-----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, JEjmz3+W5UtMT8X6ihYY9ZWV6D7j/K5gxKnbLljPx70Jksp4/J3SlhRHTraSZo/g KV6jaGPe6yRLWb5jbnGNWA== 0000936392-97-000967.txt : 19970730 0000936392-97-000967.hdr.sgml : 19970730 ACCESSION NUMBER: 0000936392-97-000967 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 23 CONFORMED PERIOD OF REPORT: 19970430 FILED AS OF DATE: 19970729 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-20488 FILM NUMBER: 97647307 BUSINESS ADDRESS: STREET 1: 3990 OLD TOWN AVE STE 206A CITY: SAN DIEGO STATE: CA ZIP: 92110 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-K 1 FORM 10-K 1 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, 1997 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission file number 0-20488 PMR CORPORATION (Exact name of registrant as specified in its charter) Delaware 23-2491707 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No. 3990 Old Town Avenue, Suite 206A San Diego, California 92110 (Address of principal executive offices) (619) 295-2227 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] YES [ ] NO 2 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 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, 1997, 5,045,778 shares of Common Stock, par value $.01 per share, were outstanding and the aggregate market value of the shares of Common Stock held by non-affiliates was approximately $51,692,000.00 based upon the closing sale price of the Registrant's Common Stock upon the NASDAQ National Market at $21.6875 per share of Common Stock. See Footnote (1) below. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Registrant's 1997 Annual Meeting of Stockholders ("1997 Proxy Statement") are incorporated by reference into Items 10, 11, 12, and 13 in Part III. If the Proxy Statement is not filed by August 28, 1997, an Amendment to this Form setting forth this information will be duly filed with the Securities and Exchange Commission. (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 3 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 here. 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 sections entitled "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as those discussed in our documents incorporated herein by reference. PMR Corporation (the "Company") is a leader in the development and management of programs and services for individuals who have been diagnosed with a Serious Mental Illness ("SMI"). These diseases, which are often chronic and life long, are primarily schizophrenia and bi-polar disorder (manic depression) and according to studies sponsored by the National Institute of Mental Health (NIMH), afflict approximately 2.8% of the U.S. population. The Company's programs have been developed to assist providers of health care services in delivering care and treatment programs which serve as alternatives to more costly inpatient behavioral healthcare for the SMI population. The Company's clinical philosophy emphasizes early intervention to identify and reduce the incidence of crises events and thus contain the high costs associated with catastrophic events. Through its disease management approach, the Company believes that its programs may achieve a reduction in health care costs and result in improved clinical outcomes. The Company operates three lines of business devoted to behavioral health care: acute outpatient psychiatric services ("Outpatient Program"), case management services ("Case Management Program") and chemical dependency services ("Chemical Dependency Program"). In recent years, the Company's principal focus has been on the growth of its Outpatient Program and Case Management Program, which are targeted exclusively to serve the SMI population. Looking forward, the Company intends to blend these products into a single, integrated continuum of outpatient services and may develop new services in the areas of site management, clinical information, outcomes analysis and residential services. The Company's original program, representing its largest source of revenues, is its Outpatient Program, which serves as an alternative to inpatient hospitalization. The Outpatient Program includes two core programs developed for varying levels of acuity: a partial hospitalization program and a structured outpatient program. It is designed for consumers who require coordinated, intensive, and comprehensive treatment services beyond those typically offered at an outpatient clinical level of care. The objective of the Outpatient Program is to provide stabilization and/or rehabilitation at costs which are typically less than those offered by inpatient providers. Since 1988, the Company has been a leader in the management of psychiatric partial hospitalization programs serving persons in the SMI population with 36programs in 11 states, including Arizona, Arkansas, California, Colorado, Hawaii, Kentucky, Illinois, Indiana, Michigan, 3 4 Tennessee and Texas. The Company also has signed contracts to open programs in Ohio and Washington in the second half of Fiscal 1998. The Company operates these Outpatient Programs under management contracts with local health care providers ("Providers") such as acute care hospitals and community mental health centers ("CMHCs"). The Case Management Program is an intensive case management service which consists of a proprietary intensive case management model which utilizes detailed protocols for delivering and managing the treatment and care of SMI patients. This program was established to work with community-based providers of mental health care (such as case management agencies and CMHC's) to develop, manage and operate case management and rehabilitation systems designed to serve the SMI population in either a managed care or the more traditional, fee-for-service environment. The Company presently operates its Case Management Programs in Nashville and Memphis, Tennessee, and in Little Rock, Russellville and El Dorado, Arkansas. Through wholly-owned subsidiaries, the Company is a provider of Chemical Dependency Programs which consist of the treatment of chemical dependency and substance abuse, primarily to patients of managed care organizations in Southern California. The Company also manages ambulatory detoxification programs in Arkansas for public sector (Medicaid and other government funded programs) patients. In fiscal 1997 the Company also began the development of a site management and clinical information division. The Company believes that it has a unique opportunity to collect, analyze and process clinical and pharma-economic data on the diseases of schizophrenia and bi-polar disorder. This information may be extremely valuable in outcomes analysis and development of "best practices" for the treatment of this patient population. The Company plans to market its network and its information to pharmaceutical companies, clinical research organizations, CMHC's and other providers. This division also intends to participate in clinical research trials as the Company has access to several thousand individuals who may be candidates for new treatments in these areas. On January 24, 1997 the Company entered into an agreement with the Applied Informatics division of United HealthCare with respect to developing this business. The Company's objective is to be a leading developer and provider of a continuum of programs which deliver cost effective mental health services for individuals within the SMI population. Since the SMI population receives the vast majority of its health care funding from state, local and federal agencies, the Company aims to develop programs which assist these entities in containing rapidly growing and often uncontrolled health care costs. Through the successful development and operation of these programs, the Company's mission is to foster the recovery of individuals from the devastating effects of serious mental illnesses and chemical dependency, and to ensure the cost-effective treatment and rehabilitation services which limit hospitalization, afford significant relief from symptoms, and contribute to better quality health care in the communities within which the Company and its subsidiaries operate. 4 5 STRATEGY In order to achieve its objectives, the Company's strategy is to (i) actively pursue new contracts for its Outpatient Programs and increase profitability of existing programs; (ii) increase the enrollment and market area of existing Case Management Programs and seek to develop new markets for case management; (iii) combine the outpatient and case management services into an integrated service and expand it to the Company's existing markets; (iv) develop the infrastructure for its site management and clinical information business and identify business opportunities to capitalize on that infrastructure; and (v) identify additional services which the Company can provide to the SMI population and the Providers which serve these clients, as part of its comprehensive disease management approach. THE MARKET AND INDUSTRY BACKGROUND According to the National Advisory Mental Health Council, which is part of the NIMH, in 1995 severe mental illness consumed $27 billion in direct medical costs and more than $74 billion in total costs (including estimates of lost productivity). Studies by the Council indicate that approximately 5.6 million Americans over the age of nine suffer from a severe mental illness such as schizophrenia, manic depression, autism, panic disorder and obsessive compulsive disorder. Schizophrenia is the primary diagnosis among the Company's patient population. Schizophrenia afflicts approximately 1% of the U.S. population. The vast majority of the costs of treating these populations are borne by federal, state and local government programs, primarily Medicare and Medicaid. According to a study by Dorothy Rice and Leonard Miller of the University of California, as of 19901, the direct medical costs of Schizoprenia are consumed in the following categories: Mental health organizations (such as CMHC's) 38% Nursing homes 31% Short stay hospitals 15% Support costs 8% Other professional services 4% Physician services 2% Pharmaceuticals 2%
The Company believes that its services participate in (or provide alternatives to) 96% of the market for clinical services as defined above. Moreover, the Company believes that in most cases, - -------- 1 The Company believes that the costs allocation has shifted since 1990 towards a higher pharmaceutical component due to the introduction and rapid adoption of several new and more costly anti-psychotic drugs. 5 6 its services offer cost effective alternatives to existing services offered primarily by locally managed not-for-profit providers. According to the NIMH, serious mental illness is defined as neuro-biological disorders of the brain and are characterized by measurable disturbances in brain function and structure. The specific biological causes of these diseases remains unknown. With the exception of autism, effective medications exist which generate medical responses in 60-90% of individuals with a serious mental illness. Unfortunately, approximately 40% of the SMI population, or 2.2 million people, do not receive these effective treatments, or often treatment of any kind. For schizophrenia, several studies have shown even higher percentages of non-treatment. The effect of de-institutionalization on the SMI population, and its link to widespread homelessness among the SMI, has been described in E. Fuller Torrey's 1997 work on the mental illness crisis, Out of the Shadows. Torrey points out that the population of SMI patients in public psychiatric hospitals declined from 558,239 in 1955 to 71,619 in 1994. The true impact of this phenomenon is actually larger since the U.S. population grew 58% over this period (and the incidence of serious mental illness has not changed). Torrey estimates that 60-75% of the de-institutionalized patients were diagnosed with schizophrenia or bi-polar disorder, which is the population of the Company's focus. Based on numerous studies of homelessness over the past fifteen years, Torrey estimates that approximately 35% of the homeless population has a severe mental illness. Although health care for SMI is funded by numerous public sources, states play a much larger role for mental health care than they do in the delivery of general health care services. For more than 150 years, state mental health authorities have been responsible for administering funds to ensure that the SMI population received adequate treatment. Typically, the state mental health authorities receive annual appropriations to operate services for individuals that have been designated based on the classification of their illness. Since the 1960s, states have been able to access third party federal payments through the Medicare and Medicaid program. State systems were historically dominated by hospitals. However, over recent years outpatient care has grown rapidly as it became recognized as a lower cost alternative and as many in-patient providers came under intense scrutiny over questionable admitting practices. In the late 1970s it became common for states to contract for services which they did not provide, generally using CMHC's, case management agencies and other not for profit service agencies. More recently, a major shift has occurred in the delivery of mental health services in the United States. State mental health authorities have now evolved from a provider of funded hospital services to a manager of a broad range of services financed from several public funding sources. Several states now contract with private, for profit, managed care companies to assume the administration and insurance risk of health care benefits for Medicaid populations. At least nine states, including Colorado, Hawaii, Iowa, Massachusetts, Minnesota, Montana, Ohio, Utah, and Tennessee have implemented "carve out" behavioral healthcare contracts within their overall Medicaid managed care programs and have contracted or are expected to contract directly with behavioral health managed care companies to provide such services. 6 7 However, contracting for the management of the SMI population is at an early stage. Individuals with a serious and persistent mental illness have a need for specialized treatment and rehabilitation services. Coordination and monitoring of services is crucial to avoid fragmentation which results because SMI needs often extend across the boundaries of different service sectors and funding streams. As states look toward implementing Medicaid managed care, the ability to effectively identify and manage services for a high utilizing and often transient SMI population becomes crucial to the success of a managed care entity. The Company believes that its contracts in Tennessee and Arkansas represent some of the early examples of third party contracts designed specifically for this population. Prior to the commencement of its case management business, the Company's principal source of revenue was the Company's Outpatient Program which relies on Medicare as its primary source of funding. With respect to the Case Management Program, the Company will largely rely upon state administered Medicaid programs for funding. See "Regulatory Matters." PROGRAMS AND OPERATIONS ACUTE OUTPATIENT PSYCHIATRIC PROGRAMS The Company's Outpatient Program consists principally of psychiatric partial hospitalization programs developed by the Company which are ambulatory outpatient programs that provide intensive, coordinated clinical services to patients with a SMI. These patients generally require coordinated, intensive, comprehensive and multi-disciplinary treatment not typically provided in a traditional outpatient setting. In 1996 the Company introduced a new service, a structured outpatient clinic, to meet the needs of patients who complete the partial hospitalization program. This program is designed to maintain the gains achieved during partial hospitalization and to prevent relapse. In 1997 the Company intends to expand its structured outpatient program to include clients that are at a lower level of clinical risk but still require maintenance to reduce the likelihood of decompensation. This expansion, which includes three levels of care, is designed to introduce techniques and protocols utilized by the Company's Case Management Program. The Outpatient Programs are operated under management contracts with Providers consisting of acute care hospitals, psychiatric hospitals and CMHC's, and are established under the governance and administrative authority of the Provider. They are designed to fit within a Provider's existing operations and are operated under the Provider's name. Duration of contracts with Providers generally range between two and five years. The Company brings to the health care Provider management expertise with respect to the establishment, development and operation of the Outpatient Program that is not usually available on an in-house basis. The Company provides complete program design and administration from start-up through ongoing operation. The Company often retains responsibility for staffing, which may include providing highly trained program administrators responsible for overall management, a medical director, a community liaison director responsible for coordination with community agencies and specialized clinical personnel. The program administrator generally has a degree in 7 8 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 and care givers have various levels of training and experience, usually in nursing, psychology or social work. The programs are normally operated in conjunction with proprietary policy and procedure manuals that have been developed by the Company which are customized for each Provider and which establish guidelines to ensure that licensing requirements are satisfied. The Company also provides many other services which are often unavailable to the Provider on an in-house basis, such as quality assurance systems, initial and on-going staff training, statistical tracking and financial analysis of program performance and utilization management reviews. Patients admitted to these programs undergo a complete assessment process that includes psychiatric, psycho-social, medical, and, as needed, other specialized evaluations. An individual treatment plan is developed by the admitting physician for each patient who is then assigned to specific treatment groups that best meets his or her needs. A care coordinator is assigned to each patient upon admission, coordinating the various services provided to the patient. Each program site provides comprehensive treatment services which may include specialty services for geriatric patients, dually diagnosed patients (those having a mental illness along with a substance abuse problem) and core treatment services for the seriously mentally ill patients. All Outpatient Programs provide programming five or six days a week. Structured outpatient services offer treatment for patients who are less symptomatic and higher functioning than patients needing partial hospitalization. Daily schedules include group psychotherapy and individual therapy. The treatment program is 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. The Company believes that its Outpatient Program appeals to health care providers as a more effective means of delivering the mental health care component. Providers have often cited as reasons to outsource the mental health component to specialized outpatient programs, factors such as; delivery of the expertise necessary for the development, management and administration of a mental health program; access to skilled psychiatric professionals and support staff needed to operate mental health care programs; and access to the expertise necessary to develop, design and manage an accredited mental health program that satisfies all regulatory, licensing and accreditation requirements. As of June 1997 the Company operates 36 outpatient programs in 11 states and has approximately 1,500 patients receiving care under programs it manages. CASE MANAGEMENT PROGRAM In 1993 the Company acquired and thereafter further refined its Case Management model, a proprietary service system for managing treatment, rehabilitation and support of services provided to consumers within the SMI population. This model was designed to allow a managed care entity 8 9 in a capitated financial system to manage the risk associated with the SMI population. It accomplishes this by making available to CMHC's, state Medicaid agencies and other payors responsible for publicly financed behavioral services, a consistent and effective approach to managing the utilization of both acute and community based services. SMI consumers, who are predominately covered by Medicaid and/or Medicare due to their disability, pose a large financial risk in a capitated system due to their heavy utilization of costly services, especially inpatient care. The Company believes that its case management model positions it to carve out the management of this high utilizing SMI population from the managed care entity that has responsibility for managing an entire public managed care system. The model can also operate in a fee-for-service environment. The Case Management Program utilizes comprehensive protocols that are based upon a specific model of intensive service coordination developed at the Boston University Center for Psychiatric Rehabilitation. The system is designed around a case manager, also known as a personal service coordinator, whose activities include: connecting with consumers; educating consumers about the services, policies and procedures of the managed care system; developing proactive, personal crisis plans; responding to consumers in crisis and linking them to emergency services; assessing consumers' service needs and developing personal services plans; and authorizing and reviewing services included in the plan utilizing service-specific protocols. Case management for the SMI population is fundamentally different from that required for commercially insured populations. The requirements are ongoing rather than episodic; the covered services are broader and include housing and basic support needs; and outcomes measurement is more multi-dimensional including components related to impairment and disability. The provider network is also different from that accessed by the typical commercial patient. The "primary care" mental health care providers are CMHC's or case management agencies. These organizations may have little experience with risk contracts or the information systems required to operate in a managed care environment. The mission of the Case Management Program is to facilitate the provision of the necessary and appropriate individualized assistance to individuals within the SMI population and enable them to live more healthy, independent, productive and satisfying lives in the community. This is applicable in a fee-for-service environment as well as in a managed care environment. In the Fall of 1995, the Company installed and commenced operation of its Case Management Program in conjunction with two case management agencies in Tennessee. The Case Management Program was further expanded in July 1996 when a program was launched in Little Rock, Arkansas in conjunction with a leading CMHC in that market. Subsequently, programs were opened with CMHC's in Russellville and El Dorado, Arkansas. As of June, 1997, the Company has enrolled more than 5,100 clients in its Case Management Programs. The Company has developed a new clinical program which provides psychiatric rehabilitation and community support services. This program is complementary to Case Management and designed to be integrated with an existing case management program. The 9 10 program includes a continuum of rehabilitative services including three levels of day treatment, skills development, skills maintenance, and individual and small group rehabilitation services designed to assist individuals with an SMI reach recovery goals. CHEMICAL DEPENDENCY PROGRAM Through wholly-owned subsidiaries, 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"). 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 works with providers to develop the programs and technologies including a full range of screening, crisis management, ambulatory care and utilization management services. Through a Management Services Agreement, the Company works with providers to develop the following programs on behalf of public sector clients: sobering and detoxification services, dual diagnosis treatment and rehabilitation, and screening and assessment triage. As of June 30, 1997 the Company operated four outpatient programs in southern California under the name of Twin Town Treatment. The Company also manages two programs in Arkansas which provides ambulatory detoxification services for public sector clients. SITE MANAGEMENT AND CLINICAL INFORMATION In January 1997, the Company began the development of a site management and clinical information division. This division, which is still in a start up phase of development, will seek to establish the infrastructure 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. 10 11 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 its Providers, to more than 20,000 individuals diagnosed with an SMI. 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"). As the need to reduce drug development time increases, the need for increasingly effective management of clinical trials is growing. Delays in recruiting and enrolling qualified patients, along with patient compliance with the protocols are significant concerns for the CROs which manage the trials. Site Management Organizations ("SMOs") are emerging as a new industry which provides commercialized clinical trials services under contract with CROs or directly with the pharmaceutical sponsor. The Company is currently in the process of developing its capabilities as a site management organization. Through its Outpatient and Case Management Programs, the Company has a large, multi-state patient base. The company is identifying qualified investigators and study coordinators, and may participate in an SMO capacity in Phase III - IV clinical trials in Fiscal 1998. PROGRAM LOCATIONS OUTPATIENT PROGRAM
LOCATION CURRENT PROVIDER COMMENCEMENT California San Diego Hospital May 1988 El Centro Hospital January 1990 Culver City CMHC July 1990 Santee Hospital December 1990 San Francisco Hospital February 1991 Los Angeles CMHC October 1991 Studio City CMHC October 1991 Oakland Hospital January 1992 Santa Ana Hospital February 1992 Vista Hospital March 1992 Union City Hospital April 1992 Riverside Hospital August 1992 San Bernardino Hospital November 1992 Signal Hill Hospital February 1993 Sacramento Hospital November 1993
11 12 Orange Hospital February 1995 San Jose County January 1996 La Jolla Hospital July 1996 Chula Vista Hospital January 1997 Arizona Tucson CMHC April 1991 Phoenix CMHC June 1992 Tempe CMHC January 1995 Arkansas Little Rock CMHC March 1994 Batesville CMHC October 1994 Russellville CMHC August 1996 Texas Conroe CMHC November 1994 Dallas CMHC January 1996 Colorado Denver Hospital June 1993 Hawaii Honolulu Hospital March 1996 Illinois Chicago Hospital April 1997 Indiana Indianapolis CMHC July 1992 Kentucky Frankfort Hospital April 1997 Tennessee Kingsport Hospital April 1997 Madison Hospital April 1997 Nashville Hospital May 1997 Michigan Detroit CMHC June 1996 CASE MANAGEMENT LOCATION AVERAGE CLIENT POPULATION COMMENCEMENT Tennessee Memphis 2,361 October 1995 Nashville 1,946 September 1995 Arkansas Little Rock 750 July 1996 El Dorado 522 September 1996 Russellville 480 September 1996 CHEMICAL DEPENDENCY
12 13 LOCATION COMMENCEMENT California / Twin Town Burbank November 1993 Los Alamitos November 1993 Orange April 1994 Torrance July 1996 Arkansas Little Rock January 1995 Russellville September 1996
CONTRACTS OUTPATIENT PROGRAM The Outpatient Program is generally administered and operated pursuant to the terms of written management contracts ("Contracts") with Providers. The Contracts generally govern the term of the program, the method by which the program is to be operated by the Company, the responsibility of the Provider for licensure, billing, insurance and the provision of healthcare services and the methods by which the Company will be compensated. Each Contract also contains certain exclusivity provisions, and establishes that the Company is an independent contractor that is not acting as an employee of, or joint venture partner with, the Provider. Program revenue derived by the Company under the Contracts generally fit within three types of arrangements: 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 program costs are the responsibility of the Provider, and 3) a fixed fee arrangement. In all cases, the Company provides on-site managerial personnel. The all-inclusive arrangements constituted approximately 70% of the Company's revenues and 33 of the 36 existing Outpatient Programs. 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 the management fee paid to the Company is disallowed as a reimbursable cost by Medicare. See "Regulatory Matters" and "Risk Factors" below, and "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." The Contracts are generally for a stated term (normally a duration 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 In the past, the majority of the Company's Contracts have operated through their stated expiration dates and have been renewed or satisfactorily re-negotiated. As the Outpatient Programs mature and increase in number, the Company anticipates that as a matter of normal business 13 14 development, Contract terminations may occur on a periodic basis. In the past, if a Contract was terminated, the Company has been successful in opening a replacement program with another Provider in the Program's geographic area, although no assurance can be given that the Company will successfully replace such terminated Contracts or programs in the future For the year ended April 30, 1997, the Company's Contracts covering sites operated by hospitals operating under Scripps Health, a San Diego provider, accounted for approximately 13% of the Company's revenues. In August 1996 the Company signed an enabling agreement (the "Columbia Agreement") with Columbia Healthcare Corporation ("Columbia"). The Columbia Agreement relates specifically to the Company's Outpatient Program and Columbia's ten state Mid-America Group which includes Alabama, Illinois, Indiana, Iowa, Kentucky, Minnesota, Mississippi, Tennessee, Wisconsin and West Virginia. The Columbia Agreement grants both Columbia and the Company mutual rights of first refusal with respect to developing Outpatient Programs for the SMI in markets of the Mid-America Group where Columbia owns or manages a hospital. As of June 1997 the Company manages five programs for Columbia hospitals in Illinois, Kentucky and Tennessee and has signed contracts for two additional programs. CASE MANAGEMENT Through implementation of its Case Management Program, the Company is responsible to develop and implement detailed operating protocols relative 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. The case management provider is responsible to provide to the Company or in affiliation with the Company, staff personnel and program facilities, and retain final discretionary authority to approve the related policy manual, staffing issues and overall program operations. In the Fall of 1995, pursuant to Management and Affiliation Agreements, the Company commenced the operation of its Case Management Program with two case management agencies in Nashville, Tennessee and Memphis, Tennessee. In March and April 1996, the Company also executed Management and Affiliation Agreements with three CMHCs in Arkansas and those agreements became operational in the summer of 1996. The terms of the Management and Affiliation Agreements range from four to six years and may only be terminated for cause upon the occurrence of such events such 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. Pursuant to the terms of the Management and Affiliation Agreements, through a wholly owned subsidiary, the Company manages and operates on behalf of each case management provider, the delivery of case management and other covered psychiatric services. Each Management and Affiliation Agreement can be operated in a fee for service or managed care environment. In Tennessee it was anticipated that the payor for services under the Management 14 15 and Affiliation Agreements would be managed care organizations operating under the Tennessee TennCare Partners State Medicaid Managed Care Program ("TennCare") but implementation of TennCare for the SMI population was delayed until July 1, 1996 and thus, the Case Management Program was implemented on a fee for service basis until conversion to TennCare at which time managed care organizations became the payor for services. Commencing on July 1, 1996, two managed care consortiums became the payors for mental health care services under TennCare. These consortiums, known respectively as Tennessee Behavioral Health ("TBH") and Premier Behavioral Health ("Premier"), were fully at risk for the approximately 1.15 million individuals who qualified for coverage based on Medicaid eligibility or other indigency standards. The Company, through its Collaborative Care subsidiary holds contracts for case management services with both of the managed care consortiums. The Company has received information that Premier has notified the state that it would withdraw from Tenncare effective, June 30, 1997. However, the Company understands that the State of Tennessee has contested the termination and that Premier has continued in its role as a managed care consortium. Effective July 1, 1997 TBH amended its contract with Tenncare and is attempting to restructure its agreements with its providers. Significant uncertainty exists as to the future structure of Tenncare and the Company's ability to maintain its case management revenues subsequent to a restructuring. For the year ended April 30, 1997, case management contracts in Tennessee accounted for 23.7% of the Company's revenues. The Company may find it necessary to significantly restructure its contracts and relationships, depending on the outcome of ongoing discussions among the interested parties in Tenncare. The potential changes, which the Company cannot predict with any degree of certainty, may have a material adverse impact on the Company's financial condition and results of operations. SEE THE SECTION ENTITLED RISK FACTORS-POTENTIAL CHANGES IN TENNCARE. For the year ended April 30, 1997, case management contracts accounted for 24.2% of the Company's revenues. MARKETING AND COMMUNITY DEVELOPMENT The Company's principal marketing efforts with respect to its Outpatient Program is concentrated in the identification of prospective Hospitals or CMHC's who may be suitable Providers. Also once having established an affiliation, the Company assigns personnel to a program site for the purpose of apprising health care and social service professionals in the local community about the availability of the services, its benefits and the type of patient clinically appropriate for service in the Outpatient Program setting. 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. A significant factor in the Company's expansion into new market areas is the ability to develop new contractual relationships with Hospitals or CMHCs. Hospitals or CMHCs who 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's marketing efforts with providers are undertaken by its own marketing and development personnel who focus upon the dissemination of information about the Company's 15 16 programs as well as the generic benefits of case management services and outpatient psychiatric programs. The Company believes, and its marketing plan emphasizes, that its Outpatient Program offers a cost effective alternative to inpatient care for many patients and can serve to shorten or obviate inpatient stays by providing a transition from the hospital for other patients. Additionally, the Company believes that these cost saving benefits, coupled with the clinical benefits provided by the less restrictive atmosphere of an intensive outpatient setting, make its Outpatient Program attractive to third party payors, including Medicare. Marketing efforts for the Company's Case Management Program have focused on developing opportunities for utilizing the Company's proprietary systems and developing relationships with key local provider groups to be in a position to respond with a strong, local support base. The Company will also market the benefits of the Case Management Program to managed care organizations and their provider networks as public-sector contracts are awarded. The development of the Company's Chemical Dependency Program focuses on expanding current contractual relationships and obtaining new provider contracts. The Company's marketing for this program is focused on at-risk payors where ambulatory chemical dependency services are of significant value. REGULATORY MATTERS COMPLIANCE WITH MEDICARE GUIDELINES FOR REIMBURSEMENT AND COVERAGE OF MANAGEMENT FEES 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 under warranty provisions 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 does not submit claims to Medicare, it may be adversely affected by reductions in Medicare payments or other Medicare 16 17 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 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 letter 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. 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 prevailing current 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. All of the partial hospitalization programs managed by the Company are treated as "provider based" programs by HCFA, which administers the Medicare program. This designation is important since partial hospitalization services are covered only when furnished by a "provider", i.e., a hospital or a CMHC. To the extent that partial hospitalization programs are not located in a site which is deemed by HCFA to be "provider-based", there would not be Medicare coverage for the services furnished at that site under Medicare's partial hospitalization benefit. In August, 1996, HCFA 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 determination is made, HCFA has not ruled out, in some situations, the possibility that it would seek retrospective recoveries from providers. 17 18 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 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 and paid for by Medicare. CHANGES IN MEDICARE'S COST BASED REIMBURSEMENT FOR PARTIAL HOSPITALIZATION SERVICES Currently proposed legislation would implement a prospective payment system ("PPS") for all outpatient hospital services, including partial hospitalization, for the calendar year beginning January 1, 1999. While the actual reimbursement rates have not been determined and thus their effect, positive or negative, is unknown, the Company may need to negotiate modifications to its contracts with Providers if such legislation is enacted. 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 percent of the charges for the services. The coinsurance 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 hospitalization programs is significant since most of the patients in programs managed by the Company are indigent or have very limited resources. The pending budget reconciliation bills in Congress would reduce the amount of Medicare allowable bad debts payable to providers, if enacted. Since the House and Senate provisions are identical, the Company expects the following reductions in Medicare allowable bad debts to occur: 25 percent for provider fiscal years beginning on or after October 1, 1997; 40 percent for provider fiscal years beginning on or after October 1, 1998; and 50 percent for provider fiscal years beginning on or after October 1, 1999. The reduction in "allowable Medicare bad debts" could have a materially adverse impact on Medicare reimbursement to the Company's Providers and could further result in the restructuring or loss of Provider contracts with the Company. 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 18 19 which the Company offers, the impact 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. As noted, 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 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. 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 requirements with respect to confidentiality and patient privacy. Indeed, both federal and state laws require providers of certain behavioral health services to maintain strict confidentiality as to treatment records and, indeed, 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 CMHC's, 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 19 20 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 is a prerequisite to participation in the Medicare programs. Additionally, the Provider's premises and programs are subject to periodic inspection and recertification. AGGRESSIVE INVESTIGATION 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 any allegations that any alleged fraud relates 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 quitam provisions of the Federal False Claims Act permit individuals to do so is that he or she will usually be entitled to approximately 15 to 30 percent 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. 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 referring of patients. The penalties under many of those statutes are severe, and the government often need not 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 quitam relator in the name of the government) will not assert that some conduct by the Company has given rise to potentially a large liability. 20 21 HUMAN RESOURCES In the aggregate, as of April 30, 1997, the Company employed approximately 800 employees, of which 434 are full-time employees. Approximately 714 employees staff clinical programs and 86 are in corporate management including finance, accounting, development, utilization review, training and education, information systems, human resources and legal. None of the Company's employees are subject to a collective bargaining agreement, and the Company believes that its employee relations are good. COMPETITION The Company competes with other health care management companies for the establishment of affiliations with acute care hospitals to operate its Outpatient Programs. Certain of the Company's competitors have greater financial and personnel resources than the Company. 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 programs and services. 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. In each of the Company's current and anticipated market areas, the Company faces competition. The Company anticipates that competition will become more intense as pressure to contain the rising costs of health care continues to intensify, and programs such as those operated by the Company are perceived to help contain mental health care costs. The Company believes that the Case Management Program provides 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 CMHC's 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. 21 22 RISK FACTORS In addition to other information contained in this Annual Report on Form 10-K, the following risk factors should be considered carefully by holders of the Company's Common Stock. 1. DEPENDENCE UPON THIRD PARTY REIMBURSEMENT A significant component of the Company's revenues derived from payments made by Hospitals and CMHC's ("Providers") to the Company relative to the management and administration by the Company of outpatient programs (the "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, 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. As a general matter, 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 related claims submitted by the Provider are denied by the 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 intermediaries for reimbursement on the Provider's cost reimbursement report. The occurrence of either of these events can have an adverse impact upon the Company's cash flow and ultimate receipt of its management fees. Applicable Medicare guidelines permit the reimbursement of contracted for management services provided that, among other things, the associated fees are "reasonable." As a general rule, Medicare guidelines indicate that contract management services costs are "deemed" reasonable if the costs incurred are comparable with marketplace prices for similar services. Although management of the Company believes that the value of the Company's services is 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 could have a material adverse effect on the Company's finances. HCFA has published criteria which partial hospitalization services must meet in order to qualify for Medicare funding. In transmittal letter number 1303 (effective January 2, 1987) 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. 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 all Medicare requirements, there can be no assurances 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. 22 23 During the fourth quarter of Fiscal Year 1994, fiscal intermediaries for Providers began a Focused Medical Review of claims for partial hospitalization services throughout the country. A Focused Medical Review consists of an intensive review by HCFA fiscal intermediaries on an industry-wide basis of certain targeted claims which HCFA has identified as being at risk of inappropriate program payment. This often occurs when HCFA identifies significant industry-wide increases in payments of certain types of services, as had been the case with the partial hospitalization benefit. The Company's initial experience with the Focused Medical Review was that there were numerous denials of Providers' claims and the denials had an adverse impact on the Company's cash flow during Fiscal 1995 because Providers delayed payment of the Company's management fee because of the substantial number of denials. On behalf of the Providers, the Company strenuously disputed these denials, particularly the interpretations implemented by one singular fiscal intermediary. The Focused Medical Review of claims for partial hospitalization services conducted by fiscal intermediaries for the Providers has substantially abated on programs managed by the Company. Although during Fiscal 1997, the number of denied claims was reduced to a modest rate, the periodic review of claims by HCFA fiscal intermediaries will likely continue at one or more programs from time to time, and there can be no assurances that a Focused Medical Review of claims will not recur at the level previously experienced by the Company. 2. CHANGES IN MEDICARE'S COST BASED REIMBURSEMENT FOR PARTIAL HOSPITALIZATION SERVICES Based on proposed legislation, a prospective payment system ("PPS") for all outpatient hospital services, including partial hospitalization, would be implemented for the calendar year beginning January 1, 1999. While the actual reimbursement rates have not been determined and thus their effect, positive or negative, is unknown, the Company may need to negotiate modifications to its contracts with Providers. 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 percent of the charges for the services. The coinsurance 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 hospitalization programs is significant since most of the patients in programs managed by the Company are indigent or have very limited resources. The pending budget reconciliation bills in Congress would reduce the amount of Medicare allowable bad debts payable to providers. Since the House and Senate provisions are identical, the Company expects the following reductions in Medicare allowable bad debts to occur: 25 percent for provider fiscal years beginning on or after October 1, 1997; 40 percent for provider fiscal years beginning on or after October 1, 1998; and 50 percent for provider fiscal years beginning on or after October 1, 1999. The reduction in "allowable Medicare bad debts" could have a materially adverse impact on 23 24 Medicare reimbursement to the Company's Providers and could further result in the restructuring or loss of Provider contracts with the Company. 3. SUFFICIENCY OF EXISTING RESERVES TO COVER UNCERTAINTIES RELATIVE TO REIMBURSEMENT ISSUES Reimbursement of the Company's management fees to Providers under the Medicare program provides a substantial source of the Company's revenues. Accordingly, the Company's Programs must at all times operate in compliance with applicable Medicare guidelines. Failure to meet such criteria could have an adverse effect on the Company's finances should a Provider elect to withhold payment of the Company's management fees or in the alternative seek a refund of such fees following an event of disallowance. The Company maintains significant reserves identified within its financial statements to cover the effect of primarily two uncertainties: (i) that 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) that 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 assurances to that effect. The obligation to pay the amounts estimated within the Company's financial statements (or such greater amounts as are due), when and if they become due, could have a material adverse impact on the Company's short term liquidity. 4. 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. These contracts generally have defined terms of duration and many have automatic renewal terms subject to termination by either party. The contracts often provide for early termination either by the Provider if specified performance criteria are not satisfied or by Company under various other circumstances. The continued success of the Company is subject to its ability to maintain, renew or extend existing management contracts and obtain new management contracts. 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 convert their mental health programs from independently managed programs to programs operated internally or to terminate their mental health programs. 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 earlier if such management contract is terminable prior to expiration. In addition, any changes in 24 25 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 would 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 material 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 or results of operations. For the Fiscal Year ended April 30, 1997 ("Fiscal 1997"), there was only one Provider that accounted for more than ten (10%) percent of the Company's revenues. Furthermore, although not attributed to a particular "customer," the Company's case management programs accounted for 24.2% of the Company's revenues during Fiscal Year 1997. These programs were largely operated under contracts with TBH and Premier and management agreements with two (2) 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 or results of operation. 5. POTENTIAL CHANGES IN TENNCARE The Company, through its Collaborative Care subsidiary holds contracts for case management services with both of the managed care consortiums. Premier has notified the state that it would withdraw from Tenncare effective, June 30, 1997. But the effectiveness of that notice is in question and Premier has continued in its role as a managed care consortium. Effective July 1, 1997 TBH amended its contract with Tenncare and is attempting to restructure its agreements with its providers. Significant uncertainty exists as to the future structure of Tenncare and the opportunity for the Company and its subsidiary subsequent to a restructuring. The Company may find it prudent to significantly restructure its contracts and relationships, depending on the outcome of ongoing discussions among the interested parties in Tenncare. The potential changes, which the Company cannot predict with any degree of certainty, may have a material adverse impact on the Company's financial condition and results of operations. 6. LIMITED OPERATING HISTORY OF CASE MANAGEMENT PROGRAMS For the fiscal year ended April 30, 1997, the Company's Case Management Programs accounted for 24.2% of the Company's total revenues. This reflects an increase from 20.9% of revenues accounted for by these Programs during Fiscal 1996. 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 assurances that the Company will be able to maintain these operations at the level realized during Fiscal 1997 or expand these Programs after Fiscal 1997. 7. DIFFICULTIES OF MANAGING RAPID GROWTH The Company expects that its outpatient psychiatric management services business and the number of its acute outpatient, case management and chemical dependency programs may increase 25 26 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 operation, 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. 8. GOVERNMENT REGULATION Mental health care is an area of extensive and frequent regulatory change. Changes in the laws or new interpretations of existing laws can have a significant effect on methods of doing business, costs of doing business and amounts of reimbursement from governmental and other payers. The Company is and will continue to be subject to varying degrees of regulation and licensing by health or social service agencies and other regulatory authorities in the various states and localities in which it operates or intends to operate. The Company must operate in compliance with applicable Medicare and Medicaid guidelines. The Company is also subject to fraud and abuse and other laws, violations of which may result in civil and criminal penalties and exclusions from participation in such programs. The Company at all times attempts to comply with all such applicable laws; however, there can be no assurance that administrative or judicial interpretation of existing laws or regulations will not have a material adverse effect on the Company's operations or financial condition. The success of the Company will be dependent in part upon its ability to satisfy the applicable regulations and requirements imposed upon its operations. The Company's operations could also be adversely affected by, among other things, regulatory developments such as mandatory increases in the scope and quality of care and implementation of certain licensing and certification standards. There can be no assurance that federal, state or local laws or regulatory procedures which might adversely affect the Company's business, financial condition, results or operations or prospects will not be expanded or imposed. There can be no assurances that the regulations applicable to the Company's operations and its arrangements with Providers will not change in the future or that future interpretations of existing laws or new laws will not result in the Company's services under its management contracts being deemed not in compliance with federal Medicare/Medicaid laws. 9. DEPENDENCE ON KEY PERSONNEL The Company depends, and will continue to depend, upon the services of its senior management and skilled personnel. The Company presently has no employment agreements with any of its senior executive officers. The Company is also dependent upon its ability to attract and retain management personnel who will be responsible for the day-to-day operations of the Company. The loss of the services of any or all such officers or the Company's inability to attract additional management personnel in the future could have a material adverse effect on the Company's financial condition or results of operations. 26 27 The Company's success and growth strategy also 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 for its business in the future. 10. COMPETITION The mental health services industry is highly competitive. There are many other companies engaged in the management of outpatient psychiatric Programs, and some of these companies are substantially more established and have greater financial and other business resources than those presently possessed by 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. The inability of the Company or its Providers to compete effectively could have a material adverse effect on the Company's business, financial condition or results of operations. 11. POSSIBLE VOLATILITY OF STOCK PRICES The market price of the Common Stock could be subject to significant fluctuations in response to various factors and events, including the liquidity of the market for the Common Stock, variations in the Company's operating results, 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. In addition, the stock market in recent years has experienced broad 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. The Company's Common Stock is traded on the Nasdaq National Market System. There can be no assurances as to the future trading prices of the Common Stock. Trading of a Company's securities depends upon a number of variables most of which are beyond the control of the Company. 12. HEALTHCARE REFORM 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 reductions to the Medicare and Medicaid programs and steps to permit greater flexibility in the administration of Medicaid. In addition, some states in which the Company operates are considering various health care reform proposals. It is uncertain at this time what legislation on health care reform may ultimately be proposed or enacted or whether other changes in the administration or interpretation of governmental health care programs will occur. 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 or results of operations. 27 28 13. CONCENTRATION OF OWNERSHIP; ANTI-TAKEOVER PROVISIONS The officers and directors of the Company and their affiliates own over fifty (50%) percent of the Company's issued and outstanding Common Stock. Consequently, such persons will be able to elect a majority of the Company's Board of Directors and control the Company's policies and day to day management at least for the foreseeable future. The Company's Board of Directors has the authority, without action by the stockholders, to issue additional shares of Preferred Stock and to fix the rights and preferences of such shares. The ability to issue additional shares of Preferred Stock together with certain provisions of the Company's Certificate of Incorporation, such as staggered 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 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. 14. 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 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 financial condition and results of operations. Claims against the Company, regardless of their merit or eventual outcome, may also have a material adverse effect upon the Company's ability to expand its business and would require management to devote time to matters unrelated to the operation of the Company's business. In addition, the Company's insurance policies must be renewed annually. There can be no assurance that the Company will be able to obtain liability insurance coverage in the future or that, if such coverage is available, it will be available on acceptable terms. 15. POTENTIAL MARKET IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE Future sales by existing stockholders could adversely affect the prevailing market price of the Common Stock. The Company presently has 5,045,303 shares of Common Stock outstanding. Of these shares, 2,548,487 are eligible for public resale as free-trading securities, and 2,661,222 shares are held by the Company's affiliates (directors, officers and principal stockholders) and are considered "restricted securities" under Rule 144 under the Securities Act of 1933, as amended (the "Securities Act"). 28 29 16. NEED FOR ADDITIONAL FINANCING TO FUND FUTURE GROWTH The Company may require additional equity or debt financing, collaborative arrangements with corporate partners or funds from other sources in order to continue the establishment, development, management and marketing of outpatient programs. No assurance can be given that funds will be available for the Company for those purposes on acceptable terms, if at all. If additional funds are raised by issuing equity securities, the Company's stockholders may experience dilution. 29 30 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 in 2002 and (ii) two leases for regional administration offices for five years' duration, (iii) thirty (30) leases for Program sites, ranging from three-to-five years' duration, none of which extend beyond 2002. The Company anticipates that it will be moving into its new facility in September 1997. 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 subleases, 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 further typically provide for termination on not less than ninety (90) days' written notice. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings required to be reported hereunder. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS No matter was submitted to a vote of the Company's stockholders during the fourth quarter of the fiscal year covered by this Report. ITEM 4A. EXECUTIVE OFFICERS OF THE CORPORATION The executive officers of the Company and their ages as of July 25, 1997 are as follows:
NAME AGE POSITION Allen Tepper 49 Chairman of the Board of Directors and Chief Executive Officer Fred D. Furman 49 President Mark P. Clein 38 Executive Vice President and Chief Financial Officer Susan D. Erskine 45 Executive Vice President Development, Secretary and Director Susan Yeagley Sullivan 47 Senior Vice President-Finance and Treasurer
ALLEN TEPPER Mr. Allen Tepper has been Chairman and CEO of the Company since October 31, 1989. Mr. Tepper was a co-founder of Consolidated Medical Corp. in 1979, which was engaged in out-patient clinic management for acute care hospitals in the Philadelphia area. The company was sold 30 31 to the Berwind Corporation in 1984. Mr. Tepper holds a Masters of Business Administration degree from Northwestern University and a Bachelors degree from Temple University. FRED D. FURMAN Mr. Fred D. Furman has been President since April 1997. Previously, he held the position of Executive Vice President - Administration and General Counsel. Prior to that, Mr. Furman was a partner at a Philadelphia law firm from 1980 to 1995. Mr. Furman is a member of the National Health Lawyers Association. He holds a Juris Doctor degree and a Bachelor's degree from Temple University. MARK P. CLEIN Mr. Mark P. Clein joined the Company in 1996 as Executive Vice President and Chief Financial Officer. From 1982 to 1995, Mr. Clein had been employed by several New York-based investment banking and venture capital firms, including Jefferies & Co., where he held the position of managing director of investment banking (specializing in the health care industry), Sprout Group, an affiliate of Donaldson, Lufkin and Jenrette, Inc. and Merrill Lynch Venture Capital, Inc., where he focused on early stage investing in the healthcare industry. 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 Ms. Susan D. Erskine has been Secretary and a Director of the Company since October 31, 1989. Ms. Erskine previously held management positions in the areas of operations, marketing and development for acute care hospitals and a public sector focused management services organization. She holds a Master's degree in Health Science and completed post graduate work at Stanford University in Education and Psychology. She has extensive experience in program development, marketing and management of psychiatric programs, both inpatient and outpatient. SUSAN YEAGLEY SULLIVAN Ms. Susan Yeagley Sullivan, CPA, has been Senior Vice President and Treasurer since May of 1996. From July 1991 through May, 1996, she held the position of Chief Financial Officer of the Company. Ms. Yeagley Sullivan was previously the Chief Financial Officer of a San Diego home health agency and of a psychiatric hospital, as well as several real estate development companies in San Diego and Dallas. Prior to that, Ms. Yeagley Sullivan was in public accounting, holding the position of audit manager at Kenneth Leventhal & Co and Ernst & Young. She holds a Masters in Business Administration degree and a Bachelors of Science in Accounting degree from San Diego State University. All officers are elected annually by the Board of Directors. Each officer serves at the discretion of the Board of Directors. There are no family relationships among the directors, officers or key employees of the Company. 31 32 PART II ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 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 1997 7/31/96 10/31/96 1/31/97 4/30/97 ----------- ------------ ----------- ----------- High 15.50 35.25 31.44 29.75 Low 8.50 14.13 20.25 16.75
QUARTERS FOR THE YEAR ENDED APRIL 1996 7/31/95 10/31/95 1/31/96 4/30/96 ----------- ------------ -------------- ----------- High 6.00 5.63 5.63 10.19 Low 3.00 3.50 4.25 4.50
RECENT SALES OF UNREGISTERED SECURITIES From May 1, 1996 to April 30, 1997, the Company has sold and issued (without payment of any selling commission to any person) the following unregistered securities: 1. During the period, the Company granted incentive stock options to employees and officers of the Company under its Employees' Stock Option Plan of 1990 (the "1990 Plan") (as amended and restated, the "1997 Equity Incentive Plan") covering an aggregate of 375,080 shares of the Company's Common Stock. The incentive stock options had exercise prices equal to at least 100% of the fair market value of a share of Common Stock on the date of grant and ranged from $11.00 to $28.50. Certain of these options vest over a period of time following their respective dates of grant. 2. On April 30, 1997, the Company granted stock options to certain executive officers of the Company in connection with the employment of such officers, covering an aggregate 87,757 shares of Common Stock at an exercise price of $19.875 per share. 3. During May and June 1996, 48,000 shares of Common Stock were issued to Ronald Slack, a former director of the Company, upon exercise of warrants for an aggregate exercise price of $242,500.00. 32 33 4. During June 1996, the Company issued 700,000 shares of Common Stock upon conversion of the Company's Series C Convertible Preferred Stock by the holders thereof. In addition, 525,000 shares of Common Stock were issued upon the exercise of Class A Warrants, Class B Warrants and Class C Warrants (which were issued in connection with the sale of Series C Convertible Preferred Stock in a private placement transaction), for aggregate exercise prices for each class of $525,000, $787,500 and $1,050,000, respectively. See "ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS- Liquidity and Capital Resources." 5. On July 1, 1996, the Company granted a consultant an option to purchase up to 4,000 shares of Common Stock at an exercise price of $11.375 per share, in connection with the services provided by the consultant. 6. On January 3, 1997, the Company granted a consultant an option to purchase up to 20,000 shares of Common Stock at an exercise price of $23.375 per share, in connection with the services provided by the consultant. 7. On April 27, 1997, the Company issued 39,524 shares of Common Stock to Proactive Partners, L.P. and Proactive Investment Managers L.P. upon the exercise of warrants issued to them in an earlier private placement transaction, for an aggregate exercise price of $332,001.60. The grant of stock options described in paragraphs 1 and 2 above were exempt from registration under the Securities Act because such transactions did not involve a "sale" of securities as such term is used in Section 2(3) of the Securities Act. The sales and issuances of securities in the transactions described in paragraphs 3 and 4 above were deemed to be exempt from registration under the Securities Act by virtue of Section 4(2) and/or Regulation D promulgated thereunder. The grant of stock options to the consultants described in paragraphs 5 and 6 above, were exempt from registration under the Securities Act because such transactions did not involve a "sale" of securities as such term is used in Section 2(3) of the Securities Act. Alternatively, if such grants did involve a sale, such grants were exempt from registration under the Securities Act by virtue of Section 4(2) and/or Regulation D promulgated thereunder. The recipients of the securities set forth above in paragraphs 2, 3, 4, 5, 6 and 7 represented their intention to acquire the securities for investment purposes only and not with a view to the distribution thereof. Appropriate legends are affixed to all stock certificates issued in such transactions. All recipients either received adequate information about the Registrant or had access through employment or other relationships, to such information. 33 34 ITEM 6. SELECTED FINANCIAL DATA (in thousands, except per share amounts)
FOR THE YEAR ENDED APRIL 30 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- INCOME STATEMENT INFORMATION Revenues $ 56,637 $ 36,315 $ 21,747 $ 22,786 $ 16,615 Net Income (loss) 3,107 918 (2,352) 825 1,157 Net Income (loss) per share Primary .54 .23 (.70) .24 .30 Fully Diluted .54 .21 (.70) .24 .30 Weighted Shares Outstanding Primary 5,772 4,540 3,337 3,312 2,839 Fully Diluted 5,772 5,043 3,337 3,313 2,858 BALANCE SHEET INFORMATION Working Capital $ 20,641 $ 10,911 $ 8,790 $ 7,705 $ 7,843 Total Assets 33,085 21,182 14,811 13,671 11,289 Long Term Debt 0 0 126 320 135 Total Liabilities 16,837 12,070 7,749 5,972 4,625 Stockholders' Equity 16,248 9,112 7,062 7,699 6,664
QUARTERS FOR THE YEAR ENDED APRIL 1997 QUARTERS FOR THE YEAR ENDED APRIL 1996 7/31/96 10/31/96 1/31/97 4/30/97 7/31/95 10/31/95 1/31/96 4/30/96 ------- -------- ------- ------- ------- -------- ------- ------- Revenues 13,028 14,293 14,190 15,126 6,006 8,215 10,154 11,940 Net Income (loss) 583 799 831 894 5 167 222 524 Net Income (loss) per share Primary .12 .13 .14 .15 .00 .04 .06 .11 Fully Diluted .11 .13 .14 .15 .00 .04 .06 .10
34 35 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially form those discussed here. Factors that could cause or contribute to such differences include, without limitation, those discussed in "ITEM 1. Business", including the section entitled "Risk Factors", as well as those discussed in any document incorporated herein by reference. OVERVIEW The following table presents a year-by-year analysis of certain of the material items that comprise elements of the Company's result of operations for the periods contained within the financial statements included in this Form 10-K. References to "fiscal year" refer to the Company's fiscal years ended April 30 of the relevant year.
