock option plans including realization of income tax benefit of $369,000 -- -- 730,149 Dividend payable on Series C preferred stock -- (17,342) (17,342) Proceeds from payment of stockholder notes 141,547 -- 141,547 Exercise of warrants to purchase common stock -- -- 3,111,376 Issuance of common stock for consulting services -- -- 45,357 Conversion of Series C convertible preferred stock -- -- -- Net income -- 3,124,041 3,124,041 ------------ ------------ ------------ Balance at April 30, 1997 -- 4,058,648 16,247,551 Issuance of common stock under stock option plans including realization of income tax benefit of $1,687,355 -- -- 2,719,956 Issuance of common stock in secondary offering, net of offering costs of $637,556 -- -- 33,120,194 Net income -- 1,458,378 1,458,378 ------------ ------------ ------------ Balance at April 30, 1998 $ -- $ 5,517,026 $ 53,546,079 ============ ============ ============
See accompanying notes. F-4 41 PMR Corporation Consolidated Statements of Cash Flows
YEARS ENDED APRIL 30, 1998 1997 1996 ------------ ------------ ------------ OPERATING ACTIVITIES Net income $ 1,458,378 $ 3,124,041 $ 1,050,063 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Special charge 2,582,896 -- -- Depreciation and amortization 1,064,873 700,734 595,896 Issuance of stock for consulting services -- 45,357 -- Provision for bad debts 5,148,580 3,084,166 1,447,983 Accrued interest income on notes receivable from stockholders -- -- (4,507) Deferred income taxes (782,000) (3,834,000) (841,000) Minority interest in loss of joint venture -- -- (524) Changes in operating assets and liabilities: Accounts and notes receivable (11,151,423) (4,980,050) (3,778,660) Refundable income tax -- -- 817,165 Prepaid expenses and other assets (620,008) (250,630) (88,487) Accounts payable and accrued expenses (404,697) 212,937 474,124 Accrued compensation and employee benefits (773,174) 675,058 1,415,780 Advances from case management agencies 759,765 (86,135) 1,012,847 Other liabilities -- (127,213) (205,034) Contract settlement reserve (1,311,935) 3,292,908 1,975,797 Income taxes payable 1,058,715 1,394,511 308,489 Deferred rent expense (5,256) (56,709) (60,331) ------------ ------------ ------------ Net cash (used in) provided by operating activities (2,975,286) 3,194,975 4,119,601 INVESTING ACTIVITIES Purchases of short-term investments, available-for-sale (20,257,045) -- -- Purchases of furniture and office equipment (2,927,837) (958,685) (179,281) Acquisition of Twin Town minority interest -- -- (185,000) ------------ ------------ ------------ Net cash used in investing activities (23,184,882) (958,685) (364,281) FINANCING ACTIVITIES Proceeds from secondary offering, net of offering costs 33,120,194 -- -- Proceeds from sale of common stock and notes receivable from stockholders 1,032,601 3,983,072 105,710 Proceeds from note payable to bank 517,397 -- 800,000 Payments on note payable to bank (35,368) -- (2,000,000) Cash dividend paid -- (89,081) (125,484) ------------ ------------ ------------ Net cash provided by (used in) financing activities 34,634,824 3,893,991 (1,219,774) ------------ ------------ ------------ Net increase (decrease) in cash 8,474,656 6,130,281 2,535,546 Cash at beginning of year 10,048,203 3,917,922 1,382,376 ------------ ------------ ------------ Cash at end of year $ 18,522,859 $ 10,048,203 $ 3,917,922 ============ ============ ============ SUPPLEMENTAL INFORMATION: Taxes paid $ 1,330,725 $ 4,611,489 $ 380,735 ============ ============ ============ Interest paid $ 20,936 $ 17,612 $ 129,108 ============ ============ ============
See accompanying notes. F-5 42 PMR Corporation Notes to Consolidated Financial Statements April 30, 1998 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION, BUSINESS AND PRINCIPLES OF CONSOLIDATION PMR Corporation ("the Company") develops, manages and markets acute outpatient psychiatric programs, psychiatric case management programs and substance abuse treatment programs. The Company operates in the healthcare industry segment. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Psychiatric Management Resources, Inc., Collaborative Care Corporation, PMR-CD, Inc., Aldine - CD, Inc. and Twin Town Outpatient. LEGISLATION, REGULATIONS AND MARKET CONDITIONS The Company is subject to extensive federal, state and local government regulation relating to licensure, conduct of operations, ownership of facilities, expansion of facilities and services and reimbursement for services. As such, in the ordinary course of business, the Company's operations are continuously subject to state and federal regulator scrutiny, supervision and control. Such regulatory scrutiny often includes inquires, investigations, examinations, audits, site visits and surveys, come of which may be non-routine. The Company believes that it is in substantial compliance with the applicable laws and regulations. However, if the Company is ever found to have engaged in improper practices, it could be subjected to civil, administrative or criminal fines, penalties or restitutionary relief. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of highly liquid investments with maturities, when acquired, of three months or less. Investments with original maturities of three months or less that were classified as cash equivalents totaled $7,816,828 and $58,342 as of April 30, 1998 and 1997, respectively. SHORT-TERM INVESTMENTS Marketable equity securities and debt securities are classified as available-for-sale. Available-for-sale securities are carried at fair value with unrealized gains and losses reported in a separate component of stockholders' equity. The costs of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization along with realized gains and losses, interest and dividends are included in interest income. The cost of securities sold is based on the specific identification method. F-6 43 PMR Corporation Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) CONCENTRATION OF CREDIT RISK The Company grants credit to contracting providers in various states without collateral. Losses resulting from bad debts have traditionally not exceeded management's estimates. The Company has receivables, aggregating $10,258,000 at April 30, 1998, from four providers, each of which comprise more than 10% of total receivables. The Company monitors the credit worthiness of these customers and believes the balances outstanding, net of allowance at April 30, 1998, are fully collectible. Substantially all of the Company's cash and cash equivalents is deposited in two banks. The Company monitors the financial status of these banks and does not believe the deposits are subject to a significant degree of risk. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures at the date of the financial statements and the amounts of revenues and expenses reported during the period. Actual results could differ from those estimates. The Company's significant accounting estimates are the allowance for uncollectible accounts and the contract settlement reserve. FURNITURE AND OFFICE EQUIPMENT Furniture and office equipment are stated at cost and are depreciated over their estimated useful lives using the straight-line method. Depreciation expense for each of the three years ended April 30, 1998 was $709,932, $344,254 and $320,212, respectively. OTHER ASSETS Other assets are comprised of the following at April 30:
1998 1997 ---------- ---------- Proprietary information and covenants not to compete $1,118,753 $1,118,753 Goodwill 978,858 978,858 Other 282,176 282,176 ---------- ---------- 2,379,787 2,379,787 Less accumulated amortization 1,243,907 878,165 ---------- ---------- $1,135,880 $1,501,622 ========== ==========
F-7 44 PMR Corporation Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Other assets are being amortized using the straight-line method over their estimated useful lives. The estimated useful life of proprietary information and covenants not to compete is five to nine years and goodwill is 15 years. EARNINGS PER SHARE In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, Earnings per Share. SFAS No. 128 is effective for financial statements issued for periods ending after December 15, 1997 and replaces APB Opinion 15, Earnings per Share ("EPS"). SFAS No. 128 requires dual presentation of basic and diluted earnings per share by entities with complex capital structures. Basic EPS includes no dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings of the entity. The Company has adopted SFAS No. 128 in the third fiscal quarter ending January 31, 1998 and has calculated its earnings per share in accordance with SFAS No. 128 for all periods presented. As required by SFAS 128, all prior periods presented have been restated. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):
YEARS ENDED APRIL 30, -------------------------------------------- 1998 1997 1996 ---------- ---------- ---------- Numerator: Net income available to common stockholders $1,458,378 $3,106,699 $ 918,377 Preferred stock dividends -- 17,342 131,686 ========== ========== ========== Net income available to common stockholders after assumed conversion of preferred stock $1,458,378 $3,124,041 $1,050,063 ========== ========== ========== Denominator: Weighted average shares outstanding for basic earning per share 6,053,243 4,727,124 3,484,172 ---------- ---------- ---------- Effects of dilutive securities: Employee stock options 596,008 707,368 158,317 Warrants 46,070 119,825 128,491 Convertible preferred stock -- 91,630 700,000 ---------- ---------- ---------- Dilutive potential common shares 642,078 918,823 986,808 Shares used in computing diluted net income per common share 6,695,321 5,645,947 4,470,980 ========== ========== ========== Earnings per common share, basic $ .24 $ .66 $ .26 ========== ========== ========== Earnings per common share, diluted $ .22 $ .55 $ .23 ========== ========== ==========
F-8 45 PMR Corporation Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) REVENUE RECOGNITION AND CONTRACT SETTLEMENT RESERVE The Company's acute outpatient psychiatric program customers are primarily acute care hospitals or community mental health centers ("Providers"). Typical contractual agreements with providers require the Company to provide, at its own expense, specific management personnel for each program site. Revenue under these programs is primarily derived from services provided under three types of agreements: 1) an all inclusive fee arrangement based on fee-for-service rates which provide that the Company is responsible for substantially all program costs, 2) a fee-for-service arrangement whereby substantially all of the program costs are the responsibility of the Provider, and 3) a fixed fee arrangement. In all cases, the Company provides on-site managerial personnel. Patients served by the acute outpatient psychiatric programs typically are covered by the Medicare program. The Company has been retained to manage and provide the outpatient psychiatric portion of a managed health care program funded by the State of Tennessee ("TennCare"). Under the terms of its agreements, the Company receives a monthly case rate payment from the managed care consortium responsible for managing the TennCare program, and is responsible for planning, coordinating and managing psychiatric case management to residents of Tennessee who are eligible to participate in the TennCare program using the proprietary treatment programs developed by the Company. The Company is also responsible for providing the related clinical care under the agreements. The Company has signed six-year contracts with two case management agencies to provide the clinical network necessary for the Company to meet its obligations under the TennCare program. Revenue under this program was approximately $14,607,000, $13,429,000, and $7,600,000 for the years ended April 30, 1998, 1997 and 1996, respectively. The Company also operates chemical dependency rehabilitation programs. Revenue from these programs for the years ended April 30, 1998, 1997 and 1996 was $2,828,000, $1,673,000 and $1,898,000, respectively. Revenue under the Acute Outpatient Psychiatric Programs is recognized when services are rendered based upon contractual arrangements with Providers at the estimated net realizable amounts. Under certain management contracts, the Company is obligated under warranty provisions to indemnify the Providers for all or some portions of the Company's management fees that may be disallowed as reimbursable to the Providers by Medicare's fiscal intermediaries. The Company has recorded contract settlement reserves F-9 46 PMR Corporation Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) to provide for possible amounts ultimately owed to its Providers resulting from disallowance of costs by Medicare and Medicare cost report settlement adjustments. Such reserve is classified as a non-current liability as ultimate resolution of substantially all of these issues is not expected to occur during fiscal 1999. Revenue under the TennCare managed care program is recognized in the period in which the related service is to be provided. INSURANCE The Company carries "occurrence basis" insurance to cover general liability, property damage and workers' compensation risks. Medical professional liability risk is covered by a "claims made" insurance policy that provides for guaranteed tail coverage. STOCK OPTIONS Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), establishes the use of the fair value based method of accounting for stock-based compensation arrangements, under which compensation cost is determined using the fair value of stock-based compensation determined as of the grant date, and is recognized over the periods in which the related services are rendered. In accordance with the provisions of SFAS No. 123, the Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related Interpretations in accounting for its employee stock options. Under APB 25, when the purchase price of restricted stock or the exercise price of the Company's employee stock options equals or exceeds the fair value of the underlying stock on the date of issuance or grant, no compensation expense is recognized. In accordance with SFAS No. 123, the Company will present pro forma disclosures of net income and earnings per share as if SFAS No. 123 had been applied. LONG-LIVED ASSETS Effective May 1, 1996, the Company adopted Financial Accounting Standards Board Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (SFAS No. 121) which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less F-10 47 PMR Corporation Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) than the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. Any impairment losses identified will be measured by comparing the fair value of the asset to its carrying amount. The Company has recognized all known material impairment losses on long-lived assets used in operations. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board issued SFAS 130, Reporting Comprehensive Income and SFAS 131, Segment Information. Both of these standards are effective for the fiscal years beginning after December 15, 1997. SFAS 130 requires that all components of comprehensive income, including net income, be reported in the financial statements in the period in which they are recognized. SFAS 131 amends the requirements for public enterprise to report financial and descriptive information about its reportable operating segments. The Company currently operates in one business and three operating segments. The adoption of this standard will require the Company to disclose additional financial and descriptive information about the operating segments. In April 1998, the Accounting Standards Executive Committee issued Statement of Position 98-5 Reporting on Costs of Start-Up Activities, (SOP 98-5) which is effective for fiscal years beginning after December 15, 1998. SOP 98-5 requires costs of start-up activities and organization costs to be expensed as incurred. In addition, all start-up costs and organization costs previously capitalized must be written off. Initial application of this SOP 98-5 will be reported as the cumulative effect of a change in accounting principle. The Company plans to adopt this change in accounting principle in the first quarter of fiscal 1999, and anticipates writing off approximately $1,000,000 in previously capitalized start-up costs. RECLASSIFICATION Certain classifications of accounts in the prior year have been reclassified to reflect current year classifications. F-11 48 PMR Corporation Notes to Consolidated Financial Statements (continued) 2. OTHER AFFILIATIONS In October 1995, the Company entered into exclusive affiliation agreements with two case management agencies in Tennessee (see Note 1). As part of these agreements, the Company issued 50,000 shares each of the Company's common stock for an aggregate value of $481,250. The agreements also provide for the Company to grant warrants to the two agencies for the purchase of up to an aggregate 550,000 shares of common stock at fair value over a six year period if certain performance criteria are met. During fiscal 1997, warrants for the purchase of 30,000 shares of the Company's common stock at the fair market value at the date of grant were earned by the case management agencies. 3. INVESTMENTS At April 30, 1998, the fair market value of the marketable securities approximates cost. The following is a summary of available-for-sale securities:
APRIL 30, 1998 -------------- U.S. government securities $16,752,478 U. S. corporate securities 2,005,187 Commercial paper 1,000,000 Certificate of Deposit 499,380 ----------- Total debt securities $20,257,045 ===========
At April 30, 1998, all short-term investments mature in one year or less. 4. LONG-TERM RECEIVABLES Long-term receivables at April 30, 1998 consist primarily of amounts due from contracting Providers for which the Company has established specific payment terms for receivable amounts which were past due or for which payment, due to contract terms, is expected to exceed one year. Management expects to receive payment on the long-term receivables as contract terms are met, none of which are expected to exceed two years. F-12 49 PMR Corporation Notes to Consolidated Financial Statements (continued) 5. PROPERTY AND EQUIPMENT Property and equipment consisted of the following at April 30:
1998 1997 ----------- ------------ Furniture and fixtures $ 1,975,766 $ 847,863 Leasehold improvements 1,133,641 532,966 Software 365,625 54,987 Start-up costs 1,744,457 1,003,907 ----------- ----------- 5,219,489 2,439,723 Accumulated depreciation (1,727,040) (1,175,980) ----------- ----------- $ 3,492,449 $ 1,263,743 =========== ===========
6. LINE OF CREDIT The Company has a credit agreement with a bank that permits borrowings of up to the lesser of 50% of the aggregate amount of eligible accounts receivable of the Company or $10,000,000 for working capital needs. The credit agreement expires on August 30, 1999 and is collateralized by substantially all of the Company's assets. Interest on borrowings is payable monthly at either the Bank's reference rate or at the Bank's Eurodollar rate plus 2%. There were no borrowings outstanding at April 30, 1998. EQUIPMENT LINE OF CREDIT The Company has a credit agreement with a bank that permits borrowings for the purchase of equipment for up to $3,000,000. The credit agreement expires on September 30, 1998, and is collateralized by the assets acquired with the proceeds from the loan. Interest at 8.36% and principle payments on borrowings are payable monthly over five years from the time of purchase. There was $482,028 outstanding under this credit agreement at April 30, 1998. 7. STOCKHOLDERS' EQUITY In June 1996, the Company called for redemption of all outstanding shares of Series C Convertible Preferred Stock. Holders of all the Series C shares exercised their options to convert such shares to Common Stock and accordingly, in July 1996, the Company issued 700,000 shares of Common Stock. In conjunction with the conversion, the Series C shareholders also exercised warrants to purchase 525,000 shares of the Company's Common Stock for net proceeds of $2,362,500. F-13 50 PMR Corporation Notes to Consolidated Financial Statements (continued) 8. STOCK OPTIONS AND WARRANTS During 1997, the Company amended its Employees' Incentive Stock Option Plan of 1990 which was renamed as the 1997 Equity Incentive Plan (the "1997 Plan") that provides for the granting of options to purchase up to 2,000,000 shares of common stock to eligible employees. Under the 1997 plan, options may be granted for terms of up to ten years and are generally exercisable in cumulative annual increments of 20 percent each year, commencing one year after the date of grant. The 1997 Plan also provides for the full vesting of all outstanding options under certain change of control events. Option prices must equal or exceed the fair market value of the common shares on the date of grant. The Company has a non qualified stock option plan for its outside directors ("the 1992 Plan"). The 1992 Plan provides for the Company to grant each outside directors options to purchase 15,000 shares of the Company's common stock annually, at the fair market value at the date of grant. Options for a maximum of 525,000 shares may be granted under this plan. The options vest 30% immediately and in ratable annual increments over the three year period following the date of grant. In 1997, the board of directors amended the 1992 Plan to provide for full vesting of all outstanding options under certain change of control events. Warrants to purchase shares of the Company's common stock were issued in each of the two years in the period ended April 30, 1997 to brokers in connection with financing transactions (see Note 8). No warrants were issued in the year ended April 30, 1998. As of April 30, 1998, broker warrants to purchase 53,000 shares of the Company's common stock at $2.50 per share were outstanding. These warrants expire on October 31, 1999. F-14 51 PMR Corporation Notes to Consolidated Financial Statements (continued) 8. STOCK OPTIONS AND WARRANTS (CONTINUED) A summary of the Company's stock option activity and related information is as follows:
WEIGHTED-AVERAGE SHARES EXERCISE PRICE ---------- --------------- Outstanding April 30, 1995 707,124 $ 4.41 Granted 897,526 7.57 Exercised (17,174) 3.40 Forfeited (32,423) 4.11 ---------- --------- Outstanding April 30, 1996 1,555,053 6.63 Granted 486,837 20.50 Exercised (96,016) 5.17 Forfeited (160,268) 8.44 ---------- --------- Outstanding April 30, 1997 1,785,606 14.72 Granted 105,000 19.78 Exercised (226,143) 4.42 Forfeited (60,855) 13.00 ---------- --------- Outstanding April 30, 1998 1,603,608 $ 10.86 ========== =========
At April 30, 1998 options and warrants to purchase 929,859 and 53,000 shares of common stock, respectively, were exercisable and 899,181 shares and 165,000 shares were available for future grant under 1997 Plan and the 1992 Plan, respectively. The weighted-average fair value of options granted was $12.37, $15.21 and $4.48 in fiscal years 1998, 1997 and 1996, respectively. A summary of options outstanding and exercisable as of April 30, 1998 follows:
WEIGHTED- WEIGHTED- AVERAGE WEIGHTED OPTIONS AVERAGE REMAINING OPTIONS -AVERAGE OUTSTANDING (IN EXERCISE PRICE EXERCISE CONTRACTUAL EXERCISABLE (IN EXERCISE THOUSANDS) RANGE PRICE LIFE THOUSANDS) PRICE --------------- -------------- --------- ----------- ------- --------- 156,247 $2.37 - $3.50 $ 3.13 5.0 103,247 $ 3.13 595,129 $3.75 - $6.00 $ 4.38 4.2 488,262 $ 4.44 300,091 $9.75 - $11.38 $ 9.86 7.2 156,593 $ 9.90 552,141 $18.88 - $28.50 $ 20.57 7.7 181,757 $ 20.61
F-15 52 PMR Corporation Notes to Consolidated Financial Statements (continued) 9. STOCK OPTIONS AND WARRANTS (CONTINUED) Adjusted pro forma information regarding net income and net income per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options and stock purchase plan under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using the "Black-Scholes" method for option pricing with the following weighted-average assumptions for fiscal 1998, 1997 and 1996:
1998 1997 1996 ----- ---- ---- Expected life (years) 5.0 6.0 6.0 Risk-free interest rate 6.34% 6.5% 6.5% Annual dividend yield -- -- -- Volatility 69% 88% 88%
For purposes of pro forma disclosures, the estimated fair value of the options granted is amortized to expense over the options' vesting period. The Company's pro forma information for the years ended April 30, 1998, 1997 and 1996, follows:
1998 1997 1996 ------- ------------- ---------- Pro forma net income (in thousands) $24,335 $ 1,967,939 $ 98,037 Pro forma earnings per share, basic $ -- $ .34 $ .02 Pro forma earnings per share, diluted $ -- $ .34 $ .02
10. INCOME TAXES Income tax expense (benefit) consists of the following:
YEAR ENDED APRIL 30 1998 1997 1996 ----------- ----------- ----------- Federal: Current $ 1,404,000 $ 4,868,000 $ 1,220,000 Deferred (612,000) (3,009,000) (685,000) ----------- ----------- ----------- 792,000 1,859,000 535,000 State: Current 392,000 1,138,000 351,000 Deferred (170,000) (825,000) (156,000) ----------- ----------- ----------- 222,000 313,000 195,000 ----------- ----------- ----------- $ 1,014,000 $ 2,172,000 $ 730,000 =========== =========== ===========
F-16 53 PMR Corporation Notes to Consolidated Financial Statements (continued) 10. INCOME TAXES (CONTINUED) Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
APRIL 30, 1998 1997 ---------- ---------- Deferred tax assets: Contract settlement reserve $3,048,000 $3,609,000 Accrued compensation and employee benefits 405,000 531,000 Allowance for bad debts 3,704,000 1,979,000 State income taxes 55,000 280,000 Depreciation and amortization 254,000 163,000 Special Charge 885,000 -- Other 179,000 159,000 ---------- ---------- Total deferred tax assets 8,530,000 6,721,000 Deferred tax liabilities: Non-accrual experience method 913,000 326,000 Contractual retainers 1,401,000 961,000 ---------- ---------- Total deferred tax liabilities 2,314,000 1,287,000 ---------- ---------- Net deferred tax assets $6,216,000 $5,434,000 ========== ==========
A reconciliation between the federal income tax rate and the effective income tax rate is as follows:
YEAR ENDED APRIL 30, 1998 1997 1996 ---- ---- ---- Statutory federal income tax rate 35% 35% 34% State income taxes, net of federal tax benefit 6 6 7 -- -- -- Effective income tax rate 41% 41% 41% == == ==
F-17 54 PMR Corporation Notes to Consolidated Financial Statements (continued) 11. CUSTOMERS Approximately 47% of the Company's revenues are derived from contracts with providers in the State of California. The remainder of the Company's revenue is derived from contracts with providers in Arizona, Arkansas, Colorado, Hawaii, Indiana, Michigan, Tennessee, and Texas. The following table summarizes the percent of revenue earned from any individual or agency which was responsible for ten percent or more of the Company's consolidated revenues. There is more than one program site for some providers.