Percentage of Revenues Percentage Year Ended April 30 Increase/Decrease 1997 1996 1997 1996 1995 vs. 1996 vs. 1995 ---- ----- ----- --------- -------- Revenues 100% 100% 100% 56% 67% Operating Expenses 73% 78% 95% 45% 38% Marketing, General and 11% 11% 14% 58% 35% Administrative Depreciation and Amortization 1% 2% 2% 18% 48% Other Operating Expense 6% 4% 6% 98% 14% Income (Loss) before Income Taxes 9% 5% (17%) 198% N/A Provision for Income Taxes (Benefit) 4% 2% (6%) 198% N/A Net Income (Loss) 5% 3% (11%) 238% N/A
In Fiscal 1997, the Company recorded net income of $3.1 million, which compares to net income of $.9 million during Fiscal 1996. The increase in profitability was due to a significant increase in revenues without a concomitant increase in operating expenses. In Fiscal 1997, revenues in the Company's Outpatient Program expanded by 49.3% as compared to Fiscal 1996 due to a significant increase in both patient census and net revenue per patient. Net revenue per patient increased as the Company maintained the focus initiated in Fiscal 1996 of providing higher intensity services to a higher acuity patient population. As most of the 35 36 costs of an outpatient center are fixed or semi-fixed, the Company experienced significant unit level operating leverage with respect to its acute outpatient program, which was the primary factor in reducing operating expenses from 78.4% of revenue in Fiscal 1996 to 73.1% of revenue in Fiscal 1997. These improvements were realized notwithstanding a significant increase in operational infrastructure in the Company's Mid-America region in anticipation of expected growth in Fiscal 1998 and beyond. While the Company anticipates that it may continue to experience additional efficiencies in its Outpatient business, it does not anticipate that improvements in margins will continue at the rate realized in Fiscal 1997. In Fiscal 1997, revenues in the case management business grew 80.3% due to the effect of a full year of operation in Tennessee, increases in enrollment in Tennessee and the launch of the business in Arkansas. Before corporate allocation, case management was modestly unprofitable as increased profits in Tennessee were balanced by start-up losses in Arkansas. The Company anticipates increasing pressure on revenues and profit margins in Tennessee given the potential restructuring of Tenncare and the continued losses experienced by Premier and TBH, the consortiums which have contracted with the Company to provide case management services. See - "ITEM 1. BUSINESS - CONTRACTS - CASE MANAGEMENT". Marketing, General and Administrative expenses increased slightly as a percentage of revenues in Fiscal 1997 as the Company invested significantly in operational infrastructure in the Company's Mid-America region in anticipation of expected growth in Fiscal 1998 and beyond. The Company does not anticipate material improvements in margins at the marketing, general and administrative level until several of the recently launched and anticipated programs in the Mid-America region begin to mature. Revenues from the Company's Outpatient, Case Management and Chemical Dependency Programs were 70.6%, 24.2%, and 5.2% respectively of total revenues in Fiscal 1997, compared to 73.8%, 20.9%, 5.3% respectively of total revenues in Fiscal 1996. The changes in the revenue mix were due primarily to the effect of a full year of operation of the Tennessee Case Management Program in Fiscal 1997 as compared to approximately eight months of operation in Fiscal 1996 as well as the commencement of the Arkansas Case Management Program in Fiscal 1997. Internal growth rates were strong within all of the business lines. RESULTS OF OPERATIONS - FISCAL YEAR ENDED APRIL 30, 1997 COMPARED TO FISCAL YEAR ENDED APRIL 30, 1996 Revenues. Revenues for Fiscal 1997 were $56.6 million, an increase of $20.3 million, or 56.0% as compared to Fiscal 1996. Of this increase, $6.1 million, or 30.0%, resulted from the Company's Case Management Program in Tennessee and Arkansas. Five percent of the increase in revenues, or $1.0 million, was attributed to growth in the Chemical Dependency Programs. These programs benefited from a full year of operation of the Little Rock public sector program in Arkansas, and from growth in the managed care business in California. Total revenue growth in Chemical Dependency was 53.0% in Fiscal 1997. The remainder of the increase in revenues came from the Company's Outpatient Program which recorded revenues of $40.0 million, an increase of 49.3% from Fiscal 1996. The growth in this business line was a combination of same site revenue increases of 40% as compared to Fiscal 36 37 1996 and the addition of eight new programs in Fiscal 1997. The Company closed two sites during Fiscal 1997. Operating Expenses. Operating expenses for Fiscal 1997 were $41.4 million, an increase of $13 million, or 45.5% as compared to Fiscal 1996. Of this increase, $5.4 million or 42.0%, resulted from the effect of a full year of operations of the Case Management Program in Tennessee and the launch of the Case Management Program in Arkansas. The remainder of the increase in operating expenses was associated primarily with increased costs to support the revenue growth at existing outpatient sites and the net increase of six Outpatient Programs during Fiscal 1997. Marketing, General and Administrative Expenses. Marketing, general and administrative expenses for Fiscal 1997 were $6.4 million, an increase of $2.3 million, or 58.0% as compared to Fiscal 1996. The increase was related to the following factors: the reorganization of the Company into three regions; the significant investment in the Mid-America region to prepare for anticipated growth associated with the agreement with Columbia Healthcare Corporation; the start-up of the site management and clinical information division; and increases in personnel in information systems, product development and utilization review. Depreciation and Amortization. Depreciation and amortization expenses for Fiscal 1997 were $701,000, an increase of $105,000, or 17.6% as compared to Fiscal 1996. The increase was due to additional capital expenditures associated with the start up of eight new programs and to increased capital expenditures for information systems. Provision for Bad Debts. Expenses related to the provision for bad debts for Fiscal 1997 were $3.1 million, an increase of approximately $1.6 million or 112.4% as compared to Fiscal 1996. The growth in the provision was due to an increase in the accrual rate for bad debt from 4.0% in Fiscal 1996 to 5.4% in Fiscal 1997 partially associated with higher rates of indigent clients in the Case Management Program, limited collection experience in the Case Management and Arkansas Chemical Dependency Program, and a more conservative accrual for denials by third party payors. Interest. Interest income was $217,000 in Fiscal 1997, compared to interest expense of $2,000 in Fiscal 1996. The improvement was due to growing cash balances throughout Fiscal 1997 and the absence of bank debt. Dividends. Dividends were $17,000, a decrease of 114,000, or 86.9% from Fiscal 1996. In June 1996, all shares of Series C Convertible Preferred Stock were surrendered and converted into 700,000 shares of common stock, thus ceasing any future dividend requirements on the Preferred Stock. See "Liquidity and Capital Resources." RESULTS OF OPERATIONS - FISCAL YEAR ENDED APRIL 30, 1996 COMPARED TO FISCAL YEAR ENDED APRIL 30, 1995 Revenues. Revenues for Fiscal 1996 were $36.3 million, an increase of $14.6 million, or 67.0% as compared to Fiscal 1995. Of this increase, $7.6 million, or 52.1%, resulted from the 37 38 commencement of the Company's Case Management Program in Tennessee. The remainder of the increase in revenues came predominantly from the Company's Outpatient Program which recorded revenues of $26.8 million, an increase of 33.3% from Fiscal 1996. Same store revenue increased 31.5% as compared to Fiscal 1995. The growth in the Outpatient Program was due to increases in average patient census and net revenue per patient at existing sites, and the opening of five programs at new sites during Fiscal 1996. The Company closed two sites during Fiscal 1996. Revenues at the Company's chemical dependency subsidiary increased 21.5% during Fiscal 1996. Operating Expenses. Operating expenses for Fiscal 1996 were $28.5 million, an increase of $7.8 million, or 37.9% as compared to Fiscal 1995. Of this increase, $6.9 million or 88.7%, resulted from the commencement of the Company's Case Management Program in Tennessee. The remainder of the increase in operating expenses was associated with increased costs to support the revenue growth at existing outpatient sites and the net increase of three Outpatient Programs during Fiscal 1996. Marketing, General and Administrative Expenses. Marketing, general and administrative expenses for Fiscal 1996 were $4.0 million, an increase of $1.0 million, or 35.0% as compared to Fiscal 1995 and as compared to an increase in revenues of 67.0%. The increase was related primarily to the following factors: the preparation for and commencement of the Company's Case Management service in Tennessee; the preparation for the commencement of the Case Management Program in Arkansas; and increased marketing of the Outpatient Program. Depreciation and Amortization. Depreciation and amortization expenses for Fiscal 1996 were $596,000, an increase of $193,000, or 47.8% as compared to Fiscal 1995. The increase was due largely to the amortization of intangible assets associated with the acquisition of the remaining interest of the Twin Town Outpatient subsidiary and covenants not to compete in Tennessee. Provision for Bad Debts and Interest Expense(net). Expenses related to the provision for bad debts and interest expense for Fiscal 1996 were $1.4 million, an increase of approximately $70,000, or 5.1% as compared to Fiscal 1995. The percentage increase for this category of expense was substantially less than the percentage increase in revenues and other expenses due to a lower provision for bad debt on Case Management revenues, substantially higher cash balances and the repayment of outstanding bank debt in the fourth fiscal quarter. Dividends. Dividends were $132,000, an increase of 100% from Fiscal 1995. In June 1996, subsequent to the end of Fiscal 1996, all shares of Series C Convertible Preferred Stock were surrendered and converted into 700,000 shares of common stock. See "Liquidity and Capital Resources." LIQUIDITY AND CAPITAL RESOURCES For Fiscal 1997, net cash provided by operating activities was $3.2 million, which compares to $4.1 million in Fiscal 1996. Working capital at April 30, 1997 was $20.6 million, an increase of $9.7 million, or 90.4%, as compared to April 30, 1996. Cash and cash equivalents at April 30, 1997 were $10.0 million, an increase of $6.1 million, or 156.4% as compared to April 30, 1996. 38 39 The increases in operating cash flow, working capital and cash and cash equivalents are due to the substantial improvement in net income during Fiscal 1997, stabilization of collections of accounts receivable, and proceeds from the exercise of outstanding options and warrants. Accounts receivable increased by $2.0 million, or 21.3% during Fiscal 1997, substantially less than the 56.0% increase in revenues during the same period. As measured by days of revenue outstanding, accounts receivable declined from 69 at April 30, 1996 to 66 at April 30, 1997. In Fiscal 1997 the Company received $3.5 million in proceeds from the exercise of outstanding options and warrants. Approximately $2.3 million of these proceeds were generated from the exercise of certain outstanding warrants that were components of a private placement transaction undertaken during Fiscal 1995. Working capital was utilized to open six additional Outpatient Programs and to fund the start up of the Arkansas Case Management Program. The Company anticipates modest additional funding requirements for case management in Arkansas in Fiscal 1998, and expects this program to be cash flow neutral during Fiscal 1998. Working capital is anticipated to be utilized during the year for operations, to continue expansion of the Company's Outpatient and Case Management Programs, for the development of the site management and clinical information business, and for the implementation and expansion of other Company programs. During Fiscal 1998, working capital is expected to be realized principally from operations, as well as from a new $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 plus one-half percent or the Eurodollar rate plus two and one-half percent. 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 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, however, in amounts that are not yet certain due to the early stage of the program's development. The Company is also 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 $500,000 in this system during Fiscal 1998. From time to time, the Company recognizes charges upon working capital as a result of certain uncertainties associated with the health care reimbursement rules as they apply to the Company's Outpatient Program. During Fiscal 1997, a majority of the Company's revenues were derived from the Company's management of its Outpatient Program. Since substantially all of the patients of the Company's Outpatient Program are eligible for Medicare, collection of a significant component of the Company's management fees is dependent upon reimbursement of claims 39 40 submitted to fiscal intermediaries by the Hospitals or CMHCs (Providers) on whose behalf these programs are managed. See "ITEM 1. BUSINESS - RISK FACTORS - DEPENDENCE ON THIRD PARTY REIMBURSEMENT". The Company maintains reserves to cover the effect of primarily two uncertainties: 1) that 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 the Providers' cost reports by fiscal intermediaries; and 2) that the Company may not receive full payment of the management fees owed to it by the Providers during the periodic review of the Providers' claims by the fiscal intermediaries. In the event that a significant amount of fees payable to the Company are disallowed, the Company's financial condition and results of operations would be materially adversely affected. The Company has been advised by HCFA that certain program-related costs are not allowable for reimbursement. Under the Company's contracts with its Providers, the Company may be responsible to indemnify Provider's 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 when and if they become due, could have a material adverse impact 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; that any disallowance will merely be offset against obligations already owed by the Provider to the Company. During Fiscal 1997, the Company recognized $634,000 in charges to working capital as a result of satisfying indemnity obligations for Providers that experienced disallowances related to the Company's management fee. The Company was fully reserved for these disallowances. The Focused Medical Review of claims for partial hospitalization services conducted by fiscal intermediaries for the Providers has substantially abated on programs managed by the Company. This has occurred as a result of a number of factors, such as the issuance of a Medicare Program Memorandum by HCFA during June 1995 (which defines partial hospitalization eligibility and the scope of covered services), as well as the intensification of the Company's utilization review and utilization management efforts. Specifically, the number of denials reported to the Company in Fiscal 1997 represented less than 2% of the estimated number of total claims submitted by Providers to fiscal intermediaries. The periodic review of claims by HCFA fiscal intermediaries will likely continue at one or more programs from time to time. To the extent claims for services have been denied in Outpatient Programs managed by the Company, the great majority of the denied claims have been appealed. Approximately 47% of these appeals have reached resolution and the Company has succeeded in securing a reversal in the substantial majority of these cases. The appeals process continues for the substantial balance of the denied claims. Given these results, and given the Company's experience during Fiscal 1997 (during which the rate of denials has declined to a modest rate), and in view of the existing reserves 40 41 established within the Company's financial statements, management does not believe fiscal intermediaries' review of outstanding claims will likely have a material adverse effect upon the Company's liquidity and capital resources during Fiscal 1998. However, there could be no assurance that increased review of outstanding claims will not recur at the level previously experienced by the Company. See "ITEM 1. BUSINESS Risk Factors." ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Financial Statements of the Company for the three fiscal years ended April 30, 1997 and specific supplementary financial information are included in this Report on pages S-1 and F-1 through F-16. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There are no matters to be reported hereunder. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS Information with regard to this item is incorporated by reference to the definitive 1997 Proxy Statement to be filed with the Securities and Exchange Commission within 120 days of April 30, 1997, under the caption "Election of Directors," or in an Amendment to this Report to be filed with the Securities and Exchange Commission. See "Item 4A. EXECUTIVE OFFICERS OF THE CORPORATION" with regard to Executive Officers. ITEM 11. EXECUTIVE COMPENSATION Information with regard to this item is incorporated herein by reference to the definitive 1997 Proxy Statement to be filed with the Securities and Exchange Commission within 120 days of April 30, 1997, under the caption "ADDITIONAL INFORMATION - Management Compensation," or in an Amendment to this Report to be filed with the Securities and Exchange Commission. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information with regard to this item is incorporated herein by reference to the definitive 1997 Proxy Statement to be filed with the Securities and Exchange Commission within 120 days of April 30, 1997, under the caption "PRINCIPAL STOCKHOLDERS," or in an Amendment to this Report to be filed with the Securities and Exchange Commission. 41 42 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information with regard to this item is incorporated herein by reference to the definitive 1997 Proxy Statement to be filed with the Securities and Exchange Commission within 120 days of April 30, 1997, under the caption "ADDITIONAL INFORMATION - Certain Transactions," or in an Amendment to this Report to be filed with the Securities and Exchange Commission. PART IV ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Page (a) The following documents are filed as part of this Report: 1. Financial Statements Report of Independent Auditors F-1 Consolidated Balance Sheets as of April 30, 1997 and 1996 F-2 Consolidated Statements of Operations for the fiscal years F-3 ended April 30, 1997, 1996 and 1995 Consolidated Statements of Stockholders' Equity for the F-4 fiscal years ended April 30, 1997, 1996 and 1995 Consolidated Statements of Cash Flows for the fiscal F-5 years ended April 30, 1997, 1996 and 1995 Notes to Consolidated Financial Statements F-6-F-16 2. Financial Statement Schedules - The following financial schedule is included herein: Page Reference Schedule II - PMR Corporation Valuation and Qualifying Accounts S-1
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are included in the financial statements or the notes thereto and therefore have been omitted. 42 43 3. The following Exhibits are filed as part of this Report:
Exhibit No. Description Method of Filing - ------- ----------- ---------------- 3.1 Restated Certificate of Incorporation of the Registrant Filed herewith 3.2 Amended and Restated ByLaws of the Registrant Filed herewith 4.1 Common Stock Specimen Certificate Incorporated by reference to the Company's Registration Statement on Form S-18 (Reg. No. 23-20095-A) filed on February 11, 1988. 10.1 1997 Equity Incentive Plan (the "1997 Plan"). Filed herewith. 10.2 Form of Incentive Stock Option Agreement under the 1997 Plan. Filed herewith. 10.3 Form of Nonstatutory Stock Option Agreement under the 1997 Filed herewith. Plan. 10.4 Outside Directors' NonQualified Stock Option Plan of 1992 Filed herewith. (the "1992 Plan"). 10.5 Form of Outside Directors' NonQualified Stock Option Filed herewith. Agreement. 10.6 Amended and Restated Stock Option Agreement dated April 30, Filed herewith. 1996, evidencing aware to Allen Tepper. 10.7 Amended and Restated Stock Option Agreement dated April 30, Filed herewith. 1996, evidencing award to Susan Erskine. 10.8 Amended and Restated Stock Option Agreement dated February Filed herewith. 1, 1996, evidencing award to Mark Clein. 10.9 Amended and Restated Stock Option Agreement dated February Filed herewith. 1, 1996, evidencing award to Mark Clein. 10.10 Amended and Restated Stock Option Agreement dated February Filed herewith. 1, 1996, evidencing award to Mark Clein. 10.11 Amended and Restated Warrant dated July 9, 1997, evidencing Filed herewith. award to Fred Furman. 10.12 Restated Management Agreement dated April 11, 1997 with Filed herewith. Scripps Health. 10.13 Sublease dated April 1, 1997 with CMS Development and Filed herewith. Management Company, Inc. 10.14 Management and Affiliation Agreement dated April 13, 1995, Filed herewith. between Mental Health Cooperative, Inc. and Tennessee Mental Health Cooperative, Inc. (Tennessee Mental Health Cooperative, Inc. subsequently changed its name to Collaborative Care Corporation) 10.15 Provider Services Agreement dated April 13, 1995, Filed herewith.
43 44 between Tennessee Mental Health Cooperative, Inc. and Mental Health Cooperative, Inc. (Tennessee Mental Health Cooperative, Inc. subsequently changed its name to Collaborative Care Corporation) 10.16 Management and Affiliation Agreement dated April 13, 1995, Filed herewith. between Case Management, Inc. and Tennessee Mental Health Cooperative, Inc. (Tennessee Mental Health Cooperative, Inc. subsequently changed its name to Collaborative Care Corporation) 10.17 Provider Services Agreement dated April 13, 1995, between Filed herewith. Tennessee Mental Health Cooperative, Inc. and Case Management, Inc. (Tennessee Mental Health Cooperative, Inc. subsequently changed its name to Collaborative Care Corporation) 21 Subsidiaries of the Corporation Filed herewith. 23.1 Consent of Ernst & Young Filed herewith. 27 Financial Data Schedule Filed herewith.
All other exhibits for which provision is made in the applicable regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (b) Reports on Form 8-K: There were no reports on Form 8-K filed during the last quarter of the fiscal year ended April 30, 1997. 44 45 SIGNATURE 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. PMR CORPORATION Dated: July 19, 1997 BY:/s/ Allen Tepper ------------------------------- Allen Tepper Chief Executive Officer BY:/s/ Mark P. Clein ------------------------------- Mark P. Clein Chief Financial 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 Officer July 19, 1997 - --------------------------- and Director Allen Tepper /s/ Susan D. Erskine Secretary, Treasurer and July 19, 1997 - --------------------------- Director Susan D. Erskine /s/ Daniel L. Frank Director July 15, 1997 - --------------------------- Daniel L. Frank /s/ Charles McGettigan Director July 15, 1997 - --------------------------- Charles C. McGettigan /s/ Richard A. Niglio Director July 16, 1997 - --------------------------- Richard A. Niglio /s/ Eugene D. Hill Director July 16, 1997 - --------------------------- Eugene D. Hill
45 46 Schedule II PMR Corporation Valuation and Qualifying Accounts
COL. A COL. B COL. C COL. D COL. E Additions Charged to Description Balance at Charged to Other Beginning of Costs and Accounts Deductions - Balance at End Period Expenses Describe Describe of Period ------ -------- -------- -------- --------- 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 $5,499,020 Year ended April 30, 1995 Allowance for doubtful accounts $ 400,000 $1,317,483 $ -- $ 294,429 $1,423,054 Contract settlement reserve $2,871,462 $3,899,000 $ -- $ 3,247,239 (2) $3,523,223
(1) Uncollectible accounts written off, net of recoveries (2) Write off of hospital receivables based on disallowances of the Company's management fee on Provider's cost reimbursement report and the Company's indemnity obligation. S-1 47 Report of 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, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended April 30, 1997. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of PMR Corporation at April 30, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended April 30, 1997, 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, present fairly in all material respects the information set forth therein. San Diego, California June 13, 1997 F-1 48 PMR Corporation Consolidated Balance Sheets
APRIL 30 1997 1996 ---------------------------------- ASSETS Current assets: Cash and cash equivalents $ 10,048,203 $ 3,917,922 Accounts receivable, net of allowance for uncollectible amounts of $5,081,177 in 1997 and $1,759,000 in 1996 11,268,962 9,289,895 Prepaid expenses and other current assets 572,136 321,506 Deferred income tax benefits 6,069,000 2,701,000 ---------------------------------- Total current assets 27,958,301 16,230,323 Furniture and office equipment, net of accumulated depreciation of $1,175,980 in 1997 and $869,261 in 1996 1,263,743 649,312 Long-term receivables 2,360,872 2,444,055 Other assets 1,501,622 1,858,102 ---------------------------------- Total assets $ 33,084,538 $ 21,181,792 ================================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 1,735,658 $ 1,522,721 Accrued compensation and employee benefits 2,951,867 2,276,809 Advances from case management agencies 926,712 1,012,847 Income taxes payable 1,703,000 308,489 Dividends payable -- 71,739 Other current liabilities -- 127,213 ---------------------------------- Total current liabilities 7,317,237 5,319,818 Deferred rent expense 92,822 149,531 Deferred income taxes 635,000 1,101,000 Contract settlement reserve 8,791,928 5,499,020 Commitments Stockholders' equity: Convertible Preferred Stock, $.01 par value, authorized shares - 1,000,000; Series C - issued and outstanding shares - 700,000 in 1996; liquidation preference $1,750,000 -- 7,000 Common Stock, $.01 par value, authorized shares - 10,000,000; issued and outstanding shares - 5,033,507 in 1997 and 3,577,917 in 1996 50,334 35,778 Additional paid-in capital 12,138,569 8,259,243 Notes receivable from stockholders -- (141,547) Retained earnings 4,058,648 951,949 ---------------------------------- 16,247,551 9,112,423 ---------------------------------- $ 33,084,538 $ 21,181,792 ==================================
See accompanying notes. F-2 49 PMR Corporation Consolidated Statements of Operations
YEAR ENDED APRIL 30 1997 1996 1995 ---------------------------------------------------------- Revenue $ 56,636,902 $ 36,315,921 $ 21,746,663 Expenses: Operating expenses 41,423,157 28,471,644 20,647,965 Marketing, general and administrative 6,350,101 4,018,685 2,976,600 Provision for bad debts 3,084,166 1,447,983 1,317,483 Depreciation and amortization 700,734 595,896 403,294 Interest, (income), expense (217,297) 2,174 61,979 Minority interest in loss of subsidiary -- (524) (108,201) ---------------------------------------------------------- 51,340,861 34,535,858 25,299,120 ---------------------------------------------------------- Income (loss) before income taxes 5,296,041 1,780,063 (3,552,457) Income tax expense (benefit) 2,172,000 730,000 (1,266,000) ---------------------------------------------------------- Net income (loss) 3,124,041 1,050,063 (2,286,457) Less dividends on: Series C Convertible Preferred Stock 17,342 131,686 65,537 ---------------------------------------------------------- Net income (loss) for common stock $ 3,106,699 $ 918,377 $ (2,351,994) ========================================================== Earnings (loss) per common share Primary $ .54 $ .23 $ (.70) ========================================================== Fully diluted $ .54 $ .21 $ (.70) ========================================================== Shares used in computing earnings (loss) per share Primary 5,772,210 4,540,280 3,337,484 ========================================================== Fully diluted 5,772,210 5,042,879 3,337,484 ==========================================================
See accompanying notes. F-3 50 PMR Corporation Consolidated Statements of Stockholders' Equity
SERIES C CONVERTIBLE PREFERRED STOCK COMMON STOCK -------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ------------------------------------------------------------- Balance at April 30, 1994 - $ - 3,307,653 $33,075 Issuance of Series C convertible preferred stock, net of issuance costs of $105,628 700,000 7,000 - - Exercise of Redeemable A Warrants to purchase common stock - - 29,003 290 Issuance of common stock under stock option plan - - 2,000 20 Accrued interest on stockholder notes - - - - Dividend payable on Series C preferred stock - - - - Net loss - - - - ------------------------------------------------------------- Balance at April 30, 1995 700,000 7,000 3,338,656 33,385 Issuance of common stock under stock option plans - - 17,174 172 Issuance of common stock for non-compete agreements and acquisition of minority interest - - 197,087 1,971 Issuance of common stock for a note receivable - - 25,000 250 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 Issuance of common stock under stock option plans including realization of income tax benefit of $369,000 - - 96,016 960 Dividend payable on Series C preferred stock - - - - Proceeds from payment of stockholder notes - - - - Exercise of warrants to purchase common stock - - 657,524 6,575 Issuance of common stock for consulting services - - 2,050 21 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 ============================================================= NOTES RECEIVABLE PAID-IN FROM RETAINED TOTAL STOCKHOLDERS' CAPITAL STOCKHOLDERS EARNINGS EQUITY ----------------------------------------------------------------------- Balance at April 30, 1994 $5,280,687 $ - $2,385,566 $7,699,328 Issuance of Series C convertible preferred stock, net of issuance costs of $105,628 1,637,372 (60,000) - 1,584,372 Exercise of Redeemable A Warrants to purchase common stock 115,723 - - 116,013 Issuance of common stock under stock option plan 16,480 - - 16,500 Accrued interest on stockholder notes - (2,626) - (2,626) Dividend payable on Series C preferred stock - - (65,537) (65,537) Net loss - - (2,286,457) (2,286,457) ----------------------------------------------------------------------- Balance at April 30, 1995 7,050,262 (62,626) 33,572 7,061,593 Issuance of common stock under stock option plans 61,202 1,184 - 62,558 Issuance of common stock for non-compete agreements and acquisition of minority interest 1,029,279 - - 1,031,250 Issuance of common stock for a note receivable 118,500 (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 8,259,243 (141,547) 951,949 9,112,423 Issuance of common stock under stock option plans including realization of income tax benefit of $369,000 729,189 - - 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 3,104,801 - - 3,111,376 Issuance of common stock for consulting services 45,336 - - 45,357 Conversion of Series C convertible preferred stock - - - - Net income - - 3,124,041 3,124,041 ----------------------------------------------------------------------- Balance at April 30, 1997 $12,138,569 $ - $4,058,648 $16,247,551 =======================================================================
See accompanying notes. F-4 51 PMR Corporation Consolidated Statements of Cash Flows
YEAR ENDED APRIL 30 1997 1996 1995 ---------------------------------------------------------- OPERATING ACTIVITIES Net income (loss) $ 3,124,041 $ 1,050,063 $ (2,286,457) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 700,734 595,896 403,294 Issuance of stock for consulting services 45,357 -- -- Provision for losses on accounts receivable 3,084,166 1,447,983 1,317,483 Accrued interest income on notes receivable from stockholders -- (4,507) (2,626) Deferred income taxes (3,834,000) (841,000) (924,000) Minority interest in loss of joint venture -- (524) (108,201) Changes in operating assets and liabilities: Accounts and notes receivable (4,980,050) (3,778,660) (3,142,713) Refundable income tax -- 817,165 (817,165) Prepaid expenses and other assets (250,630) (88,487) (176,474) Accounts payable and accrued expenses 212,937 474,124 154,831 Accrued compensation and employee benefits 675,058 1,415,780 (13,776) Advances from case management agencies (86,135) 1,012,847 -- Other liabilities (127,213) (205,034) (193,742) Contract settlement reserve 3,292,908 1,975,797 651,761 Income taxes payable 1,394,511 308,489 (356,000) Deferred rent expense (56,709) (60,331) 83,830 ---------------------------------------------------------- Net cash provided by (used in) operating activities 3,194,975 4,119,601 (5,409,955) INVESTING ACTIVITIES Purchases of furniture and office equipment (958,685) (179,281) (164,916) Acquisition of Twin Town minority interest -- (185,000) -- ---------------------------------------------------------- Net cash used in investing activities (958,685) (364,281) (164,916) FINANCING ACTIVITIES Proceeds from sale of preferred stock -- -- 1,584,372 Proceeds from sale of common stock and notes receivable from stockholders 3,983,072 105,710 132,513 Proceeds from note payable to bank -- 800,000 2,800,000 Payments on note payable to bank -- (2,000,000) (1,600,000) Cash dividend paid (89,081) (125,484) -- ---------------------------------------------------------- Net cash provided by (used in) financing activities 3,893,991 (1,219,774) 2,916,885 ---------------------------------------------------------- Net increase (decrease) in cash 6,130,281 2,535,546 (2,657,986) Cash at beginning of year 3,917,922 1,382,376 4,040,362 ---------------------------------------------------------- Cash at end of year $ 10,048,203 $ 3,917,922 $ 1,382,376 ========================================================== SUPPLEMENTAL INFORMATION: Taxes paid $ 4,611,489 $ 380,735 $ 830,000 ========================================================== Interest paid $ 17,612 $ 129,108 $ 107,831 ==========================================================
See accompanying notes. F-5 52 PMR Corporation Notes to Consolidated Financial Statements April 30, 1997 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. Prior to July 1995, Twin Town Outpatient was a 51% owned subsidiary. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of highly liquid investments with maturities, when acquired, of three months or less. 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 $6,593,000 at April 30, 1997, 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 at April 30, 1997 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. F-6 53 PMR Corporation Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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, 1997 was $344,254, $320,212 and $297,240, respectively. OTHER ASSETS Other assets are comprised of the following at April 30:
1997 1996 ------------------------------ 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 878,165 521,685 ------------------------------ $1,501,622 $1,858,102 ==============================
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 Earnings per share is computed using the weighted average number of common and common equivalent shares outstanding during the year. Common stock equivalents consist of employee and director stock options, warrants and Convertible Preferred Stock. Earnings per share is affected by the reduction of net income available for common stock by the amount of dividends on Series C Convertible Preferred Stock. The Series C Convertible Preferred Stock shares were outstanding at April 30, 1996 but were converted to common stock during fiscal 1997 (see Note 6). Assuming the conversion of the Series C preferred stock had taken place on May 1, 1995, primary earnings per share would have been unchanged in fiscal 1996. 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 (loss) 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 this entity. The Company plans to adopt SFAS No. 128 beginning with its financial statements for the third fiscal quarter ended January 31, 1998. The impact of SFAS No. 128 on the calculation of either basic or diluted net income (loss) per share for the years ended April 30, 1997, 1996 and 1995 is not expected to be material. 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 F-7 54 PMR Corporation Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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 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 $7,600,000 and $13,429,000 for the years ended April 30, 1996 and 1997, respectively. There were no such revenues in fiscal 1995. The Company also operates chemical dependency rehabilitation programs. Revenue from these programs for the years ended April 30, 1997, 1996 and 1995 was $1,673,000, $1,898,000 and $1,592,000, 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 of the Company's contracts the Company is obligated under warranty provisions to indemnify the Provider for all or some portions of the Company's management fees that may be disallowed as reimbursable to the Provider by Medicare's fiscal intermediaries. The Company has recorded 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 is classified as a non-current liability as ultimate resolution of substantially all of these issues is not expected to occur during fiscal 1998. F-8 55 PMR Corporation Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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. NEW ACCOUNTING STANDARDS On May 1, 1996, the Company adopted the Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation," Statement No. 123 allows companies to either account for stock-based compensation under the new provisions of Statement No. 123 or under the provisions of APB Opinion 25, but requires pro-forma disclosure in the footnotes to the financial statements as if the measurement provisions of Statement No. 123 had been adopted. The Company has elected to continue accounting for its stock-based compensation in accordance with the provisions of APB Opinion 25. Accordingly, the provisions of Statement No. 123 will not impact the financial position or the results of operations of the Company. The Company also 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," on May 1, 1996. The new Statement 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 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 adoption of Statement No. 121 did not have any material impact on the financial position or results of operations of the Company. F-9 56 PMR Corporation Notes to Consolidated Financial Statements (continued) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECLASSIFICATION Certain classifications of accounts in the prior year have been reclassified to reflect current year classifications. 2. ACQUISITION OF MINORITY INTEREST AND OTHER AFFILIATIONS In July 1995, the Company acquired the 49% minority interest in Twin Town Outpatient for $185,000 in cash and $550,000 in common stock (97,087 shares) for total consideration of $735,000. The total purchase price was allocated to goodwill net of minority interest of $50,142. 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. PURCHASED PROPRIETARY INFORMATION In April 1993, the Company purchased certain proprietary information relating to a complete framework and service design for assisting patients with serious and persistent mental illness to advance through the recovery process within a managed care and cost containment environment. The complete framework and service design includes the protocols, techniques, programs and service development plans needed to operate the resulting new business, for which the Company paid $50,000 cash and issued 69,118 shares of common stock valued at $8.50 per share. The seller was entitled to receive up to 225,000 additional shares of the Company's common stock during the four year period through April 1997, based on pre-tax income of the business resulting from the purchased proprietary information, which would have been accounted for as additional purchase price when, and if, issued. The earnings goals necessary in order to entitle the sellers to additional shares of the Company's common stock were not met. The purchase price included an agreement of the principals of Co-A-Les Corp., the seller, not to compete for a period of up to five years after any possible contingent purchase price shares were earned. F-10 57 PMR Corporation Notes to Consolidated Financial Statements (continued) 4. LONG-TERM RECEIVABLES Long-term receivables at April 30, 1997 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. 5. LINE OF CREDIT The Company has a credit agreement with a bank that permits borrowings 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 that expires on December 31, 1997 and is collateralized by substantially all of the Company's assets. Interest on borrowings is payable monthly at either the Bank's reference rate plus 0.5% or at the Bank's Eurodollar rate plus 2.5%. There were no borrowings outstanding at April 30, 1997. 6. STOCKHOLDERS' EQUITY In June 1996, the Company called for redemption 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. 7. STOCK OPTIONS AND WARRANTS During 1997 the board of directors of the Company amended the Employees' Incentive Stock Option Plan of 1990 and renamed it the 1997 Equity Incentive Plan (the "1997 Plan"). The 1997 Plan provides for the granting of options to purchase up to 2,000,000 shares of common stock to eligible employees and consultants to the Company. 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 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 director options to purchase 15,000 shares 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. F-11 58 PMR Corporation Notes to Consolidated Financial Statements (continued) 7. STOCK OPTIONS AND WARRANTS (CONTINUED) Warrants to purchase shares of the Company's common stock were issued in each of the three years in the period ended April 30, 1997 to brokers in connection with financing transactions (See Note 6). As of April 30, 1997, 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. Adjusted pro forma information regarding net income or loss and net income or loss 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 both 1996 and 1997: risk-free interest rates of 6.5%; dividend yield of 0%; volatility factors of the expected market price of the Company's common stock of 88%; and a weighted-average expected life of the option of 6 years. 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, 1997 and 1996, follows:
1997 1996 ---------------------------- Pro forma net income (in thousands) $ 1,968 $ 98 Pro forma income per share $ .34 $ .02 Pro forma income per share, fully diluted $ .34 $ .02
The pro forma effect on net income for the year ended April 30, 1997 and 1996 is not likely to be representative of the effects on reported income or loss in future years because these amounts reflect only two years or one year of vesting, respectively. F-12 59 PMR Corporation Notes to Consolidated Financial Statements (continued) 7. STOCK OPTIONS AND WARRANTS (CONTINUED) A summary of the Company's stock option activity and related information for the years ended April 30, is as follows:
WEIGHTED-AVERAGE EXERCISE SHARES PRICE ------------------------------------------- Outstanding April 30, 1994 401,739 $ 4.99 Granted 355,620 3.55 Exercised (29,003) 4.00 Forfeited (29,232) 4.50 ------------------------------------------- Outstanding April 30, 1995 (699,124) 4.41 Granted 897,526 7.57 Exercised (13,174) 3.40 Forfeited (32,423) 4.11 ------------------------------------------- Outstanding April 30, 1996 1,551,053 6.63 Granted 486,837 20.50 Exercised (228,540) 5.17 Forfeited (27,744) 8.44 ------------------------------------------- Outstanding April 30, 1997 1,781,606 $ 14.72 ===========================================
At April 30, 1997 options to purchase 974,913 shares of common stock were exercisable and 1,069,772 shares and 270,000 shares were available for future grant under the 1997 Plan and the 1992 Plan, respectively. The weighted-average fair value of options granted was $15.21 and $4.48 in fiscal years 1997 and 1996, respectively. A summary of options outstanding and exercisable as of April 30, 1997 follows:
WEIGHTED- WEIGHTED- WEIGHTED- OPTIONS AVERAGE AVERAGE OPTIONS AVERAGE OUTSTANDING EXERCISE PRICE EXERCISE CONTRACTUAL EXERCISABLE EXERCISE (IN THOUSANDS) RANGE PRICE LIFE (IN THOUSANDS) PRICE - ------------------------------------------------------------------------------------------------------- 964 $2.37 - $6.50 $4.21 7.23 771 $4.18 732 $7.00 - $19.875 $16.81 9.43 204 $15.244 86 $20.875 - $28.50 $23.71 9.68 - $ -
F-13 60 PMR Corporation Notes to Consolidated Financial Statements (continued) 8. INCOME TAXES Income tax expense (benefit) consists of the following:
YEAR ENDED APRIL 30 1997 1996 1995 ------------------------------------------------------- Federal: Current $ 4,868,000 $ 1,220,000 $ (284,000) Deferred (3,009,000) (685,000) (698,000) ------------------------------------------------------- 1,859,000 535,000 (982,000) State: Current 1,138,000 351,000 (58,000) Deferred (825,000) (156,000) (226,000) ------------------------------------------------------- 313,000 195,000 (284,000) ------------------------------------------------------- $ 2,172,000 $ 730,000 $(1,266,000) =======================================================
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.
1997 1996 ---------- ---------- Deferred tax assets: Contract settlement reserve $3,609,000 $2,405,000 Accrued compensation and employee benefits 531,000 501,000 Allowance for bad debts 1,979,000 497,000 State income taxes 280,000 87,000 Depreciation and amortization 163,000 77,000 Other 159,000 129,000 ---------- ---------- Total deferred tax assets 6,721,000 3,696,000 Deferred tax liabilities: Non-accrual experience method 326,000 227,000 Accrual to cash method of accounting -- 577,000 Contractual retainers 961,000 1,292,000 ---------- ---------- Total deferred tax liabilities 1,287,000 2,096,000 ---------- ---------- Net deferred tax assets $5,434,000 $1,600,000 ========== ==========
F-14 61 PMR Corporation Notes to Consolidated Financial Statements (continued) 8. INCOME TAXES (CONTINUED) A reconciliation between the federal income tax rate and the effective income tax rate is as follows:
YEAR ENDED APRIL 30 1997 1996 1995 -------------------------------- Statutory federal income tax rate 35% 34% 34% State income taxes, net of federal tax benefit 6 7 6 Other -- -- (4) -------------------------------- Effective income tax rate 41% 41% 36% ================================
9. 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 1997 1996 1995 ----------------------------------------------------------- A 23 21% - B 13 11 16% C - 11 D 11
10. 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 year ended April 30, 1997, 1996 and 1995, the Company contributed $186,000, $138,000 and $134,000, respectively, to match employee deferrals. F-15 62 PMR Corporation Notes to Consolidated Financial Statements (continued) 11. COMMITMENTS 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, 1997 are as follows: 1998 - $2,272,000; 1999 - $1,836,000; 2000 - $1,232,000; 2001 - $1,011,000; 2002 - $666,000 and $102,000 thereafter. Rent expense totaled $2,690,800, $1,950,000 and $1,811,000 for the year ended April 30, 1997, 1996 and 1995, respectively. F-16 63 Schedule 64 Schedule II PMR Corporation Valuation and Qualifying Accounts
- ---------------------------------------------------------------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E - ---------------------------------------------------------------------------------------------------------------------------------- ADDITIONS ---------------------------------- CHARGED TO DESCRIPTION BALANCE AT CHARGED TO OTHER BALANCE AT BEGINNING OF COSTS AND ACCOUNTS- DEDUCTIONS - END OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD - ---------------------------------------------------------------------------------------------------------------------------------- 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 Year ended April 30, 1995 Allowance for doubtful accounts $400,000 $1,317,483 $ - $294,429 (1) $1,423,054 Contract settlement reserve $2,871,462 $3,899,000 $ - $3,247,239 (2) $3,523,223
- ------------------ (1) Uncollectible accounts written off, net of recoveries (2) Write off of hospital receivables based on denials or estimated adjustments by Medicare 18 EX-3.1 2 EXHIBIT 3.1 1 EXHIBIT 3.1 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: FIRST. The name of the Corporation is PMR Corporation. SECOND. 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. THIRD. This Restated Certificate of Incorporation was duly adopted by the corporation in accordance with Section 245 of the General Corporation Law of the State of Delaware. FOURTH. This Restated Certificate of Incorporation of the corporation restates and integrates and does not further amend the provisions of the corporation's Certificate of Incorporation as theretofore amended or supplemented. There are no discrepancies between the provisions of the Certificate of Incorporation and the provisions of this Restated Certificate of Incorporation. 1. 2 FIFTH. The Certificate of Incorporation of the corporation shall be restated to read in full 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 General Corporation Law of the State of Delaware. ARTICLE V. A. The total number of shares of stock which the Corporation shall have authority to issue is eleven million (11,000,000) which shall be divided into three classes designated and hereinafter called "Common Stock," "Series A $4.50 Convertible Preferred Stock" and "Preferred Stock." The Common Stock shall consist of ten million (10,000,000) shares, each with a par value of One Cent ($.01). The "Series A $4.50 Convertible Preferred Stock" shall consist of two hundred thousand (200,000) shares, each with a par value of One Cent ($.01). The "Preferred Stock" shall consist of eight hundred thousand (800,000) shares, each with a par value of One Cent ($.01). The Board of Directors shall have the authority to fix by resolution such designations, powers, preferences, rights, qualifications, limitations or restrictions on the shares of Preferred Stock that may be desired. 2. 3 ARTICLE VI. AMENDMENTS TO BYLAWS. 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. No director shall be personally liable to the Company 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 Company 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 General Corporation Law of the State of Delaware, or (iv) for any transaction from which the director derived an improper personal benefit. No amendment to or repeal of this Article 7 shall apply to or have any effect on the liability or alleged liability of any director of the Company for or with respect to any acts or omissions of such director occurring prior to such amendment or repeal. ARTICLE VIII. The board of directors of the Corporation may by resolution adopted from time to time or as may be permitted by the Bylaws indemnify such persons, and to the full extent, permitted by the General Corporation Law of the State of Delaware as amended from time to time. The board of directors of the Corporation may by resolution adopted from time to time purchase and maintain insurance on behalf of such persons, and to the full extent, permitted by the General Corporation Law of the State of Delaware as amended from time to time. ARTICLE IX. AMENDMENTS TO CERTIFICATE OF INCORPORATION. 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 3. 4 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. BOARD OF DIRECTORS: A. NUMBERS, ELECTIONS AND TERMS. 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 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. NEWLY CREATED DIRECTORSHIPS AND VACANCIES. 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 4. 5 qualified. No decrease in the number of Directors constituting the Board of Directors shall shorten the term of any incumbent director. C. REMOVAL. 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. AMENDMENT, REPEAL, ETC. 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. 5. 6 IN WITNESS WHEREOF, said PMR Corporation has caused this Restated Certificate of Incorporation to be signed by its Chief Executive Officer, Allen Tepper, and attested to by its Secretary, Susan D. Erskine, this 9th day of May, 1997. /s/ Allen Tepper ----------------------- Allen Tepper Chief Executive Officer Attest: /s/ Susan D. Erskine - -------------------- Susan D. Erskine Secretary 6. EX-3.2 3 EXHIBIT 3.2 1 EXHIBIT 3.2 PMR CORPORATION AMENDED AND RESTATED BY-LAWS ARTICLE I IDENTIFICATION SECTION 1. NAME. The name of the Corporation is PMR CORPORATION. SECTION 2. REGISTERED OFFICE. The address of the registered office of the Corporation shall be 3990 Old Town Avenue, Suite 206A, San Diego, California 92110. SECTION 3. SEAL. The seal of the Corporation shall be circular in form and mounted upon a metal die, suitable for impressing the same upon paper. About the periphery of the seal shall appear the words "PMR CORPORATION". In the center of the seal shall appear the word "Delaware" and the year of incorporation of the Corporation. The seal shall be kept in the Office of the Secretary of the Corporation. SECTION 4. FISCAL YEAR. The Board of Directors shall have the power by resolution to fix the fiscal year of the Corporation. If the Board of Directors shall fail to do so, the President shall fix the fiscal year. ARTICLE II CAPITAL STOCK SECTION 1. CERTIFICATES REPRESENTING SHARES. The certificates for shares of the Corporation shall be signed by the Chairman of the Board, the President or by a Vice-President and the Secretary or an Assistant Secretary and shall be sealed with the corporate seal, which may be a facsimile, engraved or printed, but where such certificate is signed by a transfer agent or a registrar, the signature of any corporate officer upon such certificate may be a facsimile, engraved or printed. In case any officer who has signed, or whose facsimile signature has been placed upon any share certificate shall have ceased to be such officer because of death, resignation, or otherwise, before the certificate is issued, it may be issued by the Corporation with the same effect as if the officer had not ceased to be such at the date of its issue. The name of the person owning the shares represented thereby, with the number of such shares and the date of issue, shall be entered on the Corporation's books, and on the face of the share certificate. The share certificates shall be of the form, not inconsistent with the Certificate of Incorporation, as shall be approved by the Board of Directors. 1. 2 SECTION 2. FORM. Every holder of stock in the Corporation shall be entitled to have a certificate, signed by, or in the name of the Corporation by the Chairman of the Board, the President or a Vice-President and the Secretary or an Assistant Secretary of the Corporation, certifying the number of shares owned by such holder in the Corporation. If such a certificate is countersigned (1) by a transfer agent or an assistant transfer agent other than the Corporation or its employee or (2) by a registrar, other than the Corporation or its employee, the signature of any such President, Vice-President, Secretary, or Assistant Secretary may be facsimiles. In case any officer or officers who have signed, or whose facsimile signature or signatures have been used on, any such certificate or certificates shall cease to be such officer or officers of the Corporation whether because of death, resignation or otherwise before such certificate or certificates have been delivered by the Corporation, such certificate or certificates may nevertheless be issued and delivered as though the person or persons who signed such certificate or certificates or whose facsimile signature or signatures have been used thereon had not ceased to be such officer or officers of the Corporation. All certificates for shares shall be consecutively numbered or otherwise identified. The name of the person to whom the shares represented thereby are issued, with the number of shares and date of issue, shall be entered on the books of the Corporation. Shares of stock of the Corporation shall only be transferred on the books of the Corporation by the holder of record thereof or by such holder's attorney duly authorized in writing, upon surrender to the Corporation of the certificate or certificates for such shares endorsed by the appropriate person or persons, with such evidence of the authenticity of such endorsement, transfer, authorization, and other matters as the Corporation may reasonably require, and accompanied by all necessary stock transfer stamps. In that event, it shall be the duty of the Corporation to issue a new certificate to the person entitled thereto, cancel the old certificate or certificates, and record the transaction on its books. SECTION 3. LOST, STOLEN OR DESTROYED CERTIFICATES. The Corporation may issue a new certificate for shares of stock in the place of any certificate theretofore issued and alleged to have been lost, stolen or destroyed, but the Board of Directors may require the owner of such lost, stolen or destroyed certificate, or his legal representative, to furnish an affidavit as to such loss, theft, or destruction and to give a bond in such form and substance, and with such surety or sureties, with fixed or open penalty, as it may direct, to indemnify the Corporation against any claim that may be made against it on account of the alleged loss, theft or destruction of such certificate. ARTICLE III THE STOCKHOLDERS SECTION 1. PLACE OF MEETINGS. Meetings of the stockholders of the Corporation may be held at such place, either within or without the State of Delaware, as may be 2. 3 designated in the respective notices, or waivers of notice, thereof, or proxies to represent stockholders thereat. SECTION 2. STOCKHOLDERS' MEETINGS. 2.1 ANNUAL MEETING. The annual meeting of the stockholders for the election of directors and for the transaction of such other business as may properly come before the meeting shall be held in each calendar year on such day as shall be fixed by the Board of Directors from time to time. If the annual meeting shall not be called and held during a calendar year, any stockholder may call such meeting at any time thereafter. 2.2 SPECIAL MEETINGS. Special meetings of the stockholders may be called by or at the request of the Chairman of the Board, the Chief Executive Officer or President. The Secretary or any Assistant Secretary shall call a special meeting of the stockholders at the written request of a majority of the directors. At any time upon written request of any person or persons entitled to call a special meeting, it shall be the duty of the Secretary to call a special meeting of the stockholders to be held at such time as the Secretary may fix, not less than ten (10) nor more than sixty (60) days after the receipt of the request. If the Secretary shall neglect or refuse to issue such call, the person or persons making the request may do so. SECTION 3. CORPORATE RECORDS; INSPECTION. 3.1 OBLIGATION TO MAINTAIN. The Corporation shall keep at its registered office or at its principal place of business an original or duplicate record of the proceedings of the stockholders and of the Board of Directors, the original or a copy of its By-Laws, certified by the Secretary of the Corporation, the Corporation's stock ledger, and a list of its stockholders, giving the names of the stockholders in alphabetical order, and showing their respective addresses, the number and classes of shares held by each, the number and date of certificates issued for the shares, and the number and date of cancellation of every certificate surrendered for cancellation. The Corporation shall also keep appropriate, complete and accurate books or records of account, which may be kept at its registered office, or at its principal place of business. 3.2 RIGHT OF INSPECTION. Every stockholder of record shall have a right to examine, upon written demand under oath stating the purpose thereof, in person or by agent or attorney, during usual business hours, for any proper purpose, the stock ledger, the list of stockholders, the Corporation's books or records of account, and records of the proceedings of the stockholders and directors, and make copies or extracts therefrom. A proper purpose shall mean any purpose reasonably related to such person's interest as a stockholder. In every instance where an attorney or other agent shall be the person who seeks the right to inspection, the demand under oath shall be accompanied by a power of 3. 4 attorney or such other writing which authorizes the attorney or other agent to so act on behalf of the stockholder. The demand under oath shall be directed to the Corporation at its registered office in the State of Delaware or at its principal place of business. SECTION 4. NOTICE OF MEETINGS - WAIVER. Written or printed notice, stating the place, date and hour of the meeting and, in case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered not less than ten (10), nor more than sixty (60), days before the date of the meeting, either personally or by mail, by or at the direction of the President, the Secretary, or the officer or person calling the meeting, to each stockholder of record entitled to vote at such meeting, and to each holder of other securities having voting power. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail, postage prepaid, directed to the stockholder or such other security holder at his address as it appears on the records of the Corporation. An affidavit of the Secretary or an Assistant Secretary or of the transfer agent of the corporation that the notice has been given shall, in the absence of fraud, be prima facie evidence of the facts stated therein. Waiver by a stockholder of notice in writing of a stockholders' meeting, signed by him, whether before or after the time stated therein, shall be equivalent to the giving of such notice, and neither the business to be transacted at, nor the purpose of, such meeting need be specified in such waiver. Attendance by a stockholder, whether in person or by proxy, at a stockholders' meeting shall constitute a waiver of notice of such meeting, except where a person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting was not lawfully called or convened. SECTION 5. FIXING RECORD DATE. For the purpose of determining stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or entitled to receive payment of any dividend, or in order to make a determination of stockholders, such date in any case to be not more than sixty (60) days, and in case of a meeting of stockholders not less than ten (10) days, prior to the date on which the particular action, requiring such determination of stockholders, is to be taken. If no record date is fixed: (a) the record date for the determination of stockholders entitled to notice of or to vote at a meeting of stockholders, shall be at the close of business on the day next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held; (b) the record date for determining stockholders for any other purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto. When a determination of stockholders entitled to notice of or to vote at any meeting of stockholders has been made as provided in this Section, such determination shall apply to any adjournment thereof; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. 4. 5 SECTION 6. VOTING LIST. The officer of the Corporation who has charge of the stock ledger of the Corporation shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at such meeting, arranged in alphabetical order, with the address of and the number of shares held by each, which list shall be open to the examination of any stockholder, for any purpose germane to the meeting during the ordinary business hours, for a period of at least ten (10) days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified at the place where the meeting is to be held. Such list shall also be produced and kept at the time and place of the meeting during the whole time of the meeting, and shall be subject to the inspection of any stockholder who is present. The stock ledger shall be the only evidence as to who are the stockholders entitled to examine the stock ledger, the stockholder's list, or the books of the Corporation, or to vote in person or by proxy at any meeting of stockholders. SECTION 7. QUORUM. The holders of a majority of the shares outstanding and entitled to vote at a meeting, present in person or represented by proxy, shall constitute a quorum at a meeting of stockholders, except as otherwise provided by statute or by the Certificate of Incorporation. The stockholders present at a duly organized meeting may continue to do business until adjournment, notwithstanding the withdrawal of enough of the stockholders to leave less than a quorum. If a meeting cannot be organized because a quorum has not attended, the majority of those present or represented by proxy, and entitled to vote at the meeting, may, except as otherwise provided by law, adjourn the meeting to such time and place as they may determine. When a specified item of business requires a vote by a class or series (if the Corporation shall then have outstanding shares of more than one (1) class or series) voting as a class, the holders of a majority of the shares of such class or series shall constitute a quorum (as to such class or series) for the transaction of such item of business. SECTION 8. VOTING AT MEETINGS. 8.1 VOTING STOCK. Except as otherwise provided by law or by the Certificate of Incorporation, each stockholder shall have one (1) vote for each share of stock entitled to vote and held of record by such stockholder and a proportionate vote for each fractional share so held. Any action which may be taken at a meeting of the stockholders may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon present and voted and shall be filed with the Secretary of the Corporation. 5. 6 8.2 PROXIES. A stockholder, or the holder of any other security having voting power, may vote either in person or by proxy executed in writing by the stockholder, or by his duly authorized attorney-in-fact. No unrevoked proxy shall be voted or acted upon after three (3) years from the date of its execution, unless the proxy provides for a longer period. A duly executed proxy shall be irrevocable if it states that it is irrevocable and if, and only so long as, it is coupled with an interest sufficient in law to support an irrevocable power. 8.3 VOTING OF SHARES OWNED BY OTHER CORPORATIONS. Shares standing in the name of another corporation may be voted by such officer, agent or proxy as the By-Laws of such other corporation may prescribe, or, in the absence of such provision, as the board of directors of such other corporation may determine; or, in the absence of such provision or determination, as the President or Vice President and Secretary or Assistant Secretary of such other corporation may by proxy, duly executed and sealed (but not necessarily acknowledged or verified), designate. 8.4 VOTING OF SHARES OWNED BY FIDUCIARIES. Shares held by an administrator, executor, guardian or conservator may be voted by him, either in person or by proxy, without a transfer of such shares into his name. Shares standing in the name of a trustee may be voted by him, either in person or by proxy, but no trustee shall be entitled to vote shares held by him without a transfer of such shares into his name. It shall not be necessary for such fiduciary to obtain a court order authorizing him to vote such shares. The general proxy of a fiduciary shall be given the same weight and effect as the general proxy of an individual or corporation. 8.5 VOTING OF SECURITIES OWNED BY TWO OR MORE PERSONS. If shares or other securities having voting power stand of record in the names of two or more persons, the right to vote such securities and the effect of such vote shall be determined as provided in Section 217 of the General Corporation Law of Delaware, effective July 3, 1967, or any law amending or supplementing the same. 8.6 VOTING OF SHARES OWNED BY RECEIVERS. Shares standing in the name of a receiver may be voted by such receiver without the transfer thereof into his name if authority so to do be contained in an appropriate order of the court by which such receiver was appointed. 8.7 VOTING OF PLEDGED SHARES. A stockholder whose shares are pledged shall be entitled to vote such shares unless in the transfer by the pledgor on the books of the Corporation he has expressly empowered the pledgee to vote thereon, in which case only the pledgee, or his proxy, may represent such stock and vote thereon. 6. 7 8.8 ORDER OF BUSINESS. The order of business at annual meetings, and so far as practicable at all other meetings, of stockholders, shall be as follows: (a) Proof of due notice of meeting. (b) Call of roll - examination of proxies. (c) Reading and disposal of any unapproved minutes. (d) Annual reports of officers and committees. (e) Unfinished business. (f) New business. (g) Election of directors. (h) Adjournment. SECTION 9. JUDGES OF ELECTION. 9.1 APPOINTMENT OF JUDGES. In advance of any meeting of stockholders, the Board of Directors may appoint judges of election, who need not be stockholders, to act at such meeting or any adjournment thereof. If judges of election be not so appointed, the chairman of any such meeting may, and on the request of any stockholder or his proxy, shall make such appointment at the meeting. The number of judges shall be one (1) or three (3). If appointed at a meeting on the request of one (1) or more stockholders or proxies, the majority of shares present and entitled to vote shall determine whether one (1) or three (3) judges are to be appointed. No person who is a candidate for office shall act as a judge. 9.2 FAILURE TO ACT. In case any person appointed as judge fails to appear or fails or refuses to act, the vacancy may be filled by appointment made by the Board of Directors in advance of the convening of the meeting, or at the meeting by the person or officer acting as chairman. 9.3 DUTIES OF JUDGES. The judges of election shall determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, the authenticity, validity, and effect of proxies, receive votes or ballots, hear and determine all challenges and questions in any way arising in connection with the right to vote, count, and tabulate all votes, determine the result, and do such acts as may be proper to conduct the election. If there be three (3) judges of election, the decision, act or certificate of a majority shall be effective in all respects as the decision, act or certificate of all. 7. 