YEAR ENDED APRIL 30 Provider 1998 1997 1996 -------- ---- ---- ---- A 22% 23% 21% B 14 13 11
12. EMPLOYEE BENEFITS The Company maintains a tax deferred retirement plan under Section 401(k) of the Internal Revenue Code for the benefit of all employees meeting minimum eligibility requirements. Under the plan, each employee may defer up to 15% of pre-tax earnings, subject to certain limitations. The Company will match 50% of an employee's deferral to a maximum of 3% of the employee's gross salary. The Company's matching contributions vest over a five year period. For the years ended April 30, 1998, 1997 and 1996, the Company contributed $265,000, $186,000 and, $138,000, respectively, to match employee deferrals. 13. COMMITMENTS AND CONTINGENCIES The Company leases its administrative facilities and certain program site facilities under both cancelable and non-cancelable leasing arrangements. Certain non-cancelable lease agreements call for annual rental increases based on the consumer price index or as otherwise provided in the lease. The Company also leases certain equipment under operating lease agreements. Future minimum lease payments for all leases with initial terms of one year or more at April 30, 1998 are as follows: 1999 - $3,000,348; 2000 - $2,029,999; 2001 - $1,540,147; 2002 - $887,277 and 2003 - $162,009. Rent expense totaled $3,140,000, $2,690,800 and $1,950,000 for the years ended April 30, 1998, 1997 and 1996, respectively. F-18 55 PMR Corporation Notes to Consolidated Financial Statements (continued) 13. COMMITMENTS AND CONTINGENCIES (CONTINUED) LITIGATION The Company is a party to various legal proceedings arising in the normal course of business. In management's opinion, except as otherwise noted below, the outcome of these proceedings will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows. In February 1998, the Company announced that the outpatient program that it formerly managed in Dallas, Texas is subject to a civil investigation being conducted by the U.S. Department of Health and Human Services' Office of Inspector General and the U.S. Attorney's office in Dallas, Texas (collectively, the "Agencies"). The investigation is a result of a Health Care Financing Administration (""HCFA") review of partial hospitalization services rendered to 63 patients at this location. The Dallas program was operational from January 1996 to February 6, 1998. A representative of the Agencies has indicated that the investigation is civil in nature and focuses on eligibility of patients for partial hospitalization services. The eligibility determinations for participation at the Dallas program were made by board certified or board eligible psychiatrists. The Company is cooperating fully with the Agencies and, to date, no formal complaint or demand has been made by the Agencies. On July 20, 1998, the Company was informed that a qui tam suit had been filed against a subsidiary of the Company. The suit alleges a broad range of improper conduct relating to the quality of services furnished by the Company, the medical necessity of such services furnished by the Company and by physicians who admit patients to the program managed by the Company, and other matters. The suit was filed by a former employee who previously had filed a separate action for wrongful termination. The Company prevailed in that wrongful termination case when the court dismissed the case granting the Company's motion for summary judgment. Notwithstanding the similarity between the allegations in the wrongful termination case and the qui tam case, the Company cannot give any assurances with respect to the ultimate outcome of the qui tam case or its effect on the Company's business, financial condition or results of operations. Under the False Claims Act, the Department of Justice must inform the court whether it will intervene and take control of the qui tam suit. In this case, the Department of Justice has not yet made that decision, but rather is conducting an investigation. The Company has met with the Assistant United States Attorney who is coordinating the government's investigation of this case, and the Company has agreed to furnish certain documentation to the government. Due to the preliminary nature of these investigations, the Company is unable to predict the ultimate outcome of the investigations, or the material impact, if any, on the Company's business, financial condition or results of operations. 14. SPECIAL CHARGE During the fourth quarter of fiscal 1998, the Company recorded a special charge of $4,991,588. The charge resulted from management's decision to close ten program locations in the Mid-America Region, and costs to be incurred in connection with noncancelable operating commitments resulting from the HCFA withdrawal of provider status for the Company's largest partial hospitalization program. The components of the impairment and exit costs resulting from closing program locations consist of severance, noncancelable facility lease commitments, related legal costs, write-off of furniture and office equipment and intangible assets, other related costs, and additional allowances or uncollectible accounts due to anticipated difficulties associated with collection of receivables from closed locations. F-19 56 PMR Corporation Notes to Consolidated Financial Statements (continued) 14. SPECIAL CHARGE (CONTINUED) In February 1998, HCFA notified Scripps Health that the "provider based" status of its programs would be withdrawn on March 1, 1998. As a result of the notice of withdrawal of the provider based status, the Company recorded a charge for the costs to be incurred by the Company under the noncancelable operating commitment provision of its management contract with Scripps Health. Subsequent to the withdrawal, HCFA granted an extension to the program through April 15, 1998 and in June 1998, granted an additional extension of provider based status to July 15, 1998 in order for Scripps Health and the Company to implement certain agreed upon changes. However, there is no assurance that Scripps Health and the Company will be able to implement the agreed upon changes required by HCFA or that HCFA will grant additional extensions. Following is a summary of the components of the special charge by income statement line item: Provision for bad debts $2,408,692 Special charge: Location closure related costs 1,402,896 Contract losses 1,180,000 ---------- 2,582,896 ---------- $4,991,588 ==========
At April 30, 1998, special charges totaling $2,229,741 are included in accrued liabilities in the consolidated balance sheet. 15. SUBSEQUENT EVENT On June 10, 1998, the Company signed a subscription agreement with Stadtlander Drug Distribution Co., Inc. to form a new disease management company to provide pharmaceutical care for individuals with serious mental illness. The joint venture is expected to begin operations in July 1998. F-20 57 Schedule II PMR Corporation Valuation and Qualifying Accounts
- ------------------------------------------------- ---------------- ----------------- -------------------- ---------------- COL. A COL. B COL. C COL. D COL. E - ------------------------------------------------- ---------------- ----------------- -------------------- ---------------- ADDITIONS ----------------- DESCRIPTION BALANCE AT CHARGED TO BALANCE AT END BEGINNING OF COSTS AND DEDUCTIONS - OF PERIOD PERIOD EXPENSES DESCRIBE - ------------------------------------------------- ---------------- ----------------- -------------------- ---------------- Year ended April 30, 1998 Allowance for doubtful accounts $5,081,177 $5,148,580 $ 1,148,147 (1) $ 9,081,610 Contract settlement reserve $8,791,928 $2,349,382 $ 3,661,317 (2) $ 7,479,993 Year ended April 30, 1997 Allowance for doubtful accounts $1,759,182 $3,084,166 $ (237,829) (1) $ 5,081,177 Contract settlement reserve $5,499,020 $3,927,371 $ 634,463 (2) $ 8,791,928 Year ended April 30, 1996 Allowance for doubtful accounts $1,423,054 $1,447,983 $ 1,111,855 (1) $ 1,759,182 Contract settlement reserve $3,523,223 $2,390,196 $ 414,399 (2) $ 5,499,020
(1) Uncollectible accounts written off, net of recoveries (2) Write off of hospital receivables based on disallowance of the Company's management fee on Provider's cost reimbursement report and the Company's indemnity obligation S-1 EX-3.1 2 EXHIBIT 3.1 1 Exhibit 3.1 AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF PMR CORPORATION PMR CORPORATION, a corporation organized and existing under the laws of the state of Delaware, hereby certifies as follows: 1. The name of the corporation is PMR Corporation (the "Corporation"). 2. The date of the filing of the Corporation's original Certificate of Incorporation with the Secretary of State of Delaware was January 8, 1988 under the name Zaron Capital, Inc. 3. The Certificate of Incorporation of this Corporation is hereby amended and restated to read as follows: ARTICLE I. The name of this Corporation is PMR CORPORATION. ARTICLE II. The address, including street, number, city, and county, of the registered office of the Corporation in the State of Delaware is 1209 Orange Street, Wilmington, New Castle County, Delaware 19801. ARTICLE III. The name of the registered agent in Delaware at such address is The Corporation Trust Company. ARTICLE IV. The purposes of the Corporation are to engage in any lawful act or activity for which corporations may be organized under the Delaware General Corporation Law. 1. 2 ARTICLE V. A. This Corporation is authorized to issue two classes of stock to be designated, respectively, "Common Stock" and "Preferred Stock." The total number of shares of stock which the Corporation is authorized to issue is twenty million (20,000,000) shares, of which nineteen million (19,000,000) shares shall be Common Stock, each having a par value of one cent ($.01) per share and one million (1,000,000) shares shall be Preferred Stock, each having a par value of one cent ($.01) per share. B. The Preferred Stock may be issued from time to time in one or more series. The Board of Directors is hereby authorized, by filing a certificate (a "Preferred Stock Designation") pursuant to the Delaware General Corporation Law, to fix or alter from time to time the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions of any wholly unissued series of Preferred Stock, and to establish from time to time the number of shares constituting any such series or any of them; and to increase or decrease the number of shares of any series subsequent to the issuance of shares of that series, but not below the number of shares of such series then outstanding. In case the number of shares of any series shall be decreased in accordance with the foregoing sentence, the shares constituting such decrease shall resume the status that they had prior to the adoption of the resolution originally fixing the number of shares of such series. ARTICLE VI. All of the powers of this Corporation, insofar as the same may be lawfully vested by this Certificate of Incorporation in the Board of Directors are hereby conferred upon the Board of Directors of this Corporation. In furtherance and not in limitation of that power, the Board of Directors shall have the power to make, adopt, alter, amend and repeal from time to time Bylaws of this Corporation, subject to the right of stockholders entitled to vote with respect thereto to adopt, alter, amend and repeal Bylaws by the Board of Directors; provided, however, that Bylaws shall not be adopted, altered, amended or repealed by the stockholders of the Corporation except by the affirmative vote of the holders of two-thirds of the combined voting power of the then outstanding shares of stock entitled to vote on any proposed amendment to the Bylaws. ARTICLE VII. A. No director shall be personally liable to the Corporation or its stockholders for monetary damages for any breach of fiduciary duty by such director as a director, except (i) for breach of the director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) pursuant to Section 174 of the Delaware General Corporation Law, or (iv) for any transaction from which the director derived an improper personal benefit. If the Delaware General Corporation Law is amended after 2. 3 approval by the stockholders of this Article VII to authorize corporate action further eliminating or limiting the personal liability of directors, then the liability of a director shall be eliminated or limited to the fullest extend permitted by Delaware General Corporation Law, as so amended. B. Any repeal or modification of this Article VII shall be prospective and shall not affect the rights under this Article VII in effect at the time of the alleged occurrence of any act or omission to act giving rise to liability or indemnification. ARTICLE VIII. The Corporation may indemnify any person who is or was a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that the person is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against any and all expenses (including attorneys' fees), judgments, fines and amounts paid in settlement or incurred in connection with the investigation, preparation to defend or defense of such action, suit, proceeding or claim, to the fullest extent permitted by the Delaware General Corporation Law, as amended from time to time. The Corporation may purchase and maintain insurance, at its expense, to protect itself and any director, officer, employee or agent of the Corporation or another corporation, partnership, joint venture, trust or other enterprise, against any such expense, liability or loss, to the fullest extent permitted by the Delaware General Corporation Law. ARTICLE IX. Amendments to the Certificate of Incorporation of the Corporation shall require the affirmative vote of the holders of two-thirds of the combined voting power of the then outstanding shares of stock entitled to vote on any proposed amendment to the Certificate of Incorporation. Notwithstanding the foregoing, in the event that a resolution to amend the Certificate of Incorporation of the Corporation is adopted by the affirmative vote of at least eighty percent (80%) of the Board of Directors, approval of the amendment shall only require the affirmative vote of the holders of a majority of the combined voting power of the then outstanding shares of stock entitled to vote generally on such amendment, voting together as a single class. ARTICLE X. A. Except as otherwise fixed by or pursuant to provisions hereof relating to the rights of the holders of any class or series of stock having a preference over common stock as to dividends or upon liquidation to elect additional Directors under specified circumstances, the number of Directors of the Corporation shall be fixed from time to 3. 4 time by affirmative vote of a majority of the Directors then in office. The Directors, other than those who may be elected by the holders of any classes or series of stock having a preference over the common stock as to dividends or upon liquidation, shall be classified, with respect to the time for which they severally hold office, into three classes, as nearly equal in number as possible, as shall be provided in the manner specified in the Bylaws of the Corporation, one class to be originally elected for a term expiring at the annual meeting of stockholders to be held in 1997, another class to be originally elected for a term expiring at the annual meeting of stockholders to be held in 1998, and another class to be originally elected for a term expiring at the annual meeting of stockholders to be held in 1999, with each class to hold office until its successor is elected and qualified. At each annual meeting of the stockholders of the Corporation after 1996, the successors of the class of Directors whose term expires at that meeting shall be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election. Election of directors need not be by written ballot unless so provided in the Bylaws of the Corporation. B. Except as otherwise fixed by or pursuant to provisions hereof relating to the rights of the holders of any class or series of stock having a preference over common stock as to dividends or upon liquidation to elect additional Directors under specified circumstances, newly created directorships resulting from any increase in the number of directors and any vacancies on the Board of Directors resulting from death, resignation, disqualification, removal or other cause shall be filled by the affirmative vote of a majority of the remaining Directors then in office, even though less than a quorum of the Board of Directors. Any Director elected in accordance with the preceding sentence shall hold office for the remainder of the full term of the class of Directors in which the new directorship was created or the vacancy occurred and until such Director's successor shall have been elected and qualified. No decrease in the number of Directors constituting the Board of Directors shall shorten the term of any incumbent director. C. Except as otherwise fixed by or pursuant to provisions hereof relating to the rights of the holders of any class or series of stock having a preference over common stock as to dividends or upon liquidation to elect additional Directors under specified circumstances, any Director may be removed from office only for cause and only by the affirmative vote of the holders of two-thirds of the combined voting power of the then outstanding shares of stock entitled to vote generally in the election of Directors, voting together as a single class. D. Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the consent of the Board of Directors shall be required to alter, amend, or adopt any provisions inconsistent with or repeal this Article X. * * * 4. 5 4. This Amended and Restated Certificate of Incorporation has been duly adopted by the Board of Directors of this Corporation. 5. This Amended and Restated Certificate of Incorporation has been duly adopted in accordance with the provisions of Sections 228, 242 and 245 of the Delaware General Corporation Law by the board of directors and the stockholders of the Corporation. The total number of outstanding shares entitled to vote or act by written consent was 6,925,819 shares of Common Stock. A majority of the outstanding shares of Common Stock approved this Amended and Restated Certificate of Incorporation by written consent in accordance with Section 228 of the Delaware General Corporation Law and written notice of such was given by the Corporation in accordance with said Section 228. 5. 6 IN WITNESS WHEREOF, said PMR Corporation has caused this Certificate to be signed by its Chief Executive Officer, Allen Tepper, and attested to by its Secretary, Susan D. Erskine, this 6th day of March, 1998. /s/ Allen Tepper -------------------------------- Allen Tepper Chief Executive Officer Attest: /s/ Susan Erskine - -------------------------- Susan D. Erskine Secretary 6. EX-10.12 3 EXHIBIT 10.12 1 Exhibit 10.12 AMENDMENT TO RESTATED MANAGEMENT AGREEMENT This Amendment to Restated Management Agreement ("Amendment") is made effective as of July 15, 1998 ("Effective Date"), between Scripps Health, a California non-profit public benefit corporation, ("Hospital") with an address of 9888 Genesee Avenue, Post Office Box 28, La Jolla, California 92038, and PMR Corporation, a Delaware Corporation, with an office at 501 Washington Street, 5th Floor, San Diego, California 92103 ("PMR"). This Amendment shall be incorporated into the Agreement (as defined hereunder) by reference and shall amend and supplement the terms and conditions of the Agreement. In the event any of the terms and conditions of this Amendment contradict the terms of the Agreement or render any provisions ambiguous, the terms and conditions of this Amendment shall supersede and be controlling. RECITALS 1. Hospital and PMR entered into a Restated Management Agreement ("Agreement") dated April 11, 1997 and wish to amend certain terms of the Agreement to enable Hospital to comply with HCFA's interpretation of the Medicare provider-based designation rules and to maintain the provider-based designation status of its Programs under the Agreement, as mandated by HCFA's Region IX, by entering into this Amendment. AGREEMENT NOW, THEREFORE, Hospital and PMR, intending to be legally bound hereby, agree as follows: 1. Common Ownership and Control. The Programs' operation under the Agreement is subject to the ultimate control of the Hospital's Board of Trustees. The Programs shall be operated in accordance with Hospital's governing policies, bylaws, practices and procedures. This provision does not change the parties' initial agreement since the parties have always understood that the Hospital has had control over the Programs and that PMR was bound to manage the Programs in accordance with the Hospital's governing policies, bylaws, practices and procedures. 2. Program Premises. Hospital shall be assigned or sublet the leases of the Program premises (as defined under the Agreement) and shall lease directly, or otherwise own or control, the premises at which all Program services are furnished. Hospital shall be responsible for all costs associated with occupying the Program premises for operation of the Programs. Page 1 2 3. Personnel. Hospital shall employ personnel consisting of therapists, nurses, community liaison/intake workers, and care coordinators (collectively, "Personnel") who provide direct patient care to patients of the Program. Personnel shall be subject to the ultimate supervision and complete control of the Administrator of the Hospital and shall be subject exclusively to Hospital's disciplinary process, bylaws, policies and procedures, rules and regulations and all human resource requirements of the Hospital. PMR shall assist Hospital in the transfer to the Hospital of existing Personnel of the Programs who are currently employed by PMR, to the extent the Hospital independently decides to hire such persons. Hospital shall maintain files of the credentials of the Personnel showing an active review of the person's credentials by a person experienced in behavioral health employed by the Hospital. To the extent applicable, those Personnel who are allied health practitioners shall maintain membership in Hospital's allied health practitioner staff. In addition, Personnel shall wear the Hospital's identification badges to the same extent required of other personnel employed by the Hospital (although such badges may be distinguished from employee badges to the extent that the Hospital uniformly gives its personnel distinctive badges). Hospital shall ensure that a copy of the Hospital's rules governing conduct of personnel and other Hospital manuals on premises are maintained at the Program sites and that such rules and manuals are made available to Personnel of the Programs. PMR shall continue to employ or engage the Program Administrator and administrative personnel not involved in the delivery of direct patient care to patients of the Program. 4. Medical Staff Oversight. Hospital shall approve the Programs' Medical Directors who were previously, and continue to be, duly licensed psychiatrists who are active members of the Hospital's medical staff and shall report as necessary or appropriate to the Chief of the Section of Psychiatry, Department of Medicine, of the Hospital. All attending physicians at the Program shall be, as required in the past, members in good standing on the active medical staff of the Hospital. Through the Hospital's organizational structure, which is the same throughout the Hospital's system, the medical staff has ultimate oversight of the Department of Medicine, and controls the quality and credentials of its members who head its inpatient and outpatient departments. 5. Program Administrator. The Program Administrator shall report to and be accountable to the Administrator of the Hospital who is responsible for the Program and other patient care departments of the Hospital and who reports to the Scripps Health Management Team, which includes the Chief Executive Officer, and shall report through the Administrator of the Hospital to the governing body of the Hospital. The Program Administrator shall continue to submit daily reports by facsimile to the Administrator of the Hospital. The Program Administrators shall be required, as required in the past, to attend meetings of the Hospital's department managers and to attend meetings of the behavioral health managers of the Hospital and Scripps Health. Page 2 3 6. Medical Records. All patient medical records shall continue to be integrated into the unified records system of the Hospital. Medical records shall be compiled, checked for completeness and retained in accordance with Hospital's policies. The medical record number shall be issued by the Hospital upon a patient's admission to the Program. Medical record forms shall be provided by or approved by the Hospital's Medical Records Committee. 7. Indemnification. (a) Hospital agrees to indemnify, defend and hold PMR (together with its officers, directors, agents, employees and representatives) harmless from and against all claims, demands, causes of action, judgments, damages, costs and expenses (including without limitation, reasonable attorneys' fees and court costs), deficiencies and settlements which relate to matters, actions or omissions arising or occurring as a result of any activity (or lack thereof) of the Hospital or Personnel under this Agreement to the extent that the Personnel or any employee of Hospital is/are responsible for or the cause of such activity (or lack thereof). Hospital agrees to add PMR as an additional insured under its workers compensation, comprehensive general liability and property insurance policies. (b) PMR agrees to indemnify, defend and hold Hospital (together with its officers, directors, agents, employees and representatives) harmless from and against all claims, demands, causes of action, judgments, damages, costs and expenses (including without limitation, reasonable attorneys' fees and court costs), deficiencies and settlements which relate to matters, actions or omissions arising or occurring as a result of any activity (or lack thereof) of PMR under this Agreement to the extent that PMR or any employee of PMR is responsible for or the cause of such activity (or lack thereof). PMR agrees to add Hospital as an additional insured under its workers compensation and comprehensive general liability insurance policies. 8. Paragraph 7.1 of the Agreement regarding limitations on hiring is hereby void and of no force and effect; provided however, that the Hospital shall not hire, offer employment or engage any Program Administrator or PMR management personnel during the term of the Agreement and any extension or renewal thereof and for a period of one (1) year thereafter. 9. Paragraph 4 of the Agreement regarding compensation to PMR is amended such that PMR's fee is reduced, as reflected in the revised Exhibit C attached hereto, as a result of the changes set forth in Sections 2 and 3 of this Amendment. 10. The Agreement terminates with respect to the Program sites located in Vista, Chula Vista, and El Centro, California, as of the close of business on July 14, 1998. Page 3 4 All other terms and provision of the Agreement shall remain in full force and effect, except as modified herein. Page 4 5 IN WITNESS WHEREOF, the parties hereto have executed this Amendment effective as of the day and year noted above as the Effective Date. SCRIPPS HEALTH PMR CORPORATION By:/s/ E. J. Rood By:/s/ Fred Furman ------------------------------- --------------------------------- Printed Name: E.J. Rood Printed Name: Fred D. Furman -------------------- ---------------------- Title: Chief Financial Officer Title: President -------------------------- ----------------------------- Page 5 6 [EXHIBITS EXCLUDED] EX-10.19 4 EXHIBIT 10.19 1 EXHIBIT 10.19 TENNESSEE BEHAVIORAL HEALTH, INC. TENNESSEE MENTAL HEALTH COOPERATIVE, INC. PROVIDER AGREEMENT THIS AGREEMENT is made between TENNESSEE BEHAVIORAL HEALTH, INC., a Tennessee corporation ('TBH'), and TENNESSEE MENTAL HEALTH COOPERATIVE, INC., a Tennessee corporation ("Provider"). RECITALS A. Provider manages the Mental Health Cooperative, Inc., a Tennessee not-for-profit corporation ("MHC") and Case Management, Inc., a Tennessee not-for-profit corporation ("CMI") who are behavioral health providers who are duly licensed, trained and/or certified under the laws of the State to provide Designated Covered Services to Enrollees and have authorized Provider to enter into this Agreement on their behalf. Reference to "Provider" herein shall mean MHC and CMI with respect to the provision of Designated Covered Services by Provider to Enrollees and any licensing requirements. B. TBH is organized to arrange on behalf of Payors for the provision of Covered Services to Enrollees under Payor Plans sponsored, maintained or administered by such Payors. C. TBH also contracts with other managed care organizations to arrange for the provision of Covered Services to Enrollees under Payor Plans sponsored, maintained or administered by such organizations. D. TBH and Provider mutually desire to arrange for the provision of Designated Covered Services by Provider to Enrollees under such Payor Plans. NOW, THEREFORE, in consideration of the above recitals and the mutual covenants of the parties set forth below, it is agreed as follows: ARTICLE 1 DEFINITIONS The following definitions shall be used in the interpretation and implementation of this Agreement. 