8 9.4 JUDGES' CERTIFICATE. On request of the chairman of the meeting, or of any stockholder or his proxy, the judges shall make a report in writing of any challenge or question or matter determined by them, and execute a certificate of any fact found by them. Any report or certificate made by them shall be prima facie evidence of the facts stated therein. ARTICLE IV THE BOARD OF DIRECTORS SECTION 1. SECTION The business and affairs of the Corporation shall be managed by a Board of Directors (who need not be residents of the State of Delaware, nor stockholders of the Corporation). SECTION 2. NUMBERS, ELECTIONS AND TERMS. Except as otherwise fixed by or pursuant to provisions of the Certificate of Incorporation 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 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, 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. The directors shall be elected by a plurality of votes of the shares present in person or represented by proxy at the meeting and entitled to vote in the election of directors. Election of directors shall be by written ballot if any stockholder so requests. SECTION 3. SECTION Only persons who are nominated in accordance with the following procedures shall be eligible for election by the stockholders as directors of the Corporation. Nominations of persons for election as directors of the Corporation may be made at a meeting of stockholders (a) by or at the direction of the Board of Directors, (b) by any nominating committee or persons appointed by the Board of Directors or (c) by any stockholder of the Corporation entitled to vote for the election of directors at 8. 9 the meeting who complies with the notice procedures set forth in this Section 3. Such nominations, other than those made by or at the direction of the Board of Directors, shall be made pursuant to timely notice in writing to the Secretary of the Corporation. To be timely, a stockholder's notice shall be delivered to or mailed and received at the principal executive office of the Corporation not less than 50 days nor more than 75 days prior to the meeting; provided, however, that in the event that less than 60 days' notice or prior public disclosure of the date of the meeting is given or made to stockholders, notice by the stockholder to be timely must be so received not later than the close of business on the tenth day following the day on which such notice of the date of the meeting was mailed or such public disclosure was made, whichever first occurs. Such stockholder's notice to the Secretary of the Corporation shall set forth (a) as to each person whom the stockholder proposes to nominate for election or reelection as a director, (i) the name, age, business address and residence address of the person, (ii) the principal occupation or employment of the person, (iii) the class and number of shares of capital stock of the Corporation which are beneficially owned by the person and (iv) any other information relating to the person that is required to be disclosed in solicitations for proxies for election of directors pursuant to Regulation 14A under the Securities Exchange Act of 1934, as now or hereafter amended; and (b) as to the stockholder giving the notice, (i) the name and record address of such stockholder and (ii) the class and number of shares of capital stock of the Corporation which are beneficially owned by such stockholder. The Corporation may require any proposed nominee to furnish such other information as may reasonably be required by the Corporation to determine the eligibility of such proposed nominee to serve as a director of the Corporation. No person shall be eligible for election by the stockholders as a director of the Corporation unless nominated in accordance with the procedures set forth herein. The chairman of the meeting of the stockholders shall, if the facts warrant, determine and declare to the meeting that nomination was not made in accordance with the foregoing procedure, and if he should so determine, he shall so declare to the meeting and the defective nomination shall be disregarded. SECTION 4. NEWLY CREATED DIRECTORSHIPS AND VACANCIES. Except as otherwise fixed by or pursuant to provisions of the Certificate of Incorporation 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 then 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 9. 10 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. SECTION 5. PLACE OF MEETINGS. Meetings of the Board of Directors of the Corporation, annual, regular or special, may be held either within or without the State of Delaware. SECTION 6. DIRECTORS' MEETINGS. 6.1 ANNUAL MEETING. The Board of Directors shall meet each year immediately after the annual meeting of the stockholders, at the place where such meeting of the stockholders has been held for the purpose of organization, election of officers, and consideration of any other business that may properly by brought before the meeting. No notice of any kind to either old or new members of the Board of Directors for such annual meeting shall be necessary. 6.2 REGULAR MEETINGS. Regular meetings of the Board of Directors shall be held without notice at such time and place as may, from time to time, be fixed by resolution of the Board or as may be specified in the call of the meeting. 6.3 SPECIAL MEETINGS. Special meetings of the Board of Directors may be called by or at the request of the Chairman of the Board, the Chief Executive Officer or the President on at least forty-eight (48) hours notice to each director, either personally, by telephone, by mail, or by facsimile; in like manner and on like notice the Chairman of the Board, Chief Executive Officer or the President must call a special meeting on the written request of any member of the Board of Directors. Notice of any special meeting of the Board of Directors may be waived in writing signed by the person or persons entitled to such notice, whether before or after the time stated therein, and shall be equivalent to the giving of such notice. Neither the business to be transacted at, nor the purpose of, any special meeting of the Board of Directors, need be specified in the notice or waiver of notice of such meeting. Notice of such special meeting shall include the place, day and hour of such special meeting. 6.4 ADJOURNMENT. If a quorum shall not be present at any meeting of the Board of Directors, the directors present thereat may adjourn the meeting. When a meeting is adjourned, it shall not be necessary to give any notice of the adjourned meeting, or of the business to be transacted at an adjourned meeting, other than by announcement at the meeting at which such adjournment is taken. SECTION 7. QUORUM. A majority of the number of directors fixed in accordance with these By-Laws shall constitute a quorum for the transaction of business. The act of the majority of the directors present at a meeting at which a quorum is present shall be the act of the Board of Directors; provided that, if all of the directors shall severally or 10. 11 collectively consent in writing to any action to be taken by the Corporation, and the writing or writings are filed with the minutes of the proceedings of the Board of Directors, such action shall be as valid corporate action as though it had been authorized at a duly convened meeting of the Board of Directors; and provided, further, that one (1) or more directors may participate in a meeting of the Board by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other. SECTION 8. REMOVAL. Except as otherwise fixed by or pursuant to provisions of the Certificate of Incorporation 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. SECTION 9. INTEREST OF DIRECTORS AND OFFICERS IN CONTRACTS. 9.1 No contract or transaction between the Corporation and one (1) or more of its directors or officers, or between the Corporation and any other corporation, partnership, association, or other organization in which one (1) or more of its directors or officers are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee thereof which authorizes the contract or transaction, or solely because his or their votes are counted for such purpose, if: (a) The material facts as to his interest and as to the contract or transaction are disclosed or are known to the Board of Directors or the committee in good faith authorizes the contract or transaction by a vote sufficient for such purpose without counting the vote of the interested director or directors; or (b) The material facts as to his interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or (c) The contract or transaction is fair as to the Corporation as of the time it is authorized, approved or ratified by the Board of Directors, a committee thereof, or the stockholders. 9.2 Common or interested directors may be counted in determining the presence of a quorum at a meeting of the Board of Directors or of a committee which authorizes the contract or transaction. 11. 12 SECTION 10. FINANCIAL REPORT TO SHAREHOLDERS. The directors of the Corporation shall cause to be sent to the stockholders, within one hundred and twenty (120) days after the close of its fiscal year, or as soon thereafter as possible, a financial report as of the closing date of the preceding fiscal year. Such report shall be independently audited and shall give a summary of the assets and liabilities of the Corporation, the amount of dividends paid or declared during the past year, the condition, as to surplus or deficit and how acquired or created, the number of shares issued and outstanding, together with any such particulars as are necessary to disclose the general nature of the liabilities and assets of the Corporation. The report shall also set forth a balance sheet as of the closing date of the preceding fiscal or calendar year, together with a statement of income and profit and loss for the year ended on that date, accompanied by any report thereon of independent accountants. SECTION 11. COMPENSATION OF DIRECTORS. The members of the Board of Directors may pursuant to a resolution of the Board be paid a fee and expenses of attendance for attendance at all annual, regular, special and adjourned meetings of the Board or committee meetings. Any director of the Corporation may also serve the Corporation in any other capacity, and receive compensation therefor in any form. ARTICLE V COMMITTEES SECTION 1. COMMITTEES. The Board of Directors may, by resolution passed by the majority of the whole board, designate one (1) or more committees, each committee to consist of one or more directors of the Corporation, to perform such duties and make such investigations and reports as the Board of Directors shall by resolution determine unless otherwise limited by these By-Laws or by law. The Board of Directors may designate one (1) or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. No member of a committee shall continue to be a member thereof after he ceases to be a director of the Corporation. The Board of Directors shall have the power at any time to increase or decrease the number of members of any committee, to fill vacancies thereon, to change any members thereof, and to change the functions or terminate the existence thereof. Each committee shall keep regular minutes of its meetings and report the same to the Board of Directors when required. SECTION 2. COMMITTEE RULES. Each committee of the Board of Directors may fix its own rules of procedure and shall hold its meetings as provided by such rules, except as may otherwise be provided in a resolution of the Board designating such committee. Unless otherwise provided in such a resolution, the presence of at least a majority of the members of the committee shall be necessary to constitute a quorum. The 12. 13 vote of a majority of committee members present at a meeting at which a quorum is present shall be the act of a committee. ARTICLE VI THE OFFICERS SECTION 1. NUMBER. The principal officers of the Corporation shall be elected by the Board of Directors and shall consist of a Chairman of the Board, a President and/or Chief Executive Officer, one (1) or more Vice Presidents, if elected, a Chief Operating Officer and Chief Financial Officer, also if elected, a Secretary and a Treasurer, and such other subordinate officers and assistant officers and agents as may deemed necessary or desirable by the Board of Directors, in such manner and for such terms as the Board of Directors may prescribe. Any two (2) or more principal offices may be held by the same person, except the offices of President and Secretary. In its discretion, the Board of Directors may choose not to fill an office for any period that it may deem advisable. SECTION 2. GENERAL DUTIES. All officers and agents of the Corporation, as between themselves and the Corporation, shall have such authority and perform such duties in the management of the Corporation as may be provided in these By-Laws, or as may be determined by resolution of the Board of Directors not inconsistent with these By-Laws. SECTION 3. ELECTION, TERM OF OFFICE AND QUALIFICATION. The officers shall be elected annually by the Board of Directors at its annual meeting, or as soon after such annual meeting as may conveniently be possible. Each officer shall hold office until his successor is chosen and qualified; or until his death, or until he shall have resigned, or shall have been removed in the manner provided in Section 4. New offices may be created and filled at any meeting of the Board of Directors. SECTION 4. REMOVAL. Any officer or agent elected or appointed by the Board of Directors may be removed by the Board of Directors whenever in its judgment the best interests of the Corporation will be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. SECTION 5. RESIGNATIONS. Any officer may resign at any time by giving written notice to the Board of Directors, or to the Chairman of the Board, if one is elected, the President or Secretary. Such resignation shall take effect on receipt unless the time of effectiveness is specified therein, and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. 13. 14 SECTION 6. VACANCIES. Any vacancy in any office because of death, resignation, removal or any other cause shall be filled for the unexpired portion of the term in the manner prescribed in these By-Laws for election or appointment to such office. SECTION 7. THE CHAIRMAN OF THE BOARD. The Chairman of the Board, if one is elected, shall be chosen from among the directors, shall preside at all meetings of the stockholders and the Board of Directors, if present, and shall, in general, perform all duties incident to the office of Chairman of the Board and such other duties as, from time to time, may be assigned to him by the Board of Directors. SECTION 8. THE CHIEF EXECUTIVE OFFICER. The Chief Executive Officer shall be the principal executive officer of the Corporation. The Chief Executive Officer shall have general charge of the business, affairs and property of the Corporation and control over its officers, agents and employees; and shall see that all orders and resolutions of the Board of Directors are carried into effect. The Chief Executive Officer shall execute bonds, mortgages and other contracts requiring a seal, under the seal of the Corporation, except where required or permitted by law to be otherwise signed and executed and except where the signing and execution thereof shall be expressly delegated by the Board of Directors to some other officer or agent of the Corporation. The Chief Executive Officer shall have such other powers and perform such other duties as may be prescribed by the Board of Directors or as may be provided in these By-Laws. SECTION 9. THE PRESIDENT. The President shall, in the absence or disability of the Chief Executive Officer, act with all of the powers and be subject to all the restrictions of the Chief Executive Officer. The President shall also perform such other duties and have such other powers as the Board of Directors, the Chief Executive Officer or these By-Laws may, from time to time, prescribe. SECTION 10. THE VICE PRESIDENT. The Vice President or Vice Presidents, if elected, shall have such power and perform such duties as the Board of Directors may from time to time prescribe or as the President may from time to time delegate. At the request of the President, a Vice President may, in the case or the absence or inability to act of the President, temporarily act in his place. In the case of the death of the President, or in the case of his absence or inability to act, a Vice President shall act temporarily in his place until such time as the Board of Directors shall elect a new President. SECTION 11. THE SECRETARY. The Secretary shall keep or cause to be kept in books provided for the purpose the minutes of the meetings of the stockholders and of the Board of Directors, shall see that all notices are duly given in accordance with the provisions of these By-Laws and as required by law, shall be custodian of the records and of the seal of the Corporation and see that the seal is affixed to all documents, the execution of which on behalf of the Corporation under its seal is duly authorized in 14. 15 accordance with the provisions of these By-Laws; and, in general, shall perform all duties incident to the office of Secretary and such other duties as may, from time to time, be assigned to him by the Board of Directors or by the Corporation's principal executive officer. SECTION 12. THE TREASURER. The Treasurer shall: (a) in the absence of the Board's appointment of a Chief Financial Officer, whose specific duties shall be established by the Board, be the financial officer of the Corporation; (b) have charge and custody of, and be responsible for, all funds of the Corporation, and deposit all such funds in the name of the Corporation in such banks, trust companies or other depositories as shall be selected by the Board of Directors; (c) receive, and give receipts for, moneys due and payable to the Corporation from any source whatsoever; and (d) in general, perform all the duties incident to the office of Treasurer and such other duties as, from time to time, may be assigned to him by the Board of Directors or by the Corporation's principal executive officer. The Treasurer shall render to the Corporation's principal executive officer and the Board of Directors, whenever the same shall be required, an account of all his transactions as Treasurer and of the financial condition of the Corporation. He shall, if required to do so by the Board of Directors, give the Corporation a bond, the premiums for which shall be paid by the Corporation, in such amount and with such surety or sureties as may be ordered by the Board of Directors, for the faithful performance of the duties of his office and for the restoration to the Corporation, in case of his death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the Corporation. SECTION 13. OTHER OFFICERS; ASSISTANT OFFICERS AND AGENTS. Officers, assistant officers and agents, if any, other than those whose duties are provided for in these By-Laws, shall have such authority and perform such duties as may from time to time be prescribed by the Board of Directors. SECTION 14. COMPENSATION. The salaries or other compensation of the officers shall be fixed, from time to time, by the Board of Directors. No officer shall be prevented from receiving such salary by reason of the fact he is also a director of the Corporation. ARTICLE VII INDEMNIFICATION OF DIRECTORS, OFFICERS, AGENTS AND EMPLOYEES SECTION 1. INDEMNIFICATION IN SUITS AND PROCEEDINGS WITH OTHERS. The Corporation shall indemnify any person who was or is 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 (other than an action by or in the right of the 15. 16 Corporation) by reason of the fact that he 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 expenses (including attorney's fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful. SECTION 2. INDEMNIFICATION IN DERIVATIVE SUITS. The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he 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 expenses (including attorney's fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his duty to the Corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. SECTION 3. REASONABLE DEFENSE EXPENSES. To the extent that a director, officer, employee or agent of the Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Sections 1 and 2 of this Article, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorney's fees) actually and reasonably incurred by him in connection therewith. SECTION 4. STANDARD OF CONDUCT AND DETERMINATION. Any indemnification under Section 1 and 2 of this Article (unless ordered by a court) shall be made by the 16. 17 Corporation only as authorized in the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Sections 1 and 2 of this Article. Such determination shall be made (1) by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding, or (2) if such quorum is not obtainable, or, even if obtainable a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (3) by the stockholders. SECTION 5. ADVANCE OF DEFENSE EXPENSES. Expenses incurred in defending a civil or criminal action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding as authorized by the Board of Directors in the manner provided in Section 4 of this Article upon receipt of an undertaking by or on behalf of the director, officer, employee or agent to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the Corporation as authorized in this Section. SECTION 6. NONEXCLUSIVITY OF INDEMNIFICATION. The indemnification provided by this Section shall not be deemed exclusive of any other rights to which those indemnified may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such person. SECTION 7. INSURANCE AUTHORIZATION. The Corporation may purchase and maintain insurance on behalf of any person who 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 liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of this Section. SECTION 8. DEFINITION OF "CORPORATION" IN MERGERS. For purposes of this Section, references to "the Corporation" shall include, in the case of a merger or consolidation, in addition to the resulting Corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers and employees or agents, so that any person who is or was a 17. 18 director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Section with respect to the resulting or supervising corporation as he would have with respect to such constituent corporation if its separate existence had continued. SECTION 9. OTHER DEFINITIONS. For references to "fines" shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to "serving at the request of the Corporation" purposes of this Section, reference to "other enterprises" shall include employee benefit plans; shall include any service as a director, officer, employee or agent of the Corporation which imposes duties on, or involves services by, such director, officer, employee, or agent with respect to an employee benefit plan, its participants or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the Corporation" as referred to in this Section. ARTICLE VIII SPECIAL CORPORATE ACTS SECTION 1. DEPOSIT OF FUNDS. The moneys of the Corporation shall be deposited in the name of the Corporation in such depositories as the Board of Directors shall designate or otherwise authorize, and shall be drawn out only in such manner as the Board of Directors shall prescribe. SECTION 2. EXECUTION OF DEEDS, CONTRACT, ETC. Subject always to the specific directions of the Board of Directors, all deeds and mortgages made by the Corporation and all other written contracts and agreements to which the Corporation shall be a party shall be executed in its name by the Chief Executive Officer, the President or Vice President and attested by the Secretary or Assistant Secretary; and the Secretary or Assistant Secretary, when necessary or required, shall affix the corporate seal thereto. SECTION 3. ENDORSEMENT OF STOCK CERTIFICATES. Subject always to the specific directions of the Board of Directors, any share or shares of stock issued by any corporation and owned by the Corporation (including reacquired shares of stock of the Corporation) may, for sale or transfer, be endorsed in the name of the Corporation by the Chief Executive Officer, the President or a Vice President, and attested by the Secretary or an Assistant Secretary either with or without affixing thereto the corporate seal. 18. 19 SECTION 4. VOTING OF SHARES OWNED BY CORPORATION. Subject always to the specific directions of the Board of Directors, any share or shares of stock issued by any other corporation and owned or controlled by the Corporation may be voted at any stockholders' meeting of such other corporation by the Chief Executive Officer, if he be present, or in his absence, the President of the Corporation, if he be present, or in his absence by a Vice President of the Corporation who may be present. Whenever, in the judgment of the Chief Executive Officer, or, in his absence, the President, or, in his absence, a Vice President, it is desirable for the Corporation to execute a proxy or give a stockholder's consent in respect to any share or shares of stock issued by any other corporation and owned by the Corporation, such proxy or consent shall be executed in the name of the Corporation by the Chief Executive Officer, the President or a Vice President of the Corporation and shall be attested by the Secretary or Assistant Secretary of the Corporation under the corporate seal without necessity of any authorization by the Board of Directors. Any person or persons designated in the manner above stated as the proxy or proxies of the Corporation shall have full right, power and authority to vote the share or shares of stock issued by such other corporation and owned by the Corporation the same as such share or shares might be voted by the Corporation. SECTION 5. LOANS. The Corporation may lend money to, or guarantee any obligation of, or otherwise assist any officer or other employee of the Corporation or of its subsidiary, including any officer or employee who is a director of the Corporation or its subsidiary, whenever, in the judgment of the directors, such loan, guaranty or assistance may reasonably be expected to benefit the Corporation. The loan, guaranty or other assistance may be with or without interest, and may be unsecured, or secured in such manner as the Board of Directors shall approve, including, without limitation, a pledge of shares of stock of the Corporation. Nothing in this section contained shall be deemed to deny, limit or restrict the powers of guaranty or warranty of the Corporation at common law or under any statute. SECTION 6. DIVIDENDS. Dividends upon the capital stock of the Corporation, subject to the provisions of the Certificate of Incorporation, if any, may be declared by the Board of Directors at any regular or special meeting, pursuant to law. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the Certificate of Incorporation. Before payment of any dividend, there may be set aside out of any funds of the Corporation available for dividends such sum or sums as the directors from time to time, in their absolute discretion, think proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the Corporation, or any other purpose and the directors may modify or abolish any such reserve in the manner in which it was created. 19. 20 ARTICLE IX AMENDMENTS The Board of Directors shall have the power to make, adopt, alter, amend and repeal from time to time the By-Laws of the Corporation, subject to the right of the stockholders entitled to vote with respect thereto to adopt, alter, amend and repeal bylaws by the Board of Directors; provided, however, that By-Laws 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 By-Laws. 20. EX-10.1 4 EXHIBIT 10.1 1 EXHIBIT 10.1 PMR CORPORATION 1997 EQUITY INCENTIVE PLAN RECITALS A. The Plan was originally adopted as the PMR Corporation Employees' Incentive Stock Option Plan of 1990 by the Board of Directors on February 1, 1990, and was approved by the stockholders of the Company on August 16, 1990. B. The Plan was amended on July 8, 1993 to increase the number of shares of Common Stock available for grants under the Plan to 500,000, and the amendment was approved by the stockholders of the Company on October 14, 1993. C. The Plan was amended on June 14, 1995 to increase the number of shares of Common Stock available for grants under the Plan to 2,000,000, and the amendment was approved by the stockholders of the Company on October 18, 1995. D. The Plan was amended and restated on April 10, 1997, pursuant to which the Plan was renamed as the PMR Corporation 1997 Equity Incentive Plan and was amended in certain respects. Pursuant to the terms of the Plan, stockholder approval was not required for the April 10, 1997 amendment. THE PLAN 1. PURPOSES. (a) The purpose of the Plan is to provide a means by which selected Employees and Directors and Consultants may be given an opportunity to benefit from increases in the value of the common stock of the Company ("Common Stock") through the granting of (i) Incentive Stock Options, (ii) Nonstatutory Stock Options, (iii) stock bonuses, and (iv) rights to purchase restricted stock. The Plan amends and restates the PMR Corporation Employees' Incentive Stock Option Plan of 1990 (the "Prior Plan"). (b) The Company, by means of the Plan, seeks to retain the services of persons who are now Employees, Directors or Consultants, to secure and retain the services of new Employees, Directors and Consultants, and to provide incentives for such persons to exert maximum efforts for the success of the Company and its Affiliates. (c) The Company intends that the Stock Awards issued under the Plan shall, in the discretion of the Board or any Committee to which responsibility for administration of the Plan has been delegated pursuant to subsection 3(c), be either (i) Options granted pursuant to Section 6 hereof, including Incentive Stock Options and Nonstatutory Stock 1. 2 Options, or (ii) stock bonuses or rights to purchase restricted stock granted pursuant to Section 7 hereof. All Options shall be separately designated Incentive Stock Options or Nonstatutory Stock Options at the time of grant, and in such form as issued pursuant to Section 6, and a separate certificate or certificates will be issued for shares purchased on exercise of each type of Option. 2. DEFINITIONS. (a) "AFFILIATE" means any parent corporation or subsidiary corporation, whether now or hereafter existing, as those terms are defined in Sections 424(e) and (f) respectively, of the Code. (b) "BOARD" means the Board of Directors of the Company. (c) "CAUSE" shall mean termination due to the occurrence of any of the following: (a) any intentional action or intentional failure to act by Optionee which was performed in bad faith and to the material detriment of the Company; (b) Optionee intentionally refuses or intentionally fails to act in accordance with any lawful direction or order of the Company; (c) Optionee willfully and habitually neglects his duties of employment; (d) Optionee's engaging or participating in any activity which is competitive with or injurious to the Company in the judgment of the Board of Directors; (e) Optionee's commission of any fraud against the Company or use or appropriation for his personal use and benefit of any funds, assets or properties of the Company not authorized by the Company to be so used or appropriated; or (f) Optionee is convicted of a felony crime involving moral turpitude. (d) "CHANGE IN CONTROL" shall mean the occurrence of any of the following events: (i) The Company is merged, consolidated or reorganized into or with another corporation, partnership, limited liability company, or other entity or person, and as a result of such merger, consolidation or reorganization less than 70% of the combined voting power of the then-outstanding securities of such corporation, partnership, limited liability company, or other entity or person immediately after such transaction are held in the aggregate by holders of voting securities of the Company immediately prior to such transaction; (ii) The Company sells all or substantially all of its assets to any other corporation, partnership, limited liability company, or other entity or person, and thereafter, less than 70% of the combined voting power of the then-outstanding voting securities of the acquiring or consolidated entity are held in the aggregate by the holders of voting securities of the Company immediately prior to such sale; 2. 3 (iii) There is a report filed on Schedule 13D or Schedule 14D-1 (or any successor schedule, form or report), each as promulgated pursuant to the Securities Exchange Act of 1934 (the "Exchange Act") disclosing that any person (as the term "person" is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the beneficial owner (as the term "beneficial owner" is defined under Rule 13d-3 or any successor rule or regulation promulgated under the Exchange Act) representing 30% or more of the combined voting power of the then-outstanding voting securities of the Company; (iv) The Company shall file a report or proxy statement with the Securities and Exchange Commission pursuant to the Exchange Act disclosing in response to Item 1 of Form 8-K thereunder or Item 5(b) or Item 14 of Schedule 14A thereunder (or any successor schedule, form or report or item therein) that a change in control of the Company has or may have occurred or will or may occur in the future pursuant to any then-existing contract or transaction; or (v) During any period of two (2) consecutive years, individuals who at the beginning of any such period constitute the directors of the Company cease for any reason to constitute at least a majority of the Board of Directors of the Company unless the election or the nomination for election by the Company's shareholders of each director of the Company first elected during such period was approved by a vote of at least two-thirds of the directors of the Company then still in office who were directors of the Company at the beginning of such two (2)-year period. (e) "CODE" means the Internal Revenue Code of 1986, as amended. (f) "COMMITTEE" means a Committee appointed by the Board in accordance with subsection 3(c) of the Plan. (g) "COMPANY" means PMR Corporation, a Delaware corporation. (h) "CONSTRUCTIVE TERMINATION" means that the Optionee voluntarily terminates his or her employment with the Company after any of the following are undertaken, following a Change in Control, without Optionee's express written consent: (i) the assignment to Optionee of any duties or responsibilities which are inconsistent with, or result in any diminution or adverse change of, Optionee's position, status or circumstances of employment as in effect immediately prior to a Change in Control; an adverse change in Optionee's titles, offices, benefits and/or perquisites as in effect immediately prior to a Change in Control; any removal of Optionee from or any failure to re-elect Optionee to any offices held by Optionee immediately prior to a Change in Control, including, but 3. 4 not limited to, Optionee's membership on the Board, except in connection with the termination of his employment for death, disability, retirement, Cause, or any voluntary termination of employment by Optionee other than a Constructive Termination; (ii) a reduction by the Company in Optionee's annual base salary by greater than five percent (5%) from that which was in effect immediately prior to a Change in Control; (iii) a relocation of Optionee, or the Company's principal executive offices if Optionee's principal office is at such offices, to a location more than forty (40) miles from the location at which Optionee was performing his duties prior to a Change in Control, except for required travel by Optionee on the Company's business to an extent substantially consistent with Optionee's business travel obligations at the time of a Change in Control; (iv) any material breach by the Company of any material provision of Optionee's Stock Award Agreement following a Change in Control; or (v) any failure by the Company to obtain the assumption of Optionee's Stock Award Agreement by any successor or assign of the Company. (i) "CONSULTANT" means any person, including an advisor, engaged by the Company or an Affiliate to render consulting services and who is compensated for such services, provided that the term "Consultant" shall not include Directors who are paid only a director's fee by the Company or who are not compensated by the Company for their services as Directors. (j) "CONTINUOUS STATUS AS AN EMPLOYEE, DIRECTOR OR CONSULTANT" means the employment or relationship as a Director or Consultant is not interrupted or terminated. The Board, in its sole discretion, may determine whether Continuous Status as an Employee, Director or Consultant shall be considered interrupted in the case of: (i) any leave of absence approved by the Board, including sick leave, military leave, or any other personal leave; or (ii) transfers between locations of the Company or between the Company, Affiliates or their successors. (k) "DIRECTOR" means a member of the Board. (l) "EMPLOYEE" means any person, including Officers and Directors, employed by the Company or any Affiliate of the Company. Neither service as a Director nor payment of a director's fee by the Company shall be sufficient to constitute "employment" by the Company. 4. 5 (m) "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. (n) "FAIR MARKET VALUE" means, as of any date, the value of the Common Stock of the Company determined as follows: (i) If the Common Stock is listed on any established stock exchange, or traded on the Nasdaq National Market or the Nasdaq SmallCap Market, the Fair Market Value of a share of Common Stock shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or market (or the exchange or market with the greatest volume of trading in Common Stock) on the day of determination, as reported in the Wall Street Journal or such other source as the Board deems reliable; (ii) In the absence of such markets for the Common Stock, the Fair Market Value shall be determined in good faith by the Board. (o) "INCENTIVE STOCK OPTION" means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code and the regulations promulgated thereunder. (p) "NON-EMPLOYEE DIRECTOR" means a Director who either (i) is not a current Employee or Officer of the Company or its parent or subsidiary, does not receive compensation (directly or indirectly) from the Company or its parent or subsidiary for services rendered as a consultant or in any capacity other than as a Director (except for an amount as to which disclosure would not be required under Item 404(a) of Regulation S-K promulgated pursuant to the Securities Act of 1933 ("Regulation S-K"), does not possess an interest in any other transaction as to which disclosure would be required under Item 404(a) of Regulation S-K, and is not engaged in a business relationship as to which disclosure would be required under Item 404(b) of Regulation S-K; or (ii) is otherwise considered a "non-employee director" for purposes of Rule 16b-3. (q) "NONSTATUTORY STOCK OPTION" means an Option not intended to qualify as an Incentive Stock Option. (r) "OFFICER" means a person who is an officer of the Company within the meaning of Section 16 of the Exchange Act and the rules and regulations promulgated thereunder. (s) "OPTION" means a stock option granted pursuant to the Plan. (t) "OPTION AGREEMENT" means a written agreement between the Company and an Optionee evidencing the terms and conditions of an individual Option grant. Each Option Agreement shall be subject to the terms and conditions of the Plan. 5. 6 (u) "OPTIONEE" means a person to whom an Option is granted pursuant to the Plan. (v) "OUTSIDE DIRECTOR" means a Director who either (i) is not a current employee of the Company or an "affiliated corporation" (within the meaning of Treasury regulations promulgated under Section 162(m) of the Code), is not a former employee of the Company or an "affiliated corporation" receiving compensation for prior services (other than benefits under a tax qualified pension plan), was not an officer of the Company or an "affiliated corporation" at any time, and is not currently receiving direct or indirect remuneration from the Company or an "affiliated corporation" for services in any capacity other than as a Director, or (ii) is otherwise considered an "outside director" for purposes of Section 162(m) of the Code. (w) "PLAN" means this PMR Corporation 1997 Equity Incentive Plan. (x) "RULE 16b-3" means Rule 16b-3 of the Exchange Act or any successor to Rule 16b-3, as in effect when discretion is being exercised with respect to the Plan. (y) "STOCK AWARD" means any right granted under the Plan, including any Option, any stock bonus and any right to purchase restricted stock. (z) "STOCK AWARD AGREEMENT" means a written agreement between the Company and a holder of a Stock Award evidencing the terms and conditions of an individual Stock Award grant. Each Stock Award Agreement shall be subject to the terms and conditions of the Plan. 3. ADMINISTRATION. (a) The Plan shall be administered by the Board unless and until the Board delegates administration to a Committee, as provided in subsection 3(c). (b) The Board shall have the power, subject to, and within the limitations of, the express provisions of the Plan: (i) To determine from time to time which of the persons eligible under the Plan shall be granted Stock Awards; when and how each Stock Award shall be granted; whether a Stock Award will be an Incentive Stock Option, a Nonstatutory Stock Option, a stock bonus, a right to purchase restricted stock or a combination of the foregoing; the provisions of each Stock Award granted (which need not be identical), including the time or times when a person shall be permitted to receive stock pursuant to a Stock Award and the number of shares with respect to which a Stock Award shall be granted to each such person. 6. 7 (ii) To construe and interpret the Plan and Stock Awards granted under it, and to establish, amend and revoke rules and regulations for its administration. The Board, in the exercise of this power, may correct any defect, omission or inconsistency in the Plan or in any Stock Award Agreement, in a manner and to the extent it shall deem necessary or expedient to make the Plan fully effective. (iii) To amend the Plan or a Stock Award as provided in Section 13. (iv) Generally, to exercise such powers and to perform such acts as the Board deems necessary or expedient to promote the best interests of the Company which are not in conflict with the provisions of the Plan. (c) The Board may delegate administration of the Plan to a committee or committees ("Committee") of one or more members of the Board. In the discretion of the Board, a Committee may consist solely of two or more Outside Directors, in accordance with Code Section 162(m), or solely of two or more Non-Employee Directors, in accordance with Rule 16(b)-3. If administration is delegated to a Committee, the Committee shall have, in connection with the administration of the Plan, the powers theretofore possessed by the Board (and references in this Plan to the Board shall thereafter be to the Committee), subject, however, to such resolutions, not inconsistent with the provisions of the Plan, as may be adopted from time to time by the Board. The Board may abolish the Committee at any time and revest in the Board the administration of the Plan. Additionally, and notwithstanding anything to the contrary contained herein, the Board or the Committee may delegate to a committee of one or more members of the Board the authority to grant Stock Awards to certain eligible persons who are not subject to the requirements of Section 16 of the Exchange Act in accordance with guidelines approved by the Board or Committee. 4. SHARES SUBJECT TO THE PLAN. (a) Subject to the provisions of Section 12 relating to adjustments upon changes in stock, the stock that may be issued pursuant to Stock Awards shall not exceed in the aggregate two million (2,000,000) shares of Common Stock. If any Stock Award shall for any reason expire or otherwise terminate, in whole or in part, without having been exercised in full (or vested in the case of Restricted Stock), the stock not acquired under such Stock Award shall revert to and again become available for issuance under the Plan. (b) The stock subject to the Plan may be unissued shares or reacquired shares, bought on the market or otherwise. 7. 8 5. ELIGIBILITY. (a) Incentive Stock Options may be granted only to Employees. Stock Awards other than Incentive Stock Options may be granted only to Employees, Directors or Consultants. (b) No person shall be eligible for the grant of an Incentive Stock Option if, at the time of grant, such person owns (or is deemed to own pursuant to Section 424(d) of the Code) stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or of any of its Affiliates unless the exercise price of such Option is at least one hundred ten percent (110%) of the Fair Market Value of such stock at the date of grant and the Option is not exercisable after the expiration of five (5) years from the date of grant. (c) Subject to the provisions of Section 12 relating to adjustments upon changes in stock, no person shall be eligible to be granted Stock Awards covering more than Four Hundred Thousand (400,000) shares of the Company's Common Stock in any calendar year. 6. OPTION PROVISIONS. Each Option shall be in such form and shall contain such terms and conditions as the Board shall deem appropriate. The provisions of separate Options need not be identical, but each Option shall include (through incorporation of provisions hereof by reference in the Option or otherwise) the substance of each of the following provisions: (a) TERM. No Option shall be exercisable after the expiration of ten (10) years from the date it was granted. (b) PRICE. The exercise price of each Incentive Stock Option shall be not less than one hundred percent (100%) of the Fair Market Value of the stock subject to the Option on the date the Option is granted and the exercise price of each Nonstatutory Stock Option shall be not less than eighty-five percent (85%) of the Fair Market Value of the stock subject to the Option on the date the Option is granted. Notwithstanding the foregoing, an Option may be granted with an exercise price lower than that set forth in the preceding sentence if such Option is granted pursuant to an assumption or substitution for another option in a manner satisfying the provisions of Section 424(a) of the Code. (c) CONSIDERATION. The purchase price of stock acquired pursuant to an Option shall be paid, to the extent permitted by applicable statutes and regulations, either (i) in cash at the time the Option is exercised, or (ii) at the discretion of the Board or the Committee, at the time of the grant of the Option, (A) by delivery to the Company of other Common Stock of the Company, (B) according to a deferred payment or other 8. 9 arrangement (which may include, without limiting the generality of the foregoing, the use of other Common Stock of the Company) with the person to whom the Option is granted or to whom the Option is transferred pursuant to subsection 6(d), or (C) in any other form of legal consideration that may be acceptable to the Board. In the case of any deferred payment arrangement, interest shall be payable at least annually and shall be charged at the minimum rate of interest necessary to avoid the treatment as interest, under any applicable provisions of the Code, of any amounts other than amounts stated to be interest under the deferred payment arrangement. (d) TRANSFERABILITY. An Incentive Stock Option shall not be transferable except by will or by the laws of descent and distribution, and shall be exercisable during the lifetime of the person to whom the Incentive Stock Option is granted only by such person. A Nonstatutory Stock Option may be transferred to the extent provided in the Option Agreement; provided that if the Option Agreement does not expressly permit the transfer of a Nonstatutory Stock Option, the Nonstatutory Stock Option shall not be transferable except by will, by the laws of descent and distribution or pursuant to a domestic relations order satisfying the requirements of Rule 16a-12 under the Exchange Act and shall be exercisable during the lifetime of the person to whom the Option is granted only by such person or any transferee pursuant to a domestic relations order. Notwithstanding the foregoing, the person to whom the Option is granted may, by delivering written notice to the Company, in a form satisfactory to the Company, designate a third party who, in the event of the death of the Optionee, shall thereafter be entitled to exercise the Option. (e) VESTING. The total number of shares of stock subject to an Option may, but need not, be allotted in periodic installments (which may, but need not, be equal). The Option Agreement may provide that from time to time during each of such installment periods, the Option may become exercisable ("vest") with respect to some or all of the shares allotted to that period, and may be exercised with respect to some or all of the shares allotted to such period and/or any prior period as to which the Option became vested but was not fully exercised. The Option may be subject to such other terms and conditions on the time or times when it may be exercised (which may be based on performance or other criteria) as the Board may deem appropriate. The provisions of this subsection 6(e) are subject to any Option provisions governing the minimum number of shares as to which an Option may be exercised. Notwithstanding anything herein to the contrary, (i) any and all Options held by an Optionee shall become immediately exercisable if the Optionee's Continuous Status as an Employee or Consultant is, within one (1) year following a Change in Control, (1) terminated by the Company other than for Cause, or (2) terminated in a Constructive 9. 10 Termination and (ii) any and all Options held by Directors shall become immediately exercisable upon the occurrence of a Change in Control. (f) TERMINATION OF EMPLOYMENT OR RELATIONSHIP AS A DIRECTOR OR CONSULTANT. In the event an Optionee's Continuous Status as an Employee, Director or Consultant terminates (other than upon the Optionee's death or disability), the Optionee may exercise his or her Option (to the extent that the Optionee was entitled to exercise it at the date of termination) but only within such period of time ending on the earlier of (i) the date three (3) months after the termination of the Optionee's Continuous Status as an Employee, Director or Consultant (or such longer or shorter period specified in the Option Agreement), or (ii) the expiration of the term of the Option as set forth in the Option Agreement. If, at the date of termination, the Optionee is not entitled to exercise his or her entire Option, the shares covered by the unexercisable portion of the Option shall revert to and again become available for issuance under the Plan. If, after termination, the Optionee does not exercise his or her Option within the time specified in the Option Agreement, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan. An Optionee's Option Agreement may also provide that if the exercise of the Option following the termination of the Optionee's Continuous Status as an Employee, Director or Consultant (other than upon the Optionee's death or disability) would be prohibited at any time solely because the issuance of shares would violate the registration requirements under the Securities Act of 1933, as amended (the "Securities Act"), then the Option shall terminate on the earlier of (i) the expiration of the term of the Option set forth in the first paragraph of this subsection 6(f), or (ii) the expiration of a period of three (3) months after the termination of the Optionee's Continuous Status as an Employee, Director or Consultant during which the exercise of the Option would not be in violation of such registration requirements. (g) DISABILITY OF OPTIONEE. In the event an Optionee's Continuous Status as an Employee, Director or Consultant terminates as a result of the Optionee's disability, the Optionee may exercise his or her Option (to the extent that the Optionee was entitled to exercise it at the date of termination), but only within such period of time ending on the earlier of (i) the date twelve (12) months following such termination (or such longer or shorter period specified in the Option Agreement), or (ii) the expiration of the term of the Option as set forth in the Option Agreement. If, at the date of termination, the Optionee is not entitled to exercise his or her entire Option, the shares covered by the unexercisable portion of the Option shall revert to and again become available for issuance under the Plan. If, after termination, the Optionee does not exercise his or her Option within the time specified herein, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan. 10. 11 (h) DEATH OF OPTIONEE. In the event of the death of an Optionee during, or within a period specified in the Option after the termination of, the Optionee's Continuous Status as an Employee, Director or Consultant, the Option may be exercised (to the extent the Optionee was entitled to exercise the Option at the date of death) by the Optionee's estate, by a person who acquired the right to exercise the Option by bequest or inheritance or by a person designated to exercise the option upon the Optionee's death pursuant to subsection 6(d), but only within the period ending on the earlier of (i) the date twelve (12) months following the date of death (or such longer or shorter period specified in the Option Agreement), or (ii) the expiration of the term of such Option as set forth in the Option Agreement. If, at the time of death, the Optionee was not entitled to exercise his or her entire Option, the shares covered by the unexercisable portion of the Option shall revert to and again become available for issuance under the Plan. If, after death, the Option is not exercised within the time specified herein, the Option shall terminate, and the shares covered by such Option shall revert to and again become available for issuance under the Plan. (i) EARLY EXERCISE. The Option may, but need not, include a provision whereby the Optionee may elect at any time while an Employee, Director or Consultant to exercise the Option as to any part or all of the shares subject to the Option prior to the full vesting of the Option. Any unvested shares so purchased may be subject to a repurchase right in favor of the Company or to any other restriction the Board determines to be appropriate. 7. TERMS OF STOCK BONUSES AND PURCHASES OF RESTRICTED STOCK. Each stock bonus or restricted stock purchase agreement shall be in such form and shall contain such terms and conditions as the Board or the Committee shall deem appropriate. The terms and conditions of stock bonus or restricted stock purchase agreements may change from time to time, and the terms and conditions of separate agreements need not be identical, but each stock bonus or restricted stock purchase agreement shall include (through incorporation of provisions hereof by reference in the agreement or otherwise) the substance of each of the following provisions as appropriate: (a) PURCHASE PRICE. The purchase price under each restricted stock purchase agreement shall be such amount as the Board or Committee shall determine and designate in such agreement, but in no event shall the purchase price be less than eighty-five percent (85%) of the stock's Fair Market Value on the date such award is made. Notwithstanding the foregoing, the Board or the Committee may determine that eligible participants in the Plan may be awarded stock pursuant to a stock bonus agreement in consideration for past services actually rendered to the Company for its benefit. 11. 12 (b) TRANSFERABILITY. No rights under a stock bonus or restricted stock purchase agreement shall be transferable except by will or the laws of descent and distribution or, if the agreement so provides, pursuant to a domestic relations order satisfying the requirements of Rule 16a-12 under the Exchange Act, so long as stock awarded under such agreement remains subject to the terms of the agreement. (c) CONSIDERATION. The purchase price of stock acquired pursuant to a stock purchase agreement shall be paid either: (i) in cash at the time of purchase; (ii) at the discretion of the Board or the Committee, according to a deferred payment or other arrangement with the person to whom the stock is sold; or (iii) in any other form of legal consideration that may be acceptable to the Board or the Committee in its discretion. Notwithstanding the foregoing, the Board or the Committee to which administration of the Plan has been delegated may award stock pursuant to a stock bonus agreement in consideration for past services actually rendered to the Company or for its benefit. (d) VESTING. Shares of stock sold or awarded under the Plan may, but need not, be subject to a repurchase option in favor of the Company in accordance with a vesting schedule to be determined by the Board or the Committee. (e) TERMINATION OF CONTINUOUS STATUS AS AN EMPLOYEE, DIRECTOR OR CONSULTANT. In the event a Participant's Continuous Status as an Employee, Director or Consultant terminates, the Company may repurchase or otherwise reacquire any or all of the shares of stock held by that person which have not vested as of the date of termination under the terms of the stock bonus or restricted stock purchase agreement between the Company and such person. 8. CANCELLATION AND RE-GRANT OF OPTIONS. (a) The Board or the Committee shall have the authority to effect, at any time and from time to time, (i) the repricing of any outstanding Options under the Plan and/or (ii) with the consent of any adversely affected holders of Options, the cancellation of any outstanding Options under the Plan and the grant in substitution therefor of new Options under the Plan covering the same or different numbers of shares of stock, but having an exercise price per share not less than eighty-five percent (85%) of the Fair Market Value for a Nonstatutory Stock Option, one hundred percent (100%) of the Fair Market Value for an Incentive Stock Option or, in the case of an Incentive Stock Option held by a 10% stockholder (as described in subsection 5(b)), not less than one hundred ten percent (110%) of the Fair Market Value per share of stock on the new grant date. Notwithstanding the foregoing, the Board or the Committee may grant an Option with an exercise price lower than that set forth above if such Option is granted as part of a transaction to which section 424(a) of the Code applies. 12. 13 (b) Shares subject to an Option canceled under this Section 8 shall continue to be counted against the maximum award of Options permitted to be granted pursuant to subsection 5(c) of the Plan. The repricing of an Option under this Section 8, resulting in a reduction of the exercise price, shall be deemed to be a cancellation of the original Option and the grant of a substitute Option; in the event of such repricing, both the original and the substituted Options shall be counted against the maximum awards of Options permitted to be granted pursuant to subsection 5(c) of the Plan. The provisions of this subsection 8(b) shall be applicable only to the extent required by Section 162(m) of the Code. 9. COVENANTS OF THE COMPANY. (a) During the terms of the Stock Awards, the Company shall keep available at all times the number of shares of stock required to satisfy such Stock Awards. (b) The Company shall seek to obtain from each regulatory commission or agency having jurisdiction over the Plan such authority as may be required to issue and sell shares under Stock Awards; provided, however, that this undertaking shall not require the Company to register under the Securities Act of 1933 either the Plan, any Stock Award or any stock issued or issuable pursuant to any such Stock Award. If, after reasonable efforts, the Company is unable to obtain from any such regulatory commission or agency the authority which counsel for the Company deems necessary for the lawful issuance and sale of stock under the Plan, the Company shall be relieved from any liability for failure to issue and sell stock upon exercise of such Stock Awards unless and until such authority is obtained. 10. USE OF PROCEEDS FROM STOCK. Proceeds from the sale of stock pursuant to Stock Awards shall constitute general funds of the Company. 11. MISCELLANEOUS. (a) The Board shall have the power to accelerate the time at which a Stock Award may first be exercised or the time during which a Stock Award or any part thereof will vest pursuant to subsection 6(e) or 7(d), notwithstanding the provisions in the Stock Award stating the time at which it may first be exercised or the time during which it will vest. (b) Neither an Employee, Director nor a Consultant nor any person to whom a Stock Award is transferred in accordance with the Plan shall be deemed to be the holder of, or to have any of the rights of a holder with respect to, any shares subject to such 13. 14 Stock Award unless and until such person has satisfied all requirements for exercise of the Stock Award pursuant to its terms. (c) Nothing in the Plan or any instrument executed or Stock Award granted pursuant thereto shall confer upon any Employee, Consultant or other holder of Stock Awards any right to continue in the employ of the Company or any Affiliate or to continue serving as a Consultant and Director, or shall affect the right of the Company or any Affiliate to terminate the employment of any Employee with or without notice and with or without cause, or the right to terminate the relationship of any Consultant pursuant to the terms of such Consultant's agreement with the Company or Affiliate or service as a Director pursuant to the Company's By-laws. (d) To the extent that the aggregate Fair Market Value (determined at the time of grant) of stock with respect to which Incentive Stock Options are exercisable for the first time by any Optionee during any calendar year under all plans of the Company and its Affiliates exceeds one hundred thousand dollars ($100,000), the Options or portions thereof which exceed such limit (according to the order in which they were granted) shall be treated as Nonstatutory Stock Options. (e) The Company may require any person to whom a Stock Award is granted, or any person to whom a Stock Award is transferred in accordance with the Plan, as a condition of exercising or acquiring stock under any Stock Award, (1) to give written assurances satisfactory to the Company as to such person's knowledge and experience in financial and business matters and/or to employ a purchaser representative reasonably satisfactory to the Company who is knowledgeable and experienced in financial and business matters, and that he or she is capable of evaluating, alone or together with the purchaser representative, the merits and risks of exercising the Stock Award; and (2) to give written assurances satisfactory to the Company stating that such person is acquiring the stock subject to the Stock Award for such person's own account and not with any present intention of selling or otherwise distributing the stock. The foregoing requirements, and any assurances given pursuant to such requirements, shall be inoperative if (i) the issuance of the shares upon the exercise or acquisition of stock under the Stock Award has been registered under a then currently effective registration statement under the Securities Act, or (ii) as to any particular requirement, a determination is made by counsel for the Company that such requirement need not be met in the circumstances under the then applicable securities laws. The Company may, upon advice of counsel to the Company, place legends on stock certificates issued under the Plan as such counsel deems necessary or appropriate in order to comply with applicable securities laws, including, but not limited to, legends restricting the transfer of the stock. (f) To the extent provided by the terms of a Stock Award Agreement, the person to whom a Stock Award is granted may satisfy any federal, state or local tax 14. 15 withholding obligation relating to the exercise or acquisition of stock under a Stock Award by any of the following means or by a combination of such means: (1) tendering a cash payment; (2) authorizing the Company to withhold shares from the shares of the Common Stock otherwise issuable to the participant as a result of the exercise or acquisition of stock under the Stock Award; or (3) delivering to the Company owned and unencumbered shares of the Common Stock of the Company. 12. ADJUSTMENTS UPON CHANGES IN STOCK. (a) If any change is made in the stock subject to the Plan, or subject to any Stock Award, without the receipt of consideration by the Company (through merger, consolidation, reorganization, recapitalization, reincorporation, stock dividend, dividend in property other than cash, stock split, liquidating dividend, combination of shares, exchange of shares, change in corporate structure or other transaction not involving the receipt of consideration by the Company), the Plan will be appropriately adjusted in the class(es) and maximum number of shares subject to the Plan pursuant to subsection 4(a) and the maximum number of shares subject to award to any person during any calendar year pursuant to subsection 5(c), and the outstanding Stock Awards will be appropriately adjusted in the class(es) and number of shares and price per share of stock subject to such outstanding Stock Awards. Such adjustments shall be made by the Board or the Committee, the determination of which shall be final, binding and conclusive. (The conversion of any convertible securities of the Company shall not be treated as a "transaction not involving the receipt of consideration by the Company".) (b) In the event of: (1) a dissolution, liquidation or sale of substantially all of the assets of the Company; (2) a merger or consolidation in which the Company is not the surviving corporation; or (3) a reverse merger in which the Company is the surviving corporation but the shares of the Company's common stock outstanding immediately preceding the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise, then to the extent permitted by applicable law: (i) any surviving corporation or a parent of such surviving corporation shall assume any Stock Awards outstanding under the Plan or shall substitute similar Stock Awards for those outstanding under the Plan, or (ii) such Stock Awards shall continue in full force and effect. In the event any surviving corporation or its parent refuses to assume or continue such Stock Awards, or to substitute similar Stock Awards for those outstanding under the Plan, then, with respect to Stock Awards held by persons then performing services as Employees, Directors or Consultants, the vesting of such Stock Awards may, if so determined by the Board, be accelerated as provided in the Agreement thereunder. If the Stock Award does not provide for acceleration of vesting in the event of certain corporate events, then the Stock Award shall be terminated if not exercised prior to such event. 15. 16 13. AMENDMENT OF THE PLAN AND STOCK AWARDS. (a) The Board at any time, and from time to time, may amend the Plan. However, except as provided in Section 12 relating to adjustments upon changes in stock, no amendment shall be effective unless approved by the stockholders of the Company to the extent stockholder approval is necessary for the Plan to satisfy the requirements of Section 422 of the Code, Rule 16b-3 or any Nasdaq or securities exchange listing requirements. (b) The Board may in its sole discretion submit any other amendment to the Plan for stockholder approval, including, but not limited to, amendments to the Plan intended to satisfy the requirements of Section 162(m) of the Code and the regulations thereunder regarding the exclusion of performance-based compensation from the limit on corporate deductibility of compensation paid to certain executive officers. (c) It is expressly contemplated that the Board may amend the Plan in any respect the Board deems necessary or advisable to provide eligible Employees, Directors or Consultants with the maximum benefits provided or to be provided under the provisions of the Code and the regulations promulgated thereunder relating to Incentive Stock Options and/or to bring the Plan and/or Incentive Stock Options granted under it into compliance therewith. (d) Rights under any Stock Award granted before amendment of the Plan shall not be impaired by any amendment of the Plan unless (i) the Company requests the consent of the person to whom the Stock Award was granted and (ii) such person consents in writing. (e) The Board at any time, and from time to time, may amend the terms of any one or more Stock Awards; provided, however, that the rights under any Stock Award shall not be impaired by any such amendment unless (i) the Company requests the consent of the person to whom the Stock Award was granted and (ii) such person consents in writing. 14. TERMINATION OR SUSPENSION OF THE PLAN. (a) The Board may suspend or terminate the Plan at any time. Unless sooner terminated, the Plan shall terminate ten (10) years from the date the Plan is adopted by the Board or approved by the stockholders of the Company, whichever is earlier. No Stock Awards may be granted under the Plan while the Plan is suspended or after it is terminated. (b) Rights and obligations under any Stock Award granted while the Plan is in effect shall not be impaired by suspension or termination of the Plan, except with the 16. 17 consent of the person to whom the Stock Award was granted. The terms of the Prior Plan shall remain in effect and apply to grants made pursuant to the terms of the Prior Plan. 15. EFFECTIVE DATE OF PLAN. The Plan became effective on February 1, 1990, the date of adoption by the Board, and was initially approved by the stockholders on August 16, 1990 and, as amended, on October 14, 1993 and October 18, 1995. 17. EX-10.2 5 EXHIBIT 10.2 1 EXHIBIT 10.2 INCENTIVE STOCK OPTION ____________________________________, Optionee: PMR CORPORATION (the "Company"), pursuant to its 1997 Equity Incentive Plan (the "Plan"), has granted to you, the optionee named above, an option to purchase shares of the common stock of the Company ("Common Stock"). This option is intended to qualify as an "incentive stock option" within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). The grant hereunder is in connection with and in furtherance of the Company's compensatory benefit plan for participation of the Company's employees (including officers), directors or consultants. Defined terms not explicitly defined in this agreement but defined in the Plan shall have the same definitions as in the Plan. The details of your option are as follows: 1. TOTAL NUMBER OF SHARES SUBJECT TO THIS OPTION. The total number of shares of Common Stock subject to this option is ____________________ (______). 2. VESTING. Subject to the limitations contained herein, [20%] of the shares will vest (become exercisable) on each anniversary of the date of grant, beginning on ____________, 19__ , until either (i) you cease to provide services to the Company for any reason, or (ii) this option becomes fully vested. In addition, your option may become fully vested as described in the attached Change in Control Vesting Policy. 3. EXERCISE PRICE AND METHOD OF PAYMENT. (a) EXERCISE PRICE. The exercise price of this option is _________________ ($____) per share, being not less than the fair market value of the Common Stock on the date of grant of this option. (b) METHOD OF PAYMENT. Payment of the exercise price per share is due in full upon exercise of all or any part of each installment which has accrued to you. You may elect, to the extent permitted by applicable statutes and regulations, to make payment of the exercise price under one of the following alternatives: (i) Payment of the exercise price per share in cash (including check) at the time of exercise; (ii) Payment pursuant to a program developed under Regulation T as promulgated by the Federal Reserve Board which, prior to the issuance of Common Stock, results in either the receipt of cash (or check) by the Company or the receipt of 1. 