1.1 "ADDENDUM" means any amendment or supplement to this Agreement identifying a Payor Plan and setting forth certain essential provisions of the Payor Plan that are necessary for Provider to provide and bill for Designated Covered Services provided to Enrollees covered under the Plan Contract in a manner permitted by this Agreement and such Plan Contract. All provisions of each Addendum are incorporated herein by reference and shall be deemed a part of this Agreement. A list of all Addenda attached to this Agreement as of the time of its execution by the parties is set forth on the List of Addenda attached to this Agreement as Exhibit 2. Addenda may be deleted of added to this Agreement by TBH as provided in Section 13.2 of this Agreement. 1. 2 1.2 "AGREEMENT" means this Agreement, all Exhibits and Addenda and all applicable State or federal requirements that are required by law or contract to be incorporated as a part of this Agreement 1.3 "CASE MANAGER" means the Participating Provider to whom TRH has given all or some of those duties and responsibilities described in Article IV of this Agreement. 1.4 "CLEAN CLAIM" means a properly completed claim for payment for Designated Covered Services received by TBH from Provider that, in the reasonable determination of TBH, is complete (i.e. requires no further information, documentation, adjustment or alteration by Provider in order to be processed and paid by TBH or any Contract MCO), that is not contested or denied by TBH or the Contract MCO (i.e. not reasonably believed to be incorrect or fraudulent) and that is not subject to appeal or grievance procedures. 1.5 "CONTRACT MCO" mean a managed care organization that provides or arranges for the provision of health care services to Enrollees and who contracts with TBH for TBH to arrange for the provision of behavioral health care services to such Enrollees under one or more Plan Contracts which the Contract MCO sponsors, maintains or administers. 1.6 "COORDINATION OF BENEFITS" means allocation of responsibility to pay for health care services between two or more Payors covering the same Enrollee. 1.7 "COPAYMENT" means an Enrollee's share of costs for Covered Services under a Plan Contract, including cost sharing expressed as coinsurance and deductibles under such Plan Contract. Copayment varies in amount according to the terms of the applicable Plan Contract. 1.8 "COVERED SERVICES" means those behavioral health care services and supplies that are both Medically/Psychologically Necessary and covered and to be provided by Participating Providers under a Plan Contract. Coverage of Covered Services; under a Plan Contract is limited to the least intensive and/or expensive alternative treatment, supply or level of care that is consistent with professionally recognized standards of medical practice within the community and TBH Policies. 1.9 "CPT" means the appropriate published edition of Current Procedural Terminology, a listing of descriptive terms and identifying codes for reporting medical services and procedures performed by health care providers, including all updates to such listing. 1.10 "CREDENTIALING" means the process by which TBH or a Contract MCO certifies or recertifies the clinical credentials of Participating Providers or Provider Affiliates. 1.11 "DESIGNATED COVERED SERVICES" means those Covered Services identified in Exhibit 1 and in any Addenda as Covered Services to be provided by Provider or Provider Affiliates to Enrollees under this Agreement. 1.12 "DRUG FORMULARY" means the applicable listing of medications eligible for coverage as Covered Service under any prescription medication benefit offered in conjunction with a Plan Contract that is created, published and updated by TBH or a Contract MCO. A copy of the most current applicable Drug Formulary will be delivered to Provider by TBH from time to time. Each Drug Formulary will include a summary of important procedural requirements and other relevant information applicable to such benefit. 1.13 "DSM" means the latest published edition of Diagnostic and Statistical Manual of Mental Disorders a listing of diagnostic categories and criteria that provides guidelines for making diagnoses of behavioral and substance abuse disorders. A DSM diagnosis of 2. 3 a behavioral disorder is a minimum requirement for the determination of Medical/Psychological Necessity for behavioral health care. 1.14 "EMERGENCY CARE" means a Covered Service rendered by a Mobile Crisis Unit or in an inpatient facility that is Medically/Psychologically Necessary for the stabilization of behavioral disorders which, if not immediately diagnosed and treated, would result in danger to the patient or others. The attending health care provider is exclusively responsible for making medical determinations and treatment decisions; however, payment for behavioral health care services rendered will be conditioned on (a) whether Prior Authorization has been obtained, if required under the applicable Payor Plan or Plan Contract and (b) TBH's subsequent review and determination as to whether such services constitute Covered Services under the applicable Plan Contract and are consistent with professionally recognized standards of practice and TBH's Policies. Provider may appeal claims for payment of such services that are denied by TBH through those TBH Procedures related to Participating Provider appeals. 1.15 "ENROLLEE" means a person covered under a Plan Contract for the provision of Covered Services. 1.16 "EXHIBIT 1" means the exhibit marked as such that is attached to this Agreement and that describes those Designated Covered Services to be provided to Enrollees by Provider under this Agreement as of the time of the execution of this Agreement. Exhibit 1 may be revised or amended from time to time by agreement of the parties as provided in Section 13.1 of this Agreement and shall be amended to the extent provided in any Addendum. 1.17 "EXCLUDED SERVICES" means (i) all medical/surgical services, (ii) those behavioral health services and other services and supplies which are not Covered Services and (iii) those Covered Services that are not Designated Covered Services. Excluded Services rendered by Provider to Enrollees are not compensated under this Agreement. 1.18 "LIST OF ADDENDA" means the list of Addenda attached to and made a part of this Agreement as Exhibit 2. 1.19 "MEDICAL DIRECTOR" means a physician duly licensed to practice medicine in the State who is employed by or under contract with TBH to monitor the provision of Covered Services to Enrollees. 1.20 "MEDICALLY/PSYCHOLOGICALLY NECESSARY" means behavioral health services which TBH reasonably determines are necessary and appropriate for treatment of those symptoms and behaviors of an Enrollment. demonstrate the presence of a behavioral disorder as described in the DSM. The terms "necessary" and "appropriate" as used in this definition are determined by TBH according to professionally recognized standards of practice and TBH Policies. The attending health care provider is exclusively responsible for making all medical determinations and treatment decisions. However, payment of Provider for behavioral health care services rendered will be conditioned on TBH's subsequent review and determination as to whether such services were Designated Covered Services that were Medically/Psychologically Necessary. Such determination shall be based on TBH's review of the applicable Plan Contract and its determination of whether such services were consistent with professionally recognized standards of practice and TBH's Policies, subject to the provider grievance and appeal procedure set forth in TBH Procedures. The fact that a health care provider, including, where appropriate, Provider, may prescribe, order, recommend or approve a behavioral health care service does not, in itself, make such service Medically/Psychologically Necessary or make the service a Designated Covered Service even though it is not specifically listed as an exclusion or limitation. Provider may appeal claims for payment which have been denied by TBH through TBH's provider appeal procedures. 3. 4 1.21 "MOBILE CRISIS UNIT" means any Participating Provider(s) designed by TBH or State to respond to calls relating to the evaluation, treatment and/or Referral of Enrollment who may be or are in need of immediate Covered Services or other behavioral health services. Each Mobile Crisis Unit designated by TBH will respond to calls, evaluate Enrollees and make Referrals in accordance with TBH Policies and TBH procedures. 1.22 "PARTICIPATING PROVIDER" means a physician, other individual health care provider, hospital or facility credential, trained and/or licensed, as appropriate, to provide one or more Covered Services, or an independent practice association or medical group, whose members are licensed, trained or certified to provide one or more Covered Services, who contracts with TBH to provide one or more Covered Services to Enrollees. 1.23 "PAYOR" means an employer, insurance company, health maintenance organization, third party administrator, health plan, managed care organization, the State or other person, group or entity that contracts or arranges for the provision of health care services to Enrollees pursuant to one or more Plan Contracts. 1.24 "PAYOR PLAN" means any benefit plan or program adopted, implemented, established or by a Payor or Contract MCO for the purpose of providing, arranging for the provision of or making available Covered Services to Enrollees. 1.25 "PLAN CONTRACT" means the contract between TBH and a Payor or Contract MCO pursuant to which TBH has agreed to arrange for the provision of Covered Services to Enrollees. Each Plan Contract that is covered by this Agreement shall be identified by an Addendum that describes the essential provisions of the Plan Contract that are necessary for Provider to provide and bill for Designated Covered Services provided to Enrollees covered by such Plan Contract in a manner permitted by this Agreement and such Plan Contract. 1.26 "PRIOR AUTHORIZATION" means authorization of behavioral health care services for coverage as Designated Covered Services by TBH prior to the Enrollee obtaining such services. Requests for Prior Authorization will be denied if TBH reasonably determines that the behavioral health care services that are proposed for coverage are (a) not included as Covered Services under the applicable Plan Contract, (b) not Medically/Psychologically Necessary, (c) not Designated Covered Services or (d) in conflict with TBH Policies. 1.27 "PROVIDER" means collectively Tennessee Mental Health Cooperative, Inc. and MHC and CMI with respect to the provision of Designated Covered Services and licensing requirements. 1.28 "PROVIDER AFFILIATE" mean MHC, CMI and any health care provider that is (i) employed by or under contract with Provider (ii) licensed, trained, certified or otherwise qualified to provide Designated Covered Services to Enrollees pursuant to this Agreement, (iii) Credentialed to provide Designated Covered Services by TBH and (iv) authorized by TBH to provide Designated Covered Services to Enrollees on behalf of Provider under this Agreement. 1.29 "QUALITY MANAGEMENT PLAN" means those quality procedures and information TBH determines are necessary and appropriate to measure and/or ensure quality of clinical and non clinical services required by TennCare. The terms "necessary" and "appropriate", as used in this definition, are determined by TBH according to the State quality and performance standards. 1.30 "REFERRAL" means the act and process through which TBH or a Case Manager refers an Enrollee to Provider to obtain Designated Covered Services. 1.31 "STATE" means the State of Tennessee and, where appropriate, a department, agency, bureau or other subdivision thereof. 4. 5 1.32 "TBH" means Tennessee Behavioral Health. Inc. and its successors and assigns. 1.33 "TBH POLICIES" means those behavioral health care rules and policies adopted by TBH that are utilized by TBH for the purpose of determining whether any behavioral health care service provided by a Participating Provider to an Enrollee is a Medically/Psychologically Necessary Designated Covered Service. TBH shall have the right to amend or revoke TBH Policies from time to time in its discretion. Provider may object to any amendments in which case the parties shall meet to resolve their differences and, if no resolution occurs, Provider may terminate this Agreement on 90 days prior written notice to TBH. 1.34 "TBH PROCEDURES" means those rules, regulations and procedures adopted by TBH that must be followed by Participating Providers when providing and billing for Covered Services under this Agreement and which address, among other things, obtaining Prior Authorization, billing for Covered Services and appealing any TBH decision regarding whether a behavioral health care service is a Covered Service or is Medically/Psychologically Necessary. TBR shall have the right to amend TBH Procedures from time to time in its discretion. 1.35 "TBH PROVIDER MANUAL" means the manual, prepared by TBH and distributed to Participating Providers, that contains those current TBH Policies and TBH Procedures that must be readily accessible to Provider in order to carry out Provider's duties under this Agreement. TBH shall be responsible for updating the TBH Provider Manual to reflect all revisions or changes to TBH Policies or TBH Procedures and for distributing such changes or revisions to Provider. 1.36 "TENNCARE" means the program administered by the State (currently pursuant to waiver granted by the Health Care Financing Administration, United States Department of Health and Human Services) under which the State pays a monthly prepaid capitated amount to managed care organizations and behavioral health organizations for rendering or arranging necessary health care services to eligible persons, and any successor program implemented by the State. ARTICLE 2 OBLIGATIONS OF PROVIDER 2.1 DESIGNATED COVERED SERVICES. Provider shall provide Medically/Psychologically Necessary Designated Covered Services to all Enrollees entitled to coverage for such services under a Plan Contract. Provider warrant that the Designated Covered Services described in Exhibit 1 and all Addenda are within the scope of Provider's license and/or training and that Provider is professionally or otherwise qualified to provide such Designated Covered Services to Enrollees. Provider shall provide Designated Covered Services to Enrollees in accordance with a plan of care that has been approved by TBH and shall assist TBH and the Case Manager, as requested, in the establishment of such plan of care. If so indicated in Exhibit 1, Provider will serve as a Case Manager or provide one or more Mobile Crisis Units to perform those functions required under TBH Policies and TBH Procedures. 5. 6 2.2 PROVIDER AFFILIATES. 2.2.1 SERVICES. Provider shall have the right to provide Designated Covered Services to Enrollees through one or more Provider Affiliates subject to the terms of this Agreement. Provider shall permit Provider Affiliates to provide Designated Covered Services under this Agreement only if such Provider Affiliate agrees in writing to comply with, observe and be bound by the terms of this Agreement that are applicable to Provider. Where appropriate, all references to Provider in this Agreement shall be deemed to include all Provider Affiliates. Provider shall not authorize, permit or allow any Designated Covered Service to be delivered or provided by anyone other than Provider or a Provider Affiliate meeting the requirements of this Section 2.2. 2.2.2 PAYMENT OF PROVIDER AFFILIATES. Provider shall be solely and exclusively responsible for compensating all Provider Affiliates who provide Designated Covered Services to Enrollees under this Agreement and shall indemnify and hold TBH and the applicable Payor harmless from any liability, cost or expense related to or arising from any claim for payment or other compensation by a Provider Affiliate made against TBH or any Payor. The sale and exclusive obligation of TBH or any Payor to pay for Designated Covered Services rendered by Provider or any Provider Affiliate under this Agreement shall be to make payments directly to Provider pursuant to Section 3.1. 2.2.3 PROVIDER RESPONSIBILITY FOR PROVIDER AFFILIATES. Provider shall be solely and legally liable for the quality of Designated Covered Services or any other health care service that any related Provider Affiliate renders to Enrollees and for ensuring that Designated Covered Services provided by any related Provider Affiliate are within the scope of the related Provider Affiliate's license and training and meet professionally recognized standards of practice within the community. For purposes of this subsection, the term "related Provider Affiliate" shall mean a Provider Affiliate who is employed by Provider, or, in the case of a Provider that is an institution or facility, who is authorized by the rules, bylaws or regulations of such institution or facility to provide professional services to Enrollees at or on behalf of such institution or facility. 2.3 REFERRAL, PRIOR AUTHORIZATION AND MANAGED CARE REQUIREMENTS. To the extent applicable to Provider, compensation for behavioral health care services is limited to Designated Covered Services rendered by Provider which have been authorized by Referral and, when required under a Plan Co., have been rendered after Prior Authorization has been given by TBH. Provider shall abide by TBH Policies and TBH Procedures governing Referrals, Prior Authorization, utilization management, and concurrent, retrospective and prospective review of Designated Covered Services. It is Provider's responsibility to follow TBH Policies and TBH Procedures and to provide sufficient information and reports in a timely manner for TBH to complete its reviews. Prior Authorization shall only apply to Designated Covered Services to be rendered by Provider that are payable on a fee-for-service basis. 2.4 EXCLUDED SERVICES. Provider must advise the Enrollee in writing, prior to providing Excluded Services to the Enrollee, that the services are not covered by this Agreement, will not be paid for by TBH or any Contract MCO or Payor and that the Enrollee will be responsible for paying Provider directly for such services. Further, if an Enrollee requests such Excluded Services, Enrollee must acknowledge in writing, in advance of the provision of services, that neither TBH nor any Contract MCO or Payor shall be responsible for the payment of such services. 2.5 DRUG FORMULARY. Provider shall comply with the medication dispensing guidelines set forth in the Drug Formulary applicable to each Payor Plan. 6. 7 2.6 ACCESSIBILITY OF DESIGNATED COVERED SERVICES. Designated Covered Services shall be available and accessible to Enrollees from Provider during reasonable hours of operation, with provision for after-hour services, if applicable. If Provider is required to provide Emergency Care or any other Designated Covered Service as a full-time service, Emergency Care or such service shall be available and accessible 24 hours a day, 7 days a week. Provider shall monitor the accessibility of Designated Covered Services to Enrollees and shall comply with TBH's efforts to monitor and evaluate same and TRH Policies and TBH Procedures. 2.7 TREATMENT OF ENROLLEES. Provider, Provider Affiliates and Provider's staff and administrative personnel shall treat Enrollees promptly, fairly and courteously by phone, in person or in writing. Provider, Provider Affiliates and TBH, and their respective employees, shall portray each other at all times in a positive light in their interactions with Enrollees and the public. 2.8 REPORTING OF ACTIONS AGAINST PROVIDER OR A PROVIDER AFFILIATE. Provider shall notify TBH within five (5) calendar days of the occurrence of any of the following of which Provider has knowledge, such notice to include a brief description of such occurrence and the reasons therefor: 2.8.1 any action taken to restrict, suspend or revoke Provider's and/or a Provider Affiliate's license to provide any Designated Covered Service required by this Agreement; 2.8.2 any suit or arbitration action brought against Provider and/or a Provider Affiliate for malpractice; 2.8.3 any felony information or indictment or investigation instituted by the State or any federal agency with regulatory authority naming Provider and/or a Provider Affiliate; 2.8.4 any disciplinary proceeding or action naming Provider and/or a Provider Affiliate before an administrative agency of the State or any federal agency with regulatory authority over Provider or any Provider affiliate; 2.8.5 any cancellation or material modification of the professional liability insurance required to be carried by Provider or any Provider Affiliate; 2.8.6 any action taken to restrict, suspend or revoke the participation of Provider or any provider Affiliate in Medicare, CHAMPUS or TennCare; 2.8.7 any Enrollee written complaints against Provider or any Provider Affiliate, 2.8.8 any disciplinary action or action to terminate or restrict privileges at any hospital or other health care facility taken by such facility against Provider or any Provider Affiliate; and 2.8.9 any other event or situation which might materially affect the ability of Provider or any Provider Affiliate to carry out Provider's duties and obligations under this Agreement. Provider shall, provide TBH with a summary of the final disposition of any such occurrence. 2.9 QUALITY OF COVERED SERVICES. Provider shall, be solely and legally responsible for the quality of Designated Covered Services or any other health care service that Provider renders to Enrollees. Said services shall meet professionally recognized standards of practice. TBH's professional review and credentialing committees shall monitor the quality of Designated Covered Services rendered. Provider shall cooperate and comply, and shall cause all Provider Affiliates to cooperate and comply, with TBH's Quality Management Plan 7. 8 and internal quality of care review system and the reasonable decisions of the Medical Director. Provider and all Provider Affiliates shall abide by TBH Policies and TBH Procedures for Credentialing, Prior Authorization, utilization review, utilization management and quality management. Provider acknowledges that TBH's quality management program includes provisions for provider reporting, records audit, peer review, provider appeals and a grievance process for Enrollees. The minutes of the quality management committee shall be available for review by the applicable Payor or Contract MCO and State and federal regulatory agencies if required by law or contract. Provider and all Provider Affiliates shall comply with all final determinations of TBH's peer review, provider appeal and Enrollee grievance process, subject to Provider's rights of grievance and appeal under TBH Policies and TBH Procedures. 2.10 COORDINATION OF BENEFITS. Provider shall cooperate with TBH with respect to the administration of Coordination of Benefits required under a Plan Contract or Article X of this Agreement. Provider and Provider Affiliates shall consent to such release of information by TBH to other Payors as is necessary and lawful to accomplish Coordination of Benefits and will assign right to payment or bill the primary Payor as required by TBH. 2.11 THIRD PARTY LIABILITY AND WORKERS' COMPENSATION RECOVERIES. Provider shall cooperate with TBH to procure third party liability and workers' compensation recoveries. The proceeds of such recoveries shall be the exclusive property of TBH provided Provider is paid by TBH for Designated Covered Services rendered. 2.12 RECORD KEEPING AND REPORTING REQUIREMENTS. 2.12.1 RECORDS. Provider shall maintain current medical and other records in accordance with accepted standards of all information relevant to Designated Covered Services provided to Enrollees, including, but not limited to services performed, charges, day of services, medical/patient charts, prescription orders, diagnoses, documentation of orders for laboratory and other tests and rest results, Referrals and other information necessary for the evaluation of the nature, necessity, quality, quantity, appropriateness and timeliness of such services. 2.12.2 MAINTENANCE OF RECORDS. Provider shall maintain for at least five, (5) years after the date of the delivery of services and readily make available to TBH, the State, the United States Department of Health and Human Services, and any other government agency with regulatory authority, medical and behavioral health records of Enrollees receiving Designated Covered Services and all related administrative records. Upon request, TBH and such agencies shall have access at reasonable times to the books, records and papers of Provider relating to Designated Covered Services, to the cost thereof and Copayments received from Enrollees. 2.12.3 REPORTING REQUIREMENTS. Provider shall comply with the encounter, clinical information or other reporting requirements of each Plan Contract and Payor Plan and shall utilize such reporting forms as required by TBH or the Payor. 2.12.4 CONFIDENTIALITY OF INFORMATION. Provider shall assure that all material and information, in particular information relating to Enrollees, which is provided to or obtained by or through Provider's performance under this Agreement, whether verbal, written, taped, computerized or otherwise, shall be maintained and treated as confidential information to the extent confidential treatment is required under State and federal laws. Provider shall not use any such information in any manner except as necessary for the proper discharge of its obligations and securement of its rights under this Agreement. Except as expressly authorized by this Agreement, all information as to personal facts and circumstances concerning Enrollees obtained by Provider shall be treated as privileged communications shall be held confidential and shall not be divulged without the written consent of the Enrollee, provided 8. 9 that nothing stated herein shall prohibit the disclosure of information in summary, statistical or other form which does not identify particular Enrollees. The use or disclosure of information concerning Enrollees by Provider, any Provider Affiliate or TBH shall be limited to purposes directly connected with the administration of this Agreement. 2.12.5 ACCESS TO CONFIDENTIAL INFORMATION. Subject to all applicable privacy and confidentiality laws, rules and regulations, the medical records of Enrollees and administrative records related thereto shall be made available to each Participating Provider and to TBH, any appropriate Contract MCO or Payor, and their respective agents and representatives. Provider shall allow TBH inspection, audit and duplication of any and all data, billings and other records maintained on Enrollees. Inspection, audit and duplication shall occur after reasonable notice during regular working hours. Ownership and access to Provider's records of Enrollees shall be controlled by applicable laws of the State and this Agreement. TBH and State and federal regulatory agencies shall also have access to such records as required by law and pursuant to the terms of Article 7 of this Agreement. Each Enrollee and his or her authorized representatives shall be given access to such Enrollee's medical records, to the extent and in the manner provided by Tenn. Code Ann. Section 33-3-104(10), Section 63-2-101, Section 63-2-102 and 42 C.F.R. 2, and, subject to reasonable charges, be given copies thereof upon request. 2.13 INSURANCE. 2.13.1 PROFESSIONAL LIABILITY. During the term of this Agreement and for a period of three (3) years after termination, Provider shall maintain (through regular or tail coverage) professional liability insurance covering Provider and all Provider Affiliates in amounts equal to $1,000,000 per claim and $3,000,000 in the aggregate of all claims per policy year. Upon execution of this Agreement, Provider will deliver to TBH certificates of insurance or other evidence of insurance reasonably satisfactory to TBH indicating that this insurance is in effect. TBH shall be provided not less than 30 days' advance written notice prior to any cancellation, non-renewal or material change in this coverage and may require a certificate from the insuror to such effect. 2.13.2 GENERAL LIABILITY. During the term of this Agreement, Provider shall maintain general liability insurance with reasonable limits against claims for damages arising as a result of personal injury or death caused, in whole or in part, by any act or omission of Provider of any of its agents, servants and employees. 2.14 NON-DISCRIMINATION. Neither Provider nor any Provider Affiliate shall discriminate against any Enrollee solely on the grounds that the Enrollee files a complaint against Provider, a Provider Affiliate or TBH, or because of the Enrollee's race, color, national origin, ancestry, religion, sex, marital status, sexual orientation, age, physical handicap, or medical or behavioral health condition 2.15 REPORTING CHANGES OF PROVIDER INFORMATION. Provider shall notify TBH, in writing, at least 30 calendar days prior to any known or anticipated change and within ten (10) days after any unanticipated change in the address, business telephone number, business hours, tax identification number, license number and, if applicable, Drug Enforcement Agency registration number of Provider or any Provider Affiliate. 2.16 CREDENTIALING REQUIREMENTS. Each Provider Affiliate shall, prior to providing Designated Covered Services under this Agreement, meet TBH's Credentialing requirements for each Plan Contract and Payor Plan. 2.17 LICENSE REQUIREMENTS. Each Provider Affiliate shall maintain all appropriate licenses, certifications, training and standards required by applicable state and federal laws for the providing of Designated 9. 10 Covered Services under this Agreement. Tennessee Mental Health Cooperative, Inc. shall not be authorized to and shall not provide Designated Covered Services to Enrollees. 2.18 NON-SOLICITATION. Neither Provider, any Provider Affiliate nor any entity or person associated with Provider or any Provider Affiliate shall use any membership lists or other information obtained as a Participating Provider to solicit Enrollees in any way on behalf of any health plan other than the Contact Plan in which the Enrollee is enrolled. Such solicitation shall be a material breach of this Agreement. TBH acknowledges that Provider has had complete access to the identities of the Enrollee and has treated the Enrollees prior to entering into this Agreement and Provider is unrestricted in the use of any information secured prior to entering into this Agreement. 2.19 REQUIREMENTS FOR SUBMISSION OF CLAIMS BY PROVIDER. With respect to those Designated Covered Services that Provider is to be compensated for based on the submission of a Clean Claim, claims for payment shall be paid only if submitted to TBH or its designee within 60 days after the date the Designated Covered Services were rendered and only after TBH has determined that a claim is a Clean Claim. Provider shall not seek payment from Enrollees for claims for Designated Covered Services submitted to TBH except with respect to the applicable Copayment amount. Forms, used in submitting claims shall be in a format approved by TBH (generally, HCFA 1500 and UB-92 forms are in an approved format). Claim shall include, at a minimum, the following information if applicable: date of service, patient name, Enrollee identification number, Plan Contract identification number, Referring Case Manager's name and identification number, number of service units, diagnosis, billed dollar amount, Copayment amount (if applicable), CPT and DSM codes and procedure description. This Section shall only apply to claims submitted on a fee-for-service basis. 2.20 LEGAL AND PROFESSIONAL RESPONSIBILITY. Provider shall perform all of Provider's duties and obligations under this Agreement in accordance with all applicable laws, rules and regulations, including those made applicable by reason of any Contract Plan or Addendum. To the extent Provider is an individual practitioner, Provider acknowledges that he/she has an independent professional responsibility to his/her patient/Enrollee, and agrees that no action by TBH pursuant to either this Agreement or TBH Policies or TBH Procedures shall in any way absolve Provider or any Provider Affiliate from, or in any way restrict or inhibit his/her performance of professional duties and obligations due a patient/Enrollee. 2.21 TRANSFER. If Provider is an individual practitioner, then, if after reasonable efforts a satisfactory Provider-patient relationship is not established and maintained between Provider and any Enrollee, either Provider, such Enrollee or TBH may request that the Enrollee's care be transferred to another Participating Provider. No such change shall be effective, however, without the prior express approval of TBH which shall not be reasonably delayed or withheld. 2.22 CONFIDENTIALITY AND RETURN, OF PROPRIETARY INFORMATION. Provider covenants to maintain the confidentiality of any information and documents relating to or prepared pursuant to this Agreement or any Plan Contract and all information or documents supplied to Provider by TBH pursuant to this Agreement, and shall not copy such documents or use such information or documents for any purpose other than discharging Provider's duties under this Agreement. Provider shall take reasonable precautions to prevent the unauthorized disclosure of all such information and documents. TBH consents to such disclosure to Provider Affiliates to the extent necessary for Provider to arrange coverage by or otherwise engage Provider Affiliates to provide Designated Covered Services in accordance with this Agreement. Provider agrees to promptly return the TBH Provider Manual and any other TBH proprietary documents or material upon termination of this Agreement, including any copies thereof, in Provider's or Provider Affiliate's possession or control. 2.23 HOLD HARMLESS. Provider agrees that in no event, including but not limited to nonpayment of Provider by TBH, shall any Enrollee be liable for any amounts owed to Provider or any Provider Affiliate for any 10. 11 Designated Covered Service provided by Provider to Enrollees under this Agreement, except to the extent Provider shall be permitted to bill for and collect a Copayment from the Enrollee pursuant to the applicable Plan Contract. Provider shall not maintain any action at law or take any action against any Enrollee to collect sums owed or allegedly owed to Provider by TBH or any Payor or Contract MCO with respect to any Designated Covered Service. Provider shall not charge, collect or seek to collect from any Enrollee any surcharge or other amount for Designated Covered Services other than applicable Copayments nor shall Provider solicit or accept any surety or guarantee of payment from the Enrollee in excess of the amount of such Copayments. The term Enrollee, as used in this Section 2.23, includes the patent and the parent(s), guardian, spouse or any other person legally responsible for the patient. 2.24 REFERRALS. To the extent required by the Plan Contract or TBH Policies or TBH Procedures, Provider shall Refer Enrollees only to other Participating Providers and shall comply with all requirements of such Plan Contract, TBH Policies and TBH Procedures for notification of TBH or the Case Manager with respect to Referrals for Emergency Care or other Covered Services to a health care provider that is not a Participating Provider. 2.25 NO RIGHT TO REFUSE DESIGNATED COVERED SERVICES. Provider shall not refuse to provide Medically/Psychologically Necessary Designated Covered Services to any Enrollee provided the Enrollee has been certified by TBH as eligible to receive such Designated Covered Services and TBH has given its Prior Authorization for the provision of such Designated Covered Services when required under the terms of the Contract Plan or this Agreement. An individual Provider shall not be required to accept or continue treatment of an Enrollee with whom the Provider cannot, after reasonable efforts, establish or maintain a professional relationship. 2.26 MARKETING. TBH and any Contract MCO may include references to Provider, Provider Affiliates and their business addresses and telephone numbers in any Payor Plan materials provided to Enrollees, in any marketing or solicitation campaigns initiated by TBH or by any Contract MCO, and in any materials used by TBH in informing other Participating Providers of network affiliations. All marketing, advertising and publicity relative to the solicitation of Plan Contracts will be conducted by TBH and its designees. 2.27 ADDENDA. To the extent any of the obligations, responsibilities or rights of either of the parties under this Agreement shall be expanded, limited or otherwise affected by the terms of any Addendum, then the terms of such Addendum shall control, and, in the event any of the provisions or terms of an Addendum shall conflict with or be inconsistent with the terms and conditions of this Agreement, the terms and provisions of such Addendum shall control. 2.28 COMPLIANCE WITH PAYOR PLANS. Provider will comply with all requirements imposed on providers under Payor Plans and will not implement any policy or practice designed or intended to circumvent the obligation of any Enrollee to pay any Copayment. 2.29 CREDENTIALING REQUIREMENTS. Provider acknowledges that pursuant to the execution of this Agreement, it shall be necessary for TBH to perform Credentialing of Provider and Provider Affiliates, and each individual Provider and Provider Affiliate shall be required to execute a form of release and immunity authorizing TBH to obtain Credentialing information from third parties in the form of Exhibit 3 attached to this Agreement. 2.30 REPRESENTATIONS AND WARRANTIES OF PROVIDER. Provider hereby represents and warrants to TBH as follows: 2.30.1 Provider has the legal right, power and authority to execute and deliver this Agreement on behalf of MHC and CMI and to legally bind MHC and CMI to the terms, conditions and obligations 11. 12 of this Agreement as the authorized agent for MHC and CMI, to the same exam as if this Agreement had been executed and delivered by MHC and CMI. 2.30.2 Under the term of its agreement with MHC and CMI, Provider is authorized to receive payment from TBH for all Designated Covered Services provided by MHC and CMI to Enrollees and Provider shall indemnify and hold TBH, its officers, employees and agents, harmless from and against any claims made by MHC and CMI for payment for services rendered pursuant to this Agreement. 2.30.3 MHC and CMI have such licenses, certifications and other qualifications as are necessary to meet TBH's Credentialing requirements and will maintain all such licenses, certifications and qualifications for so long as MHC and CMI are providing Designated Covered Services under the terms of this Agreement. 2.30.4 MHC and CMI have appointed Provider as its agent to exercise, waive and represent the rights and interests of MHC and CNU under this Agreement including without limitation, exercising the following rights on behalf of MHC and CMI: (i) pursue grievance procedures, (ii) accept and execute Addenda adding Payor Plans or amending this Agreement, (Iii) pursue arbitration remedies and (iv) exercise rights of extension or termination of the Agreement. All rights of MHC and CMI under the Agreement shall be exercisable solely by Provider on behalf of MHC and CM1. 2.30.5 Provider shall maintain a network of MHC and CMI throughout the term of this agreement sufficient for meeting all requirements for the provision of Designated Covered Services to Enrollees imposed on TBH by reason of all Plan Contracts in effect during the term of this Agreement. ARTICLE 3 TBH'S OBLIGATIONS 3.1 COMPENSATION TO PROVIDER. In consideration for the Designated Covered Services which Provider readers to Enrollees pursuant to this Agreement, TBH shall reimburse Provider or any Provider Affiliate in accordance with the following provisions and all Addenda. Where any Addendum sets forth a compensation arrangement which is inconsistent with the following provisions, the terms of the Addendum shall govern. 3.1.1 METHOD AND AMOUNT OF COMPENSATION. Provider shall accept as payment in full for Designated Covered Services rendered to Enrollees under a Payor Plan and Plan Contract based upon and in accordance with the method and amounts, payable by TBH set forth in the Addendum) referencing such Payor Plan and Plan Contract, plus Copayments payable solely by Enrollees in accordance with such Payor Plan. 3.1.2 EXCLUSIVE COMPENSATION BY TBH. In the event that TBH fails, for any reason, to pay for Designated Covered Service, neither the Enrollee receiving such Designated Covered Services nor the Contract MCO or Payor sponsoring, maintaining or administering such Plan Contract shall be liable to Provider for sums owed by TBH under this Agreement and Provider shall not maintain an action at law or initiate collection efforts against such Enrollee or Contract MCO or Payor to collect such sum. 3.1.3 NO PAYMENT FOR EXCLUDED SERVICES. Except as provided in Section 2.4, neither an Enrollee, any Payee, any Contract MCO nor TBH shall be liable for payment for (1) any Designated Covered Service determined by TBH to be not Medically/Psychologically Necessary, (2) any Designated 12. 13 Covered Service for which Prior Authorization and/or Case Manager Referral is required under the applicable Plan Contract as a prerequisite of coverage but which is not obtained, or (3) Excluded Services. 3.1.4 TIME REQUIREMENTS FOR PAYMENT OF CLAIMS. To the extent an Addendum shall require that TBH compensate Provider on a fee for service or other basis requiring the submission of claims by Provider, TBH or its designee shall process and reimburse Provider's claims for Designated Covered Services provided to Enrollees consistent with TBH Policies and TBH Procedures and in accordance with terms of the pertinent Plan Contract. TBH shall pay ninety-five percent (95%) of Clean Claims within 30 calendar days of receipt of such claim by TBH and will pay the remaining five percent (5%) of Clean Claims within forty (40) calendar days of receipt by TBH. TBH shall process within sixty (60) calendar days of receipt all claims submitted by Provider. The term "process" means that TBH will make a determination as to whether the submitted claim is a Clean Claim or advise Provider that a submitted claim is (i) a denied claim and specify all reasons for denial or (ii) not a "Clean Claim" due to insufficient information and/or documentation and specify in detail all information and/or documentation that is needed from the Provider in order to allow or deny the claim. Resubmission of a claim with further information and/or documentation shall constitute a new claim for purposes of establishing the timeframe for claim processing and payment under this Subsection 3.1.4. 3.1.5 TIME REQUIREMENTS FOR PAYMENT OF CAPITATED PAYMENT BY TBH. To the extent an Addendum shall require that TBH compensate Provider on a capitated rate method or any other method that does not require the submission of a claim by Provider, TBH shall pay the capitated amount to Provider by no later than (i) the tenth (10th) day of the calendar month or (11) if such Addendum refers to a Plan Contract sponsored, maintained or administered by a Contract MCO or by the State, within five (5) business days after receipt of the capitation payment or other compensation payment by TBH from such Contract MCO or the State, as appropriate. 3.1.6 PAYMENT OF PROVIDER AFFILIATES. All payments due Provider and all Provider Affiliates under this Agreement shall be made directly to Provider, and Provider shall be solely responsible for paying or otherwise compensating all Provider Affiliates, as provided in Subsection 2.2.2. 3.1.7 LIMITATION ON COMPENSATION OBLIGATION. Notwithstanding any provision in the Agreement to the contrary, where TBH pays another Participating Provider on an all-inclusive per diem, percentage of premium, program or capitated rate basis, and such Participating Provider is responsible for payment of Provider's services, Provider shall look only to such Participating Provider for payment of Designated Covered Services rendered to Enrollees. 3.1.8 OTHER PAYMENT REQUIREMENTS. Other billing, claim submission and payment requirements may be included in any provider manual provided to Provider by TBH. 3.2 MONITOR QUALITY MANAGEMENT. TBH shall monitor Provider's quality management activities and compliance with TBH's quality management policies and procedures. TBH shall also monitor Provider's compliance with its Credentialing and disciplinary policies and procedures. Provider shall comply with any reasonable corrective action plans implemented by TBH. 3.3 ENROLLEE GRIEVANCES. TBH shall have primary and final responsibility for administering Enrollee grievance procedures. Provider shall be given notice of and the right to participate in any Enrollee grievance procedure. 13. 14 ARTICLE 4 CASE MANAGEMENT 4.1 CASE MANAGER DESIGNATION. If Provider is designated as a Case Manager under any Addendum, Provider shall provide the case management services described in Section 4.2 to those Enrollees who are covered by the Plan Contract described in such Addendum and who are assigned to Provider by TBH. TBH may request, in its discretion, that Provider provide some but not all case management services described in Section 4.2 depending upon the requirements of the Plan Contract. TBH shall compensate Provider for rendering such case management services in the amount and manner set forth in such Addendum, such compensation to be in addition to any amounts owing to Provider under this Agreement for providing Designated Covered Services to Enrollees. 4.2 CASE MANAGEMENT SERVICES. Case management services shall include the following services which shall be available 24 hours a day, 7 days a week: 4.2.1 serving as an intake center, identifying the health care needs of the Enrollee and developing a plan of care for such Enrollee, which includes the identification of long term and short term goals with respect to those Enrollees assigned to Case Manager pursuant to Section 4.1; 4.2.2 making Referrals and assisting the Enrollee and his or her family in accessing Covered Services and other behavioral health services in the least restrictive and most efficient and cost-effective environment; 4.2.3 processing requests from Participating Providers for the delivery of Covered Services to Enrollees and making recommendations to TBH with respect to Prior Authorization decisions relating to such proposed Covered Services; 4.2.4 monitoring the Enrollee's care to evaluate progress and advocating for the Enrollee with other Participating Providers; 4.2.5 communicating and discussing with Participating Providers the effectiveness of the plan of care for the Enrollee, any Covered Services provided to the Enrollee, any Emergency Care provided and/or notifications thereof required by this Agreement and helping TBH assure that the plan of care that has been approved by TBH is implemented and followed by Participating Providers; 4.2.6 reviewing with TBH the efficiency and effectiveness of care provided to the Enrollee by Participating Providers; 4.2.7 assisting TBH in the coordination and provision of all Covered Services to be provided to Enrollees under the Plan Contract; 4.2.8 developing linkages with the Contract MCO and with other agencies and individuals involved in the Enrollee's case; and 4.2.9 carrying out such other reasonable case management responsibilities or duties as may be delegated or assigned to Case Managers under TBH Policies or TBH Procedures and agreed by Provider, which agreement shall not be unreasonably withheld. 14. 15 ARTICLE 5 TERM This Agreement will have an initial term of one (1) year and will renew automatically for Successive one-year terms, unless earlier terminated as provided in Article VI. ARTICLE 6 TERMINATION PROVISIONS 6.1 TERMINATION BY EITHER PARTY WITHOUT CAUSE. After the initial one-year term of this Agreement, this Agreement may be terminated without cause by either party at any time upon ninety (90) calendar days' prior written notice to the other party. 6.2 IMMEDIATE TERMINATION. This Agreement shall terminate upon TBH's notice to Provider in the event of the occurrence of any of the following: 6.2.1 violation by Provider or any Provider Affiliate of any law, rule or regulation pertinent to this Agreement; 6.2.2 any act or conduct for which any of Provider's licenses or certifications to provide Designated Covered Services may be revoked or suspended or for which Provider's or any Provider Affiliate's ability to provide Designated Covered Services in accordance with this Agreement is otherwise materially impaired, 6.2.3 failure by Provider or any Provider Affiliate to comply with TBH's quality management policies, utilization management policies, Credentialing criteria, TBH Policies or TBH Procedures that is not cured within 30 days after notice from TBH; 6.2.4 any misrepresentation or fraud by Provider, or any Provider Affiliate; 6.2.5 any action by Provider or any Provider Affiliate which, in the reasonable judgment of TBH, constitutes professional misconduct; 6.2.6 Provider's failure to maintain professional liability insurance in accordance with this Agreement; or 6.2.7 If Provider is an individual, the death or disability of Provider. 6.3 TERMINATION BY EITHER PARTY DUE TO MATERIAL BREACH OF AGREEMENT. This Agreement may be terminated by either party upon thirty (30) days' prior written notice to the other party if the party to whom notice is given is in material breach of any provisions of this Agreement. The party claiming the right to terminate will set forth in the notice of intended termination the facts underlying the claim that the other is in breach of this Agreement. Remedy of the breach to the satisfaction of the party giving notice, within 30 days of receipt of notice, will nullify the intended termination notice. 15. 16 6.4 TERMINATION BY CHANGE IN LAW OR REGULATION. This Agreement may be terminated by a change in law or regulation or a judicial interpretation thereof, which renders any material term or provision of this Agreement illegal, invalid or unenforceable. Termination under this section shall be effective on the effective date of the change in law or regulation, or judicial interpretation thereof. 6.5 TERMINATION BY TBH ON REJECTION OF AMENDMENT. If Provider rejects an amendment submitted to Provider by TBH pursuant to Article XIII of this Agreement and the amendment has been submitted by TBH to all Participating Providers similar to Provider, the parties will meet within ten (10) days after rejection by Provider to resolve any differences or problems related to the amendment. If the parties fail to agree at such meeting, TBH may elect, in its discretion, to terminate this Agreement upon written notice to Provider setting forth the date of termination. 6.6 NO FURTHER FORCE OR EFFECT AFTER TERMINATION. Except as otherwise specified in Section 6.9, following the effective date of termination, this Agreement will be of no further force or effect. 6.7 CONTINUATION OF CERTAIN SERVICES. If any Enrollees are receiving Designated Covered Services as of the date of termination of this Agreement (with or without cause), Provider will continue to provide Designated Covered Services to those Enrollees in accordance with the terms of this Agreement until TBH arranges for alternative care or treatment, which will be arranged as soon as practicable, but in no event beyond the termination date of the Enrollee's coverage under the applicable Plan Contract. TBH shall continue to compensate Provider for such services in accordance with the terms of this Agreement until the Enrollee is transferred to another Participating Provider. 6.8 TRANSFER OF ENROLLEES AFTER TERMINATION. Upon notice of termination of this Agreement, Provider agrees to cooperate in an orderly transfer of Enrollees to other Participating Providers to protect and meet the behavioral health care needs of Enrollees in the transfer. 6.9 SURVIVABILITY. Notwithstanding any other provisions of this Agreement to the contrary, upon termination of this Agreement for any reason, each party will remain liable for any obligations or liabilities arising from activities occurring prior to the effective date of termination. The covenants and obligations of the parties set forth in Articles VIII, X and XX, Sections 2.10, 2.12, 2.18, 2.22, 2.23, 2.28, 6.7, 6.8 and Subsection 2.13.1, and all other covenants or obligations which by their terms or by implication are intended by the parties to continue in effect after termination of this Agreement, shall survive termination and shall remain in effect and enforceable by the parties. ARTICLE 7 AUDIT RIGHTS 7.1 AUDIT AND INSPECTION. TBH, any Contract MCO and State and federal regulatory agencies with regulatory jurisdiction have the right to conduct, or have conducted by a third party, medical. financial and other audits, inspections and evaluations of Provider's records and facilities, with respect to Designated Covered Services provided to Enrollees under this Agreement including quality appropriateness and timeliness of services. Audits and inspections by the State or federal agencies may be announced or unannounced, but other audits or inspections shall be at reasonable times, upon reasonable advance notice. Any such party or entity shall be allowed access to Provider's place of business and to all appropriate records during normal business hours, except under special circumstances (as determined by State and federal regulatory agencies) when after hour admission shall be allowed. Such audit rights shall not apply to confidential corporate information of Provider that is 16. 17 unrelated to this Agreement or the provision of Designated Covered Services. In conducting any medical audit, neither TBH nor the Contract MCO shall be entitled to examine medical or behavioral health records of patients who are not Enrollees. Provider shall cooperate fully with the auditing or inspecting party and furnish copies of medical and behavioral health records, when requested by TBH, the Contract MCO or any State or federal regulatory agency for the purpose of an audit, inspection or evaluation at no charge. TBH or the Contract MCO, as appropriate, shall be responsible for providing Provider with copies of all releases or consent from Enrollees necessary for TBH or Contract MCO to have access to such records. 7.2 MONITORING. TBH, any Contract MCO and State and federal regulatory agencies with regulatory jurisdiction shall have the right to monitor, whether on an announced or unannounced basis, all services rendered to Enrollees by Provider. ARTICLE 8 DISPUTE RESOLUTION AND ARBITRATION 8.1 DISPUTES. Except as provided in Section 8.3, if any dispute arises between the parties involving a contention by one party that the other has failed to perform it obligations and responsibilities under this Agreement, then the party making such contention shall, prior to initiating any action authorized in the Agreement, promptly give written notice to the other party pursuant to Article XVI. Such notice shall set forth in detail the basis for the party's contention. The other party shall, within thirty (30) calendar days after receipt of the notice, provide a written response seeking to satisfy the party that gave notice regarding the matter as to which notice was given. Following such response, or the failure of the second party to respond to the complaint of the first party within thirty (30) calendar days if the party that gave notice of dissatisfaction remains dissatisfied, then that party shall so notify the other party and the matter shall be promptly submitted to binding arbitration, with the cost of establishing any arbitration. 