2 irrevocable instructions to pay the aggregate exercise price to the Company from the sales proceeds; (iii) Provided that at the time of exercise the Company's Common Stock is publicly traded and quoted regularly in the Wall Street Journal, payment by delivery of already-owned shares of Common Stock, held for the period required to avoid a charge to the Company's reported earnings, and owned free and clear of any liens, claims, encumbrances or security interests, which Common Stock shall be valued at its fair market value on the date of exercise; or (iv) Payment by a combination of the methods of payment permitted by subparagraph 3(b)(i) through 3(b)(iii) above. 4. WHOLE SHARES. This option may only be exercised for whole shares. 5. SECURITIES LAW COMPLIANCE. Notwithstanding anything to the contrary contained herein, this option may not be exercised unless the shares issuable upon exercise of this option are then registered under the Securities Act or, if such shares are not then so registered, the Company has determined that such exercise and issuance would be exempt from the registration requirements of the Securities Act. 6. TERM. The term of this option commences on ____________, 19__, the date of grant, and expires on _________________ (the "Expiration Date"), which date shall be no more than ten (10) years from date this option is granted, unless this option expires sooner as set forth below or in the Plan. In no event may this option be exercised on or after the Expiration Date. This option shall terminate prior to the Expiration Date as follows: three (3) months after the termination of your Continuous Status as an Employee, Director or Consultant with the Company or an Affiliate of the Company unless one of the following circumstances exists: (a) Your termination of Continuous Status as an Employee, Director or Consultant is due to your disability. This option will then expire on the earlier of the Expiration Date set forth above or twelve (12) months following such termination of Continuous Status as an Employee, Director or Consultant. You should be aware that if your disability is not considered a permanent and total disability within the meaning of Section 422(c)(6) of the Code, and you exercise this option more than three (3) months following the date of your termination of employment, your exercise will be treated for tax purposes as the exercise of a "nonstatutory stock option" instead of an "incentive stock option." (b) Your termination of Continuous Status as an Employee, Director or Consultant is due to your death or your death occurs within three (3) months following your termination of Continuous Status as an Employee, Director or Consultant for any 2. 3 other reason. This option will then expire on the earlier of the Expiration Date set forth above or twelve (12) months after your death. (c) If during any part of such three (3)-month period you may not exercise your option solely because of the condition set forth in paragraph 5 above, then your option will not expire until the earlier of the Expiration Date set forth above or until this option shall have been exercisable for an aggregate period of three (3) months after your termination of Continuous Status as an Employee, Director or Consultant. (d) If your exercise of the option within three (3) months after termination of your Continuous Status as an Employee, Director or Consultant with the Company or with an Affiliate of the Company would result in liability under Section 16(b) of the Securities Exchange Act of 1934, then your option will expire on the earlier of (i) the Expiration Date set forth above, (ii) the tenth (10th) day after the last date upon which exercise would result in such liability or (iii) six (6) months and ten (10) days after the termination of your Continuous Status as an Employee, Director or Consultant with the Company or an Affiliate of the Company. However, this option may be exercised following termination of Continuous Status as an Employee, Director or Consultant only as to that number of shares as to which it was exercisable on the date of termination of Continuous Status as an Employee, Director or Consultant under the provisions of paragraph 2 of this option. In order to obtain the federal income tax advantages associated with an "incentive stock option," the Code requires that at all times beginning on the date of grant of the option and ending on the day three (3) months before the date of the option's exercise, you must be an employee of the Company or an Affiliate of the Company, except in the event of your death or permanent and total disability. The Company has provided for continued vesting or extended exercisability of your option under certain circumstances for your benefit, but cannot guarantee that your option will necessarily be treated as an "incentive stock option" if you provide services to the Company or an Affiliate of the Company as a consultant or exercise your option more than three (3) months after the date your employment with the Company and all Affiliates of the Company terminates. 7. EXERCISE. (a) This option may be exercised, to the extent specified above, by delivering a notice of exercise (in a form designated by the Company) together with the exercise price to the Secretary of the Company, or to such other person as the Company may designate, during regular business hours, together with such additional documents as the Company may then require pursuant to subsection 11(e) of the Plan. (b) By exercising this option you agree that: 3. 4 (i) as a precondition to the completion of any exercise of this option, the Company may require you to enter an arrangement providing for the payment by you to the Company of any tax withholding obligation of the Company arising by reason of (1) the exercise of this option; (2) the lapse of any substantial risk of forfeiture to which the shares are subject at the time of exercise; or (3) the disposition of shares acquired upon such exercise; and (ii) you will notify the Company in writing within fifteen (15) days after the date of any disposition of any of the shares of the Common Stock issued upon exercise of this option that occurs within two (2) years after the date of this option grant OR within one (1) year after such shares of Common Stock are transferred upon exercise of this option. 8. TRANSFERABILITY. This option is not transferable, except by will or by the laws of descent and distribution, and is exercisable during your life only by you. Notwithstanding the foregoing, by delivering written notice to the Company, in a form satisfactory to the Company, you may designate a third party who, in the event of your death, shall thereafter be entitled to exercise this option. 9. REDUCTION FOR DISQUALIFIED INDIVIDUALS. (a) If this option becomes fully vested in connection with Optionee's termination following a Change in Control as described in the Plan, and if Optionee is deemed to be a "disqualified individual" as defined in Section 280G of the Code (which includes certain officers and highly compensated employees of the Company), then if the aggregate of the Optionee's gain upon the exercise of the option with respect to shares that became fully vested because of a Change in Control and all other payments made to Optionee in connection with a Change in Control would constitute a "parachute payment" within the meaning of Section 280G of the Code and would, but for this subsection (a), subject Optionee to liability for the twenty percent (20%) excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then, subject to the provisions of subsection (b) hereof, the option exercise shall be reduced to the largest amount which the Company determines would result in no portion of such exercise being subject to the Excise Tax (but in no event shall the option exercise be reduced below the number of shares vested prior to acceleration in connection with a Change in Control). The Company's determination of any required deduction pursuant to this subsection (a) shall be conclusive and binding upon Optionee. However, if the Internal Revenue Service ("IRS") nevertheless determines that an exercise is subject to the Excise Tax, then subsection (b) hereof shall apply. (b) If notwithstanding the reduction described in subsection (a) hereof (or in the absence of any such reduction), the IRS determines that Optionee is liable for 4. 5 the Excise Tax as a result of the exercise, then Optionee shall be obligated to rescind within thirty (30) days after final IRS determination, the exercise of shares that subject the Optionee to the Excise Tax; provided, however, that Optionee shall not be obligated to rescind the exercise of shares that were vested prior to acceleration in connection with a Change in Control. The rescinded amount shall be the smallest such amount, if any, as shall be required so that no portion of Optionee's exercise shall be subject to the Excise Tax. In the event of any rescission hereunder, the Company shall return to Optionee the full exercise price paid by Optionee for the shares being rescinded. 10. OPTION NOT A SERVICE CONTRACT. This option is not an employment contract and nothing in this option shall be deemed to create in any way whatsoever any obligation on your part to continue in the employ of the Company, or of the Company to continue your employment with the Company. In addition, nothing in this option shall obligate the Company or any Affiliate of the Company, or their respective shareholders, Board of Directors, officers or employees to continue any relationship which you might have as a Director or Consultant for the Company or Affiliate of the Company. 11. NOTICES. Any notices provided for in this option or the Plan shall be given in writing and shall be deemed effectively given upon receipt or, in the case of notices delivered by the Company to you, five (5) days after deposit in the United States mail, postage prepaid, addressed to you at the address specified below or at such other address as you hereafter designate by written notice to the Company. 12. GOVERNING PLAN DOCUMENT. This option is subject to all the provisions of the Plan, a copy of which is attached hereto and its provisions are hereby made a part of this option, including without limitation the provisions of Section 6 of the Plan relating to option provisions, and is further subject to all interpretations, amendments, rules and regulations which may from time to time be promulgated and adopted pursuant to the 5. 6 Plan. In the event of any conflict between the provisions of this option and those of the Plan, the provisions of the Plan shall control. Dated the ____ day of __________________, 19__. Very truly yours, PMR CORPORATION By: _______________________________ Duly authorized on behalf of the Board of Directors ATTACHMENTS: 1997 Equity Incentive Plan Notice of Exercise Change in Control Vesting Policy 6. 7 The undersigned: (a) Acknowledges receipt of the foregoing option and the attachments referenced therein and understands that all rights and liabilities with respect to this option are set forth in the option and the Plan; and (b) Acknowledges that as of the date of grant of this option, it sets forth the entire understanding between the undersigned optionee and the Company and its Affiliates regarding the acquisition of stock in the Company and supersedes all prior oral and written agreements on that subject with the exception of (i) the options previously granted and delivered to the undersigned under stock option plans of the Company, and (ii) the following agreements only: NONE ____________________________________ (Initial) OTHER ____________________________________ ____________________________________ ____________________________________ ___________________________________ OPTIONEE ___________________________________ Address ___________________________________ ___________________________________ 7. 8 NOTICE OF EXERCISE PMR Corporation 3990 Old Town Avenue Suite 206A San Diego, CA 92110-0000 Date of Exercise: ___________ Ladies and Gentlemen: This constitutes notice under my stock option that I elect to purchase the number of shares for the price set forth below. Type of option: Incentive Stock option dated: ____________ Number of shares as to which option is exercised: ____________ Certificates to be issued in name of: ____________ Total exercise price: $ __________ Cash payment delivered herewith: $ __________ Value of ______ shares of common stock delivered herewith(1): $ __________ - ------------------ (1) Shares must meet the public trading requirements set forth in the option. Shares must be valued in accordance with the terms of the option being exercised, must have been owned for the minimum period required in the option, and must be owned free and clear of any liens, claims, encumbrances or security interests. Certificates must be endorsed or accompanied by an executed assignment separate from certificate. 8. 9 By this exercise, I agree (i) to provide such additional documents as you may require pursuant to the terms of the Company's 1997 Equity Incentive Plan, (ii) to provide for the payment by me to you (in the manner designated by you) of your withholding obligation, if any, relating to the exercise of this option, and (iii) to notify you in writing within fifteen (15) days after the date of any disposition of any of the shares of Common Stock issued upon exercise of this option that occurs within two (2) years after the date of grant of this option OR within one (1) year after such shares of Common Stock are issued upon exercise of this option. Very truly yours, 9. 10 PMR CORPORATION CHANGE IN CONTROL VESTING POLICY (THE "POLICY") In the event the employment of a person holding an option under the 1997 Equity Incentive Plan (the "Optionee") is, within one (1) year following a "Change in Control," (i) terminated by the Company other than for "Cause," or (ii) terminated in a "Constructive Termination," then the option held by such Optionee shall be fully vested. For purposes of this Policy, the following definitions shall apply: "CHANGE IN CONTROL" shall mean the occurrence of any of the following events: (a) The Company is merged, consolidated or reorganized into or with another corporation, partnership, limited liability company, or other entity or person, and as a result of such merger, consolidation or reorganization less than 70% of the combined voting power of the then-outstanding securities of such corporation, partnership, limited liability company, or other entity or person immediately after such transaction are held in the aggregate by holders of voting securities of the Company immediately prior to such transaction; (b) The Company sells all or substantially all of its assets to any other corporation, partnership, limited liability company, or other entity or person, and thereafter, less than 70% of the combined voting power of the then-outstanding voting securities of the acquiring or consolidated entity are held in the aggregate by the holders of voting securities of the Company immediately prior to such sale; (c) There is a report filed on Schedule 13D or Schedule 14D-1 (or any successor schedule, form or report), each as promulgated pursuant to the Securities Exchange Act of 1934 (the "Exchange Act") disclosing that any person (as the term "person" is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the beneficial owner (as the term "beneficial owner" is defined under Rule 13d-3 or any successor rule or regulation promulgated under the Exchange Act) representing 30% or more of the combined voting power of the then-outstanding voting securities of the Company; (d) The Company shall file a report or proxy statement with the Securities and Exchange Commission pursuant to the Exchange Act disclosing in response to Item 1 of Form 8-K thereunder or Item 5(b) or Item 14 of Schedule 14A thereunder (or any successor schedule, form or report or item therein) that a change in control of the Company has or may have occurred or will or may occur in the future pursuant to any then-existing contract or transaction; or 1. 11 (e) During any period of two (2) consecutive years, individuals who at the beginning of any such period constitute the directors of the Company cease for any reason to constitute at least a majority of the Board of Directors of the Company unless the election or the nomination for election by the Company's shareholders of each director of the Company first elected during such period was approved by a vote of at least two-thirds of the directors of the Company then still in office who were directors of the Company at the beginning of such two (2)-year period. "CAUSE" shall mean termination due to the occurrence of any of the following: (a) any intentional action or intentional failure to act by Optionee which was performed in bad faith and to the material detriment of the Company; (b) Optionee intentionally refuses or intentionally fails to act in accordance with any lawful direction or order of the Company; (c) Optionee willfully and habitually neglects his duties of employment; (d) Optionee's engaging or participating in any activity which is competitive with or injurious to the Company in the judgment of the Board of Directors; (e) Optionee's commission of any fraud against the Company or use or appropriation for his personal use and benefit of any funds, assets or properties of the Company not authorized by the Company to be so used or appropriated; or (f) Optionee is convicted of a felony crime involving moral turpitude. "CONSTRUCTIVE TERMINATION" means that the Optionee voluntarily terminates his or her employment with the Company after any of the following are undertaken, following a Change in Control, without Optionee's express written consent: (a) the assignment to Optionee of any duties or responsibilities which are inconsistent with, or result in any diminution or adverse change of, Optionee's position, status or circumstances of employment as in effect immediately prior to a Change in Control; an adverse change in Optionee's titles, offices, benefits and/or perquisites as in effect immediately prior to a Change in Control; any removal of Optionee from or any failure to re-elect Optionee to any offices held by Optionee immediately prior to a Change in Control, including, but not limited to, Optionee's membership on the Board, except in connection with the termination of his employment for death, disability, retirement, Cause, or any voluntary termination of employment by Optionee other than a Constructive Termination; (b) a reduction by the Company in Optionee's annual base salary by greater than five percent (5%) from that which was in effect immediately prior to a Change in Control; (c) a relocation of Optionee, or the Company's principal executive offices if Optionee's principal office is at such offices, to a location more than forty (40) miles from the location at which Optionee was performing his duties prior to a Change in 2. 12 Control, except for required travel by Optionee on the Company's business to an extent substantially consistent with Optionee's business travel obligations at the time of a Change in Control; (d) any material breach by the Company of any material provision of Optionee's Stock Award Agreement following a Change in Control; or (e) any failure by the Company to obtain the assumption of Optionee's Stock Award Agreement by any successor or assign of the Company. 3. EX-10.3 6 EXHIBIT 10.3 1 EXHIBIT 10.3 NONSTATUTORY STOCK OPTION ____________, Optionee: PMR CORPORATION (the "Company"), pursuant to its 1997 Equity Incentive Plan (the "Plan"), has granted to you, the optionee named above, an option to purchase shares of the common stock of the Company ("Common Stock"). This option is not intended to qualify as an "incentive stock option" within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). The grant hereunder is in connection with and in furtherance of the Company's compensatory benefit plan for participation of the Company's employees (including officers), directors or consultants. Defined terms not explicitly defined in this agreement but defined in the Plan shall have the same definitions as in the Plan. The details of your option are as follows: 1. TOTAL NUMBER OF SHARES SUBJECT TO THIS OPTION. The total number of shares of Common Stock subject to this option is ____________________ (_______). 2. VESTING. Subject to the limitations contained herein, [20%] of the shares will vest (become exercisable) on each anniversary of the date of grant, beginning on ____________, 19__ , until either (i) you cease to provide services to the Company for any reason, or (ii) this option becomes fully vested. In addition, your option may become fully vested as described in the attached Change in Control Vesting Policy. 3. EXERCISE PRICE AND METHOD OF PAYMENT. (a) EXERCISE PRICE. The exercise price of this option is _________________ ($____) per share, being not less than eighty-five percent (85%) of the fair market value of the Common Stock on the date of grant of this option. (b) METHOD OF PAYMENT. Payment of the exercise price per share is due in full upon exercise of all or any part of each installment which has accrued to you. You may elect, to the extent permitted by applicable statutes and regulations, to make payment of the exercise price under one of the following alternatives: (i) Payment of the exercise price per share in cash (including check) at the time of exercise; (ii) Payment pursuant to a program developed under Regulation T as promulgated by the Federal Reserve Board which, prior to the issuance of Common 1. 2 Stock, results in either the receipt of cash (or check) by the Company or the receipt of irrevocable instructions to pay the aggregate exercise price to the Company from the sales proceeds; (iii) Provided that at the time of exercise the Company's Common Stock is publicly traded and quoted regularly in the Wall Street Journal, payment by delivery of already-owned shares of Common Stock, held for the period required to avoid a charge to the Company's reported earnings, and owned free and clear of any liens, claims, encumbrances or security interests, which Common Stock shall be valued at its fair market value on the date of exercise; or (iv) Payment by a combination of the methods of payment permitted by subparagraph 3(b)(i) through 3(b)(iii) above. 4. WHOLE SHARES. This option may only be exercised for whole shares. 5. SECURITIES LAW COMPLIANCE. Notwithstanding anything to the contrary contained herein, this option may not be exercised unless the shares issuable upon exercise of this option are then registered under the Securities Act or, if such shares are not then so registered, the Company has determined that such exercise and issuance would be exempt from the registration requirements of the Securities Act. 6. TERM. The term of this option commences on ____________, 19__, the date of grant, and expires on _________________ (the "Expiration Date"), which date shall be no more than ten (10) years from date this option is granted, unless this option expires sooner as set forth below or in the Plan. In no event may this option be exercised on or after the Expiration Date. This option shall terminate prior to the Expiration Date as follows: three (3) months after the termination of your Continuous Status as an Employee, Director or Consultant with the Company or an Affiliate of the Company unless one of the following circumstances exists: (a) Your termination of Continuous Status as an Employee, Director or Consultant is due to your disability. This option will then expire on the earlier of the Expiration Date set forth above or twelve (12) months following such termination of Continuous Status as an Employee, Director or Consultant. (b) Your termination of Continuous Status as an Employee, Director or Consultant is due to your death or your death occurs within three (3) months following your termination of Continuous Status as an Employee, Director or Consultant for any other reason. This option will then expire on the earlier of the Expiration Date set forth above or twelve (12) months after your death. 2. 3 (c) If during any part of such three (3)-month period you may not exercise your option solely because of the condition set forth in paragraph 5 above, then your option will not expire until the earlier of the Expiration Date set forth above or until this option shall have been exercisable for an aggregate period of three (3) months after your termination of Continuous Status as an Employee, Director or Consultant. (d) If your exercise of the option within three (3) months after termination of your Continuous Status as an Employee, Director or Consultant with the Company or with an Affiliate of the Company would result in liability under section 16(b) of the Securities Exchange Act of 1934, then your option will expire on the earlier of (i) the Expiration Date set forth above, (ii) the tenth (10th) day after the last date upon which exercise would result in such liability or (iii) six (6) months and ten (10) days after the termination of your Continuous Status as an Employee, Director or Consultant with the Company or an Affiliate of the Company. However, this option may be exercised following termination of Continuous Status as an Employee, Director or Consultant only as to that number of shares as to which it was exercisable on the date of termination of Continuous Status as an Employee, Director or Consultant under the provisions of paragraph 2 of this option. 7. EXERCISE. (a) This option may be exercised, to the extent specified above, by delivering a notice of exercise (in a form designated by the Company) together with the exercise price to the Secretary of the Company, or to such other person as the Company may designate, during regular business hours, together with such additional documents as the Company may then require pursuant to subsection 11(e) of the Plan. (b) By exercising this option you agree that, as a precondition to the completion of any exercise, the Company may require you to enter an arrangement providing for the payment by you to the Company of any tax withholding obligation of the Company arising by reason of (1) the exercise of this option; (2) the lapse of any substantial risk of forfeiture to which the shares are subject at the time of exercise; or (3) the disposition of shares acquired upon such exercise. You also agree that the exercise of this option has not been completed and that the Company is under no obligation to issue any shares of Common Stock to you until such an arrangement is established or the Company's tax withholding obligations are satisfied, as determined by the Company. 8. TRANSFERABILITY. This option is not transferable, except by will or by the laws of descent and distribution, and is exercisable during your life only by you. Notwithstanding the foregoing, by delivering written notice to the Company, in a form 3. 4 satisfactory to the Company, you may designate a third party who, in the event of your death, shall thereafter be entitled to exercise this option. 9. REDUCTION FOR DISQUALIFIED INDIVIDUALS. (a) If this option becomes fully vested in connection with Optionee's termination following a Change in Control as described in the Plan, and if Optionee is deemed to be a "disqualified individual" as defined in Section 280G of the Code (which includes certain officers and highly compensated employees of the Company), then if the aggregate of the Optionee's gain upon the exercise of the option with respect to shares that became fully vested because of a Change in Control and all other payments made to Optionee in connection with a Change in Control would constitute a "parachute payment" within the meaning of Section 280G of the Code and would, but for this subsection (a), subject Optionee to liability for the twenty percent (20%) excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then, subject to the provisions of subsection (b) hereof, the option exercise shall be reduced to the largest amount which the Company determines would result in no portion of such exercise being subject to the Excise Tax (but in no event shall the option exercise be reduced below the number of shares vested prior to acceleration in connection with a Change in Control). The Company's determination of any required deduction pursuant to this subsection (a) shall be conclusive and binding upon Optionee. However, if the Internal Revenue Service ("IRS") nevertheless determines that an exercise is subject to the Excise Tax, then subsection (b) hereof shall apply. (b) If notwithstanding the reduction described in subsection (a) hereof (or in the absence of any such reduction), the IRS determines that Optionee is liable for the Excise Tax as a result of the exercise, then Optionee shall be obligated to rescind within thirty (30) days after final IRS determination, the exercise of shares that subject the Optionee to the Excise Tax; provided, however, that Optionee shall not be obligated to rescind the exercise of shares that were vested prior to acceleration in connection with a Change in Control. The rescinded amount shall be the smallest such amount, if any, as shall be required so that no portion of Optionee's exercise shall be subject to the Excise Tax. In the event of any rescission hereunder, the Company shall return to Optionee the full exercise price paid by Optionee for the shares being rescinded. 10. OPTION NOT A SERVICE CONTRACT. This option is not an employment contract and nothing in this option shall be deemed to create in any way whatsoever any obligation on your part to continue in the employ of the Company, or of the Company to continue your employment with the Company. In addition, nothing in this option shall obligate the Company or any Affiliate of the Company, or their respective shareholders, Board of Directors, officers or employees to continue any relationship which you might have as a Director or Consultant for the Company or Affiliate of the Company. 4. 5 11. NOTICES. Any notices provided for in this option or the Plan shall be given in writing and shall be deemed effectively given upon receipt or, in the case of notices delivered by the Company to you, five (5) days after deposit in the United States mail, postage prepaid, addressed to you at the address specified below or at such other address as you hereafter designate by written notice to the Company. 12. GOVERNING PLAN DOCUMENT. This option is subject to all the provisions of the Plan, a copy of which is attached hereto and its provisions are hereby made a part of this option, including without limitation the provisions of Section 6 of the Plan relating to option provisions, and is further subject to all interpretations, amendments, rules and regulations which may from time to time be promulgated and adopted pursuant to the Plan. In the event of any conflict between the provisions of this option and those of the Plan, the provisions of the Plan shall control. Dated the ____ day of __________________, 19__. Very truly yours, PMR CORPORATION By:____________________________ Duly authorized on behalf of the Board of Directors ATTACHMENTS: 1997 Equity Incentive Plan Notice of Exercise Change in Control Vesting Policy 5. 6 The undersigned: (a) Acknowledges receipt of the foregoing option and the attachments referenced therein and understands that all rights and liabilities with respect to this option are set forth in the option and the Plan; and (b) Acknowledges that as of the date of grant of this option, it sets forth the entire understanding between the undersigned optionee and the Company and its Affiliates regarding the acquisition of stock in the Company and supersedes all prior oral and written agreements on that subject with the exception of (i) the options previously granted and delivered to the undersigned under stock option plans of the Company, and (ii) the following agreements only: NONE___________________________________________________ (Initial) OTHER__________________________________________________ __________________________________________________ __________________________________________________ ____________________________________________ OPTIONEE ____________________________________________ Address ____________________________________________ ____________________________________________ 6. 7 NOTICE OF EXERCISE PMR Corporation 3990 Old Town Avenue Suite 206A San Diego, CA 92110-0000 Date of Exercise: ___________ Ladies and Gentlemen: This constitutes notice under my stock option that I elect to purchase the number of shares for the price set forth below. Type of option: Nonstatutory Stock option dated: ______________ Number of shares as to which option is exercised: ______________ Certificates to be issued in name of: ______________ Total exercise price: $_____________ Cash payment delivered herewith: $_____________ Value of ______ shares of common stock delivered herewith(1): $_____________ By this exercise, I agree (i) to provide such additional documents as you may require pursuant to the terms of the Company's 1997 Equity incentive Plan and (ii) to provide for the payment by me to you (in the manner designated by you) of your withholding obligation, if any, relating to the exercise of this option. Very truly yours, _________________________________ __________ (1) Shares must meet the public trading requirements set forth in the option. Shares must be valued in accordance with the terms of the option being exercised, must have been owned for the minimum period required in the option, and must be owned free and clear of any liens, claims, encumbrances or security interests. Certificates must be endorsed or accompanied by an executed assignment separate from certificate. 7. 8 PMR CORPORATION CHANGE IN CONTROL VESTING POLICY (THE "POLICY") In the event the employment or relationship as a consultant to the Company of a person holding an option under the 1997 Equity Incentive Plan (the "Optionee") is, within one (1) year following a "Change in Control," (i) terminated by the Company other than for "Cause," or (ii) terminated in a "Constructive Termination," then the option held by such Optionee shall be fully vested. Moreover, all options held by directors shall become fully vested immediately upon the occurrence of a Change in Control. For purposes of this Policy, the following definitions shall apply: "CHANGE IN CONTROL" shall mean the occurrence of any of the following events: (a) The Company is merged, consolidated or reorganized into or with another corporation, partnership, limited liability company, or other entity or person, and as a result of such merger, consolidation or reorganization less than 70% of the combined voting power of the then-outstanding securities of such corporation, partnership, limited liability company, or other entity or person immediately after such transaction are held in the aggregate by holders of voting securities of the Company immediately prior to such transaction; (b) The Company sells all or substantially all of its assets to any other corporation, partnership, limited liability company, or other entity or person, and thereafter, less than 70% of the combined voting power of the then-outstanding voting securities of the acquiring or consolidated entity are held in the aggregate by the holders of voting securities of the Company immediately prior to such sale; (c) There is a report filed after the date on which the option is granted on Schedule 13D or Schedule 14D-1 (or any successor schedule, form or report), each as promulgated pursuant to the Securities Exchange Act of 1934 (the "Exchange Act") disclosing that any person (as the term "person" is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the beneficial owner (as the term "beneficial owner" is defined under Rule 13d-3 or any successor rule or regulation promulgated under the Exchange Act) representing 30% or more of the combined voting power of the then-outstanding voting securities of the Company; (d) The Company shall file a report or proxy statement with the Securities and Exchange Commission pursuant to the Exchange Act disclosing in response to Item 1 of Form 8-K thereunder or Item 5(b) or Item 14 of Schedule 14A thereunder (or any successor schedule, form or report or item therein) that a change in 1. 9 control of the Company has or may have occurred or will or may occur in the future pursuant to any then-existing contract or transaction; or (e) During any period of two (2) consecutive years, individuals who at the beginning of any such period constitute the directors of the Company cease for any reason to constitute at least a majority of the Board of Directors of the Company unless the election or the nomination for election by the Company's shareholders of each director of the Company first elected during such period was approved by a vote of at least two-thirds of the directors of the Company then still in office who were directors of the Company at the beginning of such two (2)-year period. "CAUSE" shall mean termination due to the occurrence of any of the following: (a) any intentional action or intentional failure to act by Optionee which was performed in bad faith and to the material detriment of the Company; (b) Optionee intentionally refuses or intentionally fails to act in accordance with any lawful direction or order of the Company; (c) Optionee willfully and habitually neglects his duties of employment; (d) Optionee's engaging or participating in any activity which is competitive with or injurious to the Company in the judgment of the Board of Directors; (e) Optionee's commission of any fraud against the Company or use or appropriation for his personal use and benefit of any funds, assets or properties of the Company not authorized by the Company to be so used or appropriated; or (f) Optionee is convicted of a felony crime involving moral turpitude. "CONSTRUCTIVE TERMINATION" means that the Optionee voluntarily terminates his or her employment with the Company after any of the following are undertaken, following a Change in Control, without Optionee's express written consent: (a) the assignment to Optionee of any duties or responsibilities which are inconsistent with, or result in any diminution or adverse change of, Optionee's position, status or circumstances of employment as in effect immediately prior to a Change in Control; an adverse change in Optionee's titles, offices, benefits and/or perquisites as in effect immediately prior to a Change in Control; any removal of Optionee from or any failure to re-elect Optionee to any offices held by Optionee immediately prior to a Change in Control, including, but not limited to, Optionee's membership on the Board, except in connection with the termination of his employment for death, disability, retirement, Cause, or any voluntary termination of employment by Optionee other than a Constructive Termination; (b) a reduction by the Company in Optionee's annual base salary by greater than five percent (5%) from that which was in effect immediately prior to a Change in Control; 2. 10 (c) a relocation of Optionee, or the Company's principal executive offices if Optionee's principal office is at such offices, to a location more than forty (40) miles from the location at which Optionee was performing his duties prior to a Change in Control, except for required travel by Optionee on the Company's business to an extent substantially consistent with Optionee's business travel obligations at the time of a Change in Control; (d) any material breach by the Company of any material provision of Optionee's Stock Award Agreement following a Change in Control; or (e) any failure by the Company to obtain the assumption of Optionee's Stock Award Agreement by any successor or assign of the Company. 3. EX-10.4 7 EXHIBIT 10.4 1 EXHIBIT 10.4 PMR CORPORATION OUTSIDE DIRECTORS' NON-QUALIFIED STOCK OPTION PLAN OF 1992 SECTION 1. STATEMENT OF POLICY. The Board of Directors of PMR Corporation believes that it would be in the interest of the Corporation to adopt a stock option plan for its outside directors in order to encourage the acquisition of a personal proprietary interest in the Corporation by those directors of the Corporation who are not also employees of the Corporation. It is anticipated that stock ownership in the Corporation by such persons will stimulate their efforts and strengthen their desire to remain with the Corporation and will enable the Corporation from time to time to attract other persons of quality to become directors of the Corporation. This Plan, which is to be known as the Outside Directors Non-Qualified Stock Option Plan of 1992, is not intended to be qualified for preferential tax treatment as an incentive stock option plan under applicable provisions of the Code. SECTION 2. DEFINITIONS. When used in this Plan, unless the context otherwise requires: (a) "BOARD" shall mean the Board of Directors of the Corporation, as constituted from time to time, or any Committee appointed by the Board, as described in Section 3. (b) "CODE" shall mean the Internal Revenue Code of 1986, as amended. (c) "CORPORATION" shall mean PMR Corporation, a Delaware corporation. (d) "GRANTEE" shall mean an individual to whom an Option is granted pursuant to the terms and conditions of the Plan. (e) "OPTION" shall mean a stock option granted pursuant to the terms and conditions of the Plan. (f) "OUTSIDE DIRECTOR" shall mean a director of the Corporation who is not an employee of the Corporation or any Subsidiary. (g) "PLAN" shall mean this Outside Directors' Stock Option Plan of 1992, which was authorized by the Board on August 3, 1992, as amended from time to time. (h) "SHARE" shall mean a share of common stock of the Corporation. 1. 2 (i) "SUBSIDIARY" shall mean any company of which stock possessing more than 50% of the total combined voting power of all classes of stock is owned by the Corporation or by a Subsidiary of the Corporation, including corporations which become Subsidiaries after the date of adoption of this Plan. SECTION 3. ADMINISTRATION OF THE PLAN. The Plan shall be administered by the Board or by a Committee appointed by the Board, provided that no outside director shall sit on such Committee and no Outside Director shall vote on issues related to the Plan. Any member of said Committee so appointed may be removed at any time, with or without cause by the Board, and all vacancies on said Committee shall be filled by action of the Board. If the Committee is appointed, rules for the notice and conduct of Committee meetings and action to administer the Plan shall be prescribed by the Board. (Hereinafter, all references to the Board shall be deemed to apply to any such Committee so appointed by the Board.) SECTION 4. OPTION SHARES. The aggregate number of Shares which may be issued upon exercise of Options under the Plan shall not exceed five hundred twenty-five thousand (525,000). The Shares shall consist of authorized but unissued Shares. If any Option shall expire or terminate for any reason, without having been exercised in full, Options for the unpurchased Shares subject thereto may again be granted under the Plan. SECTION 5. TIME FOR GRANTING OPTIONS. Options may be granted by the Board pursuant to this Plan at any time as long as Shares reserved to this Plan shall remain unissued; provided, that, unless otherwise determined by the Board, options shall be granted annually as of the date of the regular meeting of the Board closest to the anniversary date of the Plan. SECTION 6. PERSONS ELIGIBLE. All Outside Directors shall be eligible to receive Options pursuant to the terms of this Plan. SECTION 7. AMOUNT LIMITATIONS ON GRANT OF OPTIONS. The number of Shares to be optioned to eligible persons shall be determined by the Board in its sole discretion; provided, however, that, unless otherwise determined by the Board, each person who is an Outside Director of the Corporation at the time of the regular meeting referenced in Section 6 shall be granted an Option to purchase fifteen thousand (15,000) Shares. SECTION 8. FORM OF OPTIONS. The written evidence of Options shall be determined from time to time by the Board. An Option Agreement signed by the Chairman of the Board or the President or a Vice President, attested by the Treasurer or Assistant Treasurer or Secretary or Assistant Secretary of the Corporation, and having the seal of the Corporation affixed thereto, shall be issued to each Grantee. Each Option 2. 3 Agreement shall specify the maximum number of Shares for which it may be exercised assuming that it fully vests in the Grantee ("Maximum Number of Shares"). SECTION 9. TERM AND VESTING OF OPTIONS. Unless otherwise determined by the Board, an Option shall vest in the Grantee and shall be exercisable by the Grantee only to the following extent: (a) Thirty percent ( 30% ) of the Maximum Number of Shares shall vest in the Grantee upon the grant of the Option; and (b) Subject to Section 15, on each of the first, second and third anniversaries of the date of grant of the Option, the Option shall vest in the Grantee to the extent of an additional twenty-three and one-third percent (23.33%) of the Maximum Number of Shares. At any time, subject to Section 12, a Grantee may exercise his Option for all or any portion of the Maximum Number of Shares which is then vested. Unless otherwise determined by the Board, and subject to Sections 12 and 15, each vested portion of an Option shall be exercisable for a term of five (5) years from the date of vesting. Upon expiration of any such term, any vested portion of an Option not exercised in full shall expire and be of no further force or effect. Notwithstanding the foregoing provisions under this Section 9, upon a Change in Control (as defined below) this Option shall be fully vested. For purposes of this Section 9, a "Change in Control" shall occur upon any of the following events: (i) The Company is merged, consolidated or reorganized into or with another corporation, partnership, limited liability company, or other entity or person, and as a result of such merger, consolidation or reorganization less than 70% of the combined voting power of the then-outstanding securities of such corporation, partnership, limited liability company, or other entity or person immediately after such transaction are held in the aggregate by holders of voting securities of the Company immediately prior to such transaction; (ii) The Company sells all or substantially all of its assets to any other corporation, partnership, limited liability company, or other entity or person, and thereafter, less than 70% of the combined voting power of the then-outstanding voting securities of the acquiring or consolidated entity are held in the aggregate by the holders of voting securities of the Company immediately prior to such sale; (iii) There is a report filed on Schedule 13D or Schedule 14D-1 (or any successor schedule, form or report), each as promulgated pursuant to the Securities Exchange Act of 1934 (the "Exchange Act") disclosing that any person (as the term 3. 4 "person" is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the beneficial owner (as the term "beneficial owner" is defined under Rule 13d-3 or any successor rule or regulation promulgated under the Exchange Act) representing 30% or more of the combined voting power of the then-outstanding voting securities of the Company; (iv) The Company shall file a report or proxy statement with the Securities and Exchange Commission pursuant to the Exchange Act disclosing in response to Item 1 of Form 8-K thereunder or Item 5(b) or Item 14 of Schedule 14A thereunder (or any successor schedule, form or report or item therein) that a change in control of the Company has or may have occurred or will or may occur in the future pursuant to any then-existing contract or transaction; or (v) During any period of two (2) consecutive years, individuals who at the beginning of any such period constitute the directors of the Company cease for any reason to constitute at least a majority of the Board of Directors of the Company unless the election or the nomination for election by the Company's shareholders of each director of the Company first elected during such period was approved by a vote of at least two-thirds of the directors of the Company then still in office who were directors of the Company at the beginning of such two (2)-year period. SECTION. 10. ASSIGNABILITY OF OPTIONS. During the lifetime of the Grantee, the Option may be exercised only by him. Options and all rights thereunder shall be nonassignable and nontransferable by the Grantee other than by will or the laws of descent and distribution and in accordance with Sections 12 and 15(b) hereof. SECTION 11. OPTION PRICE. The price per share of the shares to be purchased pursuant to the exercise of any option shall be as fixed by the Board, but in no event shall be less than the fair market value of a Share on the day on which the Option is granted. Fair market value shall be determined as provided in Section 20.2031-2 of the Federal Estate Tax Regulations and, if not inconsistent therewith, shall be the published closing bid price for such Shares on the largest public market to which they have been admitted for trading. EXERCISE OF OPTIONS SECTION 12. HOW TO EXERCISE OPTION. An Option shall be exercised by delivery of a duly signed notice in writing specifying the number of Shares to be purchased making reference to the Option Agreement, together with the full purchase price of the Shares to be purchased, to the Secretary or an officer of the Corporation appointed by the Chairman of the Board for the purpose of receiving the same; provided, however, that no 4. 5 Option granted pursuant to the Plan may be exercised at any time when the Option or the granting or exercise thereof violates any law or government' order or regulation. SECTION 13. PAYMENT FOR SHARES. Payment for the Shares purchased pursuant to the exercise of an Option, including reimbursement to the Corporation of any funds it must set aside as withholding taxes, if any, on such portion of the price as may be determined to be income subject to withholding, shall be made at the time of the exercise of the Option, in cash or by check payable to the order of the Corporation or, if approved in each case by the Board, by one of the following: (i) delivery to the Corporation of cash for at least 25% of the Option price, plus the Grantee's promissory note which shall bear interest at the rate of 9% per annum, which shall be payable over a period not to exceed two years from the date of exercise, and which shall be secured by a pledge of the Shares so purchased; or (ii) delivery to the Corporation of a number of Shares already owned by the Grantee which Shares have an aggregate market value equal to the aggregate Option price; or (iii) such other method of payment as the Board may determine, but in all cases only to the extent that the Board determines such payment or method of payment is good and legal consideration for the Shares purchased. The Corporation may lend money or guaranty loans by third parties to any individual finance the exercise of any Option granted under the Plan or to carry Shares thereby acquired, in all cases to the extent that counsel for the Corporation determines such loan or guaranty to be in conformity with applicable provisions of law. SECTION 14. COMPLIANCE WITH SECURITIES LAWS. Within a reasonable time after the due exercise of an Option, the Corporation shall cause to be delivered to the Grantee a certificate for the Shares purchased pursuant to the exercise of the option. The Corporation may postpone the issuance and delivery of Shares upon any exercise of an Option until (a) the admission of such Shares to listing on any stock exchange on which Shares of the same class are then listed and (b) the completion of such registration or other qualification of such Shares under any state or Federal law, rule or regulation as the Corporation shall determine to be necessary or advisable. Any person exercising an Option shall make such representations (including representations to the effect that such person will not dispose of such Shares in violation of the federal securities laws, if required by the Corporation) and furnish such information as may in the opinion of counsel for the Corporation be appropriate to permit the Corporation, in light of the existence or nonexistence of an effective Registration Statement under the Securities Act of 1933, with respect to such shares, to issue the Shares in compliance with the provisions of that or any comparable act. The Corporation may place any appropriate legend on any certificate evidencing the Shares. Nothing herein shall be deemed to require that the Corporation file or amend a Registration Statement. 5. 6 SECTION 15. TERMINATION OF SERVICE AS DIRECTOR. (a) In general, any unvested portion of an Option shall terminate at the close of business on the date on which the Grantee ceases to provide services to the Corporation for any reason whatsoever as a director, consultant, or employee. (b) Notwithstanding the foregoing, if the cessation of the Grantee's service as a director is due to the death or permanent and total disability (as defined in Section 22(e)(3) of the Code) of the Grantee, any unvested portion of an Option which would have vested within the unserved portion of such Grantee's term as a director shall vest as scheduled. (c) Nothing contained herein or in any Option Agreement shall be construed to confer upon any director any right to continue to serve as a director of the Corporation or any Subsidiary or to derogate from any right of the Corporation or any Subsidiary. SECTION 16. ADJUSTMENT OF OPTIONED SHARES. If, prior to the complete exercise of any Option, there shall be declared and paid a stock dividend upon the Shares, or if the Shares shall be split up, converted, exchanged, reclassified, or in any way substituted for, or if the Corporation shall merge or consolidate with another corporation, then, in any such event, the Option, to the extent that it has not been exercised, shall entitle the holder upon its future exercise to such number and kind of securities or other property, subject to the terms of the Option, to which the holder would have been entitled had such holder actually owned the Shares subject to the unexercised portion of the Option at the time of the occurrence of such stock dividend, split-up, conversion, exchange, reclassification, substitution, merger or consolidation; and the aggregate purchase price upon the future exercise of the Option shall be the same as if the originally optioned Shares of the Corporation were being purchased thereunder, provided that no fractions shall be issued and the aggregate purchase price shall be appropriately reduced on account of any fractions not so issued. If any such event should occur, the number of Shares, with respect to which Options remain to be granted or with respect to which Options may be re-granted, shall be similarly adjusted. RULES, AMENDMENTS AND INTERPRETATION SECTION 17. AMENDMENT. Except as provided in Section 18, the Board may at any time withdraw or amend the Plan and the terms and conditions of any Options not previously granted, and the Board, with the consent of the affected holder of an Option, may at any time withdraw or amend the Plan and the terms and conditions of any Option, which previously have been granted. SECTION 18. AMENDMENTS REQUIRING STOCKHOLDERS' APPROVAL. Notwithstanding the provisions of Section 17, any amendment which has the effect of 6. 7 conforming this Plan to the requirements for an Incentive Stock Option Plan as set forth in the Code shall not be effective unless approved by the shareholders of the Corporation at a meeting called for such purpose within twelve months before or after the adoption of such amendment by the Board. SECTION 19. INTERPRETATION. A determination of the Board as to any question which may arise with respect to the interpretation of the provisions of the Plan and Options shall be final. SECTION 20. RULES AND REGULATIONS. The Board may establish and revise such rules, regulations and take such other actions with respect to the Plan as are not inconsistent with the resolutions of the shareholders authorizing the Plan, and as the Board deems advisable to make the Plan and Options effective and provide for their administration. SECTION 21. EFFECTIVENESS OF THE PLAN. The Plan is effective as of August 3, 1992. 7. EX-10.5 8 EXHIBIT 10.5 1 EXHIBIT 10.5 NONSTATUTORY STOCK OPTION OUTSIDE DIRECTORS' NON-QUALIFIED STOCK OPTION PLAN OF 1992 ____________________, Optionee: PMR CORPORATION (the "Company"), pursuant to its Outside Directors' Non-Qualified Stock Option Plan of 1992 (the "Plan") has on __________, 19__ (the "Grant Date") granted to you, the optionee named above, an option to purchase shares of the common stock of the Company ("Common Stock"). This option is not intended to qualify and will not be treated as an "incentive stock option" within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). The grant hereunder is in connection with and in furtherance of the Company's compensatory benefit plan for participation of the Company's Outside Directors' (as defined in the Plan). The details of your option are as follows: 1. The total number of shares of Common Stock subject to this option is fifteen thousand (15,000). Subject to the limitations contained herein, this option shall be exercisable in accordance with the Plan. 2. The exercise price of this option is ___________________ ($_____) per share, being the "fair market value" (as defined in the Plan) of the Common Stock on the date of grant of this option. 3. Subject to the limitations contained herein, this option shall become exercisable (i.e., vest) as to four thousand five hundred (4,500) shares on the Grant Date, and shall vest further in equal annual installments of three thousand five hundred (3,500) shares on each anniversary of the Grant Date until fully vested. In addition, this option will become fully vested upon the occurrence of a Change in Control (as defined in the Plan). 4. (a) This option may be exercised, to the extent specified above, by delivering a notice of exercise (in a form designated by the Company) together with the exercise price to the Secretary of the Company, or to such other person as the Company may designate, during regular business hours, together with such additional documents as the Company may then require pursuant to section 14 of the Plan. This option may not be exercised for any number of shares which would require the issuance of anything other than whole shares. 1. 2 (b) By exercising this option you agree that the Company may require you to enter an arrangement providing for the cash payment by you to the Company of any tax withholding obligation of the Company arising by reason of the exercise of this option or the lapse of any substantial risk of forfeiture to which the shares are subject at the time of exercise. 5. Any notices provided for in this option or the Plan shall be given in writing and shall be deemed effectively given upon receipt or, in the case of notices delivered by the Company to you, five (5) days after deposit in the United States mail, postage prepaid, addressed to you at the address specified below or at such other address as you hereafter designate by written notice to the Company. 6. This option is subject to all the provisions of the Plan, a copy of which is attached hereto and its provisions are hereby made a part of this option, and is further subject to all interpretations, amendments, rules and regulations which may from time to time be promulgated and adopted pursuant to the Plan. In the event of any conflict between the provisions of this option and those of the Plan, the provisions of the Plan shall control. Dated the day of ___________________, 19__. Very truly yours, PMR CORPORATION By:___________________________________ Duly authorized on behalf of the Board of Directors ATTACHMENTS: Outside Directors' Non-Qualified Stock Option Plan of 1992, with Amendment 2. 3 The undersigned: (a) Acknowledges receipt of the foregoing option and the attachments referenced therein and understands that all rights and liabilities with respect to this option are set forth in the option and the Plan; (b) Acknowledges that as of the date of grant of this option, it sets forth the entire understanding between the undersigned optionee and the Company and its affiliates regarding the acquisition of stock in the Company and supersedes all prior oral and written agreements on that subject with the exception of (i) the options and any other stock awards previously granted and delivered to the undersigned under stock award plans of the Company, and (ii) the following agreements only: NONE __________________________________________________ (Initial) OTHER __________________________________________________ __________________________________________________ __________________________________________________ ____________________________________________ OPTIONEE ____________________________________________ Address ____________________________________________ ____________________________________________ 3. EX-10.6 9 EXHIBIT 10.6 1 EXHIBIT 10.6 "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION, OR THE AVAILABILITY OF EXEMPTION FROM REGISTRATION, UNDER THE SECURITIES ACT OF 1933, AS AMENDED, BASED ON AN OPINION LETTER OF COUNSEL SATISFACTORY TO THE COMPANY OR A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION." AMENDED AND RESTATED OPTION TO PURCHASE COMMON STOCK OF PMR CORPORATION Void after April 30, 2001 This certifies that, for value received, ALLEN TEPPER ("Holder"), is entitled, subject to the terms set forth below, to purchase from PMR CORPORATION (the "Company"), a Delaware corporation, shares of the Common Stock of the Company (the "Shares"), as constituted on the effective date hereof (the "Option Issue Date"), with the Notice of Exercise attached hereto duly executed, and simultaneous payment therefor in lawful money of the United States, at the Exercise Price as set forth in Section 2 below. The number, character and Exercise Price of the shares are subject to adjustment as provided below. 1. TERM OF OPTION. Subject to compliance with the vesting provisions identified at Paragraph 2.3 hereafter, this Option shall be exercisable, in whole or in part, during the term commencing on the Option Issue Date and ending at 5:00 p.m. on April 30, 2001, and shall be void thereafter. 2. EXERCISE PRICE, NUMBER OF SHARES AND VESTING PROVISIONS. 2.1 EXERCISE PRICE. The Exercise Price at which this Option may be exercised shall be $9.75 per share of common stock, as adjusted pursuant to Section 11 hereof. 2.2 NUMBER OF SHARES. The number of shares of the Company's Common Stock, $.01 par value per share ("Common Stock") which may be purchased pursuant to this Option shall be 25,000 shares, as adjusted pursuant to Section 11 hereof. 2.3 VESTING. The Options granted hereunder have immediately vested as of the Option Issue Date. 1. 2 2.4 DEATH OF HOLDER AND TERMINATION. (a) If the Holder shall die while in the employ of the Company, his estate, personal representatives, or beneficiary shall have the right, subject to the provisions of this Paragraph 2 hereof, to exercise the Option (only to the extent that the Holder would have been entitled to do so as of the date of his death) at any time within twelve (12) months from the date of his death. (b) In the event Holder's employment by the Company is terminated for "cause", as defined above, or Holder voluntarily terminates his employment with the Company, Holder shall have 30 days in which to exercise the Option (only to the extent that the Holder would have been entitled to do so as of the date of his termination) and thereafter, Holder's right in and to the Option shall lapse and terminate. 3. EXERCISE OF OPTION. (a) The Exercise Price shall either be payable in cash or by bank or certified check; or by cashless exercise through the delivery by the Holder to the Company of shares of the Company's Common Stock for which Holder is the record and beneficial owner, or a withholding by the Company of shares of Common Stock that Holder is otherwise entitled to receive upon exercise of the Option or by any combination thereof. If shares of common stock of the Company are tendered or withheld as payment of the Exercise Price, the value of such shares shall be their "market value" as of the trading date immediately preceding the date of exercise. The "market value" shall be: (i) If the Company's common stock is traded in the over-the-counter market and not on any national securities exchange nor in the NASDAQ Reporting System, the market value shall be the average of the mean between the last bid and ask prices per share, as reported by the National Quotation Bureau, Inc., or an equivalent generally accepted reporting service, or if not so reported, the average of the closing bid and asked prices for a share as furnished to the Company by any member of the National Association of Securities Dealers, Inc., selected by the Company for that purpose. (ii) If the Company's common stock is traded on a national securities exchange or in the NASDAQ Reporting System, the market value shall be either (1) the simple average of the high and low prices at which a share of the Company's common stock traded, as quoted on the NASDAQ-NMS or its other principal exchange, or (2) the price of the last sale of a share of common stock as similarly quoted, whichever is higher, and rounding out such figure to the next higher multiple of 12.5 cents (unless the figure is already a multiple of 12.5 cents). 2. 3 If such tender would result in an issuance of a whole number of shares and a fractional share of Common Stock, the value of such fractional share shall be paid to the Company in cash or by check by the Holder. (b) The purchase rights represented by this Option are exercisable by the Holder in whole or in part, at any time, or from time to time, by the surrender of this Option and the Notice of Exercise annexed hereto duly completed and executed on behalf of the Holder, at the office of the Company (or such other office or agency of the Company as it may designate by notice in writing to the Holder at the address of the Holder appearing on the books of the Company). (c) This Option shall be deemed to have been exercised immediately prior to the close of business on the date of its surrender for exercise as provided above, and the person entitled to receive the shares of Common Stock issuable upon such exercise shall be treated for all purposes as the holder of record of such shares as of the close of business on such date. As promptly as practicable on or after such date and in any event within ten (10) days thereafter, the Company at its expense shall issue and deliver to the person or persons entitled to receive the same a certificate or certificates for the number of shares issuable upon such exercise. In the event that this Option is exercised in part, the Company at its expense will execute and deliver a new Option of like tenor exercisable for the number of shares for which this Option may then be exercised. 4. NO FRACTIONAL SHARES OR SCRIP. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Option. In lieu of any fractional share to which the Holder would otherwise be entitled, the Company shall make a cash payment equal to the Exercise Price multiplied by such fraction. 5. REPLACEMENT OF OPTION. On receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Option and, in the case of loss, theft or destruction, or delivery of an indemnity agreement reasonably satisfactory in form and substance to the Company or, in the case of mutilation, on surrender and cancellation of this Option, the Company at its expense shall execute and deliver, in lieu of this Option, a new Option of like tenor and amount. 6. RIGHTS OF STOCKHOLDER. Except as otherwise contemplated herein, the Holder shall not be entitled to vote or receive dividends or be deemed the holder of Common Stock or any other securities of the Company that may at any time be issuable on the exercise hereof for any purpose, nor shall anything contained herein be construed to confer upon the Holder, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to stockholders at any meeting thereof, or to give or withhold consent to any corporate action (whether upon any 3. 4 recapitalization, issuance of stock, reclassification of stock, change of par value, or change of stock to no par value, consolidation, merger, conveyance or otherwise) or to receive notice of meetings, or to receive dividends or subscription rights or otherwise until the Option shall have been exercised as provided herein. 7. TRANSFER OF OPTION. 7.1 NON-TRANSFERABILITY. The Option shall not be assigned, transferred, pledged or hypothecated in any way, nor subject to execution, attachment or similar process, otherwise than by will or by the laws of descent and distribution. Any attempted assignment, transfer, pledge, hypothecation or other disposition of the Option contrary to the provisions hereof, and the levy of an execution, attachment, or similar process upon the Option, shall be null and void and without effect. 7.2 COMPLIANCE WITH SECURITIES LAWS; RESTRICTIONS ON TRANSFERS. (a) The Holder of this Option, by acceptance hereof, acknowledges that this Option and the Shares to be issued upon exercise hereof are being acquired solely for the Holder's own account and not as a nominee for any other party, and for investment (unless such shares are subject to resale pursuant to an effective prospectus), and that the Holder will not offer, sell or otherwise dispose of this Option or any Shares to be issued upon exercise hereof except under circumstances that will not result in a violation of applicable federal and state securities laws. Upon exercise of this Option, the Holder shall, if requested by the Company, confirm in writing, in a form satisfactory to the Company, that the shares of Common Stock so purchased are being acquired solely for the Holder's own account and not as a nominee for any other party, for investment (unless such shares are subject to resale pursuant to an effective prospectus), and not with a view toward distribution or resale. (b) Neither this Option nor any share of Common Stock issued upon exercise of this Option may be offered for sale or sold, or otherwise transferred or sold in any transaction which would constitute a sale thereof within the meaning of the Securities Act of 1933, as amended (the "1933 Act"), unless (i) such security has been registered for sale under the 1933 Act and registered or qualified under applicable state securities laws relating to the offer an sale of securities, or (ii) exemptions from the registration requirements of the 1933 Act and the registration or qualification requirements of all such state securities laws are available and the Company shall have received an opinion of counsel satisfactory to the Company that the proposed sale or other disposition of such securities may be effected without registration under the 1933 Act and would not result in any violation of any applicable state securities laws relating to the registration or qualification of securities for sale, such counsel and such opinion to be satisfactory to the Company. 4. 