8.2 ARBITRATION. Except as provided in Section 8.3, all claims, disputes, and other matters in question arising out of or relating to this Agreement or any breach of this Agreement shall be decided by arbitration in accordance with the rules of the American Arbitration Association, then obtaining, unless the parties mutually agree otherwise in writing. This agreement to arbitrate shall be specifically enforceable pursuant to the Tennessee Uniform Arbitration Act as codified in Tenn. Code Ann. SectionSection 29-5-301, et seq. The award rendered by the arbitrator shall be final and a judgment may be entered upon it in accordance with the applicable State law. The responsibility for any legal fees and/or costs incurred by such action shall be borne by the party designated by the arbitrator. 8.3 TBH POLICIES OR TBH PROCEDURES. The provisions of Section 8.1 and 8.2 shall not apply to (i) any determination made by TBH pursuant to TBH Policies or TBH Procedures that are subject to appeal by Provider under appeal and grievance procedures contained in TBH Policies or TBH Procedures or (ii) any decision made by Payor or TBH that may be made at the discretion of such party by the terms of this Agreement. Such appeal or grievance procedures shall be the sole remedy of Provider in such instance, and the determination resulting from such procedures shall be binding on Provider. 17. 18 ARTICLE 9 RELATIONSHIPS OF PARTIES TBH and Provider are independent contractors in relation to one another and no joint venture, partnership, employment, agency or other relationship is intended or created by this Agreement. Neither TBH nor Provider is authorized to represent or bind the other for any purposes. Neither of the parties hereto, nor any of their respective officers, agents or employees, shall be construed to be the officer, agent or employee of any other party. ARTICLE 10 COORDINATION OF BENEFITS Coordination of Benefits shall be administered in accordance with the requirements of the applicable Plan Contract. Right of subrogation and to the proceeds or savings derived from Coordination of Benefits shall be governed by the terms of the applicable Plan Contract. If a Plan Contract fails to address Coordination of Benefits or any issue related thereto, TBH shall administer Coordination of Benefits in compliance with applicable laws, and all proceeds and savings derived from Coordination of Benefits shall be the exclusive property of TBH. If Provider should receive any payment from a Payor that should have been paid to TBH or any Contract MCO under the Coordination of Benefits requirements of a Contract Plan or this Article X, Provider shall, without demand, promptly pay over such amount to TBH or the Contract MCO, as appropriate. ARTICLE 11 NO THIRD PARTY BENEFICIARY Nothing in this Agreement is intended to be construed or deemed to create any rights or remedies in any third party beneficiary, including an Enrollee, Payor or Contract MCO. Notwithstanding the preceding, a Plan Contract may, by its express terms, grant a Payor or Contract MCO rights to enforce the terms of this Agreement and other third party beneficiary rights with respect to those Payor Plans adopted, sponsored, maintained or administered by such Payor or Contract MCO. ARTICLE 12 GOVERNING LAW AND VENUE This Agreement shall be governed by the laws of the State of Tennessee, without regard to conflict of laws principles, except where otherwise required by federal law or by the laws of any State in which Provider provides Designated Covered Services to Enrollees. Any arbitration proceedings instituted under this Agreement shall be in Knox County, Tennessee, and each party hereby waives any other right of venue such party may have. 18. 19 ARTICLE 13 AMENDMENTS 13.1 RIGHT OF APPROVAL AND EFFECTIVE DATE. All amendments to this Agreement proposed by Provider must be agreed to in writing in advance of the effective date by TBH. TBH reserves the right to reject any proposed amendment in its absolute discretion. Any amendments to this Agreement proposed by TBH must be proposed in the form of an Addendum forwarded to Provider in the manner specified in Section 13.2 and will be deemed effective upon the expiration of twenty (20) calendar days after receipt of such Addendum (determined under Article XVI unless, within such 20-day period, Provider notifies TBH in writing of Provider's rejection of the requested amendment. Amendments required because of legislative, regulatory or legal requirements do not require the consent of Provider or TBH and will be effective immediately on the effective date thereof. 13.2 ADDENDA. In the event TBH desires to amend this Agreement for any reason, including, without limitation, adding an additional Payor Plan and Plan Contract not listed on the List of Addenda, such amendment shall be proposed by TBH to Provider in the form of a written Addendum which shall be sent to Provider in accordance with the provisions of Article XVI, and such amendment shall become effective as provided in Section 13. 1. In the event Provider rejects such amendment within the twenty (20) day period described in Section 13.1, TBH shall have the right, exercisable at its option, to terminate this agreement as provided in Section 6.5 or to continue this Agreement in effect without such Addendum. If such Addendum does not become effective and this Agreement is continued, Provider shall not be required to comply with the Addendum or to be a Provider under the Payor Plan described in the Addendum. 13.3 OTHER CHANGES. Any amendment to a Payor Plan, Plan Contract, TBH Policies or TBH Procedures shall not be deemed an amendment to this Agreement and may be agreed to and implemented by TBH, any Payor or Contract MCO without the consent of Provider. ARTICLE 14 ENTIRE AGREEMENT This Agreement supersedes any and all other agreement , either oral or written, between the parties with respect to the subject matter hereof, and no other agreement, statement or promise relating to the subject matter of this Agreement will be valid or binding. ARTICLE 15 ASSIGNMENT The services provided under this Agreement by Provider are unique, and Provider may not assign this Agreement, or delegate or subcontract any duties, rights and obligations under this Agreement, to any other person or entity without the prior written consent of TBH. The consent of TBH to one assignment shall not constitute a waiver of the requirement for consent of any subsequent assignment. The assigning party shall not be released or relieved from any of its obligations under this Agreement by reason of such assignment. TBH shall have the unrestricted right to assign its rights and delegate its duties and responsibilities under this Agreement. Notwithstanding the foregoing. Provider may assign its rights and obligations under this Agreement to MHC 19. 20 and/or CMI with the prior consent of TBH; however, no further or other assignment shall be permitted without the consent of TBH. ARTICLE 16 NOTICES Any notice or other communication required under this Agreement will be given in writing and sent by certified mail, return receipt requested, by overnight courier or by facsimile transmission, and will be deemed received either three (3) business days after being deposited in The United States mail, or one (1) day after delivery to any overnight courier addressed to the applicable address appearing on the signature page of this Agreement or on the date of facsimile transmission to the facsimile number set forth on such signature page. Any changes to these addresses shall be designated by notice given in accordance with this Article XVI. ARTICLE 17 SEVERABILITY The provisions of this Agreement are severable. If any provision of this Agreement is held to be invalid, illegal or otherwise unenforceable in any jurisdiction, the holding shall not affect the remaining provisions of this Agreement and shall not in any other jurisdiction, unless the effect of the severance would be to alter the obligations of a party in any material respect, in which case, this Agreement may be immediately terminated by the affected party pursuant to Section 6.4. ARTICLE 18 WAIVER OF BREACH Any waiver of any provision or right by a party must be in writing. The waiver of any breach of this Agreement by either party hereto will not constitute a continuing waiver or a waiver of any subsequent breach of either the same or any other provision of this Agreement. ARTICLE 19 NON-INDUCEMENT WARRANTY 19.1 PROVIDER WARRANT. Provider warrants and covenants he/she/it has not paid and shall not pay, either directly or indirectly, any compensation to any officer or employee of the State, or any employee or member of a federal agency, as wages, compensation, or gifts in exchange for action as an officer, agent, employee, subcontractor or consultant to Provider in connection with any work contemplated or performed in connection with this Agreement. 20. 21 19.2 TBH WARRANTY. TBH warrants and covenants it has not paid and shall not pay, either directly or indirectly, any compensation to any officer or employee of the State, or any employee or member of a federal agency, as wages, compensation, or gift in exchange for action as officer, agent employee, subcontractor or consultant to TBH in connection with any work contemplated or performed in connection with this Agreement. ARTICLE 20 LEGAL RESPONSIBILITIES 20.1 LEGAL DEFENSE. The defense of any legal action instituted on a claim of malpractice against Provider relating to services provided pursuant to this Agreement shall not be an obligation of TBH. TBH shall not be responsible for any legal expenses including, without limitation, reasonable attorney's fees, costs and necessary disbursements, in connection with any such legal action against Provider. TBH shall, however, fully cooperate with Provider by furnishing such material or information as it has available in connection with the defense of any such action. 20.2 INDEMNIFICATION. If either party is without fault and is held liable for the acts or omissions of the other party, its employees or agents, the party not at fault shall have such rights of indemnity or contribution against the party at fault as are provided by the applicable laws of the State. ARTICLE 21 NON-EXCLUSIVE AGREEMENT 21.1 PROVIDER RIGHTS. Nothing contained in this Agreement shall preclude Provider from participating in or contracting with any other Payor or other person, group or entity, whether before, during or subsequent to the term of this Agreement, with regard to the provision by Provider of any health care services. 21.2 RIGHTS OF TBH. Nothing contained in this Agreement shall preclude TBH from contracting with one or more other health care providers for services under any other contracts, agreements or arrangements, or any other business operations of TBH. Nothing in this Agreement shall be construed as imposing any duty on or otherwise requiring TBH to assign Provider to any Provider Panel, the determination of such assignment to be made solely in the discretion of TBH and/or the applicable Payor. ARTICLE 22 EFFECTIVE DATE This Agreement shall become effective on the later of: (a) the date of execution of this Agreement by the last party to execute this Agreement or (b) the date that the Plan Contract referenced in Addendum No. 1 attached to this Agreement becomes effective. 21. 22 If TBH has not entered into the Plan Contract with the State referenced in Addendum No. 1 by July 1, 1996 (or such later date as may be agreed upon by the parties), this Agreement shall automatically become null and void without becoming effective and each party shall be released from its obligations under this Agreement. 22. 23 IN WITNESS WHEREOF, the parties have executed this Agreement in multiple counterparts (including the use of counterparts signature pages if necessary) as of the dates set forth below each party's signature. ADDRESS: TBH: 1830 White Avenue TENNESSEE BEHAVIORAL HEALTH, INC. Knoxville, TN 37910 By: /s/ Rocky Davis ------------------------------------- Phone: (615) 541-2101 Title: Chief Executive Officer Fax: (615) 541-2118 Date: 12/4/95 ADDRESS: PROVIDER: 275 Cumberland Blvd. /s/ Pam Womack, President Nashville, TN 37228 ----------------------------------------- Tennessee Mental Health Cooperative Phone: (615) 259-9225 Fax: (615) 726-4843 By: ------------------------------------- Title: ---------------------------------- Date: 12/2/95 23. 24 ADDRESS: IF AN INDIVIDUAL: - ----------------------------------- - ----------------------------------- ----------------------------------------- Type or Print Name - ----------------------------------- Phone: ( ) - ----------------------------------- ----------------------------------------- Signature Date: ----------------------------------------- 24. 25 [EXHIBITS EXCLUDED] 1. EX-10.20 5 EXHIBIT 10.20 1 EXHIBIT 10.20 ADDENDUM NO. 1 TENNESSEE BEHAVIORAL HEALTH, INC. PROVIDER AGREEMENT PAYOR PLAN: The TennCare Partners Program PLAN CONTRACT: Agreement for Behavioral Health Services to Enrollees under The TennCare Partners Program between TBH and the Tennessee Department of Mental Health and Mental Retardation. EFFECTIVE DATE: This Addendum shall become effective as of the later of (i) the date the Plan Contract between the State and TBH referenced above becomes effective or (ii) the date this ADDENDUM NO. 1 is executed by the parties. COVERED SERVICES: All services described in Attachment I. PRIOR AUTHORIZATION REQUIREMENTS: All Designated Covered Services require Prior Authorization with the exception of Emergency Care or care rendered by Providers to their assigned enrollees at their discretion. Emergency Care is not subject to Prior Authorization; however, Provider is required to give notice to TBH within twenty-four (24) hours after the provision of Emergency Care or any Referral for Emergency Care. Once the Enrollee has been stabilized, any subsequent care is subject to Prior Authorization requirements. ENROLLEE ASSIGNMENT: Each enrollee will be assigned to a provider by TBH. COMPENSATION: TBH shall compensate Provider for providing Medically/Psychologically Necessary Designated Covered Services to Enrollees of the above-referenced plan as follows: As described in Attachment I. COPAYMENT: In accordance with terms of Payor Plan. WITHHOLDS: TBH reserves the right to institute withholds for any Participating Provider failing to meet performance standards as outlined by TBH Policies, TBH Procedures, TennCare, or any other regulatory or government body associated with the administration of the TennCare Program. ISSUE RESOLUTION: To the extent not specifically addressed by the terms of this Addendum, all compensation issues shall be resolved in accordance with TBH Policies and TBH Procedures. SPECIAL TERMS, CONDITIONS OR OBLIGATIONS: The following terms, conditions, covenant and obligations shall, apply to TBH or Provider, as appropriate, notwithstanding any terms or conditions of the Agreement to the contrary. A1-1 2 1. DEFINITIONS. To the extent the Plan Contract contains definitions of terms identical, similar or comparable to the terms defined in Article I of the Agreement, the definition in the Plan Contract shall control the meaning of such terms. References to the State shall mean the Tennessee Department of Mental Health and Mental Retardation and, where appropriate, the Bureau of TennCare, Tennessee Department of Finance and Administration and the Tennessee Department of Commerce and Insurance. The term "MCO" refers to each managed care organization that has entered into a Risk Agreement with the State for the provision of certain health care services to TennCare enrollees. 2. THIRD PARTY BENEFICIARY. Enrollees are the intended third party beneficiary of the Plan Contract and this Agreement and, as such, are entitled to remedies accorded to third party beneficiaries under the laws of the State. 3. CASE MANAGEMENT. If Provider is designated as a Case Manager, Provider shall not only perform the functions described in Article IV of the Agreement, but will also assist and cooperate with State and TBH in performing case management functions under the Plan Contract. 4. LABORATORY TESTING. If Provider is to provide laboratory testing as a Designated Covered Service, all laboratory testing sites utilized to provide such services must have either a Clinical Laboratory Improvement Act (CLIA) Certificate of Waiver or a Certificate of Registration along with a CLIA identification number. Those laboratories with a Certificate of Waiver may provide only the types of tests permitted under the terms of the waiver. 5. COORDINATION OF BENEFITS. TBH shall be the Payor of last resort for Designated Covered Services. TBH shall be entitled to full subrogation rights and shall be responsible for determining the legal liability of third parties to pay for Designated Covered Services and to recover any such amounts from the third party. If TBH has determined that third party liability exists for part or all of Designated Covered Services provided to an Enrollee, and the third party will make payment to Provider in a reasonable time, TBH may pay Provider only the amount, if any, by which the Provider's Clean Claim exceeds the amount of third party liability, or TBH may pay the full amount due Provider under this Agreement and assume full responsibility for collection from such third party. TBH shall not withhold payment to Provider if third party liability or the amount of liability cannot be determined or payment will not be made to Provider within a reasonable time. Provider shall make such assignment and pay over such amounts to TBH as shall be required by this paragraph or any applicable provision of TBH Policies or TBH Procedures. 6. PROVIDER WARRANTIES. Provider warrants that Provider has not been excluded from participation in the Medicare or Medicaid programs pursuant to Sections 1128 or 1156 of the Social Security Act and is in good standing with TennCare. 7. MAINTENANCE OF RECORDS. Medical health and behavioral records of Enrollees and all related administrative records shall be maintained under Section 2.12.2 of the Agreement for five (5) years after termination of the Agreement and further if the records are under review or audit until the review or audit is complete. Prior approval for the disposition of records must be requested from the State. 8. CLAIMS SUBMISSION. The time period for the submission of claims under Section 2.19 of the Agreement shall bc no less than one hundred twenty (120), and no more than one hundred eighty (180), calendar days from the date of rendering services rather than (60) days. A1-2 3 9. INDEMNIFICATION. At all times during the term of this Agreement, Provider shall indemnify and hold harmless the State as well as its officers, agents and employees (hereinafter the "Indemnified Parties") from all claims, losses or suits incurred by or brought against the Indemnified Parties as a result of failure of Provider to comply with the terms of this Agreement or the Plan Contract. 10. COMPLIANCE WITH LAWS. TBH and Provider agree to recognize and abide by all State and federal laws, regulations and guidelines applicable to TennCare, including The TennCare Partners Program, and the Plan Contract. 11. INCORPORATION OF LEGAL OR CONTRACT REQUIREMENTS. The parties hereby incorporate by reference all applicable federal and State laws or regulations and agree that revisions of such laws or regulations shall automatically be incorporated into this Addendum as they became effective. In the event the changes in this Agreement or this Addendum as a result of revision in applicable federal or State laws materially affect the position of either party, TBH and Provider agree to negotiate such further amendments as may be necessary to correct any inequities. 12. SPECIAL TERMINATION PROVISIONS. In the event of a termination of the Parties' obligations pursuant to Article VI with respect to this Addendum, Provider shall immediately make available to the State, or its designated representative, in usable form, any or all records, whether medical or financial, related to the Provider's activities undertaken pursuant to this Agreement with respect to this Addendum No. 1. Provision of such records shall be at no expense to the State. 13. OTHER CONTRACTS. Provider is required to accept compensation for Designated Covered Services provided under this Agreement as set forth above, but shall not be required to accept TennCare reimbursement amounts for services to Enrollees who are covered under any other Plan Contract. 14. QUALITY COMPLIANCE. In addition to all other requirements of this Agreement, Provider must adhere to the quality of care monitors required by the terms of the Plan Contract. 15. ARBITRATION. The State shall have no involvement in arbitration under Section 8.2 of the Agreement except to (i) enforce Section 8.2, (ii) approve the arbitration procedure proposed by TBH and (iii) to voluntarily intervene if the State deems intervention to be in the best interest of TennCare; provided, however, that the State shall not be bound by said arbitration. If at any time, the State decides that a particular dispute should be in a court of competent jurisdiction, the State shall notify the parties to the dispute of its decision to refer the dispute to a court of competent jurisdiction and said arbitration process shall cease and the dispute shall be heard in said court. The only exception to the arbitration process shall be resolution of the cost of Emergency Care and providers of services under TENN. CODE ANN. Section 33-2-601. The cost of establishing any arbitration procedure shall be borne by TBH. If a dispute between the parties involving a claim submitted by Provider to TBH is not resolved prior to entry of a final decision by the arbitrator(s), then the prevailing party at the arbitration shall be entitled to award of reasonable attorneys' fees and expenses from the non-prevailing Party. Reasonable attorneys' fees means the number of hours reasonably expended on the dispute multiplied by a reasonable hourly rate but shall not exceed ten percent (10%) of the total monetary amount in dispute or $500.00, whichever amount is greater. 16. COORDINATION OF HEALTH CARE SERVICES. To the extent and in the manner required by the terms of the Plan Contract, Provider will cooperate with each MCO and the primary care providers under contract with or employed by such MCO who provide medical services, to Enrollees in an effort to (i) coordinate and integrate health care services provided to each Enrollee by such providers and Provider, (ii) help ensure the appropriateness of all health care services provided to the Enrollee and (iii) help ensure that such health care services are. provided in a manner that allows the most efficient use of resources and the achievement of quality health outcomes. A1-3 4 17. AMENDMENT TO ADDENDUM. Notwithstanding the provision of Article XII to this Agreement, in the event this Agreement and Addendum No. 1 are executed by the parties prior to execution of the Plan Contract, this Addendum No. 1 shall automatically be amended to conform to the requirements of the Plan Contract and the State under The TennCare Partners Program. Any amendments required after execution of the Plan Contract shall, be made in accordance with the provisions of Article XIII of the Agreement. The terms of any amendment that becomes effective by reason of the first sentence of this Paragraph shall be provided to Provider by TBH within thirty (30) days after execution of the Plan Contract by TBH and the State. 18. ASSIGNMENT TO STATE. TBH shall have the right to assign to the State its rights and delegate its duties and responsibilities under this Agreement with respect to the Payor Plan and Plan Contract described in this Addendum to the extent required by the terms of the Plan Contract. A1-4 5 IN WITNESS WHEREOF, the parties have executed this Addendum No. 1 in multiple counterparts (including the use of counterpart signature pages if necessary) as of the dates set forth below each party's signature. TBH: TENNESSEE BEHAVIROAL HEALTH, INC. By: /s/ Rocky Davis ---------------------------------------------- Title: Chief Executive Officer Date: December 4, 1995 PROVIDER: IF AN ENTITY: /s/ Pam Womack, President ---------------------------------------------- TENNESSEE MENTAL HEALTH COOPERATIVE By: ------------------------------------------ Title: --------------------------------------- Date: December 4, 1995 IF AN INDIVIDUAL: ---------------------------------------------- Type or Print Name ---------------------------------------------- Type or Print Name Date: ---------------------------------------- A1-5 6 [EXHIBITS EXCLUDED] A1-6 EX-10.21 6 EXHIBIT 10.21 1 EXHIBIT 10.21 ADDENDUM NO. 2 TENNESSEE BEHAVIORAL HEALTH, INC. PROVIDER AGREEMENT (ENTITY) This Addendum No. 2 to that certain Provider Agreement ("Agreement") between Tennessee Behavioral Health, Inc. ("TBH") and the undersigned health care provider ("Provider"), with an effective date of December 11, 1995, is entered into as of the date set forth below in order to amend the Agreement to comply with the requirements of The TennCare Partners Program of the State of Tennessee, Department of Mental Health and Mental Retardation ("State") defined in Addendum No. 1 to the Agreement as the Plan Contract. All capitalized terms used in this Addendum No. 2 shall have the same meaning as used in the Agreement and Addendum No. 1. Pursuant to Article XIII of the Agreement, the parties hereby agree to amend Addendum No. 1 and the Agreement as follows: 1. AMENDMENT TO EXHIBIT 1. Exhibit 1 to the Agreement is deleted in its entirety and a new Exhibit 1 in the form attached to this Addendum No. 2 as Exhibit 1 shall be substituted in lieu thereof. 2. DELETION OF ATTACHMENT 1. All references in Addendum No. 1 to Covered Services, including any reference to Attachment 1, are hereby deleted in their entirety from the Agreement and Attachment 1 is deleted from the Agreement. 3. CLAIMS INFORMATION. Provider shall submit to TBH all necessary information to permit TBH, when determining liabilities on its annual report and quarterly financial reports, to include an amount estimated in the aggregate to provide for any unearned premium and for the payment of all claims for health care expenditures that have been incurred pursuant to or under the Plan Contract, whether reported, unreported or unpaid or for which TBH is or may be liable, and to provide for the expense, adjustment or settlement of such claims. Provider acknowledges that such liabilities must be computed by TBH in accordance with procedures to be established by the State upon reasonable consideration of the ascertained experience and character of TBH. 4. CONFLICT OF INTEREST. Provider warrants that no part of any payments made pursuant to the Agreement shall be paid directly or indirectly to any officer, employee, delegate or member of the legislative body of the State or of the United States Government as wages, compensation, or gifts in exchange for acting as officer, agent, employee, subcontractor or consultant to Provider in connection with any work contemplated or performed relative to the Agreement. Provider shall be declared in default by TBH if it is determined that Provider, its officers, agents, employees, subcontractors or consultants offered or gave gratuities of any kind to any official, employee or delegate or member of any legislative body of the State or the United States Government. 5. TERM. The provisions of Article V of the Agreement are deleted in their entirety and the following language is substituted in lieu thereof: "This Agreement shall have an initial term of two (2) years beginning December 11, 1995, and ending December 10, 1997. This Agreement shall automatically renew for successive one-year terms, unless and until terminated by either party pursuant to Article VI." 6. TERMINATION. Section 6.2 of the Agreement is amended by adding the following new subsection; deleting the word "or" from Subsection 6.2.6 and deleting the "," from Subsection 6.2.7 and adding "; or" to the end of such subsection: "6.2.8 TBH shall fail to enter a Provider Risk Contract with the State for the TennCare Partners Program by July 1, 1996, or such contract, if entered into by TBH and the State, is terminated for any reason during the term of the Agreement." 1. 2 7. AMENDMENTS. Section 13.1 of the Agreement is deleted in its entirety and the following is added in lieu thereof: "13.1 RIGHT OF APPROVAL AND EFFECTIVE DATE. All amendments to this Agreement proposed by Provider must be agreed to in writing in advance of the Effective Date by TBH. TBH reserves the right to reject any proposed amendment in its absolute discretion. Any amendments to this Agreement proposed by TBH must be proposed in the form of an Addendum forwarded to Provider in the manner specified in Section 13.2 and will be deemed effective upon the earlier of such Addendum's execution by the parties or the expiration of twenty (20) calendar days after receipt of such Addendum (determined under Article XVI) unless within such twenty (20) day period Provider notifies TBH in writing of Provider's rejection of the requested amendment. Amendments required because of legislative, regulatory or legal requirements or because of requirements imposed by the State or pursuant to any amendment to the Plan Contract shall not require the consent of Provider or TBH and will be effective as of the date specified in the Addendum containing such amendment." 8. EFFECTIVE DATE OF AGREEMENT. The provisions of Article XXII of the Agreement are deleted in their entirety and the following language is inserted in lieu thereof: "This Agreement shall be effective as of December 11, 1995." 9. AMENDMENT TO ADDENDUM NO. 1. The third paragraph of Addendum No. 1 titled "Effective Date" is deleted in its entirety and the following paragraph is inserted in lieu thereof: "EFFECTIVE DATE. This Addendum shall become effective as of December 11, 1995." 10. EFFECTIVE DATE OF ADDENDUM NO. 2. Notwithstanding that the provisions of Section 13.1 of this Agreement currently provide that any amendment to the Agreement shall become effective after a period of twenty (20) days during which Provider has an option to accept or reject such Amendment, the parties agree that, by signing below, each party agrees to make this Addendum No. 2 effective as of February 4, 1996, and that the provisions of this Addendum are incorporated into the Agreement effective as of such date. 11. DELETION OF PARAGRAPH 3.1.7. Paragraph 3.1.7 of the Agreement is hereby deleted in its entirety. During the term of the Agreement, TBH shall be the sole party responsible for paying for Designated Covered Services provided by Provider under this Agreement. 12. SPECIAL TBH REPRESENTATION. TBH represents and warrants that TBH as of this date has not entered into any exclusive arrangements for case management and related services. TBH further represents and warrants that the payments to be made to Provider hereunder are not subject to any priority right of any other 2. 3 provider whereby any other provider must be paid its percentage of premium, all inclusive per diem, program or capitated rate for case management or related services prior to Provider being paid for Designated Covered Service rendered by Provider under this Agreement. IN WITNESS WHEREOF, the parties have executed this Addendum No. 2 in multiple counterparts (including the use of counterpart signature pages, if necessary) as of February 1, 1996. PROVIDER (ENTITY): TBH: TENNESSEE MENTAL HEALTH COOPERATIVE, INC. TENNESSEE BEHAVIORAL HEALTH, INC. By: /s/ Pam Womack By: /s/ Albert R. Wesson, Jr. Title: President Title: Chief Operating Officer Date: February 4, 1996 Date: February 4, 1996 3. 4 [EXHIBITS EXCLUDED] 4. EX-10.22 7 EXHIBIT 10.22 1 EXHIBIT 10.22 ADVOCARE, INC. PROVIDER PARTICIPATION AGREEMENT THIS AGREEMENT, effective this ____ day of _________________, 1995, is by and between Green Spring Health Services, Inc., AdvoCare, Inc., a subsidiary of Green Spring Health Services, Inc., (hereinafter collectively referred to as "AdvoCare"), and THE TENNESSEE MENTAL HEALTH COOPERATIVE, INC. (hereinafter referred to as "TMHC"), a subsidiary of PMR, Inc. WHEREAS, TMHC operates programs known as the Nashville/Davidson County Mental Health Cooperative and Case Management, Inc., which provide case management, mental health, and/or chemical dependency treatment services; and WHEREAS, AdvoCare desires to engage TMHC to provide such services to individuals covered by Benefit Plans sponsored or issued by Payors, as defined in this Agreement. NOW THEREFORE, for and in consideration or the premises, the mutual promises contained herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: SECTION 1 DEFINITIONS BENEFIT PLAN: The TennCare Health Benefit Program which contains the terms and conditions of an Enrollee's coverage. COPAYMENT: The amount which may be charged to Enrollees at the time services are rendered in accordance with the terms of the Benefit Plan and which are in addition to payments made by Payor to TMHC for such services. CUSTOMARY CHARGE: The usual, reasonable and customary fees charged by a Participating Provider which do not exceed the fees the Participating Provider would charge any other person, regardless of whether the person is an Enrollee. DEDUCTIBLE: The annual amount which may be charged to Enrollees for Mental Health Services and which Enrollees may be required to pay in accordance with the terms of the Benefit Plan. EMERGENCY: The sudden and unexpected onset of a mental health emergency or severe symptoms of sufficient severity that the absence of immediate mental health intervention within twenty-four (24) hours could reasonably be expected to cause physical harm to the life and safety of the Enrollee and/or others. Emergency services may be rendered without prior authorization. 1. 2 ADVOCARE POLICIES AND PROCEDURES. All AdvoCare standards, policies, procedures, definitions, criteria, and guidelines as stated in AdvoCare handbooks, manuals, and other documents, as amended from time to time by AdvoCare. MENTAL HEALTH SERVICES: The case management, mental health and/or chemical dependency treatment services and supplies set forth in Enrollee's Benefit Plan. MEDICALLY NECESSARY MENTAL HEALTH SERVICES: Mental health services including professional services and supplies rendered by a Provider to identify or treat a mental illness that has been diagnosed or is suspected, and which are: (a) consistent with (i) the efficient diagnosis and treatment of a condition; and (ii) standards of good medical practice; (b) required for other than convenience; (c) the most appropriate supply or level of service; (d) unable to be provided in a more cost-effective and efficient manner; (c) unable to be provided at a facility providing a less intensive level of care; and (f) other criteria for assessment and placement jointly agreed to by AdvoCare and TMHC. ENROLLEE: Any individual eligible for the TennCare Mental Health Benefit Program which has enrolled with a Managed Care Organization ("MCO") where such individual has been designated by the TennCare Bureau as assigned to AdvoCare or its parent corporation, Green Spring Health Services, Inc., for the provision of mental health and/or substance abuse treatment services. PARTICIPATING PROVIDER: An organization duly licensed and qualified in the state where Mental Health Services are provided under this agreement who satisfies AdvoCare credentialing requirements, including Provider that has a Participation Agreement in effect with AdvoCare to provide Mental Health Services to Enrollees. PAYOR: Bureau of TennCare, Tennessee Department of Mental Health and Mental Retardation (TDMHMR), or other entity which has financial responsibility for payment of Mental Health Services rendered to Enrollees. SECTION 2 DUTIES OF TMHC SECTION 2.1 PROVISION OF MENTAL HEALTH SERVICES. TMHC agrees to provide Medically Necessary Mental Health Services to each Enrollee in a timely, prompt and efficient manner consistent with the standard of practice of the community in which TMHC render Mental Health Services. Such services will be provided in accordance with the Operating Policies and Procedures set forth in Exhibit A hereto. Operating Policies and Procedures, Exhibit A, 2. 3 may be amended, subject to section 12.1. TMHC warrants that the services to be provided will be provided within the scope of the TMHC providers' professional practice. SECTION 2.1.1 TMHC agree not to delegate any professional duties other than contracting for physician services to any party or facility without the approval of AdvoCare. SECTION 2.1.2 TMHC shall be bound by AdvoCare Policies and Procedures. Failure to comply with AdvoCare policies and procedures may result in loss of reimbursement to THMC and/or termination of this Agreement. TMHC acknowledges that full acceptance of this Agreement by AdvoCare is contingent upon TMHC fully satisfying AdvoCare's credentialing standards. SECTION 2.2 AUTHORIZATION AND NOTIFICATION REQUIREMENTS. All Mental Health Services provided to Enrollees by TMHC must be authorized by AdvoCare as specified in Exhibit B prior to or in the case of an Emergency, at the time of rendering services. Failure to obtain authorization from AdvoCare in accordance with these requirements, may result in the loss of reimbursement and/or termination of this Agreement. AdvoCare's utilization management procedures shall not diminish the obligation of TMHC to render Mental Health Services consistent with the applicable standard of care. SECTION 2.3 COMPLIANCE WITH CIVIL RIGHTS LAWS. TMHC agrees not to discriminate or differentiate in the treatment of any individual based on sex, marital status, age, race, color, religion, physical or mental handicap or otherwise, including by reason of the fact that the individual is an Enrollee of TennCare. TMHC agrees to ensure that mental health and substance abuse treatment services are rendered to Enrollees in the same manner, and in accordance with the same standards and with the same availability, as offered to any other individual customarily receiving services from TMHC. TMHC may not refuse to provide medically necessary or covered preventative services to a TennCare enrollee for non-medical reasons, including but not limited to, failure to pay application deductibles, copayments and/or special fees. SECTION 2.4 UTILIZATION MANAGEMENT, QUALITY ASSURANCE, PEER REVIEW AND GRIEVANCE PROCEDURES. TMHC agrees to cooperate and participate with all utilization management, quality assurance, peer review and grievance procedures, or other similar programs established by AdvoCare in the AdvoCare Provider Reference Manual or by Payor. TMHC agrees to he bound by any final determination of AdvoCare and/or Payor as it relates to any Enrollee receiving Mental Health Services from TMHC under this Agreement. AdvoCare's utilization management procedures shall not diminish the obligation of TMHC to render Mental Health Services consistent with the applicable Standard of care. SECTION 2.5 VERIFICATION AND COLLECTION OF CHARGES FROM ENROLLEES. TMHC shall verify the status of any Enrollee's eligibility for Mental Health Services by contacting Payor or AdvoCare. Non-covered services are not eligible for payment by Payor or AdvoCare. TMHC shall not be 3. 4 paid by Payor, AdvoCare or Enrollee for Mental Health Services that are deemed not medically necessary by AdvoCare including other criteria for assessment and placement jointly agreed to by AdvoCare and TMHC. SECTION 2.5.1 HOLD HARMLESS PROVISION. TMHC agrees that in no event, including but not limited to non-payment by AdvoCare or Payor, insolvency or breach of this Agreement, shall TMHC, its contractors or employees bill, charge, collect a deposit from, seek compensation, remuneration or reimbursement from, or have any recourse against any Enrollees or any other persons other than AdvoCare or its parent company Green Spring Health Services or ally such Payor contracting with AdvoCare or its parent company Green Spring Health Services, for services provided pursuant to this Agreement. This provision shall not prohibit collection of any applicable copayments or deductibles billed in accordance with the Benefit Plans of Enrollees. TMHC further agrees that: this provision shall survive the termination of this Agreement regardless of the cause giving rise to termination and shall be construed to be for the benefit of the Enrollee; and this provision supersedes any oral or written contrary agreement Now existing or hereafter entered into between TMHC and Enrollee, or persons acting on their behalf, and any modifications, additions, or deletions to this provision shall become effective on a date no earlier then that specified by the Insurance Commissioner of the state in which services are rendered. SECTION 2.6 COORDINATION OF BENEFITS. TMHC shall be paid in accordance with the Payor's coordination of benefits rules. TMHC shall make all reasonable efforts to ascertain whether other coverages exist for Enrollees to whom TMHC renders Mental Health services, and shall notify AdvoCare of any such other coverages. SECTION 2.7 REPORTING REQUIREMENTS. TMHC agrees that it will submit all data and other reports in a timely manner as specified by AdvoCare Policies and Procedures for reporting including Exhibit A. TMHC agrees to comply with the State of Tennessee reporting requirements specified on pages 48-49 requirement 3.12.2-3.12.6 of the Contract between the State of Tennessee and the Behavioral Health Organizations approved and participating in the TennCare Partners Program, November 20, 1995 (work in progress). SECTION 2.8 CLAIMS PROCESSING. When the method of payment is fee for service, TMHC agrees that it will submit all itemized claims for reimbursement no later than sixty (60) days from the date services are rendered. In the event Electronic Claims Filing ("ECF") is required by Payor, TMHC agrees that it will submit claims through a clearinghouse designated by AdvoCare. SECTION 3 COMPENSATION TO TMHC 4. 5 SECTION 3.1 COMPENSATION TO TMHC. TMHC accepts payment from Payor for Mental Health Services provided to Enrollees under this Agreement as payment in full for such services. TMHC agrees that such payment shall be made in accordance with the schedule set forth as Exhibit B or amended payment schedule subject to Section 12.1. Payment will be made within 30 days of proper submission of a clean claim for services billed on a fee for service basis. SECTION 4 RELATIONSHIP BETWEEN PARTIES SECTION 4.1 INDEPENDENT CONTRACTOR. The relationship between AdvoCare and TMHC is solely that of independent contractors and nothing in this Agreement or otherwise shall be construed or deemed to create any other relationship, including one of employment, agency or joint venture. TMHC shall maintain social security, workers' compensation, employer's liability insurance, and all other employee benefits covering TMHC's employees as required by law. SECTION 5 INDEMNIFICATION; LIABILITY INSURANCE SECTION 5.1 INDEMNIFICATION; LIABILITY INSURANCE. AdvoCare will indemnify and hold harmless TMHC and PMR, its successors and assigns, officers and directors, employees, agents, affiliates and subsidiaries, from any and all claims, demands, damages, judgments, liabilities and expenses, including but not limited to reasonable attorney fees, that arise directly or indirectly from (i) any negligent, reckless or willful acts or omissions of AdvoCare, its agents and/or employees; or (ii) any failure of AdvoCare to perform its obligations under this Agreement. TMHC will indemnify and hold harmless TennCare, Green Spring and AdvoCare, its successors and assigns, officers and directors, employees, agents, affiliates and subsidiaries, from any and all claims, demands, damages, judgments, liabilities and expenses, including but not limited to reasonable attorney fees, that arise directly or indirectly from (i) any negligent, reckless or willful acts or omissions of TMHC, its agents and/or employees; or (ii) any failure of TMHC to perform its obligations under this Agreement. SECTION 5.2 TMHC LIABILITY INSURANCE. TMHC shall procure and maintain, at TMHC's sole expense: (1) professional liability insurance in the amount of at least One Million Dollars ($1,000,000) per occurrence and One Million Dollars ($1,000,000) in the aggregate and (2) comprehensive general and/or umbrella liability insurance. TMHC medical malpractice insurance shall he either occurrence or claims-made. If the insurance policy is claims-made, TMHC shall be required to furnish and maintain an extended period reporting endorsement ("tail policy") under such terms and conditions as may be reasonably required by AdvoCare. Prior to 5. 6 or within 90 days following execution of this Agreement and at each policy renewal thereafter, TMHC shall submit to AdvoCare in writing evidence of insurance coverage. TMHC shall notify AdvoCare in writing, within 10 days of (a) any changes in carrier, termination of, renewal of or any material changes in TMHC's liability insurance, including reduction of limits, erosion of aggregate, changes in retention or non-payment of premium, (b) any settlement, judgment or other disposition of any malpractice or similar claim against TMHC. SECTION 6 LAWS, REGULATIONS, LICENSES AND ACCREDITATION SECTION 6.1 LAWS, REGULATIONS, LICENSES AND ACCREDITATION. TMHC shall comply with all applicable federal and state laws including but not limited to requirements for licensure and certification, requirements to maintain the facilities of TMHC and requirements concerning maintenance and disclosure of records. TMHC shall notify AdvoCare in writing, within 10 days of (a) any suspension, revocation, condition, limitation, qualification or other restriction, or upon initiation of any action which could reasonably lead to such restriction on a license held by TMHC and/or certification in any state in which TMHC is authorized to provide Mental Health care services; (b) any suspension, revocation or restriction of staff privileges at any licensed hospital or other facility at which a TMHC provider has staff privileges and (c) on all annual basis, any charges of malpractice or professional misconduct brought against TMHC. SECTION 7 PUBLIC RELATIONS: NAME, SYMBOLS, AND SERVICE MARKS SECTION 7.1 RIGHTS OF TMHC, ADVOCARE AND PAYOR. TMHC agrees that AdvoCare and/or Payor with whom AdvoCare has contracted, may use TMHC's name, address, telephone number and description of services in any promotional activities. TMHC further agrees to Cooperate and participate in all reasonable promotional activities undertaken by AdvoCare. Otherwise, TMHC and AdvoCare shall not use each other's name, symbol or service mark without prior written approval of the other party. AdvoCare agrees that TMHC may use AdvoCare's name, address, telephone number and description of services in any promotional activities. AdvoCare further agrees to cooperate and participate in all reasonable promotional activities undertaken by TMHC. Otherwise, AdvoCare and TMHC shall not use each other's name, symbol or service mark without prior written approval of the other party. 6. 7 SECTION 8 BOOKS AND RECORDS SECTION 8.1 ACCESS TO AND RECORDS OF BOOK AND RECORDS. TMHC agrees that it will maintain patient records (including but not limited to such records that are necessary for (the evaluation of the quality, appropriateness and timeliness of services performed), in accordance with AdvoCare procedures and to maintain financial records in accordance with generally accepted accounting principles. TMHC agrees that AdvoCare, TennCare, the Tennessee Bureau of' Investigation Medicaid Fraud Unit, the U.S. Department of Health & Human Services and the Office of the Inspector General, whether announced or unannounced, shall have access to all information and records or copies of records, free of charge related to Mental Health Services rendered by TMHC under this Agreement. Upon request TMHC members will assist in such reviews. Unless otherwise required by applicable statutes or regulations, AdvoCare shall have access to such books and records during the term of this Agreement and for five (5) years following its termination. Such information shall be retained beyond this point if the records are under review or audit. Prior approval for the disposition of records must be requested from AdvoCare if this Agreement is continuous. SECTION 8.2 CONFIDENTIALITY OF RECORDS. AdvoCare and TMHC agree to maintain the confidentiality of all information regarding Mental Health Services provided to Enrollees under this Agreement in accordance with any applicable statutes and regulations. TMHC acknowledges that in receiving, storing, processing, or otherwise dealing with information from AdvoCare or Payor about Enrollees, it is fully bound by federal and state statutes governing confidentiality of medical records, mental health records and/or alcohol and drug abuse patient records. SECTION 8.3 PATIENT ACCESS TO RECORDS. Enrollees and their representatives shall be given access to the enrollee's medical records to the extent and in the manner provided by state and federal law. They will also be given copies of such records, subject to reasonable charges. SECTION 9 CONFIDENTIALITY OF ADVOCARE'S PROPRIETARY INFORMATION SECTION 9.1 CONFIDENTIALITY OF PROPRIETARY INFORMATION. TMHC specifically agrees to keep confidential and not to disclose to others any and all business, financial, credentialing, utilization review, quality assurance, protocols or procedures, manual or other information marked or otherwise designated "Confidential" or "Proprietary" and made available to it by AdvoCare ("Confidential Information"). Upon request (of AdvoCare, or in the event of termination of this Agreement, TMHC shall promptly return all such Confidential Information to AdvoCare. TMHC agrees not to use any such Confidential Information of AdvoCare except in conjunction with the 7. 8 purposes of this Agreement. The terms of this Section shall survive termination of this Agreement. AdvoCare specifically agrees to keep confidential and not to disclose to others including any entity controlling, controlled by, or under common control with AdvoCare any and all business, financial, credentialing, utilization review, quality assurance, protocols or procedures, manual or other information marked or otherwise designated "Confidential" or "Proprietary" and made available to it by TMHC ("Confidential Information"). Upon request of TMHC, or in the event of termination of this Agreement, AdvoCare shall promptly return all such Confidential Information to TMHC. AdvoCare agrees not to use any such Confidential Information of TMHC except in conjunction with the purposes of this Agreement. The terms of this Section shall survive termination of this Agreement. SECTION 10 RESOLUTION OF DISPUTES SECTION 10.1 RESOLUTION OF DISPUTES. In the event that a dispute between AdvoCare and TMHC arises out of or is related to this Agreement, the parties to the dispute agree to negotiate in good faith to attempt to resolve the dispute. In the event the dispute is not resolved within 30 days of the date one party sent written notice of the dispute to the other party, and if any party wishes to pursue the dispute, it shall be submitted to binding arbitration in accordance with the rules of the American Arbitration Association, in no event may arbitration be initiated more than one year following the sending of written notice of the dispute. Any arbitration proceeding under this Agreement shall be conducted in the State where Mental Health Services are provided under this Agreement. Legal fees and costs incurred by each party will be borne by them. The arbitrators shall have no authority to award any punitive or exemplary damages, or to vary or ignore the terms of this Agreement, and shall be bound by controlling law. If the dispute pertains to a matter which is generally administered in accordance with AdvoCare's procedures involving, for example, credentialing or quality assurance, the procedures set forth by AdvoCare must be fully exhausted by TMHC before TMHC may invoke its right to arbitration under this Section. TMHC acknowledges that the recommendation and determination of whether Mental Health Services are Medically Necessary shall be made in accordance with AdvoCare's policies and procedures including other criteria for assessment and placement jointly agreed to by AdvoCare and TMHC. SECTION 11 TERM AND TERMINATION SECTION 11.1 TERM. The term of this Agreement shall commence on the Effective Date and it shall remain in effect until terminated. 8. 9 SECTION 11.2 TERMINATION OF AGREEMENT WITHOUT CAUSE. Either party may terminate this Agreement without cause upon ninety (90) days prior written notice of termination to the other party. SECTION 11.3 TERMINATION WITH CAUSE. AdvoCare shall have the right to terminate this Agreement immediately by giving written notice to TMHC upon the occurrence of any of the following events: (a) Termination of AdvoCare's obligation to obtain mental health/substance abuse treatment services on behalf of the Payor with which it has contracted; (b) Restriction, suspension or revocation of a TMHC provider's license or certification; (c) TMHC's loss of or failure to maintain any liability insurance, as required under this Agreement; (d) AdvoCare's failure to make payment when due subject to a 15-day right to cure; (e) TMHC's exclusion from participation in any third party payor programs; (f) TMHC's breach of any of the terms or obligations of this Agreement subject to a 30-day right to cure; (g) TMHC's bankruptcy or insolvency; (h) Submission of false or misleading billing information by TMHC. TMHC shall have the right to terminate this Agreement immediately by giving written notice to TMHC upon the occurrence of any of the following events: (a) AdvoCare's loss of or failure to maintain any liability insurance, as required under this Agreement; (b) AdvoCare's exclusion from participation in any third party payor programs; (c) AdvoCare's bankruptcy or insolvency. SECTION 11.4 CONTINUATION OF SERVICES AFTER TERMINATION. Upon request of AdvoCare, TMHC shall continue to provide Medically Necessary Mental Health Services to Enrollees who are receiving such services from TMHC as of the date of termination of this Agreement. Said services shall be in accordance with this Agreement until the Enrollee has been transitioned by AdvoCare to another Participating Provider, except that AdvoCare or Payor shall pay TMHC for such services at TMHC's Customary Charges. SECTION 11.5 INFORMATION TO ENROLLEES. TMHC acknowledges the right of AdvoCare to inform Enrollees of TMHC's termination. SECTION 12 MISCELLANEOUS SECTION 12.1 AMENDMENT. This Agreement may be amended at any time by the mutual written agreement of the parties. In addition, either party may amend this Agreement upon thirty (30) days advance written notice to the other party. If the other party does not provide a written objection to the first party within thirty (30) days, the amendment shall go into effect. 9. 10 SECTION 12.2 REGULATORY AMENDMENT. AdvoCare or TMHC may amend this Agreement to comply with applicable statutes and regulations, and shall give written notice to the other party of such amendment and its effective date. Such amendment will not require thirty (30) days advance written notice. SECTION 12.3 ASSIGNMENT. AdvoCare may assign all or any of its rights and responsibilities under this Agreement to any entity controlling, controlled by, or under common control with AdvoCare. If TMHC objects to this assignment, it may terminate this Agreement by providing 45 days notice to AdvoCare. TMHC may not assign any of its rights and responsibilities under this Agreement to any person or entity without the prior written consent of AdvoCare, which consent shall not be unreasonably withheld. Notwithstanding the foregoing, TMHC may assign its rights and obligations under this Agreement to thc Nashville/Davidson County Mental Health Cooperative or to Case Management, Inc. with no prior consent of AdvoCare. TMHC acknowledges that persons and entities under contract with AdvoCare may perform certain administrative services under this Agreement. SECTION 12.4 ENTIRE AGREEMENT. This Agreement, the Operating Policies and Procedures attached as Exhibit A and any other exhibits attached hereto constitute the entire agreement between the parties and supersedes or replaces any prior agreements between the parties, whether oral or written, relating to its subject matter. SECTION 12.5 GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the state where Mental Health Services are provided under this Agreement. SECTION 12.6 COMPLIANCE WITH APPLICABLE LAW. The parties agree to recognize and abide by all State and federal laws, regulations and guidelines applicable to the Benefit Plan. SECTION 12.7 CHANGES IN LAW. This Agreement incorporates by reference all applicable federal and state laws or regulations and revisions of such laws or regulations shall automatically be incorporated into the Agreement as they become effective. In the event that changes in the Agreement as a result of revisions of applicable federal or state law materially affect the position of either party, AdvoCare and TMHC agree to negotiate such further amendments as may be necessary to correct any inequities. SECTION 12.8 NOTICES. Any notice, request., demand, waiver, consent, approval, or other communication which is required or permitted hereunder shall be in writing and shall be deemed given only if delivered personally or sent by registered or certified mail or by express Mail courier service, postage prepaid, as follows: If to AdvoCare: If to The TMHC, Inc.: 10. 