5 (c) All Shares issued upon exercise hereof shall be stamped or imprinted with a legend in substantially the following form (in addition to any legend required by state securities laws). "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION, OR THE AVAILABILITY OF EXEMPTION FROM REGISTRATION, UNDER THE SECURITIES ACT OF 1933, AS AMENDED, BASED ON AN OPINION LETTER OF COUNSEL SATISFACTORY TO THE COMPANY OR A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION." Holder recognizes that investing in the Option and the Common Stock involves a high degree of risk, and Holder is in a financial position to hold the Option and the Common Stock indefinitely and is able to bear the economic risk and withstand a complete loss of its investment in the Option and the Common Stock. The Holder is a sophisticated investor and is capable of evaluating the merits and risks of investing in the Company. The Holder has had an opportunity to discuss the Company's business, management and financial affairs with the Company's management, has been given full and complete access to information concerning the Company, and has utilized such access to its satisfaction for the purpose of obtaining information or verifying information and have had the opportunity to inspect the Company's operation. Holder has had the opportunity to ask questions of, and receive answers from the management of the Company (and any person acting on its behalf) concerning the Option and the Common Stock and the agreements and transactions contemplated hereby, and to obtain any additional information as Holder may have requested in making its investment decision. The Holder is an "accredited investor", as defined by Regulation D promulgated under the Act. 8. RESERVATION AND ISSUANCE OF STOCK. (a) The Company covenants that during the term that this Option is exercisable, the Company will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of the shares upon the exercise of this Option, and from time to time will take all steps necessary to amend its Certificate of Incorporation to provide sufficient reserves of shares of Common Stock issuable upon the exercise of the Option. (b) The Company further covenants that all shares of Common Stock issuable upon the due exercise of this Option will be free and clear from all taxes or liens, 5. 6 charges and security interests created by the Company with respect to the issuance thereof, however, the Company shall not be obligated or liable for the payment of any taxes, liens or charges of Holder, or any other party contemplated by paragraph 7, incurred in connection with the issuance of this Option or the Common Stock upon the due exercise of this Option. The Company agrees that its issuance of this Option shall constitute full authority to its officers who are charged with the duty of executing stock certificates to execute and issue the necessary certificates for the shares of Common Stock upon the exercise of this Option. The Common Stock issuable upon the due exercise of this Option, will, upon issuance in accordance with the terms hereof, be duly authorized, validly issued, fully paid and non-assessable. 9. NOTICES. (a) Whenever the Exercise Price or number of shares purchasable hereunder shall be adjusted pursuant to Section 11 hereof, the Company shall issue a certificate signed by its Chief Financial Officer setting forth, in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method by which such adjustment was calculated, and the Exercise Price and number of shares purchasable hereunder after giving effect to such adjustment, and shall cause a copy of such certificate to be mailed (by first-class mail, postage prepaid) to the Holder of this Option. (b) All notices, advices and communications under this Option shall be deemed to have been given, (i) in the case of personal delivery, on the date of such delivery and (ii) in the case of mailing, on the third business day following the date of such mailing, addressed as follows: If to the Company: PMR Corporation 3990 Old Town Avenue, Suite 206A San Diego, CA 92110 Attn: Allen Tepper, Chief Executive Officer With a Copy to: Jeremy D. Glaser, Esquire Cooley Godward LLP 4365 Executive Drive, Suite 1100 San Diego, CA 92121-2128 and to the Holder: 6. 7 at the address of the Holder appearing on the books of the Company or the Company's transfer agent, if any. Either of the Company or the Holder may from time to time change the address to which notices to it are to be mailed hereunder by notice in accordance with the provisions of this Paragraph 9. 10. AMENDMENTS. (a) Any term of this Option may be amended with the written consent of the Company and the Holder. Any amendment effected in accordance with this Section 10 shall be binding upon the Holder, each future holder and the Company. (b) No waivers of, or exceptions to, any term, condition or provision of this Option, in any one or more instances, shall be deemed to be, or construed as, a further or continuing waiver of any such term, condition or provision. 11. ADJUSTMENTS. The number of Shares of Common Stock purchasable hereunder and the Exercise Price is subject to adjustment from time to time upon the occurrence of certain events, as follows: 11.1 REORGANIZATION, MERGER OR SALE OF ASSETS. If at any time while this Option, or any portion thereof, is outstanding and unexpired there shall be (i) a reorganization (other than a combination, reclassification, exchange or subdivision of shares otherwise provided for herein), (ii) a merger or consolidation of the Company with or into another corporation in which the Company is not the surviving entity, or a reverse triangular merger in which the Company is the surviving entity but the shares of the Company's capital stock outstanding immediately prior to the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise, or (iii) a sale or transfer of substantially all of the Company's properties and assets as, or substantially as, an entirety to any other person, then, as a part of such reorganization, merger, consolidation, sale or transfer, lawful provision shall be made so that the holder of this Option shall thereafter be entitled to receive upon payment of the Exercise Price then in effect, the number of shares of stock or other securities or property of the successor corporation resulting from such reorganization, merger, consolidation, sale or transfer that a holder of the shares deliverable upon exercise of this Option would have been entitled to receive in such reorganization, consolidation, merger, sale or transfer if this Option had been exercised immediately before such reorganization, merger, consolidation, sale or transfer, all subject to further adjustment as provided in this Section 11. The foregoing provisions of this Section 11.1 shall similarly apply to successive reorganizations, consolidations, mergers, sales and transfers and to the stock or securities of any other corporation that are at the time receivable upon the exercise of this 7. 8 Option. If the per-share consideration payable to the Holder hereof for shares in connection with any such transaction is in a form other than cash or marketable securities, then the value of such consideration shall be determined in good faith by the Company's Board of Directors. In all events, appropriate adjustment (as determined in good faith by the Company's Board of Directors) shall be made in the application of the provisions of this Option with respect to the rights and interests of the Holder after the transaction, to the end that the provisions of this Option shall be applicable after that event, as near as reasonably may be, in relation to any shares or other property deliverable after that event upon exercise of this Option. 11.2 Reclassification. If the Company, at any time while this Option, or any portion thereof, remains outstanding and unexpired, by reclassification of securities or otherwise, shall change any of the securities as to which purchase rights under this Option exist into the same or a different number of securities of any other class or classes, this Option shall thereafter represent the right to acquire such number and kind of securities as would have been issuable as the result of such change with respect to the securities that were subject to the purchase rights under this Option immediately prior to such reclassification or other change and the Exercise Price therefor shall be appropriately adjusted, all subject to further adjustment as provided in this Section 11. 11.3 SPLIT, SUBDIVISION OR COMBINATION OF SHARES. If the Company at any time while this Option, or any portion thereof, remains outstanding and unexpired shall split, subdivide or combine the securities as to which purchase rights under this Option exist, into a different number of securities of the same class, the Exercise Price and the number of shares issuable upon exercise of this Option shall be proportionately adjusted. 11.4 ADJUSTMENTS FOR DIVIDENDS IN STOCK OR OTHER SECURITIES OR PROPERTY. If while this Option, or any portion hereof, remains outstanding and unexpired the holders of the securities as to which purchase rights under this Option exist at the time shall have received, or, on or after the record date fixed for the determination of eligible Stockholders, shall have become entitled to receive, without payment therefor, other or additional stock or other securities or property (other than cash) of the Company by way of dividend, then and in each case, this Option shall represent the right to acquire, in addition to the number of shares of the security receivable upon exercise of this Option, and without payment of any additional consideration therefor, the amount of such other or additional stock or other securities or property (other than cash) of the Company that such holder would hold on the date of such exercise had it been the holder of record of the security receivable upon exercise of this Option on the date hereof and had thereafter, during the period from the date hereof to and including the date of such exercise, retained such shares and/or all other additional stock, other securities or property available by this Option as aforesaid during such period. 8. 9 11.5 The Company will not, by any voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Company, but will at all times in good faith assist in the carrying out of all the provisions of this Section 11 and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the Holders of this Option against impairment. 12. SEVERABILITY. Whenever possible, each provision of this Option shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Option is held to be invalid, illegal or unenforceable in any respect under any applicable law or rule in any jurisdiction, such invalidity, illegality or unenforceability shall not affect the validity, legality or enforceability of any other provision of this Option in such jurisdiction or affect the validity, legality or enforceability of any provision in any other jurisdiction, but this Option shall be reformed, construed and enforced in such jurisdiction as if such invalid, illegal or unenforceable provision had never been contained herein. 13. GOVERNING LAW. The corporate law of the State of Delaware shall govern all issues and questions concerning the relative rights of the Company and its stockholders. All other questions concerning the construction, validity, interpretation and enforceability of this Option and the exhibits and schedules hereto shall be governed by, and construed in accordance with, the laws of the State of Delaware, without giving effect to any choice of law or conflict of law rules or provisions (whether of the State of Delaware or any other jurisdiction) that would cause the application of the laws of any jurisdiction other than the State of Delaware. 14. JURISDICTION. In connection with the enforcement of a decision in arbitration pursuant to section 16 hereof, the Holder and the Company agree to submit to personal jurisdiction and to waive any objection as to venue in the federal or state courts in the City in which the headquarters of the Company is located, which as of the date hereof is San Diego, California. Service of process on the Company or the Holder in any action arising out of or relating to this Option shall be effective if mailed to such party at the address listed in Section 9 hereof. 15. ARBITRATION. If a dispute arises as to interpretation of this Option, it shall be decided exclusively and finally by three arbitrators in an arbitration proceeding conforming to the Rules of the American Arbitration Association applicable to commercial arbitration. The arbitrators shall be appointed as follows: one by the Company, one by the Holder and the third by the said two arbitrators, or, if they cannot agree, then the third arbitrator shall be appointed by the American Arbitration Association. The third arbitrator shall be chairman of the panel and shall be impartial. The arbitration shall take place in the City in which the headquarters of the Company is located, which as of the date hereof is San Diego, California. The decision of a majority 9. 10 of the Arbitrators shall be conclusively binding upon the parties and final, and such decision shall be enforceable as a judgment in any court of competent jurisdiction. Each party shall pay the fees and expenses of the arbitrator appointed by it, its counsel and its witnesses. The parties shall share equally the fees and expenses of the impartial arbitrator. 16. CORPORATE POWER; AUTHORIZATION; ENFORCEABLE OBLIGATIONS. The execution, delivery and performance by the Company of this Agreement: (i) are within the Company's corporate power; (ii) have been duly authorized by all necessary or proper corporate action; (iii) are not in contravention of the Company's certificate of incorporation or by-laws; (iv) will not violate in any material respect, any law or regulation, including any and all Federal and state securities laws, or any order or decree of any court or governmental instrumentality; and (v) will not, in any material respect, conflict with or result in the breach or termination of, or constitute a default under any agreement or other material instrument to which the Company is a party or by which the Company is bound. 17. SUCCESSORS AND ASSIGNS. This Option shall inure to the benefit of and be binding on the respective successors, assigns and legal representatives of the Holder and the Company. 10. 11 IN WITNESS WHEREOF, the Company has caused this Option to be executed by its officers thereunto duly authorized. Option Issue Date: April 30, 1996 HOLDER PMR CORPORATION By: /s/ Allen Tepper By: /s/ Mark Clein ------------------------ ------------------------ Allen Tepper Mark Clein, Executive Vice President 11. 12 NOTICE OF EXERCISE TO: PMR CORPORATION (1) The undersigned hereby elects to purchase _________ shares of Common Stock of PMR CORPORATION pursuant to the terms of the attached Option, and tenders herewith payment of the purchase price for such shares in full. (2) In exercising this Option, the undersigned hereby confirms and acknowledges that the shares of Common Stock to be issued upon conversion thereof are being acquired solely for the account of the undersigned and not as a nominee for any other party, and for investment (unless such shares are subject to resale pursuant to an effective prospectus), and that the undersigned will not offer, sell or otherwise dispose of any such shares of Common Stock except under circumstances that will not result in a violation of the Securities Act of 1933, as amended, or any state securities laws. (3) Please issue a certificate or certificates representing said shares of Common Stock in the name of the undersigned or in such other name as is specified below: ---------------------------- (Name) ---------------------------- (Name) - ---------------------------- ---------------------------- (Date) (Signature) 12. EX-10.7 10 EXHIBIT 10.7 1 EXHIBIT 10.7 "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION, OR THE AVAILABILITY OF EXEMPTION FROM REGISTRATION, UNDER THE SECURITIES ACT OF 1933, AS AMENDED, BASED ON AN OPINION LETTER OF COUNSEL SATISFACTORY TO THE COMPANY OR A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION." AMENDED AND RESTATED OPTION TO PURCHASE COMMON STOCK OF PMR CORPORATION Void after April 30, 2006 This certifies that, for value received, SUSAN ERSKINE ("Holder"), is entitled, subject to the terms set forth below, to purchase from PMR CORPORATION (the "Company"), a Delaware corporation, shares of the Common Stock of the Company (the "Shares"), as constituted on the effective date hereof (the "Option Issue Date"), with the Notice of Exercise attached hereto duly executed, and simultaneous payment therefor in lawful money of the United States, at the Exercise Price as set forth in Section 2 below. The number, character and Exercise Price of the shares are subject to adjustment as provided below. 1. TERM OF OPTION. Subject to compliance with the vesting provisions identified at Paragraph 2.3 hereafter, this Option shall be exercisable, in whole or in part, during the term commencing on the Option Issue Date and ending at 5:00 p.m. on April 30, 2006, and shall be void thereafter. 2. EXERCISE PRICE, NUMBER OF SHARES AND VESTING PROVISIONS. 2.1 EXERCISE PRICE. The Exercise Price at which this Option may be exercised shall be $9.75 per share of common stock, as adjusted pursuant to Section 11 hereof. 2.2 NUMBER OF SHARES. The number of shares of the Company's Common Stock, $.01 par value per share ("Common Stock") which may be purchased pursuant to this Option shall be 21,671 shares, as adjusted pursuant to Section 11 hereof. 2.3 VESTING. The Options granted hereunder have immediately vested as of the Option Issue Date. 1. 2 2.4 DEATH OF HOLDER AND TERMINATION. (a) If the Holder shall die while in the employ of the Company, his estate, personal representatives, or beneficiary shall have the right, subject to the provisions of this Paragraph 2 hereof, to exercise the Option (only to the extent that the Holder would have been entitled to do so as of the date of his death) at any time within twelve (12) months from the date of his death. (b) In the event Holder's employment by the Company is terminated for "cause", as defined above, or Holder voluntarily terminates his employment with the Company, Holder shall have 30 days in which to exercise the Option (only to the extent that the Holder would have been entitled to do so as of the date of his termination) and thereafter, Holder's right in and to the Option shall lapse and terminate. 3. EXERCISE OF OPTION. (a) The Exercise Price shall either be payable in cash or by bank or certified check; or by cashless exercise through the delivery by the Holder to the Company of shares of the Company's Common Stock for which Holder is the record and beneficial owner, or a withholding by the Company of shares of Common Stock that Holder is otherwise entitled to receive upon exercise of the Option or by any combination thereof. If shares of common stock of the Company are tendered or withheld as payment of the Exercise Price, the value of such shares shall be their "market value" as of the trading date immediately preceding the date of exercise. The "market value" shall be: (i) If the Company's common stock is traded in the over-the-counter market and not on any national securities exchange nor in the NASDAQ Reporting System, the market value shall be the average of the mean between the last bid and ask prices per share, as reported by the National Quotation Bureau, Inc., or an equivalent generally accepted reporting service, or if not so reported, the average of the closing bid and asked prices for a share as furnished to the Company by any member of the National Association of Securities Dealers, Inc., selected by the Company for that purpose. (ii) If the Company's common stock is traded on a national securities exchange or in the NASDAQ Reporting System, the market value shall be either (1) the simple average of the high and low prices at which a share of the Company's common stock traded, as quoted on the NASDAQ-NMS or its other principal exchange, or (2) the price of the last sale of a share of common stock as similarly quoted, whichever is higher, and rounding out such figure to the next higher multiple of 12.5 cents (unless the figure is already a multiple of 12.5 cents). 2. 3 If such tender would result in an issuance of a whole number of shares and a fractional share of Common Stock, the value of such fractional share shall be paid to the Company in cash or by check by the Holder. (b) The purchase rights represented by this Option are exercisable by the Holder in whole or in part, at any time, or from time to time, by the surrender of this Option and the Notice of Exercise annexed hereto duly completed and executed on behalf of the Holder, at the office of the Company (or such other office or agency of the Company as it may designate by notice in writing to the Holder at the address of the Holder appearing on the books of the Company). (c) This Option shall be deemed to have been exercised immediately prior to the close of business on the date of its surrender for exercise as provided above, and the person entitled to receive the shares of Common Stock issuable upon such exercise shall be treated for all purposes as the holder of record of such shares as of the close of business on such date. As promptly as practicable on or after such date and in any event within ten (10) days thereafter, the Company at its expense shall issue and deliver to the person or persons entitled to receive the same a certificate or certificates for the number of shares issuable upon such exercise. In the event that this Option is exercised in part, the Company at its expense will execute and deliver a new Option of like tenor exercisable for the number of shares for which this Option may then be exercised. 4. NO FRACTIONAL SHARES OR SCRIP. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Option. In lieu of any fractional share to which the Holder would otherwise be entitled, the Company shall make a cash payment equal to the Exercise Price multiplied by such fraction. 5. REPLACEMENT OF OPTION. On receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Option and, in the case of loss, theft or destruction, or delivery of an indemnity agreement reasonably satisfactory in form and substance to the Company or, in the case of mutilation, on surrender and cancellation of this Option, the Company at its expense shall execute and deliver, in lieu of this Option, a new Option of like tenor and amount. 6. RIGHTS OF STOCKHOLDER. Except as otherwise contemplated herein, the Holder shall not be entitled to vote or receive dividends or be deemed the holder of Common Stock or any other securities of the Company that may at any time be issuable on the exercise hereof for any purpose, nor shall anything contained herein be construed to confer upon the Holder, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to stockholders at any meeting thereof, or to give or withhold consent to any corporate action (whether upon any 3. 4 recapitalization, issuance of stock, reclassification of stock, change of par value, or change of stock to no par value, consolidation, merger, conveyance or otherwise) or to receive notice of meetings, or to receive dividends or subscription rights or otherwise until the Option shall have been exercised as provided herein. 7. TRANSFER OF OPTION. 7.1 NON-TRANSFERABILITY. The Option shall not be assigned, transferred, pledged or hypothecated in any way, nor subject to execution, attachment or similar process, otherwise than by will or by the laws of descent and distribution. Any attempted assignment, transfer, pledge, hypothecation or other disposition of the Option contrary to the provisions hereof, and the levy of an execution, attachment, or similar process upon the Option, shall be null and void and without effect. 7.2 COMPLIANCE WITH SECURITIES LAWS; RESTRICTIONS ON TRANSFERS. (a) The Holder of this Option, by acceptance hereof, acknowledges that this Option and the Shares to be issued upon exercise hereof are being acquired solely for the Holder's own account and not as a nominee for any other party, and for investment (unless such shares are subject to resale pursuant to an effective prospectus), and that the Holder will not offer, sell or otherwise dispose of this Option or any Shares to be issued upon exercise hereof except under circumstances that will not result in a violation of applicable federal and state securities laws. Upon exercise of this Option, the Holder shall, if requested by the Company, confirm in writing, in a form satisfactory to the Company, that the shares of Common Stock so purchased are being acquired solely for the Holder's own account and not as a nominee for any other party, for investment (unless such shares are subject to resale pursuant to an effective prospectus), and not with a view toward distribution or resale. (b) Neither this Option nor any share of Common Stock issued upon exercise of this Option may be offered for sale or sold, or otherwise transferred or sold in any transaction which would constitute a sale thereof within the meaning of the Securities Act of 1933, as amended (the "1933 Act"), unless (i) such security has been registered for sale under the 1933 Act and registered or qualified under applicable state securities laws relating to the offer an sale of securities, or (ii) exemptions from the registration requirements of the 1933 Act and the registration or qualification requirements of all such state securities laws are available and the Company shall have received an opinion of counsel satisfactory to the Company that the proposed sale or other disposition of such securities may be effected without registration under the 1933 Act and would not result in any violation of any applicable state securities laws relating to the registration or qualification of securities for sale, such counsel and such opinion to be satisfactory to the Company. 4. 5 (c) All Shares issued upon exercise hereof shall be stamped or imprinted with a legend in substantially the following form (in addition to any legend required by state securities laws). "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION, OR THE AVAILABILITY OF EXEMPTION FROM REGISTRATION, UNDER THE SECURITIES ACT OF 1933, AS AMENDED, BASED ON AN OPINION LETTER OF COUNSEL SATISFACTORY TO THE COMPANY OR A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION." Holder recognizes that investing in the Option and the Common Stock involves a high degree of risk, and Holder is in a financial position to hold the Option and the Common Stock indefinitely and is able to bear the economic risk and withstand a complete loss of its investment in the Option and the Common Stock. The Holder is a sophisticated investor and is capable of evaluating the merits and risks of investing in the Company. The Holder has had an opportunity to discuss the Company's business, management and financial affairs with the Company's management, has been given full and complete access to information concerning the Company, and has utilized such access to its satisfaction for the purpose of obtaining information or verifying information and have had the opportunity to inspect the Company's operation. Holder has had the opportunity to ask questions of, and receive answers from the management of the Company (and any person acting on its behalf) concerning the Option and the Common Stock and the agreements and transactions contemplated hereby, and to obtain any additional information as Holder may have requested in making its investment decision. The Holder is an "accredited investor", as defined by Regulation D promulgated under the Act. 8. RESERVATION AND ISSUANCE OF STOCK. (a) The Company covenants that during the term that this Option is exercisable, the Company will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of the shares upon the exercise of this Option, and from time to time will take all steps necessary to amend its Certificate of Incorporation to provide sufficient reserves of shares of Common Stock issuable upon the exercise of the Option. (b) The Company further covenants that all shares of Common Stock issuable upon the due exercise of this Option will be free and clear from all taxes or liens, 5. 6 charges and security interests created by the Company with respect to the issuance thereof, however, the Company shall not be obligated or liable for the payment of any taxes, liens or charges of Holder, or any other party contemplated by paragraph 7, incurred in connection with the issuance of this Option or the Common Stock upon the due exercise of this Option. The Company agrees that its issuance of this Option shall constitute full authority to its officers who are charged with the duty of executing stock certificates to execute and issue the necessary certificates for the shares of Common Stock upon the exercise of this Option. The Common Stock issuable upon the due exercise of this Option, will, upon issuance in accordance with the terms hereof, be duly authorized, validly issued, fully paid and non-assessable. 9. NOTICES. (a) Whenever the Exercise Price or number of shares purchasable hereunder shall be adjusted pursuant to Section 11 hereof, the Company shall issue a certificate signed by its Chief Financial Officer setting forth, in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method by which such adjustment was calculated, and the Exercise Price and number of shares purchasable hereunder after giving effect to such adjustment, and shall cause a copy of such certificate to be mailed (by first-class mail, postage prepaid) to the Holder of this Option. (b) All notices, advices and communications under this Option shall be deemed to have been given, (i) in the case of personal delivery, on the date of such delivery and (ii) in the case of mailing, on the third business day following the date of such mailing, addressed as follows: If to the Company: PMR Corporation 3990 Old Town Avenue, Suite 206A San Diego, CA 92110 Attn: Allen Tepper, Chief Executive Officer With a Copy to: Jeremy D. Glaser, Esquire Cooley Godward LLP 4365 Executive Drive, Suite 1100 San Diego, CA 92121-2128 and to the Holder: 6. 7 at the address of the Holder appearing on the books of the Company or the Company's transfer agent, if any. Either of the Company or the Holder may from time to time change the address to which notices to it are to be mailed hereunder by notice in accordance with the provisions of this Paragraph 9. 10. AMENDMENTS. (a) Any term of this Option may be amended with the written consent of the Company and the Holder. Any amendment effected in accordance with this Section 10 shall be binding upon the Holder, each future holder and the Company. (b) No waivers of, or exceptions to, any term, condition or provision of this Option, in any one or more instances, shall be deemed to be, or construed as, a further or continuing waiver of any such term, condition or provision. 11. ADJUSTMENTS. The number of Shares of Common Stock purchasable hereunder and the Exercise Price is subject to adjustment from time to time upon the occurrence of certain events, as follows: 11.1 REORGANIZATION, MERGER OR SALE OF ASSETS. If at any time while this Option, or any portion thereof, is outstanding and unexpired there shall be (i) a reorganization (other than a combination, reclassification, exchange or subdivision of shares otherwise provided for herein), (ii) a merger or consolidation of the Company with or into another corporation in which the Company is not the surviving entity, or a reverse triangular merger in which the Company is the surviving entity but the shares of the Company's capital stock outstanding immediately prior to the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise, or (iii) a sale or transfer of substantially all of the Company's properties and assets as, or substantially as, an entirety to any other person, then, as a part of such reorganization, merger, consolidation, sale or transfer, lawful provision shall be made so that the holder of this Option shall thereafter be entitled to receive upon payment of the Exercise Price then in effect, the number of shares of stock or other securities or property of the successor corporation resulting from such reorganization, merger, consolidation, sale or transfer that a holder of the shares deliverable upon exercise of this Option would have been entitled to receive in such reorganization, consolidation, merger, sale or transfer if this Option had been exercised immediately before such reorganization, merger, consolidation, sale or transfer, all subject to further adjustment as provided in this Section 11. The foregoing provisions of this Section 11.1 shall similarly apply to successive reorganizations, consolidations, mergers, sales and transfers and to the stock or securities of any other corporation that are at the time receivable upon the exercise of this 7. 8 Option. If the per-share consideration payable to the Holder hereof for shares in connection with any such transaction is in a form other than cash or marketable securities, then the value of such consideration shall be determined in good faith by the Company's Board of Directors. In all events, appropriate adjustment (as determined in good faith by the Company's Board of Directors) shall be made in the application of the provisions of this Option with respect to the rights and interests of the Holder after the transaction, to the end that the provisions of this Option shall be applicable after that event, as near as reasonably may be, in relation to any shares or other property deliverable after that event upon exercise of this Option. 11.2 Reclassification. If the Company, at any time while this Option, or any portion thereof, remains outstanding and unexpired, by reclassification of securities or otherwise, shall change any of the securities as to which purchase rights under this Option exist into the same or a different number of securities of any other class or classes, this Option shall thereafter represent the right to acquire such number and kind of securities as would have been issuable as the result of such change with respect to the securities that were subject to the purchase rights under this Option immediately prior to such reclassification or other change and the Exercise Price therefor shall be appropriately adjusted, all subject to further adjustment as provided in this Section 11. 11.3 SPLIT, SUBDIVISION OR COMBINATION OF SHARES. If the Company at any time while this Option, or any portion thereof, remains outstanding and unexpired shall split, subdivide or combine the securities as to which purchase rights under this Option exist, into a different number of securities of the same class, the Exercise Price and the number of shares issuable upon exercise of this Option shall be proportionately adjusted. 11.4 ADJUSTMENTS FOR DIVIDENDS IN STOCK OR OTHER SECURITIES OR PROPERTY. If while this Option, or any portion hereof, remains outstanding and unexpired the holders of the securities as to which purchase rights under this Option exist at the time shall have received, or, on or after the record date fixed for the determination of eligible Stockholders, shall have become entitled to receive, without payment therefor, other or additional stock or other securities or property (other than cash) of the Company by way of dividend, then and in each case, this Option shall represent the right to acquire, in addition to the number of shares of the security receivable upon exercise of this Option, and without payment of any additional consideration therefor, the amount of such other or additional stock or other securities or property (other than cash) of the Company that such holder would hold on the date of such exercise had it been the holder of record of the security receivable upon exercise of this Option on the date hereof and had thereafter, during the period from the date hereof to and including the date of such exercise, retained such shares and/or all other additional stock, other securities or property available by this Option as aforesaid during such period. 8. 9 11.5 The Company will not, by any voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Company, but will at all times in good faith assist in the carrying out of all the provisions of this Section 11 and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the Holders of this Option against impairment. 12. SEVERABILITY. Whenever possible, each provision of this Option shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Option is held to be invalid, illegal or unenforceable in any respect under any applicable law or rule in any jurisdiction, such invalidity, illegality or unenforceability shall not affect the validity, legality or enforceability of any other provision of this Option in such jurisdiction or affect the validity, legality or enforceability of any provision in any other jurisdiction, but this Option shall be reformed, construed and enforced in such jurisdiction as if such invalid, illegal or unenforceable provision had never been contained herein. 13. GOVERNING LAW. The corporate law of the State of Delaware shall govern all issues and questions concerning the relative rights of the Company and its stockholders. All other questions concerning the construction, validity, interpretation and enforceability of this Option and the exhibits and schedules hereto shall be governed by, and construed in accordance with, the laws of the State of Delaware, without giving effect to any choice of law or conflict of law rules or provisions (whether of the State of Delaware or any other jurisdiction) that would cause the application of the laws of any jurisdiction other than the State of Delaware. 14. JURISDICTION. In connection with the enforcement of a decision in arbitration pursuant to section 16 hereof, the Holder and the Company agree to submit to personal jurisdiction and to waive any objection as to venue in the federal or state courts in the City in which the headquarters of the Company is located, which as of the date hereof is San Diego, California. Service of process on the Company or the Holder in any action arising out of or relating to this Option shall be effective if mailed to such party at the address listed in Section 9 hereof. 15. ARBITRATION. If a dispute arises as to interpretation of this Option, it shall be decided exclusively and finally by three arbitrators in an arbitration proceeding conforming to the Rules of the American Arbitration Association applicable to commercial arbitration. The arbitrators shall be appointed as follows: one by the Company, one by the Holder and the third by the said two arbitrators, or, if they cannot agree, then the third arbitrator shall be appointed by the American Arbitration Association. The third arbitrator shall be chairman of the panel and shall be impartial. The arbitration shall take place in the City in which the headquarters of the Company is located, which as of the date hereof is San Diego, California. The decision of a majority 9. 10 of the Arbitrators shall be conclusively binding upon the parties and final, and such decision shall be enforceable as a judgment in any court of competent jurisdiction. Each party shall pay the fees and expenses of the arbitrator appointed by it, its counsel and its witnesses. The parties shall share equally the fees and expenses of the impartial arbitrator. 16. CORPORATE POWER; AUTHORIZATION; ENFORCEABLE OBLIGATIONS. The execution, delivery and performance by the Company of this Agreement: (i) are within the Company's corporate power; (ii) have been duly authorized by all necessary or proper corporate action; (iii) are not in contravention of the Company's certificate of incorporation or by-laws; (iv) will not violate in any material respect, any law or regulation, including any and all Federal and state securities laws, or any order or decree of any court or governmental instrumentality; and (v) will not, in any material respect, conflict with or result in the breach or termination of, or constitute a default under any agreement or other material instrument to which the Company is a party or by which the Company is bound. 17. SUCCESSORS AND ASSIGNS. This Option shall inure to the benefit of and be binding on the respective successors, assigns and legal representatives of the Holder and the Company. 10. 11 IN WITNESS WHEREO, the Company has caused this Option to be executed by its officers thereunto duly authorized. Option Issue Date: April 30, 1996 HOLDER PMR CORPORATION By: /s/ Susan Erskine By: /s/ Allen Tepper - ---------------------------- ---------------------------- Susan Erskine Allen Tepper, Chief Executive Officer 11. 12 NOTICE OF EXERCISE TO: PMR CORPORATION (1) The undersigned hereby elects to purchase _________ shares of Common Stock of PMR CORPORATION pursuant to the terms of the attached Option, and tenders herewith payment of the purchase price for such shares in full. (2) In exercising this Option, the undersigned hereby confirms and acknowledges that the shares of Common Stock to be issued upon conversion thereof are being acquired solely for the account of the undersigned and not as a nominee for any other party, and for investment (unless such shares are subject to resale pursuant to an effective prospectus), and that the undersigned will not offer, sell or otherwise dispose of any such shares of Common Stock except under circumstances that will not result in a violation of the Securities Act of 1933, as amended, or any state securities laws. (3) Please issue a certificate or certificates representing said shares of Common Stock in the name of the undersigned or in such other name as is specified below: ---------------------------- (Name) ---------------------------- (Name) - ---------------------------- ---------------------------- (Date) (Signature) 12. EX-10.8 11 EXHIBIT 10.8 1 EXHIBIT 10.8 75,000 Option/MC "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION, OR THE AVAILABILITY OF EXEMPTION FROM REGISTRATION, UNDER THE SECURITIES ACT OF 1933, AS AMENDED, BASED ON AN OPINION LETTER OF COUNSEL SATISFACTORY TO HE COMPANY OR A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION." AMENDED AND RESTATED OPTION TO PURCHASE COMMON STOCK OF PMR CORPORATION Void after February 1, 2003 This certifies that, for value received, MARK CLEIN ("Holder"), is entitled, subject to the terms set forth below, to purchase from PMR CORPORATION (the "Company"), a Delaware corporation, shares of the Common Stock of the Company (the "Shares"), as constituted on the effective date hereof (the "Option Issue Date"), with the Notice of Exercise attached hereto duly executed, and simultaneous payment therefor in lawful money of the United States, at the Exercise Price as set forth in Section 2 below. The number, character and Exercise Price of the shares are subject to adjustment as provided below. 1. TERM OF OPTION. Subject to compliance with the vesting provisions identified at Paragraph 2.3 hereafter, this Option shall be exercisable, in whole or in part, during the term commencing on the Option Issue Date and ending at 5:00 p.m. on February 1, 2003, and shall be void thereafter. 2. EXERCISE PRICE, NUMBER OF SHARES AND VESTING PROVISIONS. 2.1 EXERCISE PRICE. The Exercise Price at which this Option may be exercised shall be $4.75 per share of common stock, as adjusted pursuant to Section 11 hereof. 2.2 NUMBER OF SHARES. The number of shares of the Company's Common Stock, $.01 par value per share ("Common Stock") which may be purchased pursuant to this Option shall be 75,000 shares, as adjusted pursuant to Section 11 hereof. 1. 2 2.3 VESTING. The Options granted hereunder shall vest 100% on May 1, 2001, provided Holder remains continuously employed by the Company from June 1, 1996 through May 1, 2001. No partial vesting shall be permitted. 2.4 IMMEDIATE VESTING. Notwithstanding the provisions of Paragraph 2.3 hereof, all of the Options shall immediately vest and become immediately exercisable by Holder under any of the following circumstances: (i) Once the "market capitalization" of the Company has been equal to or greater than the average of $125,000,000 for a period of thirty (30) consecutive "trading days." For the purposes of this subparagraph 2.4(i) the term "trading day" shall mean any day on which the New York Stock Exchange is open for trading; and the term "market capitalization" shall be defined as the product of the "market value" (as such term is defined in subparagraph 3(a) hereafter) of the Company's Common Stock and the fully diluted number of shares of common stock (as determined on a basis consistent with that utilized to determine the fully diluted number of shares used in computing earnings for financial accounting purposes) outstanding as determined on each of the trading days. (ii) If a "change in control" of the Company occurs; or (iii) If during the term hereof, Holder is terminated as Chief Financial Officer of the Company for any reason whatsoever other than "cause". For purposes of subparagraph 2.4(ii), the term "change in control" shall be deemed to have occurred if (i) any "Person" who is not an existing stockholder of the Company as of the date hereof (as the term "Person" is used in Section 13(d) and Section 14(d) of the Securities Exchange Act of 1934), becomes, after the date hereof, the beneficial owner, directly or indirectly of securities of the Company representing twenty-five (25%) percent or more of the combined voting power of the Company's then outstanding securities in a transaction not approved by the Company's Board of Directors; (ii) there occurs a contested proxy solicitation of the Company's shareholders that results in the contesting party obtaining the ability to vote securities representing twenty-five (25%) percent or more of the combined voting power of the Company's then outstanding securities; or (iii) there occurs a sale, exchange, transfer or other disposition of substantially all of the assets of the Company to another entity, except to an entity controlled directly or indirectly by the Company, or a merger, consolidation or other reorganization of the Company in which the Company is not the surviving entity, or a plan of liquidation or dissolution of the Company other than pursuant to bankruptcy or insolvency laws is adopted. For the purposes of subparagraphs (i) and (ii) above, a "change in control" shall not be deemed to have occurred provided: (a) at least a majority of the Company's Board of Directors continue in such capacity immediately following such transaction; and (b) the Holder 2. 3 (provided he is employed by the Company at that time) continues to hold substantially similar positions of employment with the Company immediately following such transaction as existed prior to the transaction. For purposes of subparagraph 2.4(iii), upon the occurrence of any of the following events, a termination shall constitute a termination for "cause": (a) any act or failure to act (or series or combination thereof) by Holder done with the intent to harm in any material respect the interests of the Company, not otherwise cured to the reasonable satisfaction of the Company within fifteen (15) days of written notice from the Company identifying such act or failure to act; (b) the commission by Holder of a felony for which he is convicted by a court of competent jurisdiction; (c) the finding by a court of competent jurisdiction that Holder perpetrated a dishonest act or common law fraud against the Company or any affiliate thereof; (d) a grossly negligent act or failure to act (or series or combination thereof) by Holder detrimental to a material extent to the interests of the Company or any affiliate thereof not otherwise cured to the satisfaction of the Company within fifteen (15) days of written notice from the Company identifying such act or failure to act; (e) the continued refusal to follow the directives of the Board which are consistent with Holder's duties and responsibilities commensurate with his position as Chief Financial Officer, within fifteen (15) days of written notice to that effect from the Company, unless the failure to follow such directive was based upon a written opinion of counsel that such directives would be in violation of the Holder's fiduciary duty, if any, to the Company or would result in a violation of Delaware law. If a dispute arises between the Holder and the Company as to the occurrence, or non-occurrence, as the case may be, of an event identified in subparagraphs (a) - (e) above, such dispute shall be settled by arbitration in accordance with paragraph 16 of this Agreement. 2.5. DEATH OF HOLDER AND TERMINATION. (a) If the Holder shall die while in the employ of the Company, his estate, personal representatives, or beneficiary shall have the right, subject to the provisions of this Paragraph 2 hereof, to exercise the Option (only to the extent that the Holder would have been entitled to do so as of the date of his death) at any time within twelve (12) months from the date of his death. (b) In the event Holder's employment by the Company is terminated for "cause", as defined above, or Holder voluntarily terminates his employment with the Company, Holder shall have 30 days in which to exercise the Option (only to the extent that the Holder would have been entitled to do so as of the date of his termination) and thereafter, Holder's right in and to the Option shall lapse and terminate. 3. 4 3. EXERCISE OF OPTION. (a) The Exercise Price shall either be payable in cash or by bank or certified check; or by cashless exercise through the delivery by the Holder to the Company of shares of the Company's Common Stock for which Holder is the record and beneficial owner, or a withholding by the Company of shares of Common Stock that Holder is otherwise entitled to receive upon exercise of the Option or by any combination thereof. If shares of common stock of the Company are tendered or withheld as payment of the Exercise Price, the value of such shares shall be their "market value" as of the trading date immediately preceding the date of exercise. The "market value" shall be: (i) If the Company's common stock is traded in the over-the-counter market and not on any national securities exchange nor in the NASDAQ Reporting System, the market value shall be the avenge of the mean between the last bid and ask prices per share, as reported by the National Quotation Bureau, Inc., or an equivalent generally accepted reporting service, or if not so reported, the avenge of the closing bid and asked prices for a share as furnished to the Company by any member of the National Association of Securities Dealers, Inc., selected by the Company for that purpose. (ii) If the Company's common stock is traded on a national securities exchange or in the NASDAQ Reporting System, the market value shall be either (1) the simple average of the high and low prices at which a share of the Company's common stock traded, as quoted on the NASDAQ-NMS or its other principal exchange, or (2) the price of the last sale of a share of common stock as similarly quoted, whichever is higher, and rounding out such figure to the next higher multiple of 12.5 cents (unless the figure is already a multiple of 12.5 cents). If such tender would result in an issuance of a whole number of shares and a fractional share of Common Stock, the value of such fractional share shall be paid to the Company in cash or by check by the Holder. (b) The purchase rights represented by this Option are exercisable by the Holder in whole or in part, at any time, or from time to time, by the surrender of this Option and the Notice of Exercise annexed hereto duly completed and executed on behalf of the Holder, at the office of the Company (or such other office or agency of the Company as it may designate by notice in writing to the Holder at the address of the Holder appearing on the books of the Company). (c) This Option shall be deemed to have been exercised immediately prior to the close of business on the date of its surrender for exercise as provided above, and the person entitled to receive the shares of Common Stock issuable upon such 4. 5 exercise shall be treated for all purposes as the holder of record of such shares as of the close of business on such date. As promptly as practicable on or after such date and in any event within ten (10) days thereafter, the Company at its expense shall issue and deliver to the person or persons entitled to receive the same a certificate or certificates for the number of shares issuable upon such exercise. In the event that this Option is exercised in part, the Company at its expense will execute and deliver a new Option of like tenor exercisable for the number of shares for which this Option may then be exercised. 4. NO FRACTIONAL SHARES OR SCRIP. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Option. In lieu of any fractional share to which the Holder would otherwise be entitled, the Company shall make a cash payment equal to the Exercise Price multiplied by such fraction. 5. REPLACEMENT OF OPTION. On receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Option and, in the case of loss, theft or destruction, on delivery of an indemnity agreement reasonably satisfactory in form and substance to the Company or, in the case of mutilation, on surrender and cancellation of this Option, the Company at its expense shall execute and deliver, in lieu of this Option, a new Option of like tenor and amount. 6. RIGHTS OF STOCKHOLDER. Except as otherwise contemplated herein, the Holder shall not be entitled to vote or receive dividends or be deemed the holder of Common Stock or any other securities of the Company that may at any time be issuable on the exercise hereof for any purpose, nor shall anything contained herein be construed to confer upon the Holder, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to stockholders at any meeting thereof, or to give or withhold consent to any corporate action (whether upon any recapitalization, issuance of stock, reclassification of stock, change of par value, or change of stock to no par value, consolidation, merger, conveyance or otherwise) or to receive notice of meetings, or to receive dividends or subscription rights or otherwise until the Option shall have been exercised as provided herein. 7. TRANSFER OF OPTION. 7.1. NON-TRANSFERABILITY. The Option shall not be assigned, transferred, pledged or hypothecated in any way, nor subject to execution, attachment or similar process, otherwise than by will or by the laws of descent and distribution. Any attempted assignment, transfer, pledge, hypothecation or other disposition of the Option contrary to the provisions hereof, and the levy of an execution, attachment, or similar process upon the Option, shall be null and void and without effect. 5. 6 7.2. COMPLIANCE WITH SECURITIES LAWS; RESTRICTIONS ON TRANSFERS. (a) The Holder of this Option, by acceptance hereof, acknowledges that this Option and the Shares to be issued upon exercise hereof are being acquired solely for the Holder's own account and not as a nominee for any other party, and for investment (unless such shares are subject to resale pursuant to an effective prospectus), and that the Holder will not offer, sell or otherwise dispose of this Option or any Shares to be issued upon exercise hereof except under circumstances that will not result in a violation of applicable federal and state securities laws. Upon exercise of this Option, the Holder shall, if requested by the Company, confirm in writing, in a form satisfactory to the Company, that the shares of Common Stock so purchased are being acquired solely for the Holder's own account and not as a nominee for any other party, for investment (unless such shares are subject to resale pursuant to an effective prospectus), and not with a view toward distribution or resale. (b) Neither this Option nor any share of Common Stock issued upon exercise of this Option may be offered for sale or sold, or otherwise transferred or sold in any transaction which would constitute a sale thereof within the meaning of the Securities Act of 1933, as amended (the "1933 Act"), unless (i) such security has been registered for sale under the 1933 Act and registered or qualified under applicable state securities laws relating to the offer an sale of securities, or (ii) exemptions from the registration requirements of the 1933 Act and the registration or qualification requirements of all such state securities laws are available and the Company shall have received an opinion of counsel satisfactory to the Company that the proposed sale or other disposition of such securities may be effected without registration under the 1933 Act and would not result in any violation of any applicable state securities laws relating to the registration or qualification of securities for sale, such counsel and such opinion to be satisfactory to the Company. (c) All Shares issued upon exercise hereof shall be stamped or imprinted with a legend in substantially the following form (in addition to any legend required by state securities laws). "HE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION, OR THE AVAILABILITY OF EXEMPTION FROM REGISTRATION, UNDER THE SECURITIES ACT OF 1933, AS AMENDED, BASED ON AN OPINION LETTER OF COUNSEL SATISFACTORY TO THE COMPANY OR A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION." 6. 7 Holder recognizes that investing in the Option and the Common Stock involves a high degree of risk, and Holder is in a financial position to hold the Option and the Common Stock indefinitely and is able to bear the economic risk and withstand a complete loss of its investment in the Option and the Common Stock. The Holder is a sophisticated investor and is capable of evaluating the merits and risks of investing in the Company. The Holder has had an opportunity to discuss the Company's business, management and financial affairs with the Company's management, has been given full and complete access to information concerning the Company, and has utilized such access to its satisfaction for the purpose of obtaining information or verifying information and have had the opportunity to inspect the Company's operation. Holder has had the opportunity to ask questions of, and receive answers from the management of the Company (and any person acting on its behalf) concerning the Option and the Common Stock and the agreements and transactions contemplated hereby, and to obtain any additional information as Holder may have requested in making its investment decision. The Holder is an "accredited investor", as defined by Regulation D promulgated under the Act. 8. RESERVATION AND ISSUANCE OF STOCK. (a) The Company covenants that during the term that this Option is exercisable, the Company will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of the shares upon the exercise of this Option, and from time to time will take all steps necessary to amend its Certificate of Incorporation to provide sufficient reserves of shares of Common Stock issuable upon the exercise of the Option. (b) The Company further covenants that all shares of Common Stock issuable upon the due exercise of this Option will be free and clear from all taxes or liens, charges and security interests created by the Company with respect to the issuance thereof, however, the Company shall not be obligated or liable for the payment of any taxes, liens or charges of Holder, or any other party contemplated by paragraph 7, incurred in connection with the issuance of this Option or the Common Stock upon the due exercise of this Option. The Company agrees that its issuance of this Option shall constitute full authority to its officers who are charged with the duty of executing stock certificates to execute and issue the necessary certificates for the shares of Common Stock upon the exercise of this Option. The Common Stock issuable upon the due exercise of this Option, will, upon issuance in accordance with the terms hereof, be duly authorized, validly issued, fully paid and non-assessable. 7. 8 9. NOTICES. (a) Whenever the Exercise Price or number of shares purchasable hereunder shall be adjusted pursuant to Section 11 hereof, the Company shall issue a certificate signed by its Chief Financial Officer setting forth, in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method by which such adjustment was calculated, and the Exercise Price and number of shares purchasable hereunder after giving effect to such adjustment, and shall cause a copy of such certificate to be mailed (by first-class mail, postage prepaid) to the Holder of this Option. (b) All notices, advices and communications under this Option shall be deemed to have been given, (i) in the case of personal delivery, on the date of such delivery and (ii) in the case of mailing, on the third business day following the date of such mailing, addressed as follows: If to the Company: PMR Corporation 3990 Old Town Avenue, Suite 206A San Diego, CA 92110 Attn: Allen Tepper, Chief Executive Officer With a Copy to: Stephen M. Cohen, Esquire Buchanan Ingersoll, Professional Corporation Two Logan Square, 12th Floor 18th & Arch Streets Philadelphia, PA 19 103-2771 and to the Holder: at the address of the Holder appearing on the books of the Company or the Company's transfer agent, if any. With a Copy to: Joel I. Papernik, Esquire Squadron, Ellenoff, Plesent & Sheinfeld, LLP 551 Fifth Avenue New York, NY 10176 8. 9 Either of the Company or the Holder may from time to time change the address to which notices to it are to be mailed hereunder by notice in accordance with the provisions of this Paragraph 9. 10. AMENDMENTS. (a) Any term of this Option may be amended with the written consent of the Company and the Holder. Any amendment effected in accordance with this Section 10 shall be binding upon the Holder, each future holder and the Company. (b) No waivers of, or exceptions to, any term, condition or provision of this Option, in any one or more instances, shall be deemed to be, or construed as, a further or continuing waiver of any such term, condition or provision. 11. ADJUSTMENTS. The number of Shares of Common Stock purchasable hereunder and the Exercise Price is subject to adjustment from time to time upon the occurrence of certain events, as follows: 11.1. REORGANIZATION, MERGER OR SALE OF ASSETS. If at any time while this Option, or any portion thereof, is outstanding and unexpired there shall be (i) a reorganization (other than a combination, reclassification, exchange or subdivision of shares otherwise provided for herein), (ii) a merger or consolidation of the Company with or into another corporation in which the Company is not the surviving entity, or a reverse triangular merger in which the Company is the surviving entity but the shares of the Company's capital stock outstanding immediately prior to the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise, or (iii) a sale or transfer of substantially all of the Company's properties and assets as, or substantially as, an entirety to any other person, then, as a part of such reorganization, merger, consolidation, sale or transfer, lawful provision shall be made so that the holder of this Option shall thereafter be entitled to receive upon payment of the Exercise Price then in effect, the number of shares of stock or other securities or property of the successor corporation resulting from such reorganization, merger, consolidation, sale or transfer that a holder of the shares deliverable upon exercise of this Option would have been entitled to receive in such reorganization, consolidation, merger, sale or transfer if this Option had been exercised immediately before such reorganization, merger, consolidation, sale or transfer, all subject to further adjustment as provided in this Section 11. The foregoing provisions of this Section 11.1 shall similarly apply to successive reorganizations, consolidations, mergers, sales and transfers and to the stock or securities of any other corporation that are at the time receivable upon the exercise of this Option. If the per-share consideration payable to the Holder hereof for shares in connection with any such transaction is in a form other than cash or marketable securities, then the value of such consideration shall be determined in good faith by the Company's 9. 10 Board of Directors. In all events, appropriate adjustment (as determined in good faith by the Company's Board of Directors) shall be made in the application of the provisions of this Option with respect to the rights and interests of the Holder after the transaction, to the end that the provisions of this Option shall be applicable after that event, as near as reasonably may be, in relation to any shares or other property deliverable after that event upon exercise of this Option. 11.2. RECLASSIFICATION. If the Company, at any time while this Option, or any portion thereof, remains outstanding and unexpired, by reclassification of securities or otherwise, shall change any of the securities as to which purchase rights under this Option exist into the same or a different number of securities of any other class or classes, this Option shall thereafter represent the right to acquire such number and kind of securities as would have been issuable as the result of such change with respect to the securities that were subject to the purchase rights under this Option immediately prior to such reclassification or other change and the Exercise Price therefor shall be appropriately adjusted, all subject to further adjustment as provided in this Section 11. 11.3. SPLIT, SUBDIVISION OR COMBINATION OF SHARES. If the Company at any time while this Option, or any portion thereof, remains outstanding and unexpired shall split, subdivide or combine the securities as to which purchase rights under this Option exist, into a different number of securities of the same class, the Exercise Price and the number of shares issuable upon exercise of this Option shall be proportionately adjusted. 11.4. ADJUSTMENTS FOR DIVIDENDS IN STOCK OR OTHER SECURITIES OR PROPERTY. If while this Option, or any portion hereof, remains outstanding and unexpired the holders of the securities as to which purchase rights under this Option exist at the time shall have received, or, on or after the record date fixed for the determination of eligible Stockholders, shall have become entitled to receive, without payment therefor, other or additional stock or other securities or property (other than cash) of the Company by way of dividend, then and in each case, this Option shall represent the right to acquire, in addition to the number of shares of the security receivable upon exercise of this Option, and without payment of any additional consideration therefor, the amount of such other or additional stock or other securities or property (other than cash) of the Company that such holder would hold on the date of such exercise had it been the holder of record of the security receivable upon exercise of this Option on the date hereof and had thereafter, during the period from the date hereof to and including the date of such exercise, retained such shares and/or all other additional stock, other securities or property available by this Option as aforesaid during such period. 11.5. The Company will not, by any voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed 10. 11 hereunder by the Company, but will at all times in good faith assist in the carrying out of all the provisions of this Section 11 and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the Holders of this Option against impairment. 12. REGISTRATION RIGHTS. The Holder shall be entitled to the registration rights set forth in that certain Registration Rights Agreement of even date herewith by and between the Company and such Holder. 13. SEVERABILITY. Whenever possible, each provision of this Option shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Option is held to be invalid, illegal or unenforceable in any respect under any applicable law or rule in any jurisdiction, such invalidity, illegality or unenforceability shall not affect the validity, legality or enforceability of any other provision of this Option in such jurisdiction or affect the validity, legality or enforceability of any provision in any other jurisdiction, but this Option shall be reformed, construed and enforced in such jurisdiction as if such invalid, illegal or unenforceable provision had never been contained herein. 14. GOVERNING LAW. The corporate law of the State of Delaware shall govern all issues and questions concerning the relative rights of the Company and its stockholders. All other questions concerning the construction, validity, interpretation and enforceability of this Option and the exhibits and schedules hereto shall be governed by, and construed in accordance with, the laws of the State of Delaware, without giving effect to any choice of law or conflict of law rules or provisions (whether of the State of Delaware or any other jurisdiction) that would cause the application of the laws of any jurisdiction other than the State of Delaware. 15. JURISDICTION. In connection with the enforcement of a decision in arbitration pursuant to section 16 hereof, the Holder and the Company agree to submit to personal jurisdiction and to waive any objection as to venue in the federal or state courts in the City in which the headquarters of the Company is located, which as of the date hereof is San Diego, California. Service of process on the Company or the Holder in any action arising out of or relating to this Option shall be effective if mailed to such party at the address listed in Section 9 hereof. 16. ARBITRATION. If a dispute arises as to interpretation of this Option, it shall be decided exclusively and finally by three arbitrators in an arbitration proceeding conforming to the Rules of the American Arbitration Association applicable to commercial arbitration. The arbitrators shall be appointed as follows: one by the Company, one by the Holder and the third by the said two arbitrators, or, if they cannot agree, then the third arbitrator shall be appointed by the American Arbitration 11. 12 Association. The third arbitrator shall be chairman of the panel and shall be impartial. The arbitration shall take place in the City in which the headquarters of the Company is located, which as of the date hereof is San Diego, California. The decision of a majority of the Arbitrators shall be conclusively binding upon the parties and final, and such decision shall be enforceable as a judgment in any court of competent jurisdiction. Each party shall pay the fees and expenses of the arbitrator appointed by it, its counsel and its witnesses. The parties shall share equally the fees and expenses of the impartial arbitrator. 17. CORPORATE POWER; AUTHORIZATION; ENFORCEABLE OBLIGATIONS. The execution, delivery and performance by the Company of this Agreement: (i) are within the Company's corporate power; (ii) have been duly authorized by all necessary or proper corporate action; (iii) are not in contravention of the Company's certificate of incorporation or by-laws; (iv) will not violate in any material respect, any law or regulation, including any and all Federal and state securities laws, or any order or decree of any court or governmental instrumentality; and (v) will not, in any material respect, conflict with or result in the breach or termination of, or constitute a default under any agreement or other material instrument to which the Company is a party or by which the Company is bound. 18. SUCCESSORS AND ASSIGNS. This Option shall inure to the benefit of and be binding on the respective successors, assigns and legal representatives of the Holder and the Company. IN WITNESS WHEREOF, the Company has caused this Option to be executed by its officers thereunto duly authorized. Option Issue Date: February 1, 1996 HOLDER PMR CORPORATION By: /s/ Mark Clein By: /s/ Allen Tepper - ---------------------------- ---------------------------- Mark Clein Allen Tepper, Chief Executive Officer 12. 