11 Director of Network Development _____________________________ AdvoCare, Inc. _____________________________ 5565 Sterrett Place _____________________________ Suite 500 _____________________________ Columbia, Maryland 21044 _____________________________ or to such other address as the addressee may have specified in a notice duly given to the sender as provided herein. Such notice, request, demand, waiver, consent, approval or other communication will be deemed to have been given as of the date so delivered in case of personal delivery or express mail delivery and three (3) calendar days after being mailed, if sent by registered or certified mail. SECTION 12.9 EQUAL OPPORTUNITY. TMHC shall support Affirmative Action as it relates to providing employment opportunity for minority groups and women. Utilization of TMHC is predicated upon its full compliance with AdvoCare's Equal Employment Opportunity Policy. SECTION 12.10 OTHER TENNCARE PARTNERS CONTRACTING REQUIREMENTS. TMHC and AdvoCare mutually agree that this agreement can be amended immediately for purposes of complying with State of Tennessee requirements for contracting specified on pages 41-46, requirement 3.9.2 of the Contract between the State of Tennessee and the Behavioral Health Organizations approved and participating in the TennCare Partners Program, November 20, 1995 (work in progress). THIS AGREEMENT CONTAINS A BINDING ARRITRATION PROVISION THAT MAY BE ENFORCED BY THE PARTIES. [Signatures follow] 11. 12 ADVOCARE, INC. By /s/ Joyce N. Fitch ------------------------- Print Name Joyce N. Fitch Print Title Secretary Date November 29, 1995 GREEN SPRING HEALTH SERVICES, INC. By /s/ Joyce N. Fitch ------------------------- Print Name Joyce N. Fitch Print Title Secretary Date November 29, 1995 THE TENNESSEE MENTAL HEALTH COOPERATIVE By /s/ Pam Womack ------------------------- Print Name Pam Womack Print Title President TMHC Date December 1, 1995 12. 13 [EXHIBITS EXCLUDED] EX-10.23 8 EXHIBIT 10.23 1 EXHIBIT 10.23 TENNCARE PARTNERS PROGRAM AMENDMENT TO THE ADVOCARE OF TENNESSEE, INC. PROVIDER PARTICIPATION AGREEMENT THIS AMENDMENT, made by and between GREEN SPRING HEALTH SERVICES, INC., ADOVCARE OF TENNESSEE, INC., a subsidiary of Green Spring Health Services, Inc. (hereinafter collectively referred to as "Green Spring"), and the TENNESSEE MENTAL HEALTH COOPERATIVE, INC. (hereinafter referred to as "TMHC") is effective of February 13, 1996, for the purpose of amending the Green Spring Health Services Provider Participation Agreement ("Agreement") heretofore made and entered into between Green Spring and TMHC so as to apply additionally to the rendering of Mental Health Services by TMHC persons receiving services under the TennCare Partners Program. WHEREAS, this Amendment is intended to extend basic principles set forth in the Agreement, to make such principles workable in the context of the TennCare Partners Program; and WHEREAS, Green Spring and TMHC have a mutual interest in promoting the ability of the health care delivery system to provide quality health care to persons who receive services under the TennCare Partners Program and, by entering into this Agreement, set out their mutual endeavor to make quality health care services available to such persons in a manner consistent with the standard of care required by law and with the medical needs of such persons; and WHEREAS, Green Spring and TMHC recognize the necessity for making certain amendments to the Agreement so as to make such Agreement applicable, as amended, to Mental Health Services rendered by TMHC under the TennCare Partners Program; and WHEREAS, TMHC manages Mental Health Cooperative, a not-for-profit Tennessee corporation ("MHC") and Case Management, Inc., a not-for-profit Tennessee corporation, ("CMI") who are qualified, licensed and duly certified to provide Mental Health Services in Tennessee and each has authorized TMHC to enter into the Agreement and this Amendment on their behalf and reference to TMHC in the Agreement and Amendment shall mean MHC and CMI with respect to the provision of Mental Health Services, licensing requirements and professional liability insurance requirements; and WHEREAS, Green Spring and TMHC desire to continue the Agreement without change except for the additional mutual obligations and responsibilities set forth in this Amendment. 1. 2 NOW, THEREFORE, in consideration of the premises and the mutual promises and covenants herein contained, it is AGREED: 1. DEFINITIONS - Except as otherwise stated herein, for purposes of this Amendment the following definitions apply: 1.1 "AMENDMENT" means this written TennCare Partners Program Amendment which includes the Exhibits concerning grievances and quality monitoring and all modifications and updates to such Exhibits as the same may by subsequently modified or updated. 1.2 "CONSUMER" means individual(s) either (1) enrolled with Green Spring or a Managed Care Organization for whom Green Spring manages Mental Health Services and covered under TennCare in accordance with eligibility requirements as established by TennCare or (2) individuals(s) not eligible for TennCare but designated by the State or courts of appropriate jurisdiction as a "Judicial Referral" and assigned by the State to Green Spring or (3) individual(s) not eligible for TennCare but designated by the State as a "Priority Participant" and qualified for participation in the TennCare Partners Program based on Poverty Guidelines as established by the State and assigned by the State to Green Spring. 1.3 "GREEN SPRING POLICIES AND PROCEDURES FOR THE TENNCARE PARTNERS PROGRAM" shall include all Green Spring standards, policies, procedures, definition, criteria, and guidelines for the TennCare Partners Program as stated in Green Spring handbooks, manuals, and other documents, including, but not limited to, the AdvoCare of Tennessee Provider Reference Manual and procedure guides, as amended from time to time by Green Spring. If there are conflicts between the requirements stated above in 1.3 and the agreement, the agreement shall control. 1.4 "JUDICIAL REFERRAL" means an individual who is not enrolled in the TennCare Partners Program but who has been referred to TDMHMR by the court system for psychiatric evaluations and/or treatment. 1.5 "MANAGED CARE ORGANIZATION" or MCO means the health care plans qualified by the State and contracting with the State to serve TennCare Enrollees. 1.6 "MENTAL HEALTH SERVICES" means those inpatient and outpatient psychiatric and substance abuse services provided to persons receiving services under the TennCare Partners Program, including, but not limited to, case management. 2. 3 1.7 "PRIORITY PARTICIPANT" means an individual who has been classified under State guidelines as CRG 1,2 or 3 or TPG 2. 1.8 "REASONABLE NOTICE" means thirty (30) days from the date on which notice is given, except in cases of suspected fraud or abuse, in which case notice shall be Reasonable Notice when given. 1.9 "STATE" means the State of Tennessee, including but not limited to the Tennessee Department of Mental and Mental Retardation ("TDMHMR") as the State Agency which is responsible for administration of the TennCare Partners Program. As used in this Amendment in connection with State's right to inspect, audit and duplicate financial and medical records on persons receiving TMHC Services under the TennCare Partners Program and TMHC's obligation to prepare and to maintain such financial and medical records, and to make such records on persons receiving services under the TennCare Partners Program available to the State, or its agents, "State" means the State of Tennessee including, but not limited to, the Tennessee Bureau of Investigation ("TBI") Medicaid Fraud Control Unit ("MFCU"), TDMHMR, Tennessee Department of Commerce and Insurance ("TDCI") and the TennCare Bureau. 1.10 "TENNCARE PARTNERS PROGRAM" means the health benefit program established by the Tennessee Department of Mental Health and Mental Retardation under which Green Spring, among others, arranges for Mental Health Services to benefit persons defined by the State to receive services under the TennCare Partners Program. 1.11 "TENNCARE" ("TENNCARE PROGRAM") means that program established by the State of Tennessee, consistent with waivers granted by the Health Care Financing Administration within the United States Department of Health and Human Services, whereby the State of Tennessee has been granted the authority to pay a monthly prepaid capitated payment amount to MCOs rendering or arranging necessary medical services to persons who are or who would have been Medicaid-eligible under the Medicaid Program as it was administered during Tennessee's fiscal year 1992-93 and non-Medicaid-eligible Tennesseans who are uninsured or who are unisurable and are enrolled in TennCare. 1.12 "TENNCARE BUREAU" means that Bureau within the Tennessee Department of Finance and Administration having the administrative authority for operation of the TennCare Program. 3. 4 2. RELATIONSHIP BETWEEN GREEN SPRING, TMHC AND STATE 2.1 Green Spring, TMHC, and State are independent legal entities. Nothing in this Amendment shall be construed or be deemed to create a relationship of employer and employee or principal and agent, partnership, joint venture or any relationship other than that of independent parties contracting with each other solely to carry out the provisions of this Amendment. 2.2 The Parties hereby expressly acknowledge its understanding that this Amendment constitutes a legally binding agreement. They further acknowledge and agree that they have not entered in this Amendment based upon representations by any person other than a part hereto, and that no person, entity, or organization other than a party hereto, shall be held accountable or liable to the other for any obligations created under this Amendment. This paragraph shall not create any additional obligations whatsoever on the part of a party hereto other than those obligations created under other provisions of the Agreement and this Amendment. 3. TMHC SERVICES AND RESPONSIBILITIES 3.1 Conflict of Interest - TMHC warrants that no monies have been or will be paid directly or indirectly to any officer, employee, or delegate or member of the legislative body of the State of Tennessee or of the United States Government or any officer or employee of Green Springs as wages, compensation, or gifts in exchange for acting as officer, agent, employee, contemplated or performed relative to this Amendment. This Amendment may be terminated, immediately and effective upon the giving of notice thereof, by Green Spring if it is determined that the TMHC, its agents, employees, subcontractors or consultants offered or gave gratuities of any kind to any official, employee or delegate or member of the legislative body of the State of Tennessee or of the United States Government or any officer or employee of Green Spring. TMHC represents that no member of, employee of, or delegate of Congress, the U.S. General Accounting Office, U.S. Department of Health and Human Services, U.S. Health Care Financing Administration, any other Federal agency, or Green Spring has benefited or will benefit financially or materially from this Amendment. 3.2 TMHC agrees that Green Spring and the State shall have the right to monitor and evaluate the quality of services delivered under this Amendment, whether announced or unannounced, and initiate corrective 4. 5 action to improve quality of care in accordance with prevailing standards and/or standards established by TDMHMR. TMHC shall promptly comply with corrective action plans as set forth by Green Springs and/or the State shall promptly submit all required reports and clinical information. Said monitoring and evaluation includes, but is not limited to, internal and external quality assurance/quality improvement review, utilization review, peer review and grievance procedures established by Green Spring and/or TDMHMR. TMHC agrees to adhere to the Quality of Care Monitors included in Exhibit D ("Standards for BHO Quality Monitoring Programs"). 3.3 After Reasonable Notice except under special circumstances as determined in the sole discretion of the State, TMHC shall permit Green Spring and the State, or their agents to conduct on-site inspections of TMHC office(s). 3.4 TMHC, MHC, and CMI shall secure and maintain such liability, workers compensation and malpractice and/or professional liability insurance coverage as shall reasonable determined to be necessary to protect Consumers and Green Spring. TMHC shall provide written verification of such coverage to Green Springs upon request and without charge. 3.5 TMHC shall abide by all state and federal laws, regulations and guidelines applicable to TennCare and the TennCare Partners Program. It is further agreed that Green Spring and TMHC will renegotiate this Amendment if revisions in applicable federal and/or state laws or regulations make changes in this Amendment necessary. 3.6 TMHC shall not refuse to provide medically necessary covered services to a person receiving services under the TennCare Partners Program for non-medical reasons, because of (1) the fact that the patient is a Consumer, or (2) failure to pay applicable deductibles, coinsurance and/or special fees, or (3) the fact that Green Spring and a TennCare MCO dispute financial responsibility for the service. In the case of such a dispute between Green Spring and a TennCare MCO, Green Spring agrees to abide by State's requirements for the resolution of such disputes. TMHC shall not be required to accept or continue treatment of a Consumer with whom TMHC, in good faith, determines, it cannot establish and/or maintain a professional relationship. 3.7 TMHC shall involve the Consumer in TMHC's treatment planning processes, shall offer the Consumer reasonable opportunity to participate in establishing treatment plans, and shall document Consumer's 5. 6 involvement and participation by obtaining Consumer's signature on such plans. 3.8 For Consumers who refuse referral to Case Management of refuse to participate in treatment planning, TMHC shall obtain a written statement signed by the Consumer documenting such refusal. TMHC shall mail a copy of said statement of refusal to Green Spring in a timely manner and shall maintain the original of said statement in its internal records. 3.9 TMHC shall implement an internal policy and procedure which requires that, when a Consumer is given a prescription for medication, the prescribing physician shall obtain any authorizations required by Green Spring's designated Pharmacy Benefit Manager. 3.10 TMHC shall coordinate physical and mental health care including, but not limited to, (1) means for two-way referral, which assures immediate access for emergency care and a provision of urgent and routine care according to TennCare guidelines, and (2) means for the transfer of information (to include items before and after the visit), and (3) maintenance of confidentiality. 3.11 When referring a Consumer to another level of care, TMHC shall make the referral to a properly credentialed provider in Green Spring's AdvoCare network. When TMHC cannot locate an appropriate provider, TMHC shall contact a Green Spring Care Manager or such other agency as Green Spring may from time to time designate for such purpose. 3.12 TMHC agrees that all laboratory testing sites providing services under this Amendment shall have either a Clinical Laboratory Improvement Act ("CLIA") certificate of waiver or a certificate of registration along with CLIA identification number. TMHC further agrees that those laboratories with certificates of waiver will provide only the types of tests permitted under the terms of their waiver. 3.13 TMHC shall implement an internal grievance policy and procedure which, at a minimum, (1) includes the elements described in more detail in Exhibit C, and (2) addresses both formal and informal grievances. TMHC agrees to make TDMHMR-approved grievance forms available to all Consumers at any sites where Consumers receive such services. 3.14 TMHC shall respond in a timely manner to provider satisfaction surveys administered in connection with the TennCare Partners Program. 6. 7 3.15 At all times during the term of this Amendment, TMHC shall indemnify and hold TDMHMR, the TennCare Bureau, and TDCI harmless from all claims, losses, or suits relating to activities undertaken pursuant to this Amendment. 3.16 TMHC shall provide Green Spring prompt and timely reporting of TDMHMR- directed data collection and outcomes reporting. 3.17 At all times during the term of this Amendment, TMHC shall hold Green Springs harmless for its proportionate share of any liquidated damages Green Springs accrues from TDMHMR or the State as the direct result of TMHC's failure to perform in accordance with the terms of the Agreement and this Amendment. 3.18 In consideration of the rates established in Exhibit B to the Agreement, TMHC agrees to provide the functions and/or services delineated in Exhibit E to this Amendment (1) during the term of the Agreement and this Amendment and (2) in such amount as agreed to in Exhibit B. TMHC warrants (1) that the functions and/or services delineated in Exhibit E are within the scope of TMHC's, MHC's and CMI's professional/technical practice and (2) that MHC and CMI hold a currently valid license to provide the functions and/or services delineated in Exhibit E, if such license is required under State or federal law or regulation. 4. COMPENSATION TMHC will be compensated according to the terms set forth in Exhibit B of the Agreement, which is not superceded by this amendment and the terms of which remain in effect. 4.1 TMHC shall file claims for payment with Green Spring for all Mental Health Services rendered to Consumers. 4.2 TMHC shall submit all such claims within one hundred twenty (120) days of the date of service, or, for inpatient services, within one hundred twenty (120) days from the date of discharge; provided, however, in the case of retroactive TennCare eligibility determinations, claims, must be submitted within the later of one hundred (120) days from the date of service or discharge, as applicable, or sixty (60) days from the date of final eligibility determination by TennCare. Neither Green Spring nor the consumer will be obligated to pay such claims filed after expiration of the applicable period, and such claims shall not be billed to the Consumer. Green Spring will process in the normal course of its business all claims submitted by TMHC. 7. 8 4.3 Green Spring shall make payments to TMHC for Mental Health Services rendered to Consumers pursuant to the provisions set forth in this Amendment, with at least 95% of clean claims adjudicated as defined by the State within 30 days of receipt. 4.4 TMHC agrees that the only amounts for which Consumers (including Consumer's parents, guardian or any other legally responsible person) may be liable and be billed by TMHC shall be (i) mental health services not covered by the TennCare Partners Program and (ii) deductible and coinsurance amounts (a) related to Mental Health Services rendered by TMHC to Consumers and (b) as determined by Green Spring at the time of claims payment. 4.5 TMHC agrees not to implement any policy that would circumvent the obligations of the Consumer to pay any non-covered service, deductible, or coinsurance amounts as provided in the TennCare Partners Program. 4.6 TMHC shall bill Green Spring on forms, at times and in a manner acceptable to Green Spring. Green Spring shall give Reasonable Notice of any required change(s) in claims submission procedures. TMHC shall furnish, on request and without charge, all information reasonably required by Green Spring and the State to verify and substantiate the provision of Mental Health Services to Consumers and the charges for such services. 4.7 TMHC shall be required to accept TennCare Partners Program reimbursement amounts set forth in Exhibit B of the Agreement only for Mental Health Services rendered to Consumers, and TMHC shall not be required to accept TennCare Partners Program reimbursement amounts for services provided to persons who are covered under another health plan operated or administered by Green Spring. 4.8 TMHC shall not receive more than one hundred five percent (105%) of the rates established in Exhibit B of the Agreement as the final payment amount, such that under no circumstances shall TMHC receive from Green Spring as an incentive or bonus more than five percent (5%) of the rates established in the Agreement as final payment. TMHC shall not be liable for a portion of any excess benefit costs associated with the provision of services pursuant to this Amendment. TMHC shall not be required to absorb any amount of Green Spring's excess administrative and/or management fees. 4.9 The TennCare Partners Program shall be the payor of last resort for all covered Mental Health Services. TMHC and Green Spring agree to abide by TDMHMR rules relating to Third Party Resources. 8. 9 5. RECORDS, ACCESS, INSPECTION AND CONFIDENTIALITY 5.1 TMHC shall prepare and maintain all required financial and medical records on Consumers. Such records shall include, but not be limited to, Pre-Admission Authorization documentation and medical records pertaining to services, dates and charges, servicing providers, costs, utilization, records necessary for the evaluation of the quality, appropriateness and timeliness of services, and any other records needed to meet the requirements of governmental regulatory agencies or as may be requested by Green Spring and the State. Such records shall be maintained on site in accordance with prudent record keeping procedures and as required by law, but in no case for less than five years after the termination of the Program Participation Agreement. Records shall be retained further, if the records are under review or audit, until the review or audit is complete. If the Program Participation Agreement renews automatically from year to year, TMHC agrees to obtain prior approval from TDMHMR before disposing of records. 5.2 TMHC shall allow Consumers and their representatives access to Consumer's medical records, to the extent and in the manner provided by Tennessee Code Annotated Sections 33-3-104(10), 63-2-101(a) & (b) and 63-2-102, 42, CFR 2, and, subject to reasonable charges, shall provide copies thereof upon request. 5.3 TMHC agrees to allow on-site inspection, audit and duplication at no charge, of any and all data, billings and other records maintained by TMHC or under TMHC's direction on Consumers by agents of Green Spring and the State. Inspection, audit and duplication shall occur during regular working hours and after Reasonable Notice, except under special circumstances as determined in the sole discretion of the State. TMHC shall cooperate in such reviews upon request. 5.4 TMHC shall make available to the State and Green Spring, or its designated representatives, in a form reasonably acceptable for usage by the TennCare Bureau or TDMHMR and their designated representatives, any or all records, whether medical or financial, related to TMHC activities undertaken pursuant to this Amendment. 5.5 The State (including but not limited to TDMHMR, TDCI, the TennCare Bureau), U.S. Department of Health and Human Services, Office of Inspector General, and Comptroller shall have the right to evaluate through inspection, whether announced or unannounced, or other means any records pertinent to this Agreement including quality, 9. 10 appropriateness and timeliness of services and such evaluation, and when performed, shall be performed with the cooperation of TMHC. Upon request, TMHC shall assist in such reviews including the provision of complete copies of medical records. 5.6 Notwithstanding termination of this Amendment, Green Spring and the State shall continue to have access to the records to the extent permitted by law and as necessary to fulfill the terms of this Amendment. 6. GENERAL PROVISIONS 6.1 The Provider Participation Agreement, the Exhibit A - Operating Policies and Procedures, the Exhibit B - Fee Schedule, and this TennCare Partners Program Amendment and Exhibits, as amended from time to time, contain the entire agreement between the parties relating to the rights granted and the obligations assumed by the parties for Consumers. Any prior agreements, promises, negotiations or representations, either oral or written, relating to the subject matter of this Amendment not expressly set forth in this Amendment are of no force or effect. 6.2 This Amendment sets out additional agreements made between the parties pertaining to and only to the provision of and payment for Mental Health Services provided to Consumers. 6.3 In the event of conflict between the terms of the Agreement, the Exhibit A Operating Policies and Procedures, and this TennCare Partners Program Amendment, the terms of this TennCare Partners Program Amendment shall control. This Amendment shall change or modify the Agreement and the Exhibit A Operating Policies and Procedures with respect to the provision of Mental Health Services to Consumers. In the event of any conflict with Exhibit B, the terms of Exhibit B shall control. 6.4 TMHC shall not subcontract this Amendment or any portion of this Amendment without prior written consent of Green Spring, and any attempt there at shall be void. Such consent by Green Spring shall not be unreasonably withheld provided, however, any subcontract must conform to all applicable provisions of the TennCare Partners Program as then administered by the State, including, but not limited to, prior approval of such subcontract by TDMHMR. 6.5 Amendment - The Provider Participation Agreement and this Amendment or any part, article, section, or exhibit may be amended at any time during the term of the Amendment by written agreement of the parties hereto. Such further amendment shall only be valid when reduced 10. 11 to writing, duly signed and attached to the original of the Agreement or Amendment. 6.6 This Amendment incorporates by reference all applicable federal and State laws, regulations, and provider contract requirements, and revisions of such laws, regulations, or requirements shall automatically be incorporated into this Amendment as they become effective. In the event changes in the Amendment as a result of revisions and applicable federal or State law materially affect the position of either party, Green Spring and TMHC agree to negotiate such further amendments as may be necessary to correct any inequities. 