13 NOTICE OF EXERCISE TO: PMR CORPORATION (1) The undersigned hereby elects to purchase ______ shares of Common Stock of PMR CORPORATION pursuant to the terms of the attached Option, and tenders herewith payment of the purchase price for such shares in full. (2) In exercising this Option, the undersigned hereby confirms and acknowledges that the shares of Common Stock to be issued upon conversion thereof are being acquired solely for the account of the undersigned and not as a nominee for any other party, and for investment (unless such shares are subject to resale pursuant to an effective prospectus), and that the undersigned will not offer, sell or otherwise dispose of any such shares of Common Stock except under circumstances that will not result in a violation of the Securities Act of 1933, as amended, or any state securities laws. (3) Please issue a certificate or certificates representing said shares of Common Stock in the name of the undersigned or in such other name as is specified below: ---------------------------- (Name) ---------------------------- (Name) - ---------------------------- ---------------------------- (Date) Signature) 13. EX-10.9 12 EXHIBIT 10.9 1 EXHIBIT 10.9 125,000 Option/MC "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION, OR THE AVAILABILITY OF EXEMPTION FROM REGISTRATION, UNDER THE SECURITIES ACT OF 1933, AS AMENDED, BASED ON AN OPINION LETTER OF COUNSEL SATISFACTORY TO THE COMPANY OR A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION." AMENDED AND RESTATED OPTION TO PURCHASE COMMON STOCK OF PMR CORPORATION Void after February 1, 2003 This certifies that, for value received, MARK CLEIN ("Holder"), is entitled, subject to the terms set forth below, to purchase from PMR CORPORATION (the "Company"), a Delaware corporation, shares of the Common Stock of the Company (the "Shares"), as constituted on the effective date hereof (the "Option Issue Date"), with the Notice of Exercise attached hereto duly executed, and simultaneous payment therefor in lawful money of the United States, at the Exercise Price as set forth in Section 2 below. The number, character and Exercise Price of the shares are subject to adjustment as provided below. 1. TERM OF OPTION. Subject to compliance with the vesting provisions identified at Paragraph 2.3 hereafter, this Option shall be exercisable, in whole or in part, during the term commencing on the Option Issue Date and ending at 5:00 p.m. on February 1, 2003, and shall be void thereafter. 2. EXERCISE PRICE, NUMBER OF SHARES AND VESTING PROVISIONS. 2.1 EXERCISE PRICE. The Exercise Price at which this Option may be exercised shall be $4.75 per share of common stock, as adjusted pursuant to Section 11 hereof. 2.2 NUMBER OF SHARES. The number of shares of the Company's Common Stock, $.01 par value per share ("Common Stock") which may be purchased pursuant to this Option shall be 125,000 shares, as adjusted pursuant to Section 11 hereof. 1. 2 2.3 VESTING. The Options granted hereunder shall vest in accordance with the following schedule: (i) 20% provided Holder remains continuously employed by the Company from June 1, 1996 through February 1, 1997; (ii) 40% provided Holder remains continuously employed by the Company from June 1, 1996 through February 1, 1998; (iii) 60% provided Holder remains continuously employed by the Company from June 1, 1996 through February 1, 1999; (iv) 80% provided Holder remains continuously employed by the Company from June 1, 1996 through February 1, 2000; and (v) 100% provided Holder remains continuously employed by the Company from June 1, 1996 through February 1, 2001. 2.4 IMMEDIATE VESTING. Notwithstanding the provisions of Paragraph 2.3 hereof, all of the Options shall immediately vest and become immediately exercisable by Holder under any of the following circumstances: (i) Once the "market capitalization" of the Company has been equal to or greater than the average of $100,000,000 for a period of thirty (30) consecutive "trading days." For the purposes of this subparagraph 2.4(i) the term "trading day" shall mean any day on which the New York Stock Exchange is open for trading; and the term "market capitalization" shall be defined as the product of the "market value" (as such term is defined in subparagraph 3(a) hereafter) of the Company's Common Stock and the fully diluted number of shares of common stock (as determined on a basis consistent with that utilized to determine the fully diluted number of shares used in computing earnings for financial accounting purposes) outstanding as determined on each of the trading days. (ii) If a "change in control" of the Company occurs; or (iii) If during the term hereof, Holder is terminated in form or substance as Chief Financial Officer of the Company for any reason whatsoever other than "cause". For purposes of subparagraph 2.4(ii), the term "change in control" shall be deemed to have occurred if (i) any "Person" who is not an existing stockholder of the Company as of the date hereof (as the term "Person" is used in Section 13(d) and Section 14(d) of the Securities Exchange Act of 1934), becomes, after the date hereof, the beneficial owner, 2. 3 directly or indirectly of securities of the Company representing twenty-five (25%) percent or more of the combined voting power of the Company's then outstanding securities in a transaction not approved by the Company's Board of Directors; (ii) there occurs a contested proxy solicitation of the Company's shareholders that results in the contesting party obtaining the ability to vote securities representing twenty- five (25%) percent or more of the combined voting power of the Company's then outstanding securities; or (iii) there occurs a sale, exchange, transfer or other disposition of substantially all of the assets of the Company to another entity, except to an entity controlled directly or indirectly by the Company, or a merger, consolidation or other reorganization of the Company in which the Company is not the surviving entity, or a plan of liquidation or dissolution of the Company other than pursuant to bankruptcy or insolvency laws is adopted. For the purposes of subparagraphs (i) and (ii) above, a "change in control" shall not be deemed to have occurred provided: (a) at least a majority of the Company's Board of Directors continue in such capacity immediately following such transaction; and (b) the Holder (provided he is employed by the Company at that time) continues to hold substantially similar positions of employment with the Company immediately following such transaction as existed prior to the transaction. For purposes of subparagraph 2.4(iii), upon the occurrence of any of the following events, a termination shall constitute a termination for "cause": (a) any act or failure to act (or series or combination thereof) by Holder done with the intent to harm in any material respect the interests of the Company, not otherwise cured to the reasonable satisfaction of the Company within fifteen (15) days of written notice from the Company identifying such act or failure to act; (b) the commission by Holder of a felony for which he is convicted by a court of competent jurisdiction; (c) the finding by a court of competent jurisdiction that Holder perpetrated a dishonest act or common law fraud against the Company or any affiliate thereof; (d) a grossly negligent act or failure to act (or series or combination thereof) by Holder detrimental to a material extent to the interests of the Company or any affiliate thereof not otherwise cured to the satisfaction of the Company within fifteen (15) days of written notice from the Company identifying such act or failure to act; (e) the continued refusal to follow the directives of the Board which are consistent with Holder's duties and responsibilities commensurate with his position as Chief Financial Officer, within fifteen (15) days of written notice to that effect from the Company, unless the failure to follow such directive was based upon a written opinion of counsel that such directives would be in violation of the Holder's fiduciary duty, if any, to the Company or would result in a violation of Delaware law. If a dispute arises between the Holder and the Company as to the occurrence, or non-occurrence, as the case may be, of an event identified in subparagraphs (a) - (e) above, such dispute shall be settled by arbitration in accordance with paragraph 16 of this Agreement. 3. 4 2.5. DEATH OF HOLDER AND TERMINATION. (a) If the Holder shall die while in the employ of the Company, his estate, personal representatives, or beneficiary shall have the right, subject to the provisions of this Paragraph 2 hereof, to exercise the Option (only to the extent that the Holder would have been entitled to do so as of the date of his death) at any time within twelve (12) months from the date of his death. (b) In the event Holder's employment by the Company is terminated for "cause", as defined above, or Holder voluntarily terminates his employment with the Company, Holder shall have 30 days in which to exercise the Option (only to the extent that the Holder would have been entitled to do so as of the date of his termination) and thereafter, Holder's right in and to the Option shall lapse and terminate. 3. EXERCISE OF OPTION. (a) The Exercise Price shall either be payable in cash or by bank or certified check; or by cashless exercise through the delivery by the Holder to the Company of shares of the Company's Common Stock for which Holder is the record and beneficial owner, or a withholding by the Company of shares of Common Stock that Holder is otherwise entitled to receive upon exercise of the Option or by any combination thereof. If shares of common stock of the Company are tendered or withheld as payment of the Exercise Price, the value of such shares shall be their "market value" as of the trading date immediately preceding the date of exercise. The "market value" shall be: (i) If the Company's common stock is traded in the over-the-counter market and not on any national securities exchange nor in the NASDAQ Reporting System, the market value shall be the average of the mean between the last bid and ask prices per share, as reported by the National Quotation Bureau, Inc., or an equivalent generally accepted reporting service, or if not so reported, the average of the closing bid and asked prices for a share as furnished to the Company by any member of the National Association of SecUrities Dealers, Inc., selected by the Company for that purpose. (ii) If the Company's common stock is traded on a national securities exchange or in the NASDAQ Reporting System, the market value shall be either (1) the simple average of the high and low prices at which a share of the Company's common stock traded, as quoted on the NASDAQ-NMS or its other principal exchange, or (2) the price of the last sale of a share of common stock as similarly quoted, whichever is higher, and rounding out such figure to the next higher multiple of 12.5 cents (unless the figure is already a multiple of 12.5 cents). If such tender would result in 4. 5 an issuance of a whole number of shares and a fractional share of Common Stock, the value of such fractional share shall be paid to the Company in cash or by check by the Holder. (b) The purchase rights represented by this Option are exercisable by the Holder in whole or in part, at any time, or from time to time, by the surrender of this Option and the Notice of Exercise annexed hereto duly completed and executed on behalf of the Holder, at the office of the Company (or such other office or agency of the Company as it may designate by notice in writing to the Holder at the address of the Holder appearing on the books of the Company). (c) This Option shall be deemed to have been exercised immediately prior to the close of business on the date of its surrender for exercise as provided above, and the person entitled to receive the shares of Common Stock issuable upon such exercise shall be treated for all purposes as the holder of record of such shares as of the close of business on such date. As promptly as practicable on or after such date and in any event within ten (10) days thereafter, the Company at its expense shall issue and deliver to the person or persons entitled to receive the same a certificate or certificates for the number of shares issuable upon such exercise. In the event that this Option is exercised in part, the Company at its expense will execute and deliver a new Option of like tenor exercisable for the number of shares for which this Option may then be exercised. 4. NO FRACTIONAL SHARES OR SCRIP. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Option. In lieu of any fractional share to which the Holder would otherwise be entitled, the Company shall make a cash payment equal to the Exercise Price multiplied by such fraction. 5. REPLACEMENT OF OPTION. On receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Option and, in the case of loss, theft or destruction, on delivery of an indemnity agreement reasonably satisfactory in form and substance to the Company or, in the case of mutilation, on surrender and cancellation of this Option, the Company at its expense shall execute and deliver, in lieu of this Option, a newOption of like tenor and amount. 6. RIGHTS OF STOCKHOLDER. Except as otherwise contemplated herein, the Holder shall not be entitled to vote or receive dividends or be deemed the holder of Common Stock or any other securities of the Company that may at any time be issuable on the exercise hereof for any purpose, nor shall anything contained herein be construed to confer upon the Holder, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to stockholders at any meeting thereof, or to give or withhold consent to any corporate action (whether 5. 6 upon any recapitalization, issuance of stock, reclassification of stock, change of par value, or change of stock to no par value, consolidation, merger, conveyance or otherwise) or to receive notice of meetings, or to receive dividends or subscription rights or otherwise until the Option shall have been exercised as provided herein. 7. TRANSFER OF OPTION. 7.1. NON-TRANSFERABILITY. The Option shall not be assigned, transferred, pledged or hypothecated in any way, nor subject to execution, attachment or similar process, otherwise than by will or by the laws of descent and distribution. Any attempted assignment, transfer, pledge, hypothecation or other disposition of the Option contrary to the provisions hereof, and the levy of an execution, attachment, or similar process upon the Option, shall be null and void and without effect. 7.2. COMPLIANCE WITH SECURITIES LAWS; RESTRICTIONS ON TRANSFERS. (a) The Holder of this Option, by acceptance hereof, acknowledges that this Option and the Shares to be issued upon exercise hereof are being acquired solely for the Holder's own account and not as a nominee for any other party, and for investment (unless such shares are subject to resale pursuant to an effective prospectus), and that the Holder will not offer, sell or otherwise dispose of this Option or any Shares to be issued upon exercise hereof except under circumstances that will not result in a violation of applicable federal and state securities laws. Upon exercise of this Option, the Holder shall, if requested by the Company, confirm in writing, in a form satisfactory to the Company, that the shares of Common Stock so purchased are being acquired solely for the Holder's own account and not as a nominee for any other party, for investment (unless such shares are subject to resale pursuant to an effective prospectus), and not with a view toward distribution or resale. (b) Neither this Option nor any share of Common Stock issued upon exercise of this Option may be offered for sale or sold, or otherwise transferred or sold in any transaction which would constitute a sale thereof within the meaning of the Securities Act of 1933, as amended (the "1933 Act"), unless (i) such security has been registered for sale under the 1933 Act and registered or qualified under applicable state securities laws relating to the offer and sale of securities, or (ii) exemptions from the registration requirements of the 1933 Act and the registration or qualification requirements of all such state securities laws are available and the Company shall have received an opinion of counsel satisfactory to the Company that the proposed sale or other disposition of such securities may be effected without registration under the 1933 Act and would not result in any violation of any applicable state securities laws relating to the registration or qualification of securities for sale, such counsel and such opinion to be satisfactory to the Company. 6. 7 (c) All Shares issued upon exercise hereof shall be stamped or imprinted with a legend in substantially the following form (in addition to any legend required by state securities laws). "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION, OR THE AVAILABILITY OF EXEMPTION FROM REGISTRATION, UNDER THE SECURITIES ACT OF 1933, AS AMENDED, BASED ON AN OPINION LETTER OF COUNSEL SATISFACTORY TO THE COMPANY OR A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION." Holder recognizes that investing in the Option and the Common Stock involves a high degree of risk, and Holder is in a financial position to hold the Option and the Common Stock indefinitely and is able to bear the economic risk and withstand a complete loss of its investment in the Option and the Common Stock. The Holder is a sophisticated investor and is capable of evaluating the merits and risks of investing in the Company. The Holder has had an opportunity to discuss the Company's business, management and financial affairs with the Company's management, has been given full and complete access to information concerning the Company, and has utilized such access to its satisfaction for the purpose of obtaining information or verifying information and have had the opportunity to inspect the Company's operation. Holder has had the opportunity to ask questions of, and receive answers from the management of the Company (and any person acting on its behalf) concerning the Option and the Common Stock and the agreements and transactions contemplated hereby, and to obtain any additional information as Holder may have requested in making its investment decision. The Holder is an "accredited investor", as defined by Regulation D promulgated under the Act. 8. RESERVATION AND ISSUANCE OF STOCK. (a) The Company covenants that during the term that this Option is exercisable, the Company will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of the shares Upon the exercise of this Option, and from time to time will take all steps necessary to amend its Certificate of Incorporation to provide sufficient reserves of shares of Common Stock issuable upon the exercise of the Option. (b) The Company further covenants that all shares of Common Stock issuable upon the due exercise of this Option will be free and clear from all taxes or liens, 7. 8 charges and security interests created by the Company with respect to the issuance thereof, however, the Company shall not be obligated or liable for the payment of any taxes, liens or charges of Holder, or any other party contemplated by paragraph 7, incurred in connection with the issuance of this Option or the Common Stock upon the due exercise of this Option. The Company agrees that its issuance of this Option shall constitute full authority to its officers who are charged with the duty of executing stock certificates to execute and issue the necessary certificates for the shares of Common Stock upon the exercise of this Option. The Common Stock issuable upon the due exercise of this Option, will, upon issuance in accordance with the terms hereof, be duly authorized, validly issued, fully paid and non-assessable. 9. NOTICES. (a) Whenever the Exercise Price or number of shares purchasable hereunder shall be adjusted pursuant to Section 11 hereof, the Company shall issue a certificate signed by its Chief Financial Officer setting forth, in reasonable detail, the event requiting the adjustment, the amount of the adjustment, the method by which such adjustment was calculated, and the Exercise Price and number of shares purchasable hereunder after giving effect to such adjustment, and shall cause a copy of such certificate to be mailed (by first-class mail, postage prepaid) to the Holder of this Option. (b) All notices, advices and communications under this Option shall be deemed to have been given, (i) in the case of personal delivery, on the date of such delivery and (ii) in the case of mailing, on the third business day following the date of such mailing, addressed as follows: If to the Company: PMR Corporation 3990 Old Town Avenue, Suite 206A San Diego, CA 92110 Attn: Allen Tepper, Chief Executive Officer With a Copy to: Stephen M. Cohen, Esquire Buchanan Ingersoll, Professional Corporation Two Logan Square, 12th Floor 18th & Arch Streets Philadelphia, PA 19103-2771 and to the Holder: 8. 9 at the address of the Holder appearing on the books of the Company or the Company's transfer agent, if any. With a Copy to: Joel I. Papernik, Esquire Squadron, Ellenoff, Plesent & Sheinfeld, LLP 551 Fifth Avenue New York, NY 10176 Either of the Company or the Holder may from time to time change the address to which notices to it are to be mailed hereunder by notice in accordance with the provisions of this Paragraph 9. 10. AMENDMENTS. (a) Any term of this Option may be amended with the written consent of the Company and the Holder. Any amendment effected in accordance with this Section 10 shall be binding upon the Holder, each future holder and the Company. (b) No waivers of, or exceptions to, any term, condition or provision of this Option, in any one or more instances, shall be deemed to be, or construed as, a further or continuing waiver of any such term, condition or provision. 11. ADJUSTMENTS. The number of Shares of Common Stock purchasable hereunder and the Exercise Price is subject to adjustment from time to time upon the occurrence of certain events, as follows: 11.1. REORGANIZATION, MERGER OR SALE OF ASSETS. If at any time while this Option, or any portion thereof, is outstanding and unexpixed there shall be (i) a reorganization (other than a combination, reclassification, exchange or subdivision of shares otherwise provided for herein), (ii) a merger or consolidation of the Company with or into another corporation in which the Company is not the surviving entity, or a reverse triangular merger in which the Company is the surviving entity but the shares of the Company's capital stock outstanding immediately prior to the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise, or (iii) a sale or transfer of substantially all of the Company's properties and assets as, or substantially as, an entirety to any other person, then, as a part of such reorganization, merger, consolidation, sale or transfer, lawful provision shall be made so that the holder of this Option shall thereafter be entitled to receive upon payment of the Exercise Price then in effect, the number of shares of Stock or other securities or property of the successor corporation resulting from such reorganization, merger, consolidation, sale or transfer that a holder of the shares deliverable upon exercise of this Option would 9. 10 have been entitled to receive in such reorganization, consolidation, merger, sale or transfer if this Option had been exercised immediately before such reorganization, merger, consolidation, sale or transfer, all subject to further adjustment as provided in this Section 11. The foregoing provisions of this Section 11.1 shall similarly apply to successive reorganizations, consolidations, mergers, sales and transfers and to the stock or securities of any other corporation that are at the time receivable upon the exercise of this Option. If the per-share consideration payable to the Holder hereof for shares in connection with any such transaction is in a form other than cash or marketable securities, then the value of such consideration shall be determined in good faith by the Company's Board of Directors. In all events, appropriate adjustment (as determined in good faith by the Company's Board of Directors) shall be made in the application of the provisions of this Option with respect to the rights and interests of the Holder after the transaction, to the end that the provisions of this Option shall be applicable after that event, as near as reasonably may be, in relation to any shares or other property deliverable after that event upon exercise of this Option. 11.2. RECLASSIFICATION. If the Company, at any time while this Option, or any portion thereof, remains outstanding and unexpired, by reclassification of securities or otherwise, shall change any of the securities as to which purchase rights under this Option exist into the same or a different number of securities of any other class or classes, this Option shall thereafter represent the right to acquire such number and kind of securities as would have been issuable as the result of such change with respect to the securities that were subject to the purchase rights under this Option immediately prior to such reclassification or other change and the Exercise Price therefor shall be appropriately adjusted, all subject to further adjustment as provided in this Section l1. 11.3. SPLIT, SUBDIVISION OR COMBINATION OF SHARES. If the Company at any time while this Option, or any portion thereof, remains outstanding and unexpired shall split, subdivide or combine the securities as to which purchase rights under this Option exist, into a different number of securities of the same class, the Exercise Price and the number of shares issuable upon exercise of this Option shall be proportionately adjusted. 11.4. ADJUSTMENTS FOR DIVIDENDS IN STOCK OR OTHER SECURITIES OR PROPERTY. If while this Option, or any portion hereof, remains outstanding and unexpired the holders of the securities as to which purchase rights under this Option exist at the time shall have received, or, on or after the record date fixed for the determination of eligible Stockholders, shall have become entitled to receive, without payment therefor, other or additional stock or other securities or property (other than cash) of the Company by way of dividend, then and in each case, this Option shall represent the right to acquire, in addition to the number of shares of the security receivable upon exercise of this Option, and without payment of any additional consideration therefor, the amount of such other or 10. 11 additional stock or other securities or property (other than cash) of the Company that such holder would hold on the date of such exercise had it been the holder of record of the security receivable upon exercise of this Option on the date hereof and had thereafter, during the period from the date hereof to and including the date of such exercise, retained such shares and/or all other additional stock, other securities or property available by this Option as aforesaid during such period. 11.5 The Company will not, by any voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Company, but will at all times in good faith assist in the carrying out of all the provisions of this Section 11 and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the Holders of this Option against impairment. 12. REGISTRATION RIGHTS. The Holder shall be entitled to the registration rights set forth in that certain Registration Rights Agreement of even date herewith by and between the Company and such Holder. 13. SEVERABILITY. Whenever possible, each provision of this Option shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Option is held to be invalid, illegal or unenforceable in any respect under any applicable law or rule in any jurisdiction, such invalidity, illegality or unenforceability shall not affect the validity, legality or enforceability of any other provision of this Option in such jurisdiction or affect the validity, legality or enforceability of any provision in any other jurisdiction, but this Option shall be reformed, construed and enforced in such jurisdiction as if such invalid, illegal or unenforceable provision had never been contained herein. 14. GOVERNING LAW. The corporate law of the State of Delaware shall govern all issues and questions concerning the relative rights of the Company and its stockholders. All other questions concerning the construction, validity, interpretation and enforceability of this Option and the exhibits and schedules hereto shall be governed by, and construed in accordance with, the laws of the State of Delaware, without giving effect to any choice of law or conflict of law rules or provisions (whether of the State of Delaware or any other jurisdiction) that would cause the application of the laws of any jurisdiction other than the State of Delaware. 15. JURISDICTION. In connection with the enforcement of a decision in arbitration pursuant to section 16 hereof, the Holder and the Company agree to submit to personal jurisdiction and to waive any objection as to venue in the federal or state courts in the City in which the headquarters of the Company is located, which as of the date hereof is San Diego, California. Service of process on the Company or the Holder in any 11. 12 action arising out of or relating to this Option shall be effective if mailed to such party at the address listed in Section 9 hereof. 16. ARBITRATION. If a dispute arises as to interpretation of this Option, it shall be decided exclusively and finally by three arbitrators in an arbitration proceeding conforming to the Rules of the American Arbitration Association applicable to commercial arbitration. The arbitrators shall be appointed as follows: one by the Company, one by the Holder and the third by the said two arbitrators, or, if they cannot agree, then the third arbitrator shall be appointed by the American Arbitration Association. The third arbitrator shall be chairman of the panel and shall be impartial. The arbitration shall take place in the City in which the headquarters of the Company is located, which as of the date hereof is San Diego, California. The decision of a majority of the Arbitrators shall be conclusively binding upon the parties and final, and such decision shall be enforceable as a judgment in any court of competent jurisdiction. Each party shall pay the fees and expenses of the arbitrator appointed by it, its counsel and its witnesses. The parties shall share equally the fees and expenses of the impartial arbitrator. 17. CORPORATE POWER; AUTHORIZATION; ENFORCEABLE OBLIGATIONS. The execution, delivery and performance by the Company of this Agreement: (i) are within the Company's corporate power; (ii) have been duly authorized by all necessary or proper corporate action; (iii) are not in contravention of the company's certificate of incorporation or by-laws; (iv) will not violate in any material respect, any law or regulation, including any and all Federal and state securities laws, or any order or decree of any court or governmental instrumentality; and (v) will not, in any material respect, conflict with or result in the breach or termination of, or constitute a default under any agreement or other material instrument to which the Company is a party or by which the Company is bound. 18. SUCCESSORS AND ASSIGNS. This Option shall inure to the benefit of and be binding on the respective successors, assigns and legal representatives of the Holder and the Company. IN WITNESS WHEREO, the Company has caused this Option to be executed by its officers thereunto duly authorized. Option Issue Date: February 1, 1996 HOLDER PMR CORPORATION By: /s/ Mark Clein By: /s/ Allen Tepper - ---------------------------- ---------------------------- Mark Clein Allen Tepper, Chief Executive Officer 12. 13 NOTICE OF EXERCISE TO: PMR CORPORATION (1) The undersigned hereby elects to purchase ____________ shares of Common Stock of PMR CORPORATION pursuant to the terms of the attached Option, and tenders herewith payment of the purchase price for such shares in full. (2) In exercising this Option, the undersigned hereby confirms and acknowledges that the shares of Common Stock to be issued upon conversion thereof are being acquired solely for the account of the undersigned and not as a nominee for any other party, and for investment (unless such shares are subject to resale pursuant to an effective prospectus), and that the undersigned will not offer, sell or otherwise dispose of any such shares of Common Stock except under circumstances that will not result in a violation of the Securities Act of 1933, as amended, or any state securities laws. (3) Please issue a certificate or certificates representing said shares of Common Stock in the name of the undersigned or in such other name as is specified below: ---------------------------- (Name) ---------------------------- (Name) - ---------------------------- ---------------------------- (Date) (Signature) 13. EX-10.10 13 EXHIBIT 10.10 1 EXHIBIT 10.10 20,000 Options/MC "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION, OR THE AVAILABILITY OF EXEMPTION FROM REGISTRATION, UNDER THE SECURITIES ACT OF 1933, AS AMENDED, BASED ON AN OPINION LETTER OF COUNSEL SATISFACTORY TO THE COMPANY OR A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION." AMENDED AND RESTATED OPTION TO PURCHASE COMMON STOCK OF PMR CORPORATION Void after February 1, 2003 This certifies that, for value received, MARK CLEIN ("Holder"), is entitled, subject to the terms set forth below, to purchase from PMR CORPORATION (the "Company"), a Delaware corporation, shares of the Common Stock of the Company (the "Shares"), as constituted on the effective date hereof (the "Option Issue Date"), with the Notice of Exercise attached hereto duly executed, and simultaneous payment therefor in lawful money of the United States, at the Exercise Price as set forth in Section 2 below. The number, character and Exercise Price of the shares are subject to adjustment as provided below. 1. TERM OF OPTION. Subject to compliance with the vesting provisions identified at Paragraph 2.3 hereafter, this Option shall be exercisable, in whole or in part, during the term commencing on the Option Issue Date and ending at 5:00 p.m. on February 1, 2003, and shall be void thereafter. 2. EXERCISE PRICE, NUMBER OF SHARES AND VESTING PROVISIONS. 2.1 EXERCISE PRICE. The Exercise Price at which this Option may be exercised shall be $4.75 per share of common stock, as adjusted pursuant to Section 11 hereof. 2.2 NUMBER OF SHARES. The number of shares of the Company's Common Stock, $.01 par value per share ("Common Stock") which may be purchased pursuant to this Option shall be 20,000 shares, as adjusted pursuant to Section 11 hereof. 1. 2 2.3 VESTING. The Options granted hereunder have immediately vested as of the Option Issue Date. 2.4. DEATH OF HOLDER AND TERMINATION. (a) If the Holder shall die while in the employ of the Company, his estate, personal representatives, or beneficiary shall have the right, subject to the provisions of this Paragraph 2 hereof, to exercise the Option (only to the extent that the Holder would have been entitled to do so as of the date of his death) at any time within twelve (12) months from the date of his death. (b) In the event Holder's employment by the Company is terminated for "cause", as defined above, or Holder voluntarily terminates his employment with the Company, Holder shall have 30 days in which to exercise the Option (only to the extent that the Holder would have been entitled to do so as of the date of his termination) and thereafter, Holder's right in and to the Option shall lapse and terminate. 3. EXERCISE OF OPTION. (a) The Exercise Price shall either be payable in cash or by bank or certified check; or by cashless exercise through the delivery by the Holder to the Company of shares of the Company's Common Stock for which Holder is the record and beneficial owner, or a withholding by the Company of shares of Common Stock that Holder is otherwise entitled to receive upon exercise of the Option or by any combination thereof. If shares of common stock of the Company are tendered or withheld as payment of the Exercise Price, the value of such shares shall be their "market value" as of the trading date immediately preceding the date of exercise. The "market value" shall be: (i) If the Company's common stock is traded in the over-the-counter market and not on any national securities exchange nor in the NASDAQ Reporting System, the market value shall be the average of the mean between the last bid and ask prices per share, as reported by the National Quotation Bureau, Inc., or an equivalent generally accepted reporting service, or if not so reported, the average of the closing bid and asked prices for a share as furnished to the Company by any member of the National Association of Securities Dealers, Inc., selected by the Company for that purpose. (ii) If the Company's common stock is traded on a national securities exchange or in the NASDAQ Reporting System, the market value shall be either (1) the simple average of the high and low prices at which a share of the Company's common stock traded, as quoted on the NASDAQ-NMS or its other principal exchange, or (2) the price of the last sale of a share of common stock as similarly quoted, 2. 3 whichever is higher, and rounding out such figure to the next higher multiple of 12.5 cents (unless the figure is already a multiple of 12.5 cents). If such tender would result in an issuance of a whole number of shares and a fractional share of Common Stock, the value of such fractional share shall be paid to the Company in cash or by check by the Holder. (b) The purchase rights represented by this Option are exercisable by the Holder in whole or in part, at any time, or from time to time, by the surrender of this Option and the Notice of Exercise annexed hereto duly completed and executed on behalf of the Holder, at the office of the Company (or such other office or agency of the Company as it may designate by notice in writing to the Holder at the address of the Holder appearing on the books of the Company). (c) This Option shall be deemed to have been exercised immediately prior to the close of business on the date of its surrender for exercise as provided above, and the person entitled to receive the shares of Common Stock issuable upon such exercise shall be treated for all purposes as the holder of record of such shares as of the close of business on such date. As promptly as practicable on or after such date and in any event within ten (10) days thereafter, the Company at its expense shall issue and deliver to the person or persons entitled to receive the same a certificate or certificates for the number of shares issuable upon such exercise. In the event that this Option is exercised in part, the Company at its expense will execute and deliver a new Option of like tenor exercisable for the number of shares for which this Option may then be exercised. 4. NO FRACTIONAL SHARES OR SCRIP. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Option. In lieu of any fractional share to which the Holder would otherwise be entitled, the Company shall make a cash payment equal to the Exercise Price multiplied by such fraction. 5. REPLACEMENT OF OPTION. On receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Option and, in the case of loss, theft or destruction, or delivery of an indemnity agreement reasonably satisfactory in form and substance to the Company or, in the case of mutilation, on surrender and cancellation of this Option, the Company at its expense shall execute and deliver, in lieu of this Option, a new Option of like tenor and amount. 6. RIGHTS OF STOCKHOLDER. Except as otherwise contemplated herein, the Holder shall not be entitled to vote or receive dividends or be deemed the holder of Common Stock or any other securities of the Company that may at any time be issuable on the exercise hereof for any purpose, nor shall anything contained herein be construed 3. 4 to confer upon the Holder, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to stockholders at any meeting thereof, or to give or withhold consent to any corporate action (whether upon any recapitalization, issuance of stock, reclassification of stock, change of par value, or change of stock to no par value, consolidation, merger, conveyance or otherwise) or to receive notice of meetings, or to receive dividends or subscription rights or otherwise until the Option shall have been exercised as provided herein. 7. TRANSFER OF OPTION. 7.1. NON-TRANSFERABILITY. The Option shall not be assigned, transferred, pledged or hypothecated in any way, nor subject to execution, attachment or similar process, otherwise than by will or by the laws of descent and distribution. Any attempted assignment, transfer, pledge, hypothecation or other disposition of the Option contrary to the provisions hereof, and the levy of an execution, attachment, or similar process upon the Option, shall be null and void and without effect. 7.2. COMPLIANCE WITH SECURITIES LAWS; RESTRICTIONS ON TRANSFERS. (a) The Holder of this Option, by acceptance hereof, acknowledges that this Option and the Shares to be issued upon exercise hereof are being acquired solely for the Holder's own account and not as a nominee for any other party, and for investment (unless such shares are subject to resale pursuant to an effective prospectus), and that the Holder will not offer, sell or otherwise dispose of this Option or any Shares to be issued upon exercise hereof except under circumstances that will not result in a violation of applicable federal and state securities laws. Upon exercise of this Option, the Holder shall, if requested by the Company, confirm in writing, in a form satisfactory to the Company, that the shares of Common Stock so purchased are being acquired solely for the Holder's own account and not as a nominee for any other party, for investment (unless such shares are subject to resale pursuant to an effective prospectus), and not with a view toward distribution or resale. (b) Neither this Option nor any share of Common Stock issued upon exercise of this Option may be offered for sale or sold, or otherwise transferred or sold in any transaction which would constitute a sale thereof within the meaning of the Securities Act of 1933, as amended (the "1933 Act"), unless (i) such security has been registered for sale under the 1933 Act and registered or qualified under applicable state securities laws relating to the offer an sale of securities, or (ii) exemptions from the registration requirements of the 1933 Act and the registration or qualification requirements of all such state securities laws are available and the Company shall have received an opinion of counsel satisfactory to the Company that the proposed sale or other disposition of such securities may be effected without registration under the 1933 Act and 4. 5 would not result in any violation of any applicable state securities laws relating to the registration or qualification of securities for sale, such counsel and such opinion to be satisfactory to the Company. (c) All Shares issued upon exercise hereof shall be stamped or imprinted with a legend in substantially the following form (in addition to any legend required by state securities laws). "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES MAY NOT BE SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION, OR THE AVAILABILITY OF EXEMPTION FROM REGISTRATION, UNDER THE SECURITIES ACT OF 1933, AS AMENDED, BASED ON AN OPINION LETTER OF COUNSEL SATISFACTORY TO THE COMPANY OR A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION." Holder recognizes that investing in the Option and the Common Stock involves a high degree of risk, and Holder is in a financial position to hold the Option and the Common Stock indefinitely and is able to bear the economic risk and withstand a complete loss of its investment in the Option and the Common Stock. The Holder is a sophisticated investor and is capable of evaluating the merits and risks of investing in the Company. The Holder has had an opportunity to discuss the Company's business, management and financial affairs with the Company's management, has been given full and complete access to information concerning the Company, and has utilized such access to its satisfaction for the purpose of obtaining information or verifying information and have had the opportunity to inspect the Company's operation. Holder has had the opportunity to ask questions of, and receive answers from the management of the Company (and any person acting on its behalf) concerning the Option and the Common Stock and the agreements and transactions contemplated hereby, and to obtain any additional information as Holder may have requested in making its investment decision. The Holder is an "accredited investor", as defined by Regulation D promulgated under the Act. 8. RESERVATION AND ISSUANCE OF STOCK. (a) The Company covenants that during the term that this Option is exercisable, the Company will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of the shares upon the exercise of this Option, and from time to time will take all steps necessary to amend its Certificate of 5. 6 Incorporation to provide sufficient reserves of shares of Common Stock issuable upon the exercise of the Option. (b) The Company further covenants that all shares of Common Stock issuable upon the due exercise of this Option will be free and clear from all taxes or liens, charges and security interests created by the Company with respect to the issuance thereof, however, the Company shall not be obligated or liable for the payment of any taxes, liens or charges of Holder, or any other party contemplated by paragraph 7, incurred in connection with the issuance of this Option or the Common Stock upon the due exercise of this Option. The Company agrees that its issuance of this Option shall constitute full authority to its officers who are charged with the duty of executing stock certificates to execute and issue the necessary certificates for the shares of Common Stock upon the exercise of this Option. The Common Stock issuable upon the due exercise of this Option, will, upon issuance in accordance with the terms hereof, be duly authorized, validly issued, fully paid and non-assessable. 9. NOTICES. (a) Whenever the Exercise Price or number of shares purchasable hereunder shall be adjusted pursuant to Section 11 hereof, the Company shall issue a certificate signed by its Chief Financial Officer setting forth, in reasonable detail, the event requiring the adjustment, the amount of the adjustment, the method by which such adjustment was calculated, and the Exercise Price and number of shares purchasable hereunder after giving effect to such adjustment, and shall cause a copy of such certificate to be mailed (by first-class mail, postage prepaid) to the Holder of this Option. (b) All notices, advices and communications under this Option shall be deemed to have been given, (i) in the case of personal delivery, on the date of such delivery and (ii) in the case of mailing, on the third business day following the date of such mailing, addressed as follows: If to the Company: PMR Corporation 3990 Old Town Avenue, Suite 206A San Diego, CA 92110 Attn: Allen Tepper, Chief Executive Officer With a Copy to: Stephen M. Cohen, Esquire Buchanan Ingersoll, Professional Corporation 6. 7 Two Logan Square, 12th Floor 18th & Arch Streets Philadelphia, PA 19103-2771 and to the Holder: at the address of the Holder appearing on the books of the Company or the Company's transfer agent, if any. with a Copy to: Joel I. Papernik, Esquire Squadron, Ellenoff, Plesent & Sheinfeld, LLP 551 Fifth Avenue New York, NY 10176 Either of the Company or the Holder may from time to time change the address to which notices to it are to be mailed hereunder by notice in accordance with the provisions of this Paragraph 9. 10. AMENDMENTS. (a) Any term of this Option may be amended with the written consent of the Company and the Holder. Any amendment effected in accordance with this Section 10 shall be binding upon the Holder, each future holder and the Company. (b) No waivers of, or exceptions to, any term, condition or provision of this Option, in any one or more instances, shall be deemed to be, or construed as, a further or continuing waiver of any such term, condition or provision. 11. ADJUSTMENTS. The number of Shares of Common Stock purchasable hereunder and the Exercise Price is subject to adjustment from time to time upon the occurrence of certain events, as follows: 11.1. REORGANIZATION, MERGER OR SALE OF ASSETS. If at any time while this Option, or any portion thereof, is outstanding and unexpired there shall be (i) a reorganization (other than a combination, reclassification, exchange or subdivision of shares otherwise provided for herein), (ii) a merger or consolidation of the Company with or into another corporation in which the Company is not the surviving entity, or a reverse triangular merger in which the Company is the surviving entity but the shares of the Company's capital stock outstanding immediately prior to the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise, or (iii) a sale or transfer of substantially all of the Company's properties and 7. 8 assets as, or substantially as, an entirety to any other person, then, as a part of such reorganization, merger, consolidation, sale or transfer, lawful provision shall be made so that the holder of this Option shall thereafter be entitled to receive upon payment of the Exercise Price then in effect, the number of shares of stock or other securities or property of the successor corporation resulting from such reorganization, merger, consolidation, sale or transfer that a holder of the shares deliverable upon exercise of this Option would have been entitled to receive in such reorganization, consolidation, merger, sale or transfer if this Option had been exercised immediately before such reorganization, merger, consolidation, sale or transfer, all subject to further adjustment as provided in this Section 11. The foregoing provisions of this Section 11.1 shall similarly apply to successive reorganizations, consolidations, mergers, sales and transfers and to the stock or securities of any other corporation that are at the time receivable upon the exercise of this Option. If the per-share consideration payable to the Holder hereof for shares in connection with any such transaction is in a form other than cash or marketable securities, then the value of such consideration shall be determined in good faith by the Company's Board of Directors. In all events, appropriate adjustment (as determined in good faith by the Company's Board of Directors) shall be made in the application of the provisions of this Option with respect to the rights and interests of the Holder after the transaction, to the end that the provisions of this Option shall be applicable after that event, as near as reasonably may be, in relation to any shares or other property deliverable after that event upon exercise of this Option. 11.2. RECLASSIFICATION. If the Company, at any time while this Option, or any portion thereof, remains outstanding and unexpired, by reclassification of securities or otherwise, shall change any of the securities as to which purchase rights under this Option exist into the same or a different number of securities of any other class or classes, this Option shall thereafter represent the right to acquire such number and kind of securities as would have been issuable as the result of such change with respect to the securities that were subject to the purchase rights under this Option immediately prior to such reclassification or other change and the Exercise Price therefor shall be appropriately adjusted, all subject to further adjustment as provided in this Section 11. 11.3. SPLIT, SUBDIVISION OR COMBINATION OF SHARES. If the Company at any time while this Option, or any portion thereof, remains outstanding and unexpired shall split, subdivide or combine the securities as to which purchase rights under this Option exist, into a different number of securities of the same class, the Exercise Price and the number of shares issuable upon exercise of this Option shall be proportionately adjusted. 11.4. ADJUSTMENTS FOR DIVIDENDS IN STOCK OR OTHER SECURITIES OR PROPERTY. If while this Option, or any portion hereof, remains outstanding and unexpired the holders of the securities as to which purchase rights under this Option exist at the time 8. 9 shall have received, or, on or after the record date fixed for the determination of eligible Stockholders, shall have become entitled to receive, without payment therefor, other or additional stock or other securities or property (other than cash) of the Company by way of dividend, then and in each case, this Option shall represent the right to acquire, in addition to the number of shares of the security receivable upon exercise of this Option, and without payment of any additional consideration therefor, the amount of such other or additional stock or other securities or property (other than cash) of the Company that such holder would hold on the date of such exercise had it been the holder of record of the security receivable upon exercise of this Option on the date hereof and had thereafter, during the period from the date hereof to and including the date of such exercise, retained such shares and/or all other additional stock, other securities or property available by this Option as aforesaid during such period. 11.5 The Company will not, by any voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Company, but will at all times in good faith assist in the carrying out of all the provisions of this Section 11 and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the Holders of this Option against impairment. 12. REGISTRATION RIGHTS. The Holder shall be entitled to the registration rights set forth in that certain Registration Rights Agreement of even date herewith by and between the Company and such Holder. 13. SEVERABILITY. Whenever possible, each provision of this Option shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Option is held to be invalid, illegal or unenforceable in any respect under any applicable law or rule in any jurisdiction, such invalidity, illegality or unenforceability shall not affect the validity, legality or enforceability of any other provision of this Option in such jurisdiction or affect the validity, legality or enforceability of any provision in any other jurisdiction, but this Option shall be reformed, construed and enforced in such jurisdiction as if such invalid, illegal or unenforceable provision had never been contained herein. 14. GOVERNING LAW. The corporate law of the State of Delaware shall govern all issues and questions concerning the relative rights of the Company and its stockholders. All other questions concerning the construction, validity, interpretation and enforceability of this Option and the exhibits and schedules hereto shall be governed by, and construed in accordance with, the laws of the State of Delaware, without giving effect to any choice of law or conflict of law rules or provisions (whether of the State of Delaware or any other jurisdiction) that would cause the application of the laws of any jurisdiction other than the State of Delaware. 9. 10 15. JURISDICTION. In connection with the enforcement of a decision in arbitration pursuant to section 16 hereof, the Holder and the Company agree to submit to personal jurisdiction and to waive any objection as to venue in the federal or state courts in the City in which the headquarters of the Company is located, which as of the date hereof is San Diego, California. Service of process on the Company or the Holder in any action arising out of or relating to this Option shall be effective if mailed to such party at the address listed in Section 9 hereof. 16. ARBITRATION. If a dispute arises as to interpretation of this Option, it shall be decided exclusively and finally by three arbitrators in an arbitration proceeding conforming to the Rules of the American Arbitration Association applicable to commercial arbitration. The arbitrators shall be appointed as follows: one by the Company, one by the Holder and the third by the said two arbitrators, or, if they cannot agree, then the third arbitrator shall be appointed by the American Arbitration Association. The third arbitrator shall be chairman of the panel and shall be impartial. The arbitration shall take place in the City in which the headquarters of the Company is located, which as of the date hereof is San Diego, California. The decision of a majority of the Arbitrators shall be conclusively binding upon the parties and final, and such decision shall be enforceable as a judgment in any court of competent jurisdiction. Each party shall pay the fees and expenses of the arbitrator appointed by it, its counsel and its witnesses. The parties shall share equally the fees and expenses of the impartial arbitrator. 17. CORPORATE POWER; AUTHORIZATION; ENFORCEABLE OBLIGATIONS. The execution, delivery and performance by the Company of this Agreement: (i) are within the Company's corporate power; (ii) have been duly authorized by all necessary or proper corporate action; (iii) are not in contravention of the Company's certificate of incorporation or by-laws; (iv) will not violate in any material respect, any law or regulation, including any and all Federal and state securities laws, or any order or decree of any court or governmental instrumentality; and (v) will not, in any material respect, conflict with or result in the breach or termination of, or constitute a default under any agreement or other material instrument to which the Company is a party or by which the Company is bound. 18. SUCCESSORS AND ASSIGNS. This Option shall inure to the benefit of and be binding on the respective successors, assigns and legal representatives of the Holder and the Company. IN WITNESS WHEREO, the Company has caused this Option to be executed by its officers thereunto duly authorized. Option Issue Date: February 1, 1996 10. 11 HOLDER PMR CORPORATION By: /s/ Mark Clein By: /s/ Allen Tepper ---------------------------- ---------------------------- Mark Clein Allen Tepper, Chief Executive Officer 11. 12 NOTICE OF EXERCISE TO: PMR CORPORATION (1) The undersigned hereby elects to purchase _________ shares of Common Stock of PMR CORPORATION pursuant to the terms of the attached Option, and tenders herewith payment of the purchase price for such shares in full. (2) In exercising this Option, the undersigned hereby confirms and acknowledges that the shares of Common Stock to be issued upon conversion thereof are being acquired solely for the account of the undersigned and not as a nominee for any other party, and for investment (unless such shares are subject to resale pursuant to an effective prospectus), and that the undersigned will not offer, sell or otherwise dispose of any such shares of Common Stock except under circumstances that will not result in a violation of the Securities Act of 1933, as amended, or any state securities laws. (3) Please issue a certificate or certificates representing said shares of Common Stock in the name of the undersigned or in such other name as is specified below: ---------------------------- (Name) ---------------------------- (Name) - ---------------------------- ---------------------------- (Date) (Signature) 12. EX-10.11 14 EXHIBIT 10.11 1 Exhibit 10.11 AMENDED AND RESTATED WARRANT TO PURCHASE COMMON STOCK OF PMR CORPORATION Void after 5:00 p.m. Eastern Standard Time on April 26, 2000 This is to verify that, FOR VALUE RECEIVED, Fred Furman, (hereinafter referred to as the "Holder") is entitled to purchase, subject to the terms and conditions hereof, from PMR Corporation, a Delaware corporation ("Company"), 90,000 shares of Common Stock, par value $.01 per share of the Company (the "Common Stock") at any time during the period commencing at 9:00 a.m., Eastern Standard Time on April 26, 1995 (the "Commencement Date") and ending at 5:00 p.m. Eastern Standard Time on April 25, 2000 (the "Termination Date") at an exercise price of $3.50 per share of Common Stock. The number of shares of Common Stock purchasable upon exercise of this Warrant are subject to certain limitations upon exercise identified at Paragraph 8 hereafter. Furthermore, the number of shares of Common Stock purchasable upon exercise of this Warrant and the exercise price per share shall be subject to adjustment from time to time upon the occurrence of certain events as set forth below. This Warrant amends and restates and supercedes that certain warrant dated as of April 26, 1995, with respect to the purchase of up to 90,000 shares of Common Stock. The shares of Common Stock or any other shares or other units of stock or other securities or property, or any combination thereof then receivable upon exercise of this Warrant, as adjusted from time to time, are sometimes referred to hereinafter as "Exercise Shares". The exercise price per share as from time to time in effect is referred to hereinafter as the "Exercise Price". 1. EXERCISE OF WARRANT; ISSUANCE OF EXERCISE SHARES. (a) EXERCISE OF WARRANT. Subject to the vesting period set forth hereafter, this Warrant may be exercised in whole or in part at any time or from time to time on or after the Commencement Date and until and including the Termination Date, upon surrender on any business day to the Company at its principal office, presently located at the address of the Company set forth in Paragraph 9 hereof, (or such other office of the Company, if any, as shall theretofore have been designated by the Company by written notice to the Holder), together with: (i) a completed and executed Notice of Warrant Exercise in the form set forth in Appendix A hereto and made a part hereof and (ii) payment of the full Exercise Price for the amount of Exercise Shares set forth in the 1. 2 Notice of Warrant Exercise, in lawful money of the United States of America by certified check or cashier's check, made payable to the order of the Company. In the event that this Warrant shall be duly exercised in part prior to the Termination Date, the Company shall issue a new Warrant or Warrants of like tenor evidencing the rights of the Holder thereof to purchase the balance of the Exercise Shares purchasable under the Warrant so surrendered that shall not have been purchased. No adjustments shall be made for any cash dividends on Exercise Shares issuable upon exercise of the Warrant. The Company shall cancel Warrant Certificates surrendered upon exercise of Warrants. (b) ISSUANCE OF EXERCISE SHARES; DELIVERY OF WARRANT CERTIFICATE. The Company shall, within ten (10) business days or as soon thereafter as is practicable of the exercise of this Warrant, issue in the name of and cause to be delivered to the Holder (or such other person or persons, if any, as the Holder shall have designated in the Notice of Warrant Exercise) one or more certificates representing the Exercise Shares to which the Holder (or such other person or persons) shall be entitled upon such exercise under the terms hereof. Such certificate or certificates shall be deemed to have been issued and the Holder (or such other person or persons so designated) shall be deemed to have become the record holder of the Exercise Shares as of the date of the due exercise of this Warrant. (c) EXERCISE SHARES FULLY PAID AND NON-ASSESSABLE. The Company agrees and covenants that all Exercise Shares issuable upon the due exercise of the Warrant represented by this Warrant Certificate will, upon issuance in accordance with the terms hereof, be duly authorized, validly issued, fully paid and non-assessable and free and clear of all taxes (other than taxes which, pursuant to Paragraph 2 hereof, the Company shall not be obligated to pay) or liens, charges, and security interests created by the Company with respect to the issuance thereof. (d) RESERVATION OF EXERCISE SHARES. At the time of or before taking any action which would cause an adjustment pursuant to this Paragraph increasing the number of shares of capital stock constituting the Exercise Shares, the Company will take any corporate action which may, in the opinion of its counsel, be necessary in order that the Company have remaining, after such adjustment, a number of shares of such capital stock unissued and unreserved for other purposes sufficient to permit the exercise of all the then outstanding Warrants of like tenor immediately after such adjustment; the Company will also from time to time take action to increase the authorized amount of its capital stock constituting the Exercise Shares if at any time the number of shares of capital stock authorized but remaining unissued and unreserved for other purposes shall be insufficient to permit the exercise of the Warrants then outstanding. The Company may but shall not be limited to reserve and keep available, out of the aggregate of its authorized but 2. 3 unissued shares of capital stock, for the purpose of enabling it to satisfy any obligation to issue Exercise Shares upon exercise of Warrants, through the Termination Date, the number of Exercise Shares deliverable upon the full exercise of this Warrant and all other Warrants of like tenor then outstanding. At the time of or before taking any action which would cause an adjustment pursuant to this Paragraph, reducing the Exercise price below the then par value (if any) of the Exercise Shares issuable upon exercise of the Warrants, the Company will take any corporate action which may, in the opinion of its counsel, be necessary in order to assure that the par value per share of the Exercise Shares is at all times equal to or less than the Exercise Price per share and so that the Company may validly and legally issue fully paid and non-assessable Exercise Shares at the Exercise Price, as so adjusted; the Company will also from time to time take such action if at any time the Exercise Price is below the then par value of the Exercise Shares. (e) FRACTIONAL SHARES. The Company shall not be required to issue fractional shares of capital stock upon the exercise of this Warrant or to deliver Warrant Certificates which evidence fractional shares of capital stock. In the event that any fraction of an Exercise Share would, except for the provisions of this subparagraph (e), be issuable upon the exercise of this Warrant, the Company shall pay to the Holder exercising the Warrant an amount in cash equal to such fraction multiplied by the Current Market Value of the Exercise Share. For purposes of this subparagraph (e), the current Market Value shall be determined as follows: (i) if the Exercise Shares are traded in the over-the-counter market and not on any national securities exchange and not in the NASDAQ Reporting System, the average of the mean between the last bid and asked prices per share, as reported by the National Quotation Bureau, Inc., or an equivalent generally accepted reporting service, for the last business day prior to the date on which this Warrant is exercised, or if not so reported, the average of the closing bid and asked prices for an Exercise Share as furnished to the Company by any member of the National Association of Securities Dealers, Inc., selected by the Company for that purpose. (ii) if the Exercise Shares are listed or traded on a national securities exchange or in the NASDAQ National Market System, the closing price on the principal national securities exchange on which they are so listed or traded or in the NASDAQ National Market System, as the case may be, on the last business day prior to the date of the exercise of this Warrant. The closing price referred to in this clause (ii) shall be the last reported sales price or, in case no such reported sale takes place on such day, the average of the reported closing bid and asked prices, in either case on the national securities exchange on which the Exercise Shares are then listed or in the NASDAQ Reporting System; or 3. 4 (iii) if no such closing price or closing bid and asked prices are available, as determined in any reasonable manner as may be prescribed by the Board of Directors of the Company. 2. PAYMENT OF TAXES. The Company need not pay any documentary stamp taxes, if any, attributable to the initial issuance of Exercise Shares upon the exercise of this Warrant. Furthermore, the Company shall not be required to pay any tax or taxes which may be payable in respect of any transfer involved in the issue of any Warrant Certificates or any certificates for Exercise Shares in a name other than that of the Holder of a Warrant Certificate surrendered upon the exercise of a Warrant, and the Company shall not be required to issue or deliver such certificates unless or until the person or persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid. 3. MUTILATED OR MISSING WARRANT CERTIFICATES. In case any Warrant Certificate shall be mutilated, lost, stolen or destroyed, the Company may in its discretion issue, in exchange and substitution for and upon cancellation of the mutilated Warrant Certificate, or in lieu of and in substitution for the Warrant Certificate lost, stolen or destroyed, a new Warrant Certificate or Warrant Certificates of like tenor and in the same aggregate denomination, but only (i) in the case of loss, theft or destruction, upon receipt of evidence satisfactory to the Company of such loss, theft or destruction of such Warrant Certificate and indemnity or bond, if requested, also satisfactory to them and (ii) in the case of mutilation, upon surrender of the mutilated Warrant. Applicants for such substitute Warrant Certificates shall also comply with such other reasonable regulations and pay such other reasonable charges as the Company or its counsel may prescribe. 4. RIGHTS OF HOLDER. The Holder shall not, by virtue of anything contained in this Warrant Certificate or otherwise, be entitled to any right whatsoever, either in law or equity, of a stockholder of the Company, including without limitation, the right to receive dividends or to vote or to consent or to receive notice as a shareholder in respect of the meetings of shareholders or the election of directors of the Company or any other matter. 5. ADJUSTMENT OF EXERCISE SHARES AND EXERCISE PRICE. The Exercise price and the number and kind of Exercise Shares purchasable upon the exercise of this Warrant shall be subject to adjustment from time to time upon the happening of certain events as hereinafter provided. The Exercise Price in effect at any time and the number and kind of securities purchasable upon exercise of each Warrant shall be subject to adjustment as follows: (a) In the case the Company shall (i) pay a dividend or make a distribution on its shares of Common Stock in shares of Common Stock, (ii) subdivide or classify its 4. 5 outstanding Common Stock into a greater number of shares, or (iii) combine or reclassify its outstanding Common Stock into a smaller number of shares, the Exercise Price in effect at the time of the record date for such dividend or distribution or of the effective date of such subdivision, combination or reclassification shall be proportionally adjusted so that the Holder of this Warrant exercised after such date shall be entitled to receive the aggregate number and kind of shares which, if this Warrant had been exercised by such Holder immediately prior to such date, he would have owned upon such exercise and been entitled to receive upon such dividend, subdivision, combination or reclassification. For example, if the Company declares a 2 for 1 stock dividend or stock split and the Exercise Price immediately prior to such event was $5.00 per share, the adjusted Exercise Price immediately after such event would be $2.50 per share. Such adjustment shall be made successively whenever any event listed above shall occur. (b) Whenever the Exercise Price payable upon exercise of each Warrant is adjusted pursuant to Subsection (a) above, the number of Exercise Shares purchasable upon exercise of this Warrant shall simultaneously be adjusted by multiplying the number of Exercise Shares initially issuable upon exercise of this Warrant by the Exercise Price in effect on the date hereof and dividing the product so obtained by the Exercise Price, as adjusted. (c) No adjustment in the Exercise Price shall be required unless such adjustment would require an increase or decrease of at least ten cents ($0.10) in such price; provided, however, that any adjustments which by reason of this Subsection (c) are not required to be made shall be carried forward and taken into account in any subsequent adjustment required to be made hereunder. All calculations under this Paragraph (5) shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. Anything in this Paragraph (5) to the contrary notwithstanding, the Company shall be entitled, but shall not be required, to make such changes in the exercise Price, in addition to those required by this Paragraph (5), as it, in its sole discretion, shall determine to be advisable in order that any dividend or distribution in shares of Common Stock, subdivision, reclassification or combination of Common Stock (excluding cash dividends) referred to hereinabove in this Paragraph (5) hereafter made by the Company to the holders of its Common Stock shall not result in any tax to the holders of its Common Stock or securities convertible into Common Stock. (d) Whenever the Exercise Price is adjusted, as herein provided, the Company shall promptly cause a notice setting forth the adjusted Exercise Price and adjusted number of Shares issuable upon exercise of each Warrant to be mailed to the Holders, at their last addresses appearing in the Warrant Register. The Company may retain a firm of independent certified public accountants selected by the Board of Directors (who may be the regular accountants employed by the Company) to make any computation required by 5. 6 this Paragraph (5), and a certificate signed by such firm shall be conclusive evidence of the correctness of such adjustment. (e) Whenever the Exercise Price shall be adjusted as required by the provisions of the foregoing Paragraph, the Company shall forthwith file in the custody of its secretary or an Assistant Secretary at its principal office and with its stock transfer agent, if any, an officer's certificate showing the adjusted Exercise Price determined as herein provided, setting forth in reasonable detail the facts requiring such adjustment, including a statement of the number of additional shares of Common Stock, if any, and such other facts as shall be necessary to show the reason for and the manner of computing such adjustment. Each such officer's certificate shall be made available at all reasonable times for inspection by the holder and the Company shall, forthwith after each such adjustment, mail a copy by certified mail of such certificate to the Holder. 6. RESTRICTIONS ON TRANSFERABILITY. (a) WARRANT. This Warrant shall not be transferable except by will or by the laws of descent and distribution, and shall be exercisable only by the Holder. (b) EXERCISE SHARES. (i) RESTRICTIONS ON TRANSFER; INDEMNIFICATION. No Exercise Share may be offered for sale or sold, or otherwise transferred or sold in any transaction which would constitute a sale thereof within the meaning of the Securities Act of 1933, as amended (the "1933 Act"), unless (i) such security has been registered for sale under the 1933 Act and registered or qualified under applicable state securities laws relating to the offer and sale of securities, or (ii) exemptions from the registration requirements of the 1933 Act and the registration or qualification requirements of all such state securities laws are available and the Company shall have received an opinion of counsel satisfactory to the Company that the proposed sale or other disposition of such securities may be effected without registration under the 1933 Act and would not result in any violation of any applicable state securities laws relating to the registration or qualification of securities for sale, such counsel and such opinion to be satisfactory to the Company. The Holder agrees to indemnify and hold harmless the Company against any loss, damage, claim or liability arising from the disposition of this Warrant or any Exercise Share held by such holder or any interest therein in violation of the provisions of this Paragraph 6. (ii) RESTRICTIVE LEGENDS. Unless and until otherwise permitted by this Paragraph 6, each Certificate representing Exercise Shares issued upon exercise of this Warrant or to any transferee of the person to whom the Exercise Shares were issued, shall bear a legend setting forth the requirements of Paragraph (b)(ii) of this Paragraph 6, 6. 7 together with such other legend or legends as may otherwise be deemed necessary or appropriate by counsel to the Company. (iii) NOTICE OF PROPOSED TRANSFERS. Prior to any transfer, offer to transfer or attempted transfer of any Exercise Share, the holder of such security shall give written notice to the Company of such holder's intention to effect such transfer. Each such notice shall (x) describe the manner and circumstances of the proposed transfer in sufficient detail, and shall contain an undertaking by the person giving such notice to furnish such other information as may be required, to enable counsel to render the opinions referred to below, and shall (y) designate the counsel for the person giving such notice, such counsel to be satisfactory to the Company. The person giving such notice shall submit a copy thereof to the counsel designated in such notice and the Company shall submit a copy thereof to its counsel, and the following provisions shall apply: (A) If, in the opinion of each such counsel, the proposed transfer of the Exercise Share may be effected without registration of such security under the 1933 Act, the Company shall, as promptly as practicable, so notify the holder of such security and such holder shall thereupon be entitled to transfer such security in accordance with the terms of the notice delivered by such holder to the Company. Each certificate evidencing the securities thus to be transferred (and each certificate evidencing any untransferred balance of the securities evidenced by such certificate) shall bear the restrictive legends referred to in subparagraph (b)(ii) above, unless in the opinion of each such counsel such legend is not required in order to insure compliance with the 1933 Act. (B) If, in the opinion of either of such counsel, the proposed transfer of securities may not be effected without registration under the 1933 Act, the Company shall, as promptly as practicable, so notify the holder thereof. However, the Company shall have no obligation to register such securities under the 1933 Act, except as otherwise provided herein. The holder of the securities giving the notice under this subparagraph (b)(iii) shall not be entitled to transfer any of the securities until receipt of notice from the Company under Paragraph (A) of this subparagraph (b)(iii) or registration of such securities under the 1933 Act has become effective. (d) REMOVAL OF LEGEND. The Company shall, at the request of any registered holder of an Exercise Share, exchange the certificate representing such security for a certificate representing the same security not bearing the restrictive legend required by subparagraph (b)(ii) if, in the opinion of counsel to the Company, such restrictive legend is no longer necessary. 7. 8 7. REGISTRATION UNDER THE SECURITIES ACT OF 1933. To the extent that the Exercise Shares constitute "restricted securities" under the 1933 Act, the Holder may cause the Exercise Shares to be registered by the Company as follows: (a) The Company shall advise the Holder by written notice prior to the filing of a registration statement under the 1933 Act, (excluding registration on Forms S-8, S-4, or any successor forms thereto) covering securities of the Company to be offered and sold to the public generally and shall, upon the request of the Holder given at least ten (10) business days prior to the filing of such registration statement, include in any such registration statement such information as may be required to permit a public offering of the Exercise Shares by the Holder. The Company shall supply prospectuses and qualify the Exercise Shares for sale in such states as the Company qualifies its securities; provided, however, that the Company will not be required to maintain the registration of the Exercise Shares for any longer period than it shall require for its own purposes. The Holder shall furnish such information as may be reasonably requested by the Company in order to include such Exercise Shares in the registration statement. (b) The following provisions of this Paragraph 7 shall also be applicable: (i) The Company shall bear the entire cost and expense of any registration of securities initiated by it under subparagraphs (a) and (b) of this Paragraph (7) notwithstanding that Exercise Shares subject to this Warrant may be included in any such registration. The Holder, whose Exercise Shares are included in any such registration statement pursuant to this Paragraph (7) shall, however, bear the fees of its own counsel and any registration fees, transfer taxes or underwriting discounts or commissions applicable to the Exercise Shares sold by it pursuant thereto and bear any other costs imposed by applicable federal or state securities laws, rules or regulations. (ii) In connection with any such Registration covered by subparagraphs (a) or (b), notwithstanding anything to the contrary contained herein, the Company shall have no obligation: (A) to assist or cooperate in the offering or disposition of any such Exercise Shares; (B) to indemnify or hold harmless the Holders of such securities being registered or any underwriter designated by such Holders; (C) to obtain a commitment from an underwriter relative to the sale of such Exercise Shares; or (D) to include such Exercise Shares within an underwritten offering of the Company. 8. LIMITATIONS UPON EXERCISE. (a) Holder's right to purchase all 90,000 shares covered by the Warrant shall vest on April 26, 1995. (b) Notwithstanding the above, this Warrant must be exercised by the later of: (i) while the Holder is employed by the Company; or (ii) within three months of the date 8. 9 the Holder's employment is terminated; or (iii) in the event of the death or the total and permanent disability (as defined in Section 22(e)(3) of the Internal Revenue Code of 1986) of the Holder, within one year of the date employment is terminated. 9. NOTICES. All notices or other communications under this Warrant Certificate shall be in writing and shall be deemed to have been given if delivered by hand or mailed by certified mail, postage prepaid, return receipt request, addressed as follows: If to the Company: PMR Corporation 3990 Old Town Avenue Suite 206A San Diego, CA 92110 Attention: Chief Executive Officer, Mr. Allen Tepper and to the Holder: Fred Furman 3990 Old Town Avenue Suite 206A San Diego, CA 92110 at the address of the Holder appearing on the books of the Company or the Company's transfer agent, if any. Either of the Company or the Holder may from time to time change the address to which notices to it are to be mailed hereunder by notice in accordance with the provisions of the Paragraph 9. 10. SUPPLEMENTS AND AMENDMENTS. The Company may from time to time supplement or amend this Warrant Certificate without the approval of any holders of Warrants in order to cure any ambiguity or to correct or supplement any provision contained herein which may be defective or inconsistent with any other provision, or to make any other provisions in regard to matters or questions herein arising hereunder which the Company may deem necessary or desirable and which shall not materially adversely affect the interests of the Holder. 11. SUCCESSORS AND ASSIGNS. This Warrant shall inure to the benefit of and be binding on the respective successors, assigns and legal representatives of the Holder and the Company. 9. 10 12. SEVERABILITY. If for any reason any provision, paragraph or terms of this Warrant Certificate is held to be invalid or unenforceable, all other valid provisions herein shall remain in full force and effect and all terms, provisions and paragraphs of this Warrant shall be deemed to be severable. 13. GOVERNING LAW. This Warrant shall be deemed to be a contract made under the laws of the State of Delaware and for all purposes shall be governed by and construed in accordance with the laws of said State. 14. HEADINGS. Paragraph and subparagraph headings, used herein are included herein for convenience of reference only shall not affect the construction of this Warrant Certificate nor constitute a part of this Warrant Certificate for any other purpose. IN WITNESS WHEREOF, the Company has caused this Amended and Restated Warrant to be duly executed as of this 9th day of July, 1997. PMR Corporation By:/s/ Allen Tepper ---------------------------------- Allen Tepper, Chief Executive Officer 10. 11 APPENDIX A NOTICE OF WARRANT EXERCISE Pursuant to a Warrant by and between the undersigned and PMR Corporation, a Delaware corporation (the "Company"), dated as of July 9, 1997, and subject to the vesting periods set forth therein, the undersigned hereby irrevocably elects to exercise its warrant to the extent of purchasing ______________ shares of Common Stock, $.01 par value (the "Warrant Shares"), of the Company as provided for therein. Payment of the full Purchase Price of the Warrant Shares is enclosed herewith, in the form of a check made payable to the Company. The undersigned requests that a certificate for the Warrant Shares be issued in the name of: _________________________________ _________________________________ _________________________________ (Please print name, address and social security number) Dated:____________________________, 199___ Address: _________________________________ _________________________________ _________________________________ Signature: ________________________________ 11. EX-10.12 15 EXHIBIT 10.12 1 EXHIBIT 10.12 RESTATED MANAGEMENT AGREEMENT THIS AGREEMENT is restated as of the 11th day of April, 1997, by and between Scripps Health, a California non-profit public benefit corporation (the "Hospital"), with an address of 9888 Genesee Avenue, Post Office Box 28, La Jolla, California 92038, and PMR Corporation, a Delaware corporation ("PMR")duly authorized as a foreign corporation doing business in California, with an address of Cabrillo Plaza, 3990 Old Town Avenue, Suite 206A, San Diego, California 92110. RECITALS A. The parties entered into a prior management agreement in July, 1996 and addenda related thereto and wish to consolidate the management agreement and addenda into one restated agreement ("Agreement") for ease of reference. B. Hospital is licensed as a general acute care hospital in California and desires to establish an outpatient acute psychiatric program (the "Program"). C. PMR is in the business of developing and administering outpatient acute psychiatric programs. D. Hospital desires to avail itself of PMR's services and PMR desires to provide such services to Hospital as set forth herein (the "Agreement"). NOW, THEREFORE, the parties hereto, intending to be legally bound hereby, agree as follows: 1. Term and Termination. 1.1 Term. The term of this Agreement (the "Term") shall begin October 1, 1996 and shall terminate September 30, 1999. Prior to October 1, 1996, the parties shall continue to be bound by the terms of the previous Management Agreement between them entered into on August 11, 1993. The prior Management Agreement shall terminate effective September 30, 1996. 1.2 Termination for Cause. Either party shall have the right to terminate this Agreement prior to the end of the Term upon written notice to the other party if such other party has defaulted in the performance of any of the terms of this 2 Agreement and such default has continued uncured for more than sixty (60) days after written notice of such default. The process and the time period for resolving notices issued pursuant to this clause is as set forth in Paragraph 1.5. The actual damages to be assessed to the defaulting party shall be determined in accordance with Paragraph 1.3. 1.3 Termination Compensation. If prior to September 30, 1998, this Agreement is terminated without cause prior to its specified Term as set forth in Paragraph 1.1 above, either by Hospital or PMR, the parties agree that a determination of actual damages will be difficult, and, thus, it is agreed that liquidated damages of Two Hundred Fifty Thousand Dollars ($250,000.00) shall be paid by the terminating party to the other party. A voluntary termination is defined as any termination without cause prior to the specified Term of this Agreement EXCEPT the following terminations: a. A termination for cause pursuant to Paragraph 1.2; b. A termination pursuant to Paragraph 1.4; c. A termination due to the sale or closing of Hospital for any reason; d. A termination due to the termination of the business of PMR for any reason; e. A termination due to the lack of appropriate licenses and certifications as a result of suspension, revocation, failure to obtain, or any other reason; or due to the application of laws requiring termination of this Agreement without cause or penalty; or f. A termination of a Program at a specific site by the mutual consent of the parties. 1.4 Economic Feasibility: Performance Levels; Regulatory Changes; Admission and Service Criteria. Hospital and PMR have determined that the PMR Program is based upon assumptions of economic viability which rely upon the achievement of certain specific performance levels, the continuation of existing payment and reimbursement practices of payors and third-party payors, and the patterns of patient medical utilization pertaining to admissions and services deemed necessary by payors, third-party payors, and medical experts. In the event that any one of these assumptions is determined to be invalid with respect to this 2 3 Agreement, the parties shall meet in an attempt to set new thresholds of evaluation. If the parties cannot agree within a period of sixty (60) days or less, the Agreement shall terminate without any obligation by either party for the liquidated damages set forth in Paragraph 1.3 or any other liability hereunder arising specifically as a consequence of such termination. These assumptions of economic viability are more specifically defined as follows: 1.4.1 Anticipated Performance. Hospital and PMR, upon due analysis, have projected that certain performance levels are essential for economic viability. Upon due consideration, these minimum levels are established as 6,000 patient visits per year for each Program site. 1.4.2 Payment and Reimbursement. Hospital and PMR have determined that the existing payment criteria and reimbursement methodologies projected for this Program for services to patients under this Program are adequate for economic viability. 1.4.3 Admission and Service Criteria. Hospital is recognized as one of the outstanding and quality institutions in the community, and PMR is recognized as a competent and quality organization for the resources provided under this Agreement. Pursuant to these reputations, Hospital and PMR agree that the criteria for admission and service to patients under this Agreement shall be consistent with the medical utilization and service standards promulgated by Medicare and other third-party payors for admission to service and for services rendered under this Agreement and that any deviation from these standards shall render this Program economically not viable within the meaning of this Subparagraph. Conformity to these standards shall be monitored in accordance with the provisions of Subparagraphs 2.1.i(d) and 3.4.5 relating to utilization review. 1.5 Avoidance of Termination. Within thirty (30) days of receipt of a notice issued pursuant to Paragraph 1.2 or Section 5, Hospital and PMR shall meet and use their best efforts to negotiate a solution to the problem with respect to which such notice was sent. Such good faith negotiations shall particularly be required with reference to notices given pursuant to Section 5. In the event Hospital and PMR are unable to negotiate a solution to the problem within a sixty (60) day period following the initial meeting for the purpose of negotiating a solution to the problem, the Agreement may be terminated by the party initiating notice pursuant to Paragraph 1.2, the termination to be effective on the sixtieth day aforementioned. 3 4 1.6 Multi-facility Operations. Hospital and PMR acknowledge that Hospital is a system of community hospitals and health care capabilities and that the Program envisioned and defined by this Agreement may have application at more than one of Hospital's provider facilities. Accordingly, the parties agree that this Agreement shall encompass any and all of the Hospital's provider facilities in which the Program is placed and that Hospital shall have the final decision with respect to placement of Program, after due consultation with PMR and appropriate analyses. In and of itself, a discontinuation of the Program at a provider facility shall not be deemed to be a termination of this Agreement as long as the Program continues in operation hereunder in at least one provider site. It is further agreed that Hospital's provider facilities at which the Program will be placed will be identified and agreed to in writing by Hospital and PMR and that additional placements of the Program may occur upon approval of Hospital as also agreed to in writing by Hospital and PMR. It is further acknowledged by PMR that the Program when placed at Hospital's provider facility is the responsibility of the Administrator of subject facility and that all decisions involving the respective Program, subject to the authority of this Agreement, shall be subject to the Administrator's authority and responsibility. 1.7 Joint Resources and Medical Directors. PMR and Hospital acknowledge that the Program will be centrally administered through the Department of Behavioral Medicine of Hospital, or as otherwise designated by Hospital, and that Hospital will provide resources through the Department of Behavioral Medicine in support of Program including but not limited to the following: 1.7.1 Medical Director. Hospital, at its discretion but with consultation from PMR, will provide a medical director (the "Hospital Medical Director") and related medical direction to Program. The Hospital Medical Director appointed by Hospital will coordinate medical direction with on-site Medical Director appointed by PMR. The Hospital Medical Director shall be responsible directly to Hospital for conduct of medical affairs and for coordination of medical activities with PMR and with on-site Medical Directors appointed by PMR. 1.7.2 Administration and Management Services. Hospital, through its Department of Behavioral Medicine, or as otherwise designated, shall provide administrative and management 4 5 services to Program in cooperation with PMR, its staff and resources. The provision of these administrative and management services, including the logistical resources they constitute (space, equipment, campus overhead, etc.) shall be supplemental and supportive to PMR, its staff and resources; and these provisions for services shall not be construed to modify, interfere with, or otherwise obstruct the performance of the obligations of PMR as set forth in Section 2 of Agreement. 2. Obligations of PMR. 2.1 General. PMR shall cause to be furnished administrative management services necessary to develop and operate the Program so as to provide high quality patient care. Such services shall include the following: a. obtaining, with the appropriate cooperation of Hospital, all necessary licenses and Medicare certification; b. planning, design and production of all community liaison and educational literature; c. Program development; d. ongoing Program administration; e. ongoing community liaison support; f. staff development and continuing education; g. administration of occupational and rehabilitation therapies; h. quality assurance, which shall include: (a) determining compliance with Hospital's quality assurance program; (b) providing outcome-oriented quality assurance assistance designed to achieve improvement in over-all quality of care; (c) reviewing and monitoring Program staff with respect to the quality and scope of patient services. i. utilization review, which shall include: (a) review of admitting physician's determination 5 6 of a qualified patient's need for care; (b) document outcome-related improvements to the patient from Program; (c) ongoing review of patient records to monitor medical necessity determination by professional staff; (d) establishment of a utilization review sub-unit for monitoring utilization and admission criteria which shall include Hospital's Medical Director, Executive Director of Department of Behavioral Medicine, and utilization review personnel (as designated by Hospital) and which shall meet no less often than every sixty (60) days to evaluate utilization and admissions to Program and report findings and recommendations to the Administrator of Hospital's provider facility in which Program is placed. j. coordination with community agencies that have clients in need of the Program services; k. assistance in developing contracts for services with third-party payors; l. assistance in insuring compliance with all licensing agencies; m. selection of necessary non-physician medical and non-medical personnel; and n. social services, publication materials, expend-able supplies, rental expenses, drugs, office equipment and other items necessary to administer the Program. 2.2 Program Development. PMR shall assist Hospital in the development, upgrading and maintenance of the Program to meet or exceed applicable state, federal and JCAHO standards. Such assistance shall consist of the development and maintenance of a comprehensive set of procedures and policies for Hospital (the "Policy Manual") covering all aspects of the Program that are not inconsistent with Hospital's procedures and policies. The Policy Manual, and periodic additions, deletions or amendments thereto, shall be submitted to Hospital for its approval pursuant to Subparagraph 3.8.1. 2.3 Program Premises. PMR shall identify suitable premises for Program locations and, upon approval of locations and plans for design and renovation of premises by Hospital, 6 7 shall negotiate and secure leases for the premises, design and renovate premises, furnish and equip consistent with Program needs, and shall make available such premises to the Program. Subject to Section 2.3.1, lease and or rental expenses shall be an operating expenses of PMR. 2.3.1 Premises Owned or Leased by Hospital. In the event a Program is located on premises owned or leased by Hospital, Hospital shall pay all costs associated with that Program's premises including rent, insurance, utilities, maintenance, etc. 2.4 Personnel to be Provided. 2.4.1 Program Administrator/Medical Director. PMR shall provide for each Program location having a design size of sixty (60) or more patients a Program Administrator, a Medical Director, and the personnel necessary to operate the Program except as otherwise provided herein. The Program Administrator shall perform the functions as provided in Exhibit A hereto and shall report to and be accountable to the Chief Executive Officer of the Hospital or his/her designee and shall report through the Chief Executive Officer to the governing body of the Hospital. The Medical Director shall perform the functions as provided in Exhibit B hereto and shall maintain a reporting relationship to the Chief Medical Officer of the Hospital. 2.4.2 Assignment of PMR Personnel. The following PMR personnel will be available to Hospital personnel on an as-needed basis to ensure the overall success of Program: (a) the President of PMR will be available to participate in regular administrative meetings at Hospital and to interface with the senior personnel of Hospital on overall progress of Program. (b) the Chief Financial Officer of PMR will be available to consult with financial personnel of Hospital administration on issues related to reimbursement, billings and audits. (c) the Executive Vice President and Senior Vice President of PMR will be available to participate in planning forums held at Hospital to explore issues related to the expansion of the Program and/or development of other adjunctive services and to assist with the solution of problems in key areas with the Hospital administrators and to monitor ongoing progress. 7 8 (d) the Regional Vice President who is assigned to the region in which Hospital is located will be available to consult on administrative and personnel matters. (e) the Vice President-Quality Assurance of PMR, who shall be a board-certified psychiatrist, the Clinical Director of PMR, a licensed Social Worker, and the Vice President of Quality Development will be available to Hospital to consult on matters relating to the quality of the service provided by the Program. In addition, the Vice President-Quality Assurance will be available to consult on operating protocols and on Program operations. 2.4.3 Selection of Assigned Personnel. PMR shall select the persons who will serve in each of the capacities listed in Subparagraphs 2.4.1 and 2.4.2; provided, however, that, pursuant to the review of qualifications contemplated by Paragraph 3.6, all such personnel shall be reasonably satisfactory to Hospital. 2.4.4 Availability of Assigned Personnel. PMR agrees that all personnel listed in Subparagraph 2.4.2 will be available to Hospital when required for issues related to operations and management of the Program. 2.5 Employment Services. PMR will recruit, select, evaluate and nominate all medical and non-medical personnel for Hospital's evaluation pursuant to Paragraph 3.6. All non-physician personnel shall be retained and paid for by PMR, following approval by Hospital. All physician personnel shall be nominated by PMR subject to Hospital's approval as set forth in Section 3.7.3. 2.6 Supervision and Control of Personnel. PMR shall be responsible for the direction and control of all Program personnel with respect to administrative services except to the extent Hospital may be responsible as provided in this Agreement, and shall cause all personnel to comply to the extent applicable with all terms and conditions of this Agreement and with the Policy Manual, as amended and as approved by Hospital pursuant to Subparagraph 3.8.1. 2.7 Qualification. Any personnel performing services at the Program and selected by, employed by or having a contract with PMR pursuant to Paragraphs 2.5 or 2.6 shall be appropriately licensed and qualified to perform such services. 8 9 2.8 Requirement of Hospital Staff Membership. The Program Medical Director and other PMR staff members as appropriate must qualify for and be members in good standing at all times of the Medical Staff or Allied Medical Staff of Hospital. If such membership in good standing of the Medical Director or applicable PMR staff member is suspended, revoked or terminated, then the Medical Director or such PMR staff member shall not be permitted to render services at the Program until such good standing membership has been fully restored and PMR shall provide the services of a comparable professional during the interim or as permanent replacement. 2.9 Insurance. 2.9.1 PMR Insurance. For the Term of this Agreement, PMR shall procure and maintain at its own cost comprehensive general and medical/professional liability insurance with elements of self-insurance or deductibles common to the industry covering personal injury, bodily injury, and property damage in the following amounts: (a) Personal/bodily injury: $1,000,000 per claimant and $3,000,000 annual aggregate. (b) Property damage: $500,000 per occurrence and $500,000 annual aggregate. 2.9.2 Other Policy Requirements. Hospital shall be named as an additional insured on such insurance policy and such coverage shall be primary. Such insurance shall be written on an occurrence basis by an insurance company authorized to transact the insurance business in the state in which Hospital is located; provided, however, such insurance may be written on a claims-made basis if tail coverage is guaranteed at the time the primary insurance policy is written and PMR purchases and maintains such tail coverage upon the termination of Agreement for the maximum reporting period available or five (5) years, whichever is longer. 3. Obligations of Hospital. 3.1 Licensing. The Program shall be operated as and considered a department of the Hospital and shall be licensed in the name of Hospital with all appropriate authorities. Hospital shall, at all times, be the owner and holder of all licenses and accreditations with respect to the Program. 9 10 3.2 Personnel and Supplies. Hospital shall provide PMR with access to services and supplies through appropriate departments of Hospital (including, but not limited to, food services, purchasing capabilities and contracts, laundry arrangements and the like), which services and supplies shall be contracted separately and paid for by PMR at Hospital's cost. 3.3 Program Premises. Hospital shall inspect and approve premises, in consultation with PMR, and shall specify for PMR the trade style and related public displays that shall accompany premises for Program identification. PMR will incur the cost, to the extent reasonable, for the trade style and public displays in connection with lease and renovation of the premises. 3.4 Billing and Maintenance of Statistical Information. 3.4.1 Hospital to be Provider. Hospital shall be the contracting party for the Program and shall be the "provider" within the meaning of all contracts and agreements for services with all patients of the Program and all third-party payors. Hospital has the duty to verify all third-party payor existence and under the direction and supervision of PMR will verify Program coverage for each patient. 3.4.2 Billing for Program Services. Hospital or its designee shall perform the function of billing for all services rendered at the Program, shall collect and maintain all statistical and collection information necessary for the management of the Program and shall pay the costs thereof. 3.4.3 Medical Records. All patient medical records shall be the property of Hospital and shall be integrated into the unified records system of the Hospital. 3.4.4 Record Request. Hospital will promptly notify PMR of any payor request for records information from a third party or intermediary regarding a Program patient. 3.5 Insurance. 3.5.1 Hospital Insurance. For the Term of this Agreement, Hospital shall procure and maintain at its own cost comprehensive general and hospital professional liability insurance with elements of self-insurance or deductibles common to the industry covering personal injury, bodily injury, and property damage in the following amounts: 10 11 (a) Personal/bodily injury: $1,000,000 per claimant and $3,000,000 annual aggregate. (b) Property damage: $500,000 per occurrence and $500,000 annual aggregate. 3.5.2 Other Policy Requirements. PMR shall be named as an additional insured on such insurance policy and such coverage shall be primary. Such insurance shall be written on an occurrence basis by an insurance company authorized to transact insurance business in the state in which Hospital is located; provided, however, such insurance may be written on a claims-made basis if tail coverage is guaranteed at the time the primary insurance policy is written and Hospital purchases and maintains such tail coverage upon the termination of Agreement for the maximum reporting period available or five (5) years, whichever is longer. 3.5.3 Risk Management Program. Hospital, or its nominee, shall create and manage, in cooperation with PMR, a risk management program designed to monitor and minimize all insurable risks related to the Program. Risk management techniques and discussions shall be a regular part of the procedures implemented pursuant to Subparagraph 3.8.1. 3.6 Employment of Personnel. PMR will timely advise Hospital of the employment of all personnel in the Program and Hospital shall review the qualifications of all such personnel, whether employees or independent contractors of PMR, and shall make any objection to such employment within ninety (90) days of the date of their employment. All such personnel shall be deemed approved by Hospital unless PMR is otherwise notified within the ninety (90) day period noted herein. 3.7 Medical Supervision. 3.7.1 Administration of Hospital. The Administrator of Hospital's provider facility in which Program is placed shall be responsible for the operation of the Program conducted by Hospital and the implementation of policies with respect to Hospital. Notwithstanding the authority granted to PMR, Hospital shall retain and at all times exercise control over the affairs of Hospital, shall establish general operating policies, pursuant to Subparagraph 3.8.1, to be carried out by PMR pursuant to this Agreement and shall be accountable and responsible for all duties of Hospital. Hospital is responsible for all patient affairs and Medical Staff relationships with respect to the Program. Hospital shall have final authority to approve the 11 12 Policy Manual and staffing plan established for it. 3.7.2 Lines of Authority. The Medical Director of the Program shall be responsible to the Department of Medicine of Hospital's provider facility Medical Staff, or as otherwise designated, in which Program is placed in all matters pertaining to the medical policies and medical operations of the Program. The Program Director shall report to the Administrator of Hospital's provider facility in which Program is placed. Additionally, Hospital shall establish lines of authority for interface between PMR and the Medical Staff and hospital departments for each discipline for which PMR provides related services hereunder, and Hospital shall supervise and have responsibility for all hospital departmental activities involving PMR services. 3.7.3 Corporate Practice of Medicine. Each party hereto acknowledges and agrees that neither party is authorized or licensed to practice medicine in California and will neither have nor exercise any control or direction over the methods by which physicians shall provide professional medical services to patients of Hospital. Each party's sole interest and authority is to ensure that the services and obligations performed hereunder by that party's employees or agents (which shall not include the performance or direction of professional medical services to patients of Hospital) are being performed in a competent and efficient manner. Notwithstanding the foregoing, Hospital shall ensure that all attending physicians who shall provide services to patients of the Program shall be members of the Hospital's medical staff and that all active members of Hospital's Medical Staff shall maintain all required licenses to practice medicine and shall remain in compliance with all applicable hospital and Medical Staff bylaws and regulations. Further, Hospital, through its Medical Staff and related committees, shall maintain appropriate control over the quality of patient services rendered at the Hospital, in accordance with all applicable laws, rules and regulations. 3.7.4 Medical Staff Committees. All medical staff committees at the Hospital are responsible for all medical activities at the Program. 3.8 Coordination. Hospital shall meet regularly with the Program Administrator and the Medical Director of the Program to discuss the operation of the Program. 12 13 3.8.1 Approval of Policy Manual. Hospital shall promptly review and evaluate all changes to the Policy Manual suggested by PMR pursuant to Paragraph 2.2. Neither the original Policy Manual nor any such changes shall be implemented without approval by Hospital which shall bear responsibility for the medical and operating appropriateness of the Policy Manual and any changes thereto. 3.8.2 Community Liaison. The Hospital shall regularly consult with the Program Administrators and senior PMR personnel with regard to the creation and implementation of pro-active community education and outreach activities with respect to the Program. 4. Compensation and Expense. In consideration of all the services to be provided by PMR, as set forth in this Agreement, it is agreed that proper, fair and competitive compensation to PMR, as of the date of this Agreement, is as set forth in the attached fee schedule, identified as Exhibit C. PMR represents that the fees set forth in such Exhibit are consistent with the fair market value of the services for which such fees are charged and are reasonable and customary within its industry and within the local area served by Hospital. Hospital shall provide PMR monthly, no later than the date on which fees are due and payable to PMR, a report of patient activity/census sufficient to allow PMR to verify the calculation of fees made by Hospital. 4.1 Uncompensated Care; Contracted Services; Capitation Agreements. The fee schedule as set forth in Exhibit C notwithstanding, PMR and Hospital agree that payment due to PMR for services rendered under this Agreement as set forth in Exhibit C shall be reduced in cases involving uncompensated care. Uncompensated care is defined as all cases in which the actual payment to Hospital for its services to patients is less than the payment anticipated to be received by Hospital. The payment anticipated to be received by Hospital is in all cases the actual retail charge EXCEPT in cases in which Hospital has agreed to accept less than the retail charge through contracts and formal arrangements with third-party payors. The fee payable to PMR for cases involving uncompensated care shall be reduced to the percentage relationship the actual payment bears to the retail charge. For all categories of cases in which Hospital agrees to accept less than the retail charge through contracts and formal arrangements with third-party payors, which are for these purposes referred to as Contracted Services, and Capitation Arrangements, Hospital and PMR shall agree upon the methodology 13 14 for, form of, conditions for, and amount of payment (which together shall be termed METHOD OF PAYMENT)to PMR for services rendered to patients pursuant to this Agreement who are beneficiaries of these Contracted Services and Capitation Arrangements. These agreements between PMR and Hospital for payment to PMR for services rendered to patients covered by these Contracted Services and Capitation Arrangements shall be formalized in writing as addenda to this Agreement on Exhibit D from time to time as these Contracted Services and Capitation Arrangements are consummated. Hospital and PMR agree that services to Medicare beneficiaries are not categories of cases currently subject to the provisions of this paragraph. It is acknowledged by Hospital and PMR that neither Hospital nor PMR anticipates that the other is required under these provisions to provide economic subsidy one to the other, but, that each anticipates to retain the economic advantages upon which this Agreement is predicated. Therefore Hospital and PMR agree to consult one with the other with respect to all categories of cases in which Hospital elects to or is required to accept less than the retail charge for payment and agree to use their best efforts to negotiate an agreement with respect to METHOD OF PAYMENT to PMR of services to be rendered pursuant to the third party payor arrangement. Hospital and PMR acknowledge and agree that in the event of a lack of accord with respect to payment to PMR for services to be rendered to beneficiaries of these third party payor Contracted Services and Capitation Arrangements, the economic provisions of Sections 1.3 and 1.4 underlying this Agreement shall control. 4.2 Payment of Fees. Payment to PMR for fees due PMR for services under this Agreement shall be made by Hospital by the end of the second month following the month in which the services are provided by PMR to Hospital, provided however, with respect to any Program initiated after June 1, 1996, payment shall be made by Hospital by the end of the month following the month in which the services are provided by PMR to Hospital. 4.3 Concurrent Review. In the event that a payor with whom Hospital is regularly engaged denies Hospital reimbursement of fees paid to PMR with respect to any patient of the Program as a consequence of the payor's determination that the services rendered were inappropriate or otherwise non-chargeable to the determining payor, PMR shall not be entitled to be paid its fees with respect to such patient services. PMR, on Hospital's behalf, shall process and appeal the denial of any such claims 14 15 which PMR determines should be appealed and in the event the denial is overturned and payment for the services made by the payor to Hospital, Hospital in turn shall promptly pay to PMR its Management Fee with respect to the services rendered by PMR. If there are denied claims or claims in review outstanding at the termination of this Agreement (and during the term of the Agreement), Hospital shall not bear any financial risk for such denied claims or appeals, (except to the extent that such claims are paid to Hospital), but Hospital shall cooperate in the processing of appeals with respect to those claims and Hospital shall regularly and promptly provide PMR with all information relating to these claims including the overturning of denials from receipt of payment and if requested by PMR, Hospital shall appoint PMR's designee as Hospital's designee to process these claims and communicate with intermediaries or third party payors. 4.4 Annual Review of Fees. The parties shall meet annually to review the fee schedule which shall be effective until replaced by adjustments agreed upon between the parties. Any such adjustments shall be made in good faith recognition of cost increases which have occurred in Hospital's local market area since any prior adjustment plus other factors deemed relevant by the parties. 5. Standards of Services. PMR and Hospital hereby agree, in connection with the operation of Hospital and the Program, to comply with all laws, rules, and regulations of all governmental authorities having jurisdiction over each, and any recommendations and policies resulting from Hospital's quality assurance program and its general policies and procedures as well as recommendations made by PMR's Vice President-Quality Assurance which recommendations are designed to comply with applicable laws, rules, or regulations. The parties hereto acknowledge that a material part of the consideration for this Agreement is the other party's compliance with the provisions of this Section 5. The parties further acknowledge that the non-compliance by either with any of the applicable laws, rules, and regulations applicable to such party may have a material adverse effect on the other party. The parties therefore agree to cooperate in good faith with each other to monitor and ensure such compliance. 5.1 Ongoing Quality and Compliance Reviews. The performance of all services rendered hereunder shall be reviewed as part of Hospital's ongoing quality assurance program and by PMR's Vice President-Quality Assurance pursuant to the provisions of Paragraph 2.4 above. In the event of non-compliance with any standards for service set forth herein or applicable laws, rules, or regulations by either party hereto, the other party shall give 15 16 the non-complying party notice thereof, and such party shall so comply or cause such compliance as soon as practicable thereafter, but in any event within thirty (30) days after such notice. 5.2 Change in Laws or Regulations. The parties acknowledge that applicable laws, rules, and regulations or interpretations thereof may change at any time during the Term of this Agreement or any extensions thereof and that such change or interpretations may require a modification of this Agreement. Notwithstanding the provisions of Paragraph 10.6, the parties hereby agree to give each other immediate notice of such change in applicable laws, rules, or regulations, whereupon the parties shall meet in good faith to negotiate a modification of this Agreement such that it complies with such changes in applicable laws, rules, or regulations. 5.3 Notice from Governmental/Regulatory Entities. The parties hereby agree to give each other a copy of any notice or contact received from any governmental or regulatory entity having jurisdiction thereof with respect to the Program that any activity of such party is in violation of any applicable law, rule, or regulation and to continue to promptly inform the other party of all responses and procedures taken as a result of such notice or contact until the alleged violation is cured, and to provide such other party with evidence of the successful conclusion of the event. 6. Independent Contractor. No relationship of employer and employee or of joint venture between PMR and Hospital is created by this Agreement, it being mutually understood and acknowledged that PMR is at all times acting and performing as an independent contractor hereunder. Hospital shall neither have nor exercise any control or direction over the methods by which PMR or its employees perform their administrative functions; provided, however, that any medical services which may be rendered by PMR personnel shall be rendered under the direct supervision and control of appropriate Hospital staff. No contracted provider or employee of PMR shall have any claim under this Agreement or otherwise against Hospital for salary or other compensation, vacation or sick pay, sick leave, retirement benefits, social security, workers' compensation, disability or unemployment insurance benefits or any other employee benefits of any kind. 7. Non-Interference. 7.1 Anti-Raiding. During the Term of this Agreement and thereafter for a period of one (1) year, either party may hire an 16 17 employee or independent contractor of the other party, provided that the party offering employment or engagement first obtains the approval of the other party. This provision shall have no force or effect to inhibit either party from hiring or engaging the employee or independent contractor of the other party from and after the first anniversary date of the termination of this Agreement without the prior consent of the other party. 7.2 Patient Care. Notwithstanding Paragraph 7.1, neither party shall hereby be prohibited from dealing with and providing services to any patient. 7.3 Exclusive Dealing, Right of First Refusal. During the Term of the Agreement, in San Diego County, California, neither party, except through or with the other party, shall enter into any agreement with any person or other business entity to provide for the furnishing of any service related to this Agreement ("Services"). The term Services shall also include outpatient chemical dependency and case management services except for those Services presently being delivered in San Diego County by Hospital. In the event either party wishes to provide for the furnishing of any Services in San Diego County, California, such party must offer in writing to the other party the right to participate in the furnishing of such Services and the offeree party shall have thirty (30) days from receipt of the writing to accept or reject such offer. In the event there is no response to the offer or the offer is rejected, the offeror shall be free to provide such Services in San Diego County, California as set forth in the written offer without the participation of the offeree. 8. Access to Books and Records/Confidentiality. 8.1 Record Maintenance and Access. Until the expiration of four (4) years after the furnishing of the services called for by this Agreement, PMR shall, upon request, make available to the Secretary, U.S. Comptroller General, and their representatives, this Agreement and all other books, documents and records as are necessary to certify the nature and extent of the costs incurred by Hospital in purchasing services under this Agreement. If PMR provides such services through a subcontract worth Ten Thousand Dollars ($10,000.00) or more over a twelve-month period with a related organization, the subcontract shall also contain a clause permitting access by the Secretary, Comptroller General, and their representatives to the books and records of the related organization. 17 18 8.2 Mutual Confidentiality. Hospital and PMR agree that some information received by one party from the other pursuant to this Agreement shall be confidential. Except as provided in Paragraph 8.1 or as may otherwise be required by law or legal process, it is therefore agreed that any information received by one party from the other, and clearly designated in writing as "CONFIDENTIAL", or in any other matter which indicates its confidential nature (hereinafter referred to as "Confidential Information"), shall not be disclosed by the other party and shall not be used by the other party for purposes other than those contemplated by this Agreement. Confidential Information includes, without limitation, information as to any patient as well as information relating to business practices, costs, users or purchasers of either party's services, research or services. Confidential Information does not include: (a) information which has become known to third parties or has become publicly known through no fault of the receiving party; or (b) information already in the receiving party's possession prior to the disclosure of said information to the receiving party; or (c) information subsequently disclosed to the receiving party by a third party who is not under any obligation or confidentiality to the disclosing party; or (d) information approved for disclosure by prior written consent of the disclosing party; or (e) information which the parties have agreed as necessary to disclose. 8.3 Proprietary Information of PMR. The partial hospitalization system developed by PMR and provided to Hospital for use in the Program pursuant to this Agreement, the materials encompassing the system and the improvements to the system developed by PMR from time to time, all of which are referred to herein as the "System," are the proprietary property and trade secrets of PMR. The System includes, but is not limited to, methods, techniques and other know-how and the Program materials supplied during the Term, such as the so-called Generic Policies and Procedures manual, the Program Managers Handbook, the admissions screening system, the core medical record system and forms, the guidelines and forms for conducting effective treatment planning meetings, the utilization review systems and forms, the post-discharge follow-up system and forms, the community rela- 18 19 tions development and maintenance systems and forms, the key-monitor management system, and the materials setting forth and explaining the principal and special treatment modalities, including the generic focused treatment product, the Substance Abuse/Mental Illness Dual Diagnosis Tract (also known as MICA), the Community Transition Tract (also known as CTT), the Developmental Disabilities/Mental Illness Tract and the Geriatric Senior/Affective Disorders program. This Agreement is for services only. Hospital agrees that it shall not acquire any rights to, or to use, such proprietary property, trade secrets or the materials by virtue of the payment of fees hereunder or the provision during the Term of such materials for use by the Hospital. 9. Service of Notices. All notices and other communications and all legal process in regard hereto shall be validly given or served if in writing and delivered personally or sent certified mail, postage prepaid, return receipt requested, to the address set forth below or such address as either party may designate to the other in writing: If to Hospital: Scripps Health 9888 Genesee Avenue Post Office Box 28 La Jolla, California 92038 Attention: Sister Mary Jo Anderson, Executive Vice President If to PMR: PMR Corporation Cabrillo Plaza 3990 Old Town Avenue, Suite 206A San Diego, California 92110 Attention: Mr. Allen Tepper, CEO 10. Miscellaneous. 10.1 Mutual Indemnity. Notwithstanding any other provision of this Agreement, each party hereto shall indemnify and hold the other party harmless from any and all claims, damages and liabilities arising out of such party's negligence in the performance or non-performance of its duties hereunder. For purposes of indemnity, negligence shall be determined by a trier of fact of competent jurisdiction. 19 20 10.2 Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their successors and assigns. 10.3 Choice of Law. The validity, enforceability and interpretation of any of the clauses of Agreement shall be determined and governed by the laws of the State of California. 10.4 Entire Agreement. This Agreement constitutes the entire agreement between the parties hereto with respect to the subject matter hereof and supersedes all prior and contemporaneous agreements, understanding, negotiations and discussions of the parties whether written or oral. 10.5 Written Notification. No amendment, modification or supplement of any provision of this Agreement shall be effective unless in writing, signed by the parties hereto; and no waiver of any party's obligations under this Agreement, or consent to any departure therefrom, shall be effective unless in writing, signed by the parties hereto and then only in the specific instance and for the specific purpose given. 10.6 Severability. If any provision of this Agreement is held to be inoperative, unenforceable or invalid under present or future laws effective during the Term of this Agreement, such shall be inoperative, unenforceable or invalid without affecting the remaining provisions. This Agreement shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part of this Agreement, and, to that end, the provisions of this Agreement are declared to be severable. Notwithstanding the foregoing, however, the parties agree to negotiate a modification of this Agreement pursuant to the provisions of Paragraph 5.2 in the event any provision of this Agreement is believed by a party in good faith to be invalid under applicable laws, rules, or regulations. 10.7 Number and Gender. Whenever the context of this Agreement requires, the singular shall include the plural and the masculine gender shall include the feminine. 10.8 Joint Negotiations. This Agreement is the product of negotiations between the parties and is not to be interpreted more strongly in favor of one party or the other in the interpretation or enforcement thereof. 10.9 Paragraph Headings. Paragraph headings in this Agreement are included for convenience of reference only and are not part of this Agreement for any other purpose. 20 21 10.10 Counterparts. This Agreement may be executed in counterparts and either party hereto may execute any counterpart, each of which, when executed and delivered, will be deemed to be an original, and all of which counterparts taken together will be deemed to be but one and the same instrument. The execution of this Agreement by any party hereto will not become effective until a counterpart hereof has been executed by each other party hereto. 10.11 Assignability. Notwithstanding Paragraph 10.2, neither party shall assign, sell or transfer this Agreement or any interest herein without the prior written consent of the other party, which consent shall not be unreasonably withheld. In the event that the primary business and/or substantially all of the assets of PMR is transferred to an affiliate of PMR, PMR shall have the right to assign all of its rights under Agreement to any such affiliate during the Term of Agreement, and any such assignee/affiliate shall acquire all of the rights and assume all of the obligations of PMR under this Agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first written above. HOSPITAL: SCRIPPS HEALTH, a California non- profit public benefit corporation By: Sister Mary Jo Anderson ---------------------------------- Title: Sr. VP Hospital Operations ------------------------------- PMR: PMR CORPORATION, a Delaware corporation By: /s/ FRED FURMAN ---------------------------------- Title: President ------------------------------- 21 22 [EXHIBITS EXCLUDED] EX-10.13 16 EXHIBIT 10.13 1 EXHIBIT 10.13 SUBLEASE BETWEEN CMS DEVELOPMENT AND MANAGEMENT COMPANY, INC. as Sublandlord AND PMR CORPORATION as Subtenant 2 TABLE OF CONTENTS ----------------- ARTICLE 1 DESCRIPTION OF LEASED SPACE, PRIME LEASE................................ 1 1.1 Demise of Leased Space.................................................. 1 1.2 Prime Lease............................................................. 1 1.3. Protection of Prime Lease............................................... 2 1.4 Sublandlord's Prime Lease Obligations................................... 2 ARTICLE 2 TERM.................................................................... 2 2.1 Commencement and Expiration............................................. 2 ARTICLE 3 RENT.................................................................... 2 3.1 Monthly Base Rent....................................................... 2 3.2 Annual Increase in Rent................................................. 3 3.3 Late Charge............................................................. 3 ARTICLE 4 - USE; LIMITATIONS........................................................ 3 4.1 Uses.................................................................... 3 4.2 Regulations and CC&R's.................................................. 4 ARTICLE 5 - CONSTRUCTION OF INITIAL IMPROVEMENTS.................................... 4 5.1 Improvement Work........................................................ 4 ARTICLE 6 - ALTERATIONS AND ADDITIONS............................................... 4 6.1 Alterations............................................................. 4 6.2 Removal of Improvements................................................. 4 ARTICLE 7 - UTILITIES AND SERVICES.................................................. 5 7.1 Utilities and Services.................................................. 5 ARTICLE 8 - INDEMNIFICATION......................................................... 5 8.1 Indemnity and Defense................................................... 5 8.2 Exculpation............................................................. 6 ARTICLE 9 - INSURANCE............................................................... 6 ARTICLE 10 - CARE OF LEASED SPACE.................................................... 7 10.1 Subtenant's Obligation.................................................. 7 ARTICLE 11 - PAYMENT OF OPERATING COSTS, PROPERTY - TAXES AND UTILITY CHARGES..................................................... 8 11.1 Costs, Taxes, and Utility Charges....................................... 8 11.2 Payment .......................................................... 8 11.3 Subtenant's Proportionate Share......................................... 8 ARTICLE 12 - BROKERAGE COMMISSIONS................................................... 9 12.1 Representations......................................................... 9 12.2 Payment................................................................. 9 ARTICLE 13 - RIGHTS RESERVED BY SUBLANDLORD.......................................... 9 13.1 Reserved Rights......................................................... 9
3 ARTICLE 14 - ASSIGNMENT AND SUBLETTING............................................... 9 14.1 Assignment.............................................................. 9 14.2 Subleasing.............................................................. 10 ARTICLE 15 - QUIET ENJOYMENT......................................................... 10 15.1 Quiet Enjoyment......................................................... 10 ARTICLE 16 - DEFAULT................................................................. 10 16.1 Subtenant's Default..................................................... 10 16.2 Remedies................................................................ 11 16.3 Damages................................................................. 11 16.4 Worth at Time of Award.................................................. 11 16.5 Waiver.................................................................. 12 16.6 Curing Subtenant's Default.............................................. 12 ARTICLE 17 - ATTORNEYS' FEES......................................................... 12 ARTICLE 18 - DESTRUCTION OR DAMAGE................................................... 12 ARTICLE 19 - CONDEMNATION............................................................ 13 ARTICLE 20 - ASSIGNMENT OF PRIME LEASE............................................... 13 ARTICLE 21 - STATEMENT OF STATUS (ESTOPPEL).......................................... 13 21.1 Certificate............................................................. 13 21.2 Estoppel................................................................ 14 ARTICLE 22 - PARKING................................................................. 14 22.1 Parking Rights.......................................................... 14 ARTICLE 23 - SECURITY DEPOSIT........................................................ 14 23.1 Security Deposit........................................................ 14 ARTICLE 24 - CERTAIN ALLOWANCES...................................................... 14 24.1 Moving Allowance........................................................ 14 24.2 Termination Fee Allowance............................................... 15 ARTICLE 25 - GENERAL PROVISIONS...................................................... 15 25.1 Successors.............................................................. 15 25.2 Entire Agreement........................................................ 15 25.3 Terms and Headings...................................................... 15 25.4 Light/Air............................................................... 15 25.5 Time ................................................................... 16 25.6 Examination............................................................. 16 25.7 No Recording............................................................ 16 25.8 Governing Law........................................................... 16 25.9 Provisions Severable.................................................... 16 25.10 Notices................................................................. 16 25.11 Waiver of Jury Trial.................................................... 17