6.7 In the event Green Spring ceases to manage or arrange for Mental Health services to Consumers, the provisions of this TennCare Partners Program Agreement as amended herein shall terminate immediately. Green Spring agrees to provide prompt notice of the termination of this Agreement to TMHC. 6.8 Arbitration - If any dispute arises between the parties involving a contention by one party that the other has failed to perform its obligations and responsibilities under this Amendment and Agreement, then the party making such contention shall promptly give written notice to the other. Such notice shall set forth in detail the basis for the party's contention, and shall be sent by Certified Mail - Return Receipt Requested. The other party shall within thirty (30) calendar days after receipt of the notice provide a written response seeking to satisfy the party that gave notice regarding the matter as to which notice was given. Following such response, or the failure of the second party to respond to the complaint of the first party within thirty (30) days, if the party that gave notice of dissatisfaction remains dissatisfied, then that party shall so notify the other party and the matter shall be promptly submitted to inexpensive and binding arbitration in accordance with the Tennessee Uniform Arbitration Act at Tennessee Code Annotated Section 29-5-301 et seq., with the costs of establishing any arbitration procedures being borne by Green Spring. TDMHMR shall have no involvement in said arbitration except (1) to enforce its contract with Green Spring, (2) to approve the arbitration procedure proposed by Green Spring, and (3) to voluntarily intervene if TDMHMR deems intervention to be in the best interest of the system, provided, however, TDMHMR shall not be bound by said arbitration. If at any time TDMHMR decides a particular dispute should be in a court of competent jurisdiction, TDMHMR shall notify the parties to the dispute of its decision to refer the dispute to a court of competent jurisdiction and said arbitration process shall cease and dispute shall be heard in said court. The only exception to the arbitration process shall be resolution of the cost for emergency medical services and providers of services under Tennessee 11. 12 Code Annotated Section 33-2-601. If a dispute between the parties involving a claim submitted by TMHC is not resolved prior to the entry of a final decision by the arbitrator(s), then the prevailing party at the arbitration shall be entitled to award of reasonable attorney's fees and expenses from the non-prevailing party. Reasonable attorney's fees means the number of hours reasonably expended on the dispute multiplied by a reasonable hourly rate, and shall not exceed ten percent (10%) of the total monetary amount in dispute or $500.00 whichever amount is greater. This arbitration procedure is subject to the approval of TDMHMR. 7. NEW CASE MANAGEMENT. Green Spring and AdvoCare represent and warrant that persons who require Mental Health Services including case management services who were not receiving case management services upon the effective date of the TennCare Partners Program shall be entitled to freely choose TMHC to provide Mental Health Services that fall within the MHC and CMI scope of services listed in Exhibit B in the areas of Nashville/Davidson County and Memphis/Shelby County subject to the terms and conditions stated in Exhibit B. 8. TERM. Notwithstanding anything in the Agreement to the contrary, the term of the Agreement shall be twelve (12) months commencing with the effective date of the TennCare Partners Program and may not be terminated early without cause, except for those situations addressed in sections 3.1 and 6.7 of this amendment. [Signatures to follow] 12. 13 GREEN SPRING HEALTH SERVICES, INC. /s/ Joyce N. Fitch - ----------------------------------------- Joyce N. Fitch Title: Vice President and General Counsel Date: February 14, 1996 TENNESSEE MENTAL HEALTH COOPERATIVE, INC. By: /s/ Pam Womack ----------------------------- Print Name: Pam Womack Print Title: President Date: February 13, 1996 13. 14 [EXHIBITS EXCLUDED] EX-10.24 9 EXHIBIT 10.24 1 Exhibit 10.24 SUBSCRIPTION AGREEMENT THIS SUBSCRIPTION AGREEMENT (this "Agreement") is entered into as of June 8, 1998, by and between, PMR CORPORATION, a Delaware corporation ("PMR"), and STADTLANDER DRUG DISTRIBUTION COMPANY, INC., a Delaware corporation ("Stadtlander"). WHEREAS, PMR and Stadtlander propose to enter into an Operating Agreement in connection with the issuance and acquisition of a membership interest in Stadt Solutions, LLC (the "Company"), substantially in the form attached hereto as Exhibit A (the "Operating Agreement"); WHEREAS, in connection with the formation of the Company, the parties hereto propose to enter into a Transition and Services Agreement with the Company in substantially the form attached hereto as Exhibit B (the "Transition and Services Agreement"); and WHEREAS, in order to induce each other to enter into the Operating Agreement and the Transition and Services Agreement (collectively, the "Related Agreements"), the parties desire to make certain representations, warranties and covenants as set forth in this Agreement. NOW, THEREFORE, in consideration of mutual covenants and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereby agree as follows: ARTICLE 1 DEFINITIONS; ORGANIZATION; CLOSING DATE 1.1 DEFINITIONS. Capitalized terms used herein and not otherwise defined herein shall have the meanings ascribed to them in the Operating Agreement. 1.2 CLOSINGS. At the First Closing (the "First Closing") and subject to the terms and conditions of this Agreement, the Company, PMR and each of Stadtlander shall perform the covenants set forth in Section 4.1(a). At the Second Closing, (the "Second Closing") each of PMR and Stadtlander shall perform the covenants set forth in Section 4.1(b). Notwithstanding anything to the contrary herein, if any party determines that it is necessary to postpone the First Closing for purposes of complying with applicable regulatory clearance or waiting period(s), then the First Closing shall be combined with the Second Closing, subject to the applicable closing conditions herein. 1.3 CLOSING DATES. Subject to Section 1.2, the First Closing shall take place at the offices of Cooley Godward LLP, whose address is 4365 Executive Drive, Suite 1100, San Diego, California 92121. The Closing shall be held at 1:00 p.m., local time, on July 1, 1998, or at such other time and place upon which PMR and Stadtlander shall agree (the date of the First Closing is hereinafter referred to as the "First Closing Date"). (a) Consummation of the Second Closing will take place at the offices of Cooley Godward LLP, 4365 Executive Drive, Suite 1100, San Diego, California 92121, at such 1. 2 time and date which is as soon as practicable after the satisfaction of the conditions set forth in Section 5.2 and Section 6.2 (the "Second Closing Date"). ARTICLE 2 REPRESENTATIONS AND WARRANTIES OF PMR PMR makes the following representations and warranties, each of which is true and correct on the date hereof, shall remain true and correct to and including each Closing Date, and shall survive each Closing as provided herein: 2.1 ORGANIZATION AND STANDING; CERTIFICATE OF INCORPORATION AND BYLAWS. PMR is a corporation duly organized and validly existing under, and by virtue of, the laws of the State of Delaware and is in good standing under such laws. PMR has all requisite corporate power and authority to own, lease and operate its properties and assets, and to carry on its business as presently conducted. PMR has furnished Stadtlander with copies of its Certificate of Incorporation and Bylaws, each as amended. Said copies are true, correct and complete and shall contain all amendments through the Closing Date. 2.2 CORPORATE POWER. PMR has and will have at the First Closing Date all requisite legal and corporate power and authority to execute and deliver this Agreement and the Related Agreements, and to carry out and perform its obligations under the terms of this Agreement and the Related Agreements. 2.3 AUTHORIZATION. All corporate action on the part of PMR, its directors and stockholders necessary for the authorization, execution, delivery and performance of this Agreement and the Related Agreements by PMR, and the performance of all of PMR's obligations hereunder and thereunder has been taken or will be taken prior to the First Closing. This Agreement and the Related Agreements, when executed and delivered by PMR, shall constitute valid and binding obligations of PMR, enforceable in accordance with their terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance, injunctive relief or other equitable remedies. 2.4 FINANCIAL. The audited consolidated balance sheet and consolidated statements of stockholders' equity of PMR as of April 30, 1997 and the audited consolidated statements of operations and statements of cash flows of PMR for the fiscal year ended April 30, 1997, each certified by Ernst & Young LLP, independent certified accountants, whose report thereon is included therein, and the unaudited condensed consolidated balance sheet of PMR as of January 31, 1998 and the unaudited condensed consolidated statements of income and cash flows of PMR for the fiscal quarter ended January 31, 1998 (as filed with the SEC) present fairly the financial position of PMR as of the date of said balance sheets and the results of operations of PMR for the periods covered by said statements of operations, in accordance with generally accepted accounting principles consistently applied, except as otherwise disclosed therein and except, in the case of unaudited statements, for normally recurring year-end adjustments. 2. 3 2.5 BUSINESS. PMR is in the business of developing and managing programs and services for individuals with serious mental illnesses in the United States, and as of the date hereof, operates programs in 13 states. 2.6 TRANSFERRED BUSINESS. Subject to the consent of third parties as applicable, PMR has and shall have at the Second Closing, the right to assign and transfer all of its rights in and to its clinical information initiative to the Company. ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF STADTLANDER Stadtlander makes the following representations and warranties, each of which is true and correct on the date hereof, shall remain true and correct to and including each Closing Date, and shall survive the Closing as provided herein: 3.1 ORGANIZATION AND STANDING; CERTIFICATE OF INCORPORATION AND BYLAWS. Stadtlander is a corporation duly organized and validly existing under, and by virtue of, the laws of the State of Delaware and is in good standing under such laws. Stadtlander has all requisite corporate power and authority to own, lease and operate its properties and assets, and to carry on its business as presently conducted. Stadtlander has furnished PMR with copies of its Certificate of Incorporation and Bylaws, each as amended. Said copies are true, correct and complete and shall contain all amendments through the Closing Date. 3.2 CORPORATE POWER. Stadtlander has and will have at the First Closing Date all requisite legal and corporate power and authority to execute and deliver this Agreement and the Related Agreements, and to carry out and perform its obligations under the terms of this Agreement and the Related Agreements. 3.3 AUTHORIZATION. All corporate action on the part of Stadtlander, its directors and stockholders necessary for the authorization, execution, delivery and performance of this Agreement and the Related Agreements by Stadtlander, and the performance of all of Stadtlander's obligations hereunder and thereunder has been taken or will be taken prior to the First Closing. This Agreement and the Related Agreements, when executed and delivered by Stadtlander, shall constitute valid and binding obligations of Stadtlander, enforceable in accordance with their terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance, injunctive relief or other equitable remedies. 3.4 TRANSFERRED BUSINESS. Subject to any applicable regulatory approvals and individual patient consents, Stadtlander has and shall have at the Second Closing, the right to assign all of its rights in and to its mental health business (as described in Section 4.1(b) below), which consists of the provision of Clozaril and related products to a number of patients that is approximately 6,000. 3.5 CLOZARIL BASE OVERHEAD CALCULATION. The calculation of the Clozaril Base Overhead set forth on Schedule B to the Operating Agreement is in all material respects an accurate representation of the current operating and overhead expenses for providing the 3. 4 pharmaceutical fulfillment and case management services to the customers of the business to be transferred as identified in Section 3.4 above and Section 4.1(b) below. Stadtlander is not currently aware of any factors that will likely result in a material increase in the Clozaril Base Overhead assuming the current volume of its Clozaril business. ARTICLE 4 COVENANTS 4.1 CLOSING; DELIVERY. (a) At the First Closing, each of PMR and Stadtlander shall execute and deliver the Operating Agreement and the Transition and Services Agreement, and each shall deliver its Initial Capital Contribution to the Company under the Operating Agreement. (b) At the Second Closing, each of PMR and Stadtlander shall deliver its Second Capital Contribution to the Company under the Operating Agreement. In addition, Company shall have the right to all of the information for Stadtlander's mental health business (which serves patients with a primary designation of "diagnosed with a mental illness," but does not include Stadtlander's correctional pharmacy division) on Stadtlander's information system and databases. Following the Second Closing, the parties will act in good faith to effect the transfer of information to Company and facilitate the use thereof. 4.2 NONCOMPETITION. PMR and Stadtlander each acknowledge and agree that upon the formation of the Company, they shall be subject to the noncompetition provisions as set forth in Article 12 of the Operating Agreement. 4.3 ANNOUNCEMENTS. Announcements concerning the transactions provided for in this Agreement and the Related Agreements by either PMR or Stadtlander shall be subject to the approval of the other in all essential respects, except that approval shall not be required as to any statements and other information which may be submitted to the Securities and Exchange Commission or required to be made pursuant to any rule or regulation of the Securities and Exchange Commission or any other securities regulatory board, or otherwise required by law. 4.4 THIRD PARTY CONSENTS. Each party shall use its best efforts to obtain all applicable third party consents (including regulatory consents or waivers, as applicable) necessary to consummate the Second Closing. ARTICLE 5 CONDITIONS TO CLOSING OF PMR 5.1 CONDITIONS TO FIRST CLOSING. The obligation of PMR to enter into the Related Agreements at the First Closing is, at the option of PMR, subject to the fulfillment of the following conditions: 4. 5 (a) REPRESENTATIONS AND WARRANTIES CORRECT. The representations and warranties made by Stadtlander in Article 3 hereof shall be true and correct when made, and shall be true and correct as of the Closing in all material respects. (b) COVENANTS. The Company and Stadtlander shall have performed or complied with in all material respects with all covenants, agreements and conditions of this Agreement to be performed by them under this Agreement on or prior to the Closing. 5.2 CONDITIONS TO SECOND CLOSING. The obligation of PMR to make its Second Contribution under the Operating Agreement is, at the option of PMR, subject to fulfillment of the following conditions: (a) The parties shall have received all such governmental or other third party approvals, consents, authorizations as may be required to permit the Second Contribution of both PMR and Stadtlander. (b) If the parties are required to file notifications of the transaction under the HSR Act, the waiting period required pursuant to the HSR Act and the regulations promulgated thereunder shall have expired or any approvals required in connection with the HSR Act and the regulations promulgated thereunder shall have been obtained. (c) There shall have been no material change in Stadtlander's mental health business described in Section 3.4 above. ARTICLE 6 CONDITIONS TO CLOSING OF STADTLANDER 6.1 CONDITIONS TO FIRST CLOSING. The obligation of Stadtlander to enter into the Related Agreements at the First Closing is, at the option of Stadtlander, subject to the fulfillment of the following conditions: (a) REPRESENTATIONS AND WARRANTIES CORRECT. The representations and warranties made by PMR in Article 2 hereof shall be true and correct when made, and shall be true and correct as of the Closing in all material respects. (b) COVENANTS. The Company and PMR shall have performed or complied with in all material respects all covenants, agreements and conditions of this Agreement to be performed by them under this Agreement on or prior to the Closing. 6.2 CONDITIONS TO SECOND CLOSING. The obligation of Stadtlander to make its Second Contribution under the Operating Agreement is, at the option of Stadtlander, subject to fulfillment of the following conditions: (a) The parties shall have received all such governmental or other third party approvals, consents, authorizations as may be required to permit the Second Capital Contribution of both Stadtlander and PMR. 5. 6 (b) If the parties are required to file notifications of the transaction under the HSR Act, the waiting period required pursuant to the HSR Act and the regulations promulgated thereunder shall have expired or any approvals required in connection with the HSR Act and the regulations promulgated thereunder shall have been obtained. (c) There shall have been no material change in PMR's clinical information initiative described in Section 2.6. ARTICLE 7 INVESTMENT REPRESENTATIONS 7.1 REPRESENTATIONS. Each of PMR and Stadtlander hereby makes the following certifications and representations with respect to the acquisition of its interests in the Company: (a) It understands that the interests it is acquiring in the Company (the "Interests") have not been registered under the Securities Act of 1933, as amended (the "Securities Act"), on the basis that no distribution or public offering of the Interests is to be effected. It understands that its Interest is deemed to constitute "restricted securities" under Rule 144 promulgated under the Securities Act. (b) It is acquiring its Interest solely for its account for investment and it has no intention of distributing or selling the Interest or any part thereof except as may be permitted under the Securities Act and any applicable state securities laws. Each party also represents that the entire legal and beneficial interests of the Interest it is acquiring is being acquired for, and will be held for its account only. (c) It recognizes that each Interest being acquired by it must be held indefinitely unless the Interest is subsequently registered under the Securities Act or an exemption from such registration is available. It recognizes that the Company has no obligation to register the Interests or to comply with any exemption from such registration. (d) It has either (i) a preexisting personal or business relationship with the Company or any of its members, officers, directors, managers, or controlling persons, or (ii) the capacity to protect its own interests in connection with the purchase of the Interests by virtue of its professional business or financial experience (or the business or financial experience of its professional advisers who are unaffiliated with and who are not compensated by the Company or any affiliate or selling agent of the Company, directly or indirectly). (e) It is aware that an Interest may not be sold pursuant to Rule 144 adopted under the Securities Act ("Rule 144") unless certain conditions are met and until it has held the Interest for at least one year. Among the conditions for use of Rule 144 is the availability of current information to the public about the issuer of the Interest. It understands that there is no such information available and that the Company has no plans to make such information available. (f) It further agrees not to make any disposition of all or any part of any Interests being acquired in any event unless and until: (i) the Interest is transferred pursuant to 6. 7 Rule 144, and the Company shall have received from it documentation acceptable to the Company that a sale of the Interest has occurred in accordance with all of the provisions of Rule 144, as in effect from time to time; or (ii) there is then in effect a registration statement under the Securities Act covering such proposed disposition and such disposition is made in accordance with said registration statement; or (iii) (A) it shall have notified the Company of the proposed disposition and shall have furnished the Company with a detailed statement of the circumstances surrounding the proposed disposition, (B) it shall have complied with all applicable provisions of the Operating Agreement, (C) it shall have furnished the Company with an opinion of counsel for the party to the effect that such disposition will not require registration of such Interest under the Securities Act, and (D) such opinion of counsel for the party shall have been concurred in by the Company's counsel and the Company shall have advised the party of such concurrence. (g) It understands and agrees that all certificates evidencing the Interest to be issued to it may bear (and if no certificate evidencing the Interest is issued by the Company, an initial transaction statement, if required, shall include) a legend substantially in the following form: "THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT AS TO THE SECURITIES UNDER SAID ACT OR AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED." 7.2 NO TRANSFER. The Company shall not be required (i) to transfer on its books any Interest which shall have been sold or transferred in violation of any of the provisions set forth in this Agreement or the Operating Agreement or (ii) to treat as owner of such Interest or to accord the right to vote as such owner or to make any distributions to any transferee to whom such Interest shall have been so transferred. ARTICLE 8 MISCELLANEOUS 8.1 GOVERNING LAW. This Agreement shall be governed in all respects by the internal laws of the State of California. 8.2 ARBITRATION. The parties agree that they shall submit any disputes arising under this Agreement to binding arbitration pursuant to Section 14.1 of the Operation Agreement, which section is incorporated herein by reference. 8.3 SUCCESSORS AND ASSIGNS. Except as otherwise provided herein, the provisions hereof shall inure to the benefit of, and be binding upon, the successors, assigns, heirs, executors and administrators of the parties hereto, provided, however, that the rights of PMR or Stadtlander to purchase its interests of the Company shall not be assignable without the consent of the other parties hereto. 7. 8 8.4 THIRD PARTY BENEFICIARY. The Company shall be a third party beneficiary with respect to the representations and warranties of PMR and Stadtlander hereunder. 8.5 ENTIRE AGREEMENT; AMENDMENT. This Agreement and the Related Agreements, and other documents delivered pursuant hereto and thereto at each Closing constitute the full and entire understanding and agreement among the parties with regard to the subjects hereof and thereof, and no party shall be liable or bound to any other party in any manner by any warranties, representations or covenants except as specifically set forth herein or therein. Except as expressly provided herein, neither this Agreement nor any term hereof may be amended, waived, discharged or terminated other than by a written instrument signed by the party against whom enforcement of any such amendment, waiver, discharge or termination is sought. 8.6 NOTICES, ETC. All notices and other communications required or permitted hereunder shall be in writing (including telecopy or similar electronic transmission) and shall be sent by telecopy or other electronic facsimile transmission or by registered or certified mail, postage prepaid, or otherwise delivered by hand or by messenger, addressed: (a) if to PMR, to: PMR Corporation 501 Washington Street, 5th Floor San Diego, CA 92103 Attn: President Tel: (619) 610-4001 Fax: (619) 610-4184 or to such other address as PMR shall have furnished to the Company and Stadtlander in writing; (b) if to Stadtlander, to: Stadtlander Drug Distribution Company, Inc. 600 Penn Center Boulevard Pittsburgh, PA 15235 Attn: President Tel: (800) 238-7828 Fax: (412) 825-8686 or to such other address as Stadtlander shall have furnished to PMR and the Company in writing. Each such notice or other communication shall for all purposes of this Agreement be treated as effective or having been given when received if delivered personally or by facsimile, or, if sent by mail, at the earlier of its receipt or 72 hours after the same has been deposited in a regularly maintained receptacle for the deposit of the United States mail, addressed and mailed as aforesaid. 8.7 DELAYS OR OMISSIONS. Except as expressly provided herein, no delay or omission to exercise any right, power or remedy accruing hereunder upon any breach of any party under this Agreement, shall impair any such right, power or remedy nor shall it be construed to be a 8. 9 waiver of any such breach or default, or an acquiescence therein, or of or in any similar breach or default thereafter occurring, nor shall any waiver of any single breach or default be deemed a waiver of any other breach or default theretofore or thereafter occurring. Any waiver, permit, consent or approval of any kind or character on the part of any party hereto of any breach or default under this Agreement, or any waiver on the part of any party hereto of any provisions or conditions of this Agreement, must be in writing and shall be effective only to the extent specifically set forth in such writing. All remedies, either under this Agreement or by law or otherwise afforded to any party hereto, shall be cumulative and not alternative. 8.8 EXPENSES. Each party bears its own expenses incurred by it with respect to this Agreement and the transactions contemplated hereby. 8.9 COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be enforceable against the parties actually executing such counterparts, and all of which together shall constitute one instrument. 8.10 SEVERABILITY. In the event that any provision of this Agreement becomes or is declared by a court of competent jurisdiction to be illegal, unenforceable or void, this Agreement shall continue in full force and effect without said provision, provided that no such severability shall be effective if it materially changes the economic benefit of this Agreement to any party. 8.11 TITLES AND SUBTITLES. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. 9. 10 IN WITNESS WHEREOF, the parties have executed this Subscription Agreement as of the date first above written. PMR: PMR CORPORATION a Delaware corporation By: /s/ Mark Clein ------------------------------------- Title: Chief Financial Officer ------------------------------------- STADTLANDER: STADTLANDER DRUG DISTRIBUTION COMPANY INC. a Delaware corporation By: /s/ Morris Perlis ------------------------------------- Title: President and Chief Executive Officer ------------------------------------- 10. 11 [EXHIBITS EXCLUDED] EX-21.1 10 EXHIBIT 21.1 1 EXHIBIT 21.1 The following is a list of the subsidiaries of PMR Corporation:
NAME: JURISDICTION OF ORGANIZATION: - -------------------------------------------------------------------------------- Business Office Solutions Corporation Delaware Collaborative Care Corporation Tennessee Collaborative Care, Inc. California BHC Acquisition Corp. Delaware PMR - CD, Inc. California Psychiatric Management Resources, Inc. California
EX-23.1 11 EXHIBIT 23.1 1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 File No. 333-38419) pertaining to the 1997 Equity Incentive Plan, 1995 Warrant Grant, and the 1996 Stock Grants and the Registration Statements (Forms S-3 File No. 033-97202 and File No. 333-34473) of PMR Corporation of our report dated June 12, 1998, except for paragraph four of Note 13, as to which the date is July 24, 1998, with respect to the consolidated financial statements of PMR Corporation included in its Annual Report (Form 10-K) for the year ended April 30, 1998, filed with the Securities and Exchange Commission. ERNST & YOUNG LLP San Diego, California July 24, 1998 EX-27.1 12 FINANCIAL DATA SCHEDULE
5 YEAR APR-30-1998 MAY-01-1997 APR-30-1998 18,522,859 20,257,045 25,737,369 9,081,610 0 60,763,807 5,219,489 1,727,040 70,449,054 8,943,392 0 0 0 69,496 47,959,554 70,449,054 0 67,523,950 0 48,255,459 1,064,873 5,148,580 (1,186,637) 2,472,378 1,014,000 1,458,378 0 0 0 1,458,378 0.24 0.22
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