4 SUBLEASE THIS SUBLEASE (the "Sublease") is made this 1st day of April, 1997 between CMS DEVELOPMENT AND MANAGEMENT COMPANY, INC., a Delaware corporation ("Sublandlord") and PMR CORPORATION, a Delaware corporation ("Subtenant"). BACKGROUND A. Pursuant to a Master Lease dated July 10, 1996 (the "Prime Lease"), Sublandlord leases from an affiliate of Lennar Partners, successor in interest to Oliver McMillan Village Hillcrest 2, L.P. (the "Prime Landlord") the fifth floor (the "Fifth Floor") in the medical building located at 501 Washington Avenue, San Diego, California (the "Building"). The Building is part of a larger "mixed use" condominium project known as the Village Hillcrest (the "Project"), which includes a rehabilitation hospital, medical offices, retail uses, a multi-screen movie theater, offices and a multi-level subterranean parking structure. Capitalized terms used herein without definition shall have the same meanings ascribed to those terms in the Prime Lease. B. Subtenant desires to lease the Fifth Floor for use as executive and administrative offices for Subtenant. Sublandlord is willing to sublease the Fifth Floor to Subtenant on the terms and conditions hereinafter set forth. ARTICLE 1 DESCRIPTION OF LEASED SPACE, PRIME LEASE 1.1 Demise of Leased Space. Sublandlord hereby leases to Subtenant and Subtenant hereby hires from Sublandlord, pursuant to the terms, covenants, conditions and uses herein set forth, the Fifth Floor, consisting of approximately 20,717 square feet of space (the "Leased Space"), outlined in black on the floor plan attached hereto as Exhibit "A". 1.2 Prime Lease. The Prime Lease is incorporated herein by this reference. Subtenant acknowledges receipt of a copy of the Prime Lease, and agrees that Subtenant's rights with respect to the use and occupancy of the Leased Space are in all respects subject to the terms, conditions and limitations of the Prime Lease. Subtenant shall be responsible for all obligations of Sublandlord under the Prime Lease relating to the use and occupancy of the Leased Space, provided that the Monthly Base -1- 5 Rent payable by Subtenant shall be as provided in Article 3 of this Sublease. 1.3. Protection of Prime Lease. Subtenant shall not do or cause to be done or suffer or permit any act or thing which would constitute a default under the Prime Lease or cause the Prime Lease or the rights of Sublandlord as lessee thereunder to be terminated or which would cause Sublandlord to become liable for any damages, costs, claims or penalties or would increase the rent or other charges or obligations of Sublandlord as lessee under the Prime Lease, or would adversely affect or reduce any of Sublandlord's rights or benefits under the Prime Lease. 1.4 Sublandlord's Prime Lease Obligations. Sublandlord agrees that it shall pay all amounts due and perform all obligations required of it under the Prime Lease in a timely manner. Sublandlord agrees that it shall not amend, modify, terminate or otherwise change the Prime Lease in any manner which affects Subtenant or this Sublease without first obtaining the approval of Subtenant, which approval shall not be unreasonably withheld. ARTICLE 2 TERM 2.1 Commencement and Expiration. The term of this Sublease shall be for a term (the "Term") commencing on the earlier of (i) substantial completion of Sublandlord's Improvement Work to the Leased Space as provided in Article 5 and Exhibit B hereto or (ii) Subtenant's occupancy of all or any substantial portion of the Leased Space ("Commencement Date"), and expiring, subject to earlier termination as provided elsewhere in this Sublease, on April 3, 2002. Under no circumstances shall the Term extend beyond the expiration, surrender or termination of the Prime Lease, whether the Prime Lease expires by its own terms, is terminated due to default or for any other reason. Provided that this Sublease is not terminated due to Subtenant's default hereunder, Sublandlord shall not attempt to extend the Prime Lease or otherwise compete with Subtenant for occupancy of the Leased Space or any part thereof upon the expiration of the Term. ARTICLE 3 RENT 3.1 Monthly Base Rent. Subtenant agrees to pay to Sublandlord, without prior notice or demand, in advance, on the first (1st) day of each and every calendar month during the Term, -2- 6 and Sublandlord shall accept, monthly base rent ("Monthly Base Rent") as follows: for the period beginning on the Commencement Date and expiring on the day preceding the nine (9) month anniversary of the Commencement Date, the Monthly Base Rent shall be Sixteen Thousand Five Hundred Ninety Dollars ($16,590) per month; for the period from and after the nine (9) month anniversary of the Commencement Date the Monthly Base Rent shall be Twenty One Thousand Seven Hundred Fifty Two Dollars ($21,752.85) per month, subject to annual increase as set forth in Section 3.2. Notwithstanding the foregoing, the Monthly Base Rent for the first full month of the Term shall be paid by Tenant upon the execution of this Sublease. If the Term shall commence or end on a day other than the first day of a month, the Monthly Base Rent for said first and last partial month shall be prorated on a per diem basis, and the Monthly Base Rent for the month in which the nine month anniversary of the Commencement Date falls shall be adjusted on a per diem basis to reflect the adjustment in Monthly Base Rent as of such anniversary as provided above. 3.2 Annual Increase in Rent. On the one year anniversary of the Commencement Date (or, if the Commencement Date is other than the first day of a calendar month, the one year anniversary of the first day of the first calendar month following the Commencement Date), and on each annual anniversary of such date during the term of this Agreement (each, an "Anniversary Date"), the Monthly Base Rent then payable under this Sublease shall be increased by a fixed four percent (4%) of the Monthly Base Rent in effect immediately preceding such Anniversary Date. 3.3 Late Charge. In the event that any payment of Monthly Base Rent or any other sum payable by Subtenant to Sublandlord hereunder (all of which sums shall be collectable as additional rent hereunder) is not paid within ten (10) days after its due date, Subtenant agrees (i) that liquidated damages for the late payment of such rent in the amount of six percent (6%) of such rent shall be and become due to Sublandlord on the eleventh day after such payment is due and (ii) to pay such liquidated damages to Sublandlord upon demand. Subtenant agrees that the foregoing liquidated damages are reasonable under the circumstances existing at the time this Sublease is executed, and understands that the foregoing liquidated damages represent compensation to Sublandlord for damages incurred by reason of Subtenant's failure to make payment of rent within ten (10) days after the date when due. ARTICLE 4 USE; LIMITATIONS 4.1 Uses. The Leased Space may be used only for executive and administrative offices for a health care company or any other use permitted under the Prime Lease. Any other use of -3- 7 the Leased Space shall require Sublandlord's consent, which may be granted or withheld in its sole discretion. 4.2 Regulations and CC&R's. In addition to the Prime Lease, this Sublease and the interest of all parties hereto shall be subject to any and all Rules and Regulations promulgated from time to time by the Prime Landlord as well as the Master Declaration and the Hospital/Medical Declaration (collectively, the "CC&R's") and to all of the covenants, conditions, restrictions, reservations, easements, liens and provisions therein contained, and Subtenant, by acceptance of this Sublease, hereby covenants and agrees to comply with the provisions of such Rules and Regulations and the CC&R's in its use and occupation of the Leased Space. Subtenant acknowledges that this Sublease shall be subordinate to the CC&R's and any amendments or modifications thereof. ARTICLE 5 CONSTRUCTION OF INITIAL IMPROVEMENTS 5.1 Improvement Work. Sublandlord shall construct initial improvements to the Leased Space in accordance with the Improvement Work Letter Agreement attached hereto as Exhibit B. ARTICLE 6 ALTERATIONS AND ADDITIONS 6.1 Alterations. Subtenant shall not make any structural alterations, improvements or additions to the Leased Space without obtaining the prior written consent of Sublandlord, which consent shall not be unreasonably withheld or delayed. Sublandlord's consent shall be conditioned upon Subtenant's removing any such additions, alterations, or improvements upon the expiration or termination of this Sublease and restoring the Leased Space to the same condition as on the date Subtenant took possession, provided that Sublandlord shall not require such removal if the Prime Landlord does not require such removal. All work performed by Subtenant pursuant to this Article shall be subject to the requirements of the Prime Lease, including but not limited to the obligation to post notices of non-responsibility and provide lien and completion bonds in certain circumstances as provided in Article 6 of the Prime Lease. 6.2 Removal of Improvements. Unless their removal is required by the Prime Landlord under the Prime Lease, all additions, alterations, and improvements made to the Leased Space by or on behalf of Subtenant shall become the property of Sublandlord and be surrendered with the Leased Space upon the expiration -4- 8 or termination of this Sublease, provided that Subtenant's personal property and trade fixtures that can be removed without material damage to the Leased Space shall remain the property of Subtenant and may be removed. Subtenant shall promptly repair any damage to the Leased Space or to the Building resulting from such removal. ARTICLE 7 UTILITIES AND SERVICES 7.1 Utilities and Services. Sublandlord shall not be obligated to provide any utilities or services to Subtenant, it being understood that Subtenant shall be entitled to receive directly from the Prime Landlord the utilities and services to be provided by the Prime Landlord to the Leased Space under the Prime Lease. If Prime Landlord shall default or delay in providing or performing any utility, service, repair, restoration or other obligation under the Prime Lease as such items pertain to the Leased Space, Sublandlord's only obligations to Subtenant on account thereof shall be (i) to permit Subtenant, at its expense, to prosecute an action against Prime Landlord for damages or specific performance for Subtenant's benefit, and (ii) to make a good faith effort, and to reasonably cooperate with Subtenant (at Subtenant's expense) in attempting, to cause Prime Landlord to provide or perform such service or obligation. Any condition resulting from such default or delay by Prime Landlord shall not constitute an eviction, actual or constructive, of Subtenant. No such default or delay shall excuse Subtenant from the payment of rent or performance or observance of any of its other obligations hereunder. ARTICLE 8 INDEMNIFICATION 8.1 Indemnity and Defense. Subtenant agrees to indemnify Sublandlord and to hold Sublandlord free and harmless from and against any and all liabilities, costs, expenses, damages, claims, and losses of every kind and nature whatsoever arising out of or related to: (a) Subtenant's use and occupancy of the Leased Space, or any work, activity, or other thing done in, on, or about the Leased Space by Subtenant or anyone claiming under Subtenant; or (b) any breach or default by Subtenant under this Sublease or of any obligations of Subtenant imposed by law; or (c) any negligent or otherwise tortious act or omission of Subtenant, its agents, employees, invitees, or contractors. The foregoing indemnity includes, but is not limited to, injuries, death, and property damage suffered by Subtenant's employees except to the extent caused by the active (as opposed to passive) -5- 9 negligence or willful acts of Sublandlord, its agents or employees. Subtenant shall, at Subtenant's sole cost and expense, and by legal counsel reasonably satisfactory to Sublandlord, defend Sublandlord in any action or proceeding arising from any such matter and shall indemnify Sublandlord and hold Sublandlord free and harmless from and against all costs, attorneys' fees, expert witness fees, and any other expenses incurred in such action or proceeding. As a material part of the consideration for Sublandlord's execution of this Sublease, Subtenant hereby assumes all risk of damage or injury to any person or property in, on, or about any part of the Leased Space in the physical possession of Subtenant or anyone claiming under Subtenant, from any cause, except to the extent of the active negligence or willful acts of Sublandlord and Sublandlord's agents and employees. Sublandlord agrees to indemnify Subtenant and to hold Subtenant free and harmless from and against any and all liabilities, costs, expenses, damages, claims and losses of every kind and nature whatsoever arising out of or related to any breach or default by Sublandlord under this Sublease or any injury, death or property damage resulting from the active (as opposed to passive) negligence or willful misconduct of Sublandlord, its agents or employees. 8.2 Exculpation. Sublandlord shall not be liable for injury or damage that may be sustained by the person or property of the Subtenant, its employees, invitees, or customers, or any other person in or about the Leased Space, caused by or resulting from fire, steam, electricity, gas, water, or rain or from the breakage, leakage, obstruction, or other defects of pipes, sprinklers, wires, appliances, plumbing, air conditioning, or lighting fixtures, whether such damage or injury results from conditions arising upon the Leased Space or upon other portions of the Building or from other sources, except to the extent such damage or injury results from the active (as opposed to passive) negligence or willful acts of Sublandlord. Sublandlord shall not be liable for any damages arising from any act or omission of Prime Landlord or any other occupant of the Tower, Building or Project. ARTICLE 9 INSURANCE 9.1 Subtenant shall maintain at its own cost and expense (i) insurance against fire and such other perils as may be included in a standard fire and special extended coverage insurance form on all of Subtenant's property located in the Leased Space in an amount adequate to cover at least ninety percent (90%) of their replacement cost; and (ii) commercial general liability insurance on an occurrence basis with limits of liabil- -6- 10 ity in an amount not less than $1,000,000 combined single limit for each occurrence with respect to loss of life, bodily or personal injury and damage to property by water or otherwise. All such insurance shall be issued by insurers approved by Sublandlord, shall provide for a deductible not greater than $10,000.00 from any loss payable, shall contain appropriate endorsements denying Subtenant's insurers the right of subrogation against Sublandlord and all parties to, or bound by, the CC&R's, and shall contain a provision whereby each insurer agrees not to cancel such insurance without 30 days prior written notice to Sublandlord. With respect only to the general liability insurance, Sublandlord and the Prime Landlord shall be named as an additional insured. On or before the Commencement Date, Subtenant shall furnish Sublandlord with certificates evidencing the aforesaid insurance coverage, and renewal certificates shall be furnished to Sublandlord at least ten (10) days prior to the expiration date of such insurance. 9.2 Sublandlord shall maintain at its own cost and expense commercial general liability insurance on an occurrence basis with limits of liability in an amount not less than $1,000,000 combined single limit for each occurrence with respect to loss of life, bodily or personal injury and damage to property. The liability insurance maintained by Sublandlord shall be secondary to the liability insurance maintained by Subtenant with respect to occurrences in, on or about the Leased Premises. Upon Subtenant's request, but not more frequently than once per year, Sublandlord shall provide Subtenant a certificate of insurance evidencing this insurance coverage. ARTICLE 10 CARE OF LEASED SPACE 10.1 Subtenant's Obligation. Except for the obligations of Prime Landlord under Article 7 and Section 10.2 of the Prime Lease, and except for the provisions of Article 18, Subtenant shall keep the Leased Space in good condition and repair, including replacements as needed, and shall not commit or permit any waste upon the Leased Space. If Subtenant fails to keep the Leased Space in reasonable repair, Sublandlord may at Sublandlord's option, after reasonable prior written notice to Subtenant, enter the Leased Space in order to keep the Leased Space in good condition and repair, and Subtenant shall immediately pay to Sublandlord the cost thereof. -7- 11 ARTICLE 11 PAYMENT OF OPERATING COSTS, PROPERTY TAXES AND UTILITY CHARGES 11.1 Costs, Taxes, and Utility Charges. Subtenant agrees to pay to Sublandlord, as additional rent under this Sublease, and at the times and in the manner provided in this Article 11, (i) Subtenant's Proportionate Share (as defined below) of the amounts by which Operating Costs and Property Taxes (as defined in the Prime Lease) for any calendar year exceed $218,265.00 (the "Expense Stop") and (ii) Subtenant's Proportionate Share of the cost of all Utilities (as defined in the Prime Lease). Subtenant's Proportionate Share of said amounts is hereinafter called "Subtenant's Share of Costs, Taxes, and Utilities." 11.2 Payment. If Prime Landlord bills Subtenant directly for Subtenant's Share of Costs, Taxes and Utilities, Subtenant shall pay the amount so billed directly to Prime Landlord as and when due. Otherwise, Subtenant's Share of Costs, Taxes, and Utilities for any calendar year shall be due and payable to Sublandlord no later than twenty (20) days after Sublandlord delivers to Subtenant, after the calendar year has ended, a copy of the statement of Costs, Taxes and Utilities provided by Prime Landlord to Sublandlord. If pursuant to the Prime Lease Sublandlord is required to pay estimated monthly installments on account thereof, Subtenant shall upon demand pay to Sublandlord estimated monthly installments of Subtenant's Share of Costs, Taxes and Utilities. If the monthly installments paid by Subtenant on account of Costs, Taxes and Utilities for any year is more or less than the actual Subtenant's Share of such costs for such year, Subtenant shall pay the amount due or receive a credit as provided in Section 11.2 of the Prime Lease. If the Commencement Date is other than January 1, Subtenant's Share of Costs, Taxes, and Utilities for the calendar year in which the Commencement Date occurs shall be multiplied by a fraction, the numerator of which shall be the number of days from the Commencement Date to the following December 31 and the denominator of which shall be 365 and Subtenant's Share of Costs, Taxes, and Utilities for the calendar year in which the Term expires shall be multiplied by a fraction, the numerator of which shall be the number of days in the calendar year to the expiration date and the denominator of which shall be 365. 11.3 Subtenant's Proportionate Share. "Subtenant's Proportionate Share" shall mean, with respect to Costs and Taxes, 100% of the total such costs allocated to the Fifth Floor. With respect to Utilities that are charged to tenants in the Tower without regard to occupancy or usage, Subtenant's Proportionate -8- 12 Share shall be 100% of the total such costs allocated to the Fifth Floor; otherwise Subtenant's Proportionate Share with respect to Utilities shall mean the percentage obtained by dividing the rentable area of the Leased Space by the total occupied area of the Fifth Floor. ARTICLE 12 BROKERAGE COMMISSIONS 12.1 Representations. Sublandlord and Subtenant each represent and warrant to the other that it has not dealt with any broker or agent other than Lambert Smith Hampton (San Diego), Inc. (the "Broker"). Subtenant and Sublandlord agree to indemnify and hold the other harmless for, from and against any claims for brokerage commissions with respect to this Sublease made by any broker or agent other than the Broker with whom, as applicable, Subtenant or Sublandlord may have dealt with respect to this Sublease. The foregoing indemnification shall include the reasonable attorneys' fees of the party being indemnified. 12.2 Payment. Sublandlord shall pay the Broker a commission for its services in connection with this Sublease in accordance with the terms of a separate agreement between Sublandlord and the Broker. ARTICLE 13 RIGHTS RESERVED BY SUBLANDLORD 13.1 Reserved Rights. In addition to the rights reserved by Prime Landlord pursuant to Section 13.1 of the Prime Lease, Sublandlord shall have the right to enter upon the Leased Space at reasonable times and with reasonable notice for the purposes of making inspections and for access to any pipe or utility chases or similar areas accessible from the Leased Space. ARTICLE 14 ASSIGNMENT AND SUBLETTING 14.1 Assignment. Subtenant shall not assign this Sublease without Sublandlord's prior written consent, which consent shall not be unreasonably withheld so long as the financial condition of the proposed assignee is acceptable to Sublandlord. No assignment shall relieve Subtenant of its obligations hereunder. -9- 13 14.2 Subleasing. Subtenant shall not sublease the Leased Space or any portion thereof without the prior written consent of Sublandlord, which consent shall not be unreasonably withheld so long as the financial condition of the proposed sublessee is acceptable to Sublandlord. No sublease shall release Subtenant from responsibility for performance of the terms, covenants and conditions of this Sublease with respect to the space covered by any sublease. ARTICLE 15 QUIET ENJOYMENT 15.1 Ouiet Enjoyment. Subtenant, provided no default exists hereunder and is continuing, shall have quiet and peaceable enjoyment of the Leased Space throughout the Term without hindrance or molestation by Sublandlord or by anyone claiming by, through or under Sublandlord. ARTICLE 16 DEFAULT 16.1 Subtenant's Default. The occurrence of any one or more of the following events shall constitute a default and breach of this Sublease by Subtenant: (a) if Subtenant fails to pay any Rent or any other charges required to be paid by Subtenant under this Sublease when due and payable for a period of five (5) days after written notice thereof is received by Subtenant specifying such failure, provided that Subtenant shall not be entitled to such notice and grace period more than two times in any consecutive twelve (12) month period; or (b) if Subtenant fails to perform promptly and fully any other covenant, condition, or agreement contained in this Sublease and such failure continues for twenty (20) days after receipt of written notice thereof from Sublandlord to Subtenant or such longer time as is reasonably required by Subtenant to cure; or (c) if Subtenant makes a general assignment for the benefit of creditors or provides for an arrangement, composition, extension, or adjustment with its creditors; or (d) if Subtenant files a voluntary petition for relief, or if a petition against Subtenant in a proceeding under the federal bankruptcy laws or other insolvency laws is filed and not withdrawn or dismissed within ninety (90) days thereafter, or if under the provisions of any law providing for reorganization or winding up of corporations any court of competent jurisdiction assumes jurisdiction, custody, or control of Subtenant or any substantial part of its property and such jurisdiction, custody, or control remains in force unrelinquished, unstayed, or unterminated for a period of ninety (90) days; or (e) if, in any proceeding or action in which Subtenant -10- 14 is a party, a trustee, receiver, agent, or custodian is appointed to take charge of the Leased Space or any of Subtenant's property (or has the authority to do so) for the purpose of enforcing a lien against the Leased Space or Subtenant's property. 16.2 Remedies. In the event of Subtenant's default hereunder, then in addition to all other rights or remedies available to Sublandlord, Sublandlord shall have the right, at Sublandlord's option, without further notice or demand of any kind, to the following: (a) terminate this Sublease and Subtenant's right to possession of the Leased Space and reenter the Leased Space and take possession thereof, and Subtenant shall have no further claim to the Leased Space under this Sublease; or (b) continue this Sublease in effect and collect Rent or other charges that have or thereafter become due and payable; or (c) elect the remedy set forth in subpart (b) of this Section 16.2, and thereafter elect to terminate this Sublease and Subtenant's right to possession of the Leased Space under subpart (a) of this Section 16.2. 16.3 Damages. Should Sublandlord elect to terminate this Sublease under the provisions of Section 16.2, Sublandlord may recover as damages from Subtenant the following: (a) the worth at the time of the award of any unpaid Rent which had been earned at the time of termination; plus (b) the worth at the time of the award of the amount by which the unpaid Rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Subtenant proves could have been reasonably avoided; plus (c) the worth at the time of the award of the amount by which the unpaid Rent for the balance of the Term after the time of the award exceeds the amount of the rental loss that Subtenant proves could be reasonably avoided; plus (d) any other actual and reasonable amount necessary to compensate Sublandlord for all detriment proximately caused by Subtenant's failure to perform its obligations under this Sublease or that in the ordinary course of things would be likely to result therefrom, limited to any costs or expenses (including attorneys, fees) incurred by Sublandlord in (i) retaking possession of the Leased Space, (ii) maintaining the Leased Space after Subtenant's default, (iii) preparing the Leased Space for reletting to a new Subtenant, including any repairs or alterations, and (iv) reletting the Leased Space, including brokers, commissions. The term "Rent," as used in this Sublease, includes the Monthly Base Rent plus all additional rent under this Sublease and all other sums becoming due that are the equivalent of rent. 16.4 Worth at Time of Award. "The worth at the time of the award," as that phrase is used in Section 16.3(a) and (b), is to be computed by allowing interest at the maximum rate allowed by law at the time of the award. "The worth at the time of the award" as that phrase is used in Section 16.3(c), is to be -11- 15 computed by discounting the amount at the discount rate of the Federal Reserve Bank at the time of the award plus one percent (l%). 16.5 Waiver. Waiver by Sublandlord of any breach of any term, covenant, or condition of this Sublease shall not be deemed a waiver of such term, covenant, or condition. Acceptance of Rent by Sublandlord subsequent to any breach hereof shall not be deemed a waiver of any preceding breach other than the failure to pay the particular Rent so accepted, regardless of Sublandlord's knowledge of any breach at the time of such acceptance of Rent. Sublandlord shall not be deemed to have waived any term, covenant, or condition unless Sublandlord gives Subtenant written notice of such waiver. 16.6 Curing Subtenant's Default. If Subtenant defaults in the performance of any of its obligations under this Sublease, then, after prior written notice to Subtenant of its intention to do so, Sublandlord may, but shall not be obligated to, and without waiving such default, perform the same for the account and at the expense of Subtenant. Subtenant shall pay Sublandlord all costs of such performance promptly upon receipt of a bill therefor. ARTICLE 17 ATTORNEYS' FEES 17.1 In the event that either party to this Sublease commences any action or proceeding against the other by reason of any default or alleged default of any term or condition of this Sublease, or for interpretation of this Sublease, the prevailing party in such action or proceeding will be entitled to recover such amount as the court may judge to be reasonable attorneys, fees. The court shall determine the prevailing party. ARTICLE 18 DESTRUCTION OR DAMAGE 18.1 If the Building or any portion thereof, including the Leased Space, is damaged or destroyed by fire or other casualty, the provisions of Article 18 of the Prime Lease shall apply. Anything contained in this Sublease to the contrary notwithstanding, Sublandlord may, in its sole discretion, exercise any option available to Sublandlord under the Prime Lease to terminate the Prime Lease in the event of fire or other casualty. 18.2 If the Leased Space is partially damaged or destroyed by fire or other casualty, the Monthly Base Rent shall -12- 16 equitably abate, to the extent that the Leased Space is rendered untenantable, for the period from the date of such damage or destruction to the date the damage is repaired or restored, but only to the extent that the monthly base rent payable by Sublandlord under the Prime Lease and allocable to the Leased Space is similarly abated. Thus, for example, if one third of the monthly base rent under the Prime Lease allocable to the Leased Space is abated, one third of the Monthly Base Rent payable hereunder shall be abated for the same period. ARTICLE 19 CONDEMNATION 19.1 If the Leased Space is condemned and taken by any authority, the provisions of Article 19 of the Prime Lease shall apply. ARTICLE 20 ASSIGNMENT OF PRIME LEASE 20.1 Sublandlord may assign, in whole or in part, Sublandlord's interest in this Sublease and may assign all of its interest under the Prime Lease. In the event of any assignment by Sublandlord of the Prime Lease and this Sublease, Sublandlord shall be, and is hereby entirely free and relieved of, all liability under any and all covenants and obligations contained in or derived from this Sublease or arising out of any act, occurrence or omission relating to the Leased Space which occurs after the consummation of such sale, exchange, or assignment, except for obligations, if any, owing at the time of such sale, exchange or assignment. ARTICLE 21 STATEMENT OF STATUS (ESTOPPEL) 21.1 Certificate. Within ten (10) days after written request from one party to the other, the party so requested shall execute and deliver to the other or its named designee a written statement certifying that (a) this Sublease is unmodified and in full force and effect or is in full force and effect as modified and stating the modifications; (b) the amount of the Monthly Base Rent and the date to which Monthly Base Rent and additional rent have been paid in advance; (c) the amount of any security deposited with Sublandlord; and (d) that Sublandlord or Subtenant, as the case may be, is not in default hereunder or, if either is -13- 17 claimed to be in default, setting forth the nature of any claimed default. 21.2 Estoppel. Any such statement described in Section 22.1 may be relied upon by a purchaser, assignee, or lender. ARTICLE 22 PARKING 22.1 Parking Rights. Tenant shall have the right, pursuant to Article 23 of the Prime Lease and any applicable rules and regulations adopted by Prime Landlord, to park automobiles in the Parking Structure. Subtenant must make arrangements for such parking, and pay all required fees directly to, Prime Landlord. ARTICLE 23 SECURITY DEPOSIT 23.1 Security Deposit. Upon the execution of this Sublease Subtenant shall deposit with Sublandlord the sum of Forty Three Thousand Five Hundred Six Dollars ($43,506.00) (the "Security Deposit") to be held as collateral security for the payment of Base Rent and all other sums of money payable by Subtenant under this Sublease, and for the faithful performance of all other covenants and agreements of Subtenant under this Sublease. The Security Deposit, without interest, shall be repaid to Subtenant within thirty (30) days after the expiration or sooner termination of this Sublease, provided Subtenant shall have made all such payments and performed all such covenants and agreements. Upon any default by Subtenant hereunder, at Sublandlord's sole option, Sublandlord may apply all or part of the Security Deposit on account of such default, and thereafter Subtenant shall promptly restore the original amount of the Security Deposit. ARTICLE 24 CERTAIN ALLOWANCES 24.1 Moving Allowance. In consideration for the faithful performance by Subtenant of all of its obligations under this Sublease, Sublandlord shall pay Subtenant a moving allowance in the amount of $16,590.00 to reimburse Subtenant for third party costs incurred in connection with the relocation of its -14- 18 offices to the Leased Space. Sublandlord shall pay this moving allowance to Subtenant within thirty (30) days after Subtenant takes possession of the Leased Space and commences payment of Monthly Base Rent. 24.2 Termination Fee Allowance. In consideration for the faithful performance by Subtenant of all of its obligations under this Sublease, Sublandlord shall pay Subtenant a termination fee allowance in the amount of $50,000 to reimburse Subtenant for the termination fee payable by Subtenant to its existing landlord to terminate its existing lease and other costs to be incurred by Subtenant. Sublandlord shall pay this termination fee allowance within thirty (30) days after Subtenant takes possession of the Leased Space and commences the payment of Monthly Base Rent. ARTICLE 25 GENERAL PROVISIONS 25.1 Successors. The terms and conditions herein contained shall, subject to the provisions as to assignment, apply to and bind the heirs, successors, executors, administrators, and assigns of the parties hereto. 25.2 Entire Agreement. This Sublease together with the Exhibits attached hereto contains the entire agreement between the parties and shall not be modified in any manner except by an instrument in writing executed by the parties or their respective successors in interest. All such Exhibits are incorporated into and made a part of this Sublease. 25.3 Terms and Headings. The words "Sublandlord" and "Subtenant" as used herein shall include the plural as well as the singular. Words used in any gender include other genders. If there be more than one Subtenant the obligations hereunder imposed upon Subtenant shall be joint and several. Introductory headings at the beginning of each numbered Article and Section of this Sublease are solely for the convenience of the parties and should not be deemed to be a limitation upon or description of the contents of any such paragraph. 25.4 Light/Air. No rights to light or air over any property whether belonging to Sublandlord or to any other person, are granted to Subtenant by this Sublease. -15- 19 25.5 Time. Time is of the essence of this Sublease with the exception of Sublandlord's delivery of possession hereunder. 25.6 Examination. Submission of this instrument for examination or signature by Subtenant does not constitute a reservation of or option for lease, and it is not effective as a lease or otherwise until execution by and delivery to both Sublandlord and Subtenant. 25.7 No Recording. Subtenant shall not record this Sublease without the prior consent of Sublandlord. 25.8 Governing Law. This Sublease shall be governed by and construed in accordance with the laws of the State of California. 25.9 Provisions Severable. If any provision of the Sublease shall be determined to be illegal or unenforceable, such provision shall be deemed severable from the balance of this Sublease, which shall remain in full force and effect. 25.10 Notices. All notices given between the parties will be given in writing and mailed or delivered to the following addresses: To the Sublandlord: Horizon/CMS Healthcare Corporation 6001 Indian School Road, NE Suite 530 Albuquerque, NM 87110 Attention: Mr. Jeff Stuve To the Subtenant: PMR Corporation Fifth Floor 501 Washington Avenue San Diego, CA Attention:_________________________________ -16- 20 25.11 Waiver of Jury Trial. Each of Sublandlord and Subtenant waive trial by jury in any action arising out of or in connection with the Sublease. IN WITNESS WHEREOF, the parties have signed this Sublease as of the day and year first above written. SUBLANDLORD: CMS DEVELOPMENT AND MANAGEMENT COMPANY, INC., a Delaware corporation By: /s/ J. SEAN DAILY ------------------------------------ SUBTENANT: PMR CORPORATION, a Delaware corporation By: /s/ FRED FURMAN ------------------------------------ -17- 21 [EXHIBITS EXCLUDED] EX-10.14 17 EXHIBIT 10.14 1 EXHIBIT 10.14 MANAGEMENT AND AFFILIATION AGREEMENT BETWEEN MENTAL HEALTH COOPERATIVE, INC. AND TENNESSEE MENTAL HEALTH COOPERATIVE, INC. DATED APRIL 13, 1995 2 TABLE OF CONTENTS
PAGE ---- I. TERM AND TERMINATION...................................................................... 2 1.1 Conditions Precedent and Term.................................................. 2 1.1.1 Conditions Precedent............................................... 2 1.1.2 Term............................................................... 2 1.2 Termination by Agreement....................................................... 3 1.3 Termination for Cause.......................................................... 3 1.4 Adverse Effect Upon Tax-Exempt Status.......................................... 4 1.5 Termination Due to Legislative or Administrative Changes....................... 4 1.6 Avoidance of Termination....................................................... 4 1.7 Sale of TMHC Assets Upon Termination........................................... 5 II. AFFILIATION; APPOINTMENT AND AUTHORITY OF MANAGER......................................... 5 2.1 Affiliation with Manager....................................................... 5 2.2 Contracts with Case Manager.................................................... 5 2.3 Authority of Manager........................................................... 6 III. OBLIGATIONS OF MANAGER.................................................................... 6 3.1 Capitalization of Provider Operations and Expansion............................ 6 3.2 Management and Administrative Services......................................... 6 3.2.1 Financial Responsibilities......................................... 6 3.2.2 Policies and Procedures............................................ 7 3.2.3 Management Information Systems..................................... 7 3.2.4 Roll-Out Systems................................................... 7 3.2.5 Personnel and Employment Matters................................... 7 3.2.6 Authorization and Utilization Management........................... 8 3.2.7 Quality Assurance.................................................. 8 3.2.8 Collaborative Care Enhancement..................................... 9 3.2.9 Marketing.......................................................... 9 3.2.10 Contract Development............................................... 9 3.2.11 Additional Services................................................ 9 3.3 Program Development............................................................ 10 3.4 Provider Facilities............................................................ 10 3.5 Insurance...................................................................... 10 3.5.1 Manager Insurance.................................................. 10 3.5.2 Other Policy Requirements.......................................... 11 3.6 Indemnification................................................................ 11 3.7 Provider Designee to Manager's Board of Directors.............................. 11 3.8 Approval of Subsequent Amendments of Manager's Charter and Bylaws.............. 11 IV. OBLIGATIONS OF PROVIDER................................................................... 11 4.1 Execution and Delivery of Services Agreement................................... 11 4.1.1 Case Management.................................................... 12
-i- 3 4.1.2 Crisis Services for Children and Adolescents....................... 12 4.1.3 Respite Care....................................................... 12 4.1.4 Crisis Service..................................................... 12 4.1.5 Clinical Operations................................................ 12 4.1.6 Other Psychiatric Services......................................... 12 4.2 Amendment of Provider Charter and Bylaws....................................... 13 4.2.1 Provider's Board Positions......................................... 13 4.2.2 Management Advisory Committee...................................... 13 4.2.3 Approval of Subsequent Amendments of Charter and Bylaws............ 13 4.3 Certifications, Licenses, Etc.................................................. 13 4.4 Provider to be "Provider of Services".......................................... 13 4.5 Program Facilities............................................................. 13 4.6 Medical Records................................................................ 14 4.7 Insurance...................................................................... 14 4.7.1 Provider Insurance................................................. 14 4.7.2 Other Policy Requirements.......................................... 14 4.7.3 Risk Management Program............................................ 14 4.8 Indemnification................................................................ 14 4.9 Employment of Provider Personnel............................................... 15 4.9.1 Employment Practices............................................... 15 4.9.2 Supervision and Control............................................ 15 4.10 Supervision of Case Management Programs........................................ 15 V. MANAGEMENT FEE, EXPENSES, AND DISBURSEMENT OF FUNDS........................................ 16 5.1 General Parameters for Financial Arrangements.................................. 16 5.1.1 Case Management Activities......................................... 16 5.1.2 Capital Investments................................................ 16 5.1.3 Capitated, Case Rate, and Other Payments........................... 16 5.1.4 State Grants....................................................... 17 5.1.5 Subcapitated Payment............................................... 17 5.1.6 Payment for Old Asset Depreciation................................. 17 5.1.7 Management Fee..................................................... 17 5.1.8 Payment for New Asset Depreciation................................. 18 5.1.9 Retained Reserves.................................................. 18 5.1.10 Return of Capital Investments...................................... 18 5.1.11 Distribution of Remaining Retained Reserves........................ 18 5.1.12 Example of Financial Distributions................................. 19 5.2 The Model...................................................................... 19 5.2.1 Projected Payments................................................. 20 5.3 Actual Payments of Compensation................................................ 20 5.4 Priority of Payments........................................................... 20 5.5 Quarterly Review of Financial Arrangements..................................... 21 5.6 Accumulation and Payment of Shortfalls......................................... 22 5.7 Fair Market Value of Compensation.............................................. 22 5.8 Receipt of Capitated Payments and Grants by Remittance Clearinghouse........... 22
-ii- 4 VI. REPRESENTATIONS AND WARRANTIES........................................................... 23 6.1 Provider's Representations and Warranties...................................... 23 6.1.1 Corporate Capacity................................................. 23 6.1.2 Corporate Powers; Consents; Absence of Conflicts With Other Agreements, Etc.................................................... 23 6.1.3 Securities Representations......................................... 23 6.1.4 Manager's Name..................................................... 26 6.2 Manager's Representations and Warranties....................................... 26 6.2.1 Corporate Capacity................................................. 26 6.2.2 Corporate Powers; Consents; Absence of Conflicts With Other Agreements, Etc.............................................. 26 VII. STANDARDS OF SERVICES.................................................................... 27 7.1 Ongoing Quality and Compliance Reviews........................................ 27 7.2 Change in Laws or Regulations................................................. 27 7.3 Notice from Governmental/Regulators Entities.................................. 28 VIII. INDEPENDENT CONTRACTOR................................................................... 28 IX. COVENANT NOT TO COMPETE.................................................................. 28 9.1 Noncompetition................................................................. 28 9.2 Anti-Raiding................................................................... 29 9.3 Severability of Non-Compete Covenants.......................................... 29 X. CONFIDENTIALITY AGREEMENT................................................................ 29 10.1 Confidentiality of Agreements.................................................. 29 10.2 Confidential Information....................................................... 30 10.3 Proprietary Information of Manager............................................. 30 10.3.1 Acknowledgment of Proprietary Interest............................. 30 10.3.2 Covenant Not to Divulge Trade Secrets.............................. 31 10.3.3 Return of Materials at Termination................................. 31 10.3.4 Application to Provider Representatives............................ 31 XI. STOCK TRANSACTIONS....................................................................... 31 11.1 Stock Warrant Agreement........................................................ 31 11.2 Registration Rights............................................................ 32 11.3 Provider's Covenants Regarding Stock Transactions.............................. 32 XII. ARBITRATION.............................................................................. 33 XIII. MISCELLANEOUS............................................................................ 33 13.1 Service of Notices............................................................. 33 13.2 Binding Effect................................................................. 34 13.3 Choice of Law.................................................................. 34 13.4 Entire Agreement............................................................... 34 13.5 Amendments..................................................................... 34
-iii- 5 13.6 Severability................................................................... 35 13.7 Number and Gender.............................................................. 35 13.8 Joint Negotiations............................................................. 35 13.9 Headings....................................................................... 35 13.10 Assignment..................................................................... 35 13.11 Counterparts................................................................... 35 13.12 Attorneys Fees................................................................. 35
-iv- 6 EXHIBIT A - Manager's Home Office Personnel EXHIBIT B - Form of Provider Services Agreement EXHIBIT C - Materials Reviewed by Provider EXHIBIT D - Definition of Accredited Investor EXHIBIT E - Form of Stock Warrant Agreement EXHIBIT F - Form of Registration Rights Agreement EXHIBIT G - Financial Model for Management and Affiliation Agreement EXHIBIT H - Information Regarding Capitated and Subcapitated Payments EXHIBIT I - Permitted Investments EXHIBIT J - Collaborative Care Model (Table of Contents only) EXHIBIT K - Example of Financial Distributions
-v- 7 MANAGEMENT AND AFFILIATION AGREEMENT THIS MANAGEMENT AND AFFILIATION AGREEMENT (this "Agreement") is made as of the 13th day of April, 1995, by and between MENTAL HEALTH COOPERATIVE, INC., a Tennessee non-profit corporation ("Provider"), and TENNESSEE MENTAL HEALTH COOPERATIVE, INC., a Tennessee for-profit corporation ("Manager"). RECITALS A. Provider is a Tennessee non-profit corporation that is exempt from federal income tax as an organization described in Section 501(c)(3) of the Internal Revenue Code of 1986, as amended (the "IRC"). B. Provider is a qualified provider of case management and other psychiatric services. C. PMR Corporation a/k/a Psychiatric Management Resources, Inc. ("PMR") is a Delaware for-profit corporation in the business of developing and administering outpatient acute psychiatric case management programs. D. The State of Tennessee has created a statewide program, known as TennCare, to provide managed care health coverage to the State's Medicaid and uninsured population through contracts with a number of managed care organizations ("MCOs"). E. The TennCare program legislation is to be amended to include the provision of certain covered services to patients that suffer from serious and persistent mental illness ("SPMI"). F. PMR has expertise in developing and managing psychiatric case management programs for SPMI patients. G. PMR has created a wholly-owned, for-profit subsidiary (i.e., Manager), to contract with payers, including MCOs participating in the TennCare program, for the provision of case management and other covered psychiatric services to persons in the State of Tennessee covered by those payers. H. Manager desires to contract with qualified Tennessee case management companies to provide case management and other covered psychiatric services to the persons in the State of Tennessee covered by the payers and the TennCare program. 8 I. Provider desires to affiliate with and avail itself of PMR's management services and Manager desires to provide such services to Provider as set forth in this Agreement. J. Provider and Manager have executed a Provider Services Agreement of even date herewith (the "Services Agreement") pursuant to which Provider has agreed to provide "Covered Services" to "Covered Persons" in accordance with "Payer Plan Agreements" as those terms are defined in the Services Agreement. K. Case Management, Inc. ("CMI") is a qualified provider of case management and other psychiatric services located in Memphis, Tennessee. L. Manager and CMI intend to execute a Management and Affiliation Agreement (the "CMI Management Agreement") that is substantially the same as this Agreement. M. Manager and CMI intend to execute a Provider Services Agreement (the "CMI Services Agreement") that is substantially the same as the Services Agreement executed by Provider. NOW, THEREFORE, Manager and Provider, intending to be legally bound hereby, agree as follows: I. TERM AND TERMINATION. 1.1 Conditions Precedent and Term. 1.1.1 Conditions Precedent. As conditions precedent to the effectiveness of this Agreement and the commencement of the Term hereof, (i) the relevant Tennessee statutes, regulations, and other legislation, including without limitation those relating to the TennCare program, shall be amended or otherwise appropriately modified, so that (a) the TennCare program includes coverage of SPMI patients and (b) the services to be provided to SPMI patients and adolescents by Manager and Provider pursuant to the contracts with the MCOs (i.e., Payer Plan Agreements) and by Provider pursuant to the Services Agreement shall be reimbursed in full by the TennCare program and/or other Tennessee programs, and (ii) Manager shall directly execute a Payer Plan Agreement with a MCO (i.e., a Payer) for the provision of such services upon the terms and conditions set forth in the Services Agreement. The satisfaction of these conditions precedent shall be evidenced by a written acknowledgement to that effect, which has been executed by Manager and Provider. The date on which the Manager and the Provider agree and acknowledge that the above-described conditions precedent have been satisfied and this Agreement is effective is referred to herein as the "Effective Date." 1.1.2 Term. Provided that the conditions precedent set forth in subparagraph 1.1.1 above are satisfied, the term of this Agreement (the "Term") shall be six (6) years, commencing upon the Effective Date first mentioned above. Unless and until -2- 9 terminated in accordance with the terms of this Agreement set forth below, this Agreement shall automatically renew for successive one (1) year periods thereafter. If either party intends not to renew this Agreement upon the expiration of the initial or any renewal Term, that party must give the other party at least sixty (60) days' written notice of such intent not to renew, in which case this Agreement shall terminate at the end of the then-expiring initial or renewal Term. 1.2 Termination by Agreement. In the event Provider and Manager shall mutually agree in writing, this Agreement may be terminated on the date specified in such written agreement. 1.3 Termination for Cause. Either party shall have the right, but not the obligation, to terminate this Agreement at any time for cause by giving written notice to the other party of such intent to terminate the Agreement. Cause for termination includes, but is not limited to: 1.3.1 the material breach of any of the representations and warranties set forth in Article VI below; 1.3.2 the disciplining, loss of license, or loss of certification, accreditation, or qualification of Provider by any licensing, regulatory, or professional organization or agency with jurisdiction over Provider; 1.3.3 the failure of either party to maintain the required liability insurance coverage protection; 1.3.4 a finding by any licensing, regulatory, or professional organization that this Agreement violates any state or federal law; 1.3.5 any change in federal or state law that causes this Agreement to be in violation of any federal or state law or regulation and the parties fail to reach agreement regarding amendment of this Agreement so as to comply with such law or regulation in the manner set forth in Section 1.5 below; 1.3.6 the habitual neglect or continued failure of either party to perform its duties and obligations under the Agreement; 1.3.7 the initiation of bankruptcy, insolvency, dissolution, liquidation, or receivership proceedings by or against either party; 1.3.8 an admission by either party in writing that it is unable to pay its debts as they mature or the making by either party of a general assignment for the benefit of creditors; -3- 10 1.3.9 the breach of any other material provision of this Agreement by either party if after sixty (60) days' written notice setting forth the details of the breach and the intent to terminate is given by the terminating party and the breach is not cured by the breaching party during such time period, unless such breach cannot reasonably be cured within such sixty (60) day period and the breaching party has begun to cure such breach during such sixty 60) day period and diligently pursues such remedial action until such breach is cured; 1.3.10 the material breach of the Services Agreement described in Section 4.1 below, or the Stock Warrant Agreement or Registration Rights Agreement described in Article XI below; or 1.3.11 the termination of the Services Agreement for any reason. 1.4 Adverse Effect Upon Tax-Exempt Status. In the event that (i) it is ever determined that any of the transactions contemplated by this Agreement shall have a material adverse effect upon the Provider's non-profit status under state law or Provider's tax-exempt status under IRC Section 501(c)(3), and (ii) an opinion letter stating such conclusion is delivered to the parties by legal counsel having recognized expertise in such matters, then both parties agree to negotiate in good faith to amend the Agreement to conform with the then-existing laws and regulations regarding such non-profit and tax-exempt status. If agreement cannot be reached with respect to such amendments within ninety (90) days of notice from Provider (including delivery of the above-referenced legal opinion) of such determination that the Agreement has an adverse effect upon Provider's non-profit or tax-exempt status (or such earlier time required by law), then this Agreement may be immediately terminated by Provider by written notice to Manager. 1.5 Termination Due to Legislative or Administrative Changes. In the event that there shall be a change in the statutes, regulations, or instructions relating to the Tennessee Medicaid or TennCare programs, the adoption of any new legislation or regulations applicable to this Agreement, a change in any applicable third party payer reimbursement system (including, without limitation, those of the Payers and the Payer Plan Agreements described in the Services Agreement) or the initiation of an enforcement action with respect to legislation, regulations, or instructions applicable to this Agreement, any of which affects the continuing viability or legality of this Agreement or materially affects the compensation that Provider and Manager will receive under this Agreement, then both parties agree to negotiate in good faith to amend the Agreement to conform with the then-existing laws and regulations. If agreement cannot be reached with respect to such amendments within ninety (90) days of such change, adoption, or enforcement (or such earlier time as may be required by such legislation or regulations), this Agreement may be immediately terminated by either party by written notice to the other party. 1.6 Avoidance of Termination. Within five (5) days of receipt of a notice issued pursuant to subparagraph 1.3.9 above, Provider and Manager shall meet and use their best efforts to negotiate a solution to the problem with respect to which such notice was sent. -4- 11 Such good faith negotiations shall particularly be required with reference to notices given pursuant to subparagraphs 1.4 and 1.5. Notwithstanding such meeting, the times for termination of the Agreement as set forth in this Article I shall remain in effect unless Manager and Provider agree otherwise. 1.7 Sale of TMHC Assets Upon Termination. In the event that this Agreement is terminated by Provider for cause pursuant to Section 1.3 above, then Provider shall have the right, upon giving Manager the notice specified below, to (i) purchase Manager's fixed assets that were specifically utilized in the provision of services by Manager and/or Provider pursuant to this Agreement and the related Services Agreement, and (ii) receive an assignment of the contracts (i.e., Payer Plan Agreements) between Manager and Payers that relate to the case management services to be furnished by Provider pursuant to the Services Agreement; provided that such Payer Plan Agreements can then be assigned to Provider, and provided further that in the event such Payer Plan Agreement cannot be assigned to Provider without the Payer's consent, that Manager shall use its best efforts to procure the consent of such assignment from the appropriate Payer. For so long as the value of Manager's unrecouped capital investment relating to the assets to be transferred exceeds the fair market value of such assets, the purchase price shall equal the sum of the fair market value of such assets and the fair market value of the contracts to be assigned (in no case, however, shall the purchase price exceed the Manager's unrecouped capital investment). For so long as the value of Manager's unrecouped capital investment is less than the fair market value of the fixed assets to be assigned, then the purchase price shall equal the fair market value of such assets. Provider shall notify Manager in writing within thirty (30) days of such termination of this Agreement whether Provider desires to exercise its right to purchase such assets and receive an assignment of such agreements, and thereafter, Manager shall transfer such assets and assign such Payer Plan Agreements to Provider as reasonably soon as possible after payment by Provider of the consideration specified herein in cash or cash equivalents. In the event that Provider fails to provide such notice within the thirty (30) day period, then it shall be conclusively presumed that Provider does not desire to exercise such option and the option granted herein shall terminate. To the extent that under these conditions Provider desires to purchase Manager's assets and receive an assignment of Payer Plan Agreements that also relate to services performed by CMI, then Provider must obtain the prior written consent of CMI before Provider may purchase those assets or receive an assignment of those Payer Plan Agreements. II. AFFILIATION; APPOINTMENT AND AUTHORITY OF MANAGER. 2.1 Affiliation with Manager. Except to the extent otherwise permitted by Section 9.1 below, Provider agrees to affiliate with Manager on an exclusive basis for the Term of this Agreement for the management and administration of Provider and the expansion of Provider's facilities, services, and programs. 2.2 Contracts with Case Manager. Provider acknowledges and agrees that Manager shall be permitted to contract with and manage CMI (Case Management, Inc.) and other case management organizations that provide services and programs similar to those of Provider and CMI, so long as such organizations other than CMI have received the prior -5- 12 written approval of Provider. Provider, CMI, and the other case management organizations that have been approved by Provider and CMI and executed a similar management and affiliation agreement with Manager are referred to herein collectively as the "Case Managers" and individually as a "Case Manager." 2.3 Authority of Manager. Provider appoints Manager as the sole and exclusive provider of management, administrative, and business services specifically described herein for Provider. Manager shall have the commensurate power and authority to provide such management, administrative, and business services for Provider. Pursuant to the terms and conditions of the Services Agreement, Manager shall be permitted to contract with the "Payers" for the provision of Covered Services by Provider to Covered Persons as those terms are defined in the Services Agreement. III. OBLIGATIONS OF MANAGER. 3.1 Capitalization of Provider Operations and Expansion. Manager and Provider desire and intend to expand Provider's and CMI's services and case management programs into a number of markets and communities throughout the State of Tennessee in order to adequately service the TennCare Payer contracts. In connection with such expansion, Manager acknowledges and agrees that it shall assist Provider in expanding Provider's current facilities, services, and programs in Davidson County and in acquiring new facilities for Provider and developing new Provider services and programs (i.e., roll-out programs) in new Tennessee markets, which have been identified and agreed upon by Manager and Provider. In order to ensure that Manager has adequate capital to perform its obligations under this Agreement, Manager shall obtain an irrevocable letter of credit from a bank mutually acceptable to Manager and Provider pursuant to which Manager may draw up to Two Million and No/100ths Dollars ($2,000,00.00) for a term of one (1) year. Manager shall obtain the letter of credit on or before the Effective Date, and Manager agrees that funds obtained pursuant to the letter of credit shall be utilized only for the obligations of Manager under this Agreement and the CMI Management Agreement. Notwithstanding the foregoing, Provider acknowledges that Manager shall draw upon the letter of credit or otherwise obtain capital funds and spend such funds in Manager's sole discretion after consultation with Provider and CMI. 3.2 Management and Administrative Services. Manager shall cause to be furnished all administrative and management services necessary to develop and operate the Provider's facilities and case management programs in each of the markets mutually acceptable to Manager and Provider, so as to provide high quality patient care. In connection therewith, Manager shall create and staff a home office that shall provide full-service management and administrative services for Provider, including the following: 3.2.1 Financial Responsibilities. Manager shall be responsible for administering Provider's accounts receivable (including receipt of capitated payments and other billing and collection activities), accounts payable, and implementation of appropriate accounting systems. In performing such financial duties, Manager shall use reasonable -6- 13 efforts to operate Provider in a manner that will preserve and enhance the economic viability and stability of Provider. 3.2.2 Policies and Procedures. Manager shall be responsible for creation and implementation of all detailed operating protocols for the provision of Provider's case management and other psychiatric services. Such protocols include provision of appropriate policies and procedures manuals, program manager handbooks, admissions screening systems, the core medical records systems and forms, guidelines and forms for treatment planning meetings, utilization review systems and forms, post-discharge follow-up systems and forms, community relations development and maintenance systems and forms, a key- monitor management system, and materials regarding principal and special treatment modalities. Manager shall submit such protocols to Provider's Board of Directors for approval before implementation. In the event that Provider's Board of Directors disapproves of any such protocols, then representatives of Manager and Provider shall revise the disapproved protocols so that such protocols are reasonably acceptable to both Manager and Provider. 3.2.3 Management Information Systems. Manager shall provide all management information systems (including appropriate computer hardware and software) necessary for the operations of Provider in the Provider's various facilities throughout the State of Tennessee. 3.2.4 Roll-Out Systems. Manager shall provide the policies and procedures for the creation of new sites for Provider services and facilities and development of new treatment programs for SPMI patients. 3.2.5 Personnel and Employment Matters. (a) Provider's Personnel. Except for Manager's home office personnel described below, all personnel at the Provider's various facilities, including those providing case management and patient care services (e.g., "Health Professionals" as that term is defined in the Services Agreement) shall be employees of or independent contractors with Provider. Manager shall assist Provider in recruitment, training, and evaluation of all Provider employees and independent contractors, and Manager shall make recommendations to Provider's officers and directors regarding such employment matters. All personnel recruited by Manager to perform services at the Provider's facilities or in the Provider's case management programs shall be appropriately licensed and qualified to perform such services. Although Manager shall be responsible for management of Provider's payroll, Provider is responsible for the actual payment of Provider's employees and independent contractors and the provision of funds for such payments. Provider's employees and independent contractors shall not be eligible for nor participate in any of the health or benefit plans of either Manager or PMR; Provider shall be totally responsible for providing any and all health or other benefits for its employees. -7- 14 (b) Manager's Home Office Personnel. In providing the management and administrative services described herein, Manager shall create and staff a home office. In connection therewith, Manager shall employ or hire as independent contractors persons for those positions described in Exhibit A hereto. Manager shall, in its sole discretion, select the persons who will serve in each of the capacities listed in Exhibit A hereto, provided, however, all such personnel shall be reasonably satisfactory to Provider. Manager agrees that all personnel listed in Exhibit A will be available to Provider when required for issues related to operation and management of the Provider's facilities and case management programs. Manager is responsible for payment of Manager's employees and independent contractors and the provision of funds for such payments. Manager's employees and independent contractors shall not be eligible for nor participate in any of the health or benefit plans of Provider; Manager shall be totally responsible for providing any and all health or other benefits for its employees. (c) Employment Practices. Employment practices of Manager shall comply with all applicable federal and state laws, rules, regulations, and guidelines and the rules, regulations, and guidelines of regulatory agencies having appropriate jurisdiction over such matters. (d) Supervision and Control. Manager shall be responsible for the direction and control of all of Manager's employees and independent contractors and shall cause all personnel to comply to the extent applicable with all terms and conditions of this Agreement and with the protocols, as amended and as approved by Provider pursuant to subparagraph 3.2.2, and the Policy Manual, as amended and approved pursuant to subparagraph 3.3. 3.2.6 Authorization and Utilization Management. (a) Preauthorization and MCO Utilization Review. Manager shall coordinate authorization of services and utilization management with each Payer. Manager shall provide a central office for the authorization of services to Payer patients by Provider. Manager's medical director, in consultation with Payer medical directors and Provider medical directors, psychiatrists, and nurses shall determine patient treatment programs and length of stay. (b) Utilization Review of Provider Programs. Manager shall coordinate utilization review of the Provider's programs, which shall include: (i) review of the determination of a qualified patient's need for care; (ii) document outcome-related improvements to the patient from Provider's case management programs; and (iii) ongoing review of patient records to monitor medical necessity determination by professional staff. 3.2.7 Quality Assurance. Manager shall coordinate quality assurance reviews with respect to Provider's case management and psychiatric service programs, which shall include: -8- 15 (a) determining compliance with Provider's quality assurance program; (b) providing outcome-oriented quality assurance assistance designed to achieve improvement in over-all quality of care; and (c) reviewing and monitoring Provider's case management program staff with respect to the quality and scope of patient services. 3.2.8 Collaborative Care Enhancement. Manager shall use reasonable efforts to enhance the Collaborative Care Model that has been developed for Provider. The Collaborative Care Model in its current state, which includes the matters described in the table of contents in Exhibit J attached hereto, shall be provided to the Provider upon the effectiveness of this Agreement. 3.2.9 Marketing. Manager shall market and advertise the services provided to Payer patients by Provider. 3.2.10 Contract Development. Manager and Provider shall jointly develop (including negotiation and execution of definitive agreements) contracts for the provision of services to Payer patients by Provider (i.e., the Payer Plan Agreements defined in the Services Agreement). In this regard, Manager shall use its best efforts to develop appropriate Payer Plan Agreements with Payers participating in the TennCare program for the provision of services to Payer patients in Tennessee covered by a Payer. In developing such Payer Plan Agreements, Manager shall have the power and authority to negotiate and execute contracts and obligate Provider to the extent permitted by Section 2.1 of the Services Agreement. 3.2.11 Additional Services. Manager shall provide the following additional management and administrative services: (a) assisting Provider (with Provider's cooperation) in obtaining all necessary certifications, licenses, permits, accreditations, etc., and assisting Provider in insuring compliance with all licensing and regulatory agencies; (b) planning, design and production of all community liaison and educational literature; (c) ongoing administration of Provider's case management and psychiatric service programs; (d) ongoing community liaison support; (e) Provider staff development and continuing education; (f) coordination with community agencies that have clients in need of the Provider's case management programs and psychiatric services; and -9- 16 (g) such other management or administrative services that are specifically identified and mutually agreed upon by Manager and Provider. 3.3 Program Development. Manager shall assist Provider in developing and expanding Provider's case management and psychiatric service programs. Manager shall assist Provider in the development, upgrading, and maintenance of the Provider's case management programs to meet or exceed applicable state, federal, agency, and third-party payer standards. Such assistance shall consist of the development and maintenance of a comprehensive set of procedures and policies for Provider (the "Policy Manual") covering all aspects of the Provider's case management programs. The Policy Manual and periodic additions, deletions, or amendments thereto, shall be submitted to Provider's Board of Directors for its prior approval, which approval shall not be unreasonably withheld. In the event that any aspect of the Policy Manual is not approved, it shall be revised so that it is reasonably acceptable to both Provider and Manager. 3.4 Provider Facilities. Manager shall assist Provider in expanding the Provider's current facilities in Davidson County. Manager and Provider shall jointly identify and agree upon suitable facilities for the provision of Provider's case management program services in locations other than Provider's current facilities in Davidson County. Manager shall assist Provider in the negotiations to acquire such premises by lease or otherwise. Provider shall be responsible for obtaining such premises by execution of the applicable lease or purchase agreements, and the rental for such acquired premises shall be Provider's cost and expense. To the extent that the landlord provides a separate build-out allowance or includes the cost of build-out in the rental rate, Provider shall be responsible for the cost of such build-out. Manager shall be responsible for the build-out costs in excess of the landlord's allowance and/or the rental component for build-out, as well as furnishing and equipping of such premises, and the cost of such furniture, equipment, and excess build-out shall be Manager's cost and expense. All such premises and the build-out thereof shall be approved by Manager and Provider. The capital necessary for the equipping, furnishing and excess build-out of such facilities shall be provided by Manager in accordance with subparagraph 3.1 above and shall be reimbursed to Manager in accordance with Article V below. 3.5 Insurance. 3.5.1 Manager Insurance. For the Term of this Agreement, Manager shall procure and maintain at its own cost comprehensive general and professional liability insurance with elements of self-insurance or deductibles common to the industry covering personal injury, bodily injury, and property damage in the following amounts: (a) Personal/bodily injury: One Million and No/100ths Dollars ($1,000,000.00) per claimant and Three Million and No/100ths Dollars ($3,000,000.00) annual aggregate. -10- 17 (b) Property damage: Five Hundred Thousand and No/100ths Dollars ($500,000.00) per occurrence and Five Hundred Thousand and No/100ths Dollars ($500,000.00) annual aggregate. 3.5.2 Other Policy Requirements. Such insurance shall be written on an occurrence basis by an insurance company authorized to transact the insurance business in the State of Tennessee; provided, however, that such insurance may be written on a claims-made basis if tail coverage is guaranteed at the time the primary insurance policy is written and Manager purchases and maintains such tail coverage upon the termination of Agreement for the maximum reporting period available or five (5) years, whichever is longer. 3.6 Indemnification. Manager agrees to indemnify and hold harmless Provider and Provider's directors, officers, employees, independent contractors, and agents ("Provider Indemnitees") from and against any and all claims, demands, causes of action, costs, and liabilities (including, without limitation, reasonable attorneys' fees), caused by, resulting from, or attributable to the grossly negligent or intentional acts or omissions of Manager and/or Manager's directors, officers, employees, independent contractors, and agents with respect to the duties and obligations imposed on Manager hereunder. Manager shall have the right, at Manager's sole expense, of defending any such third party claim. Notwithstanding anything to the contrary herein, Manager is not obligated to indemnify the Provider Indemnitees or any other party for any claims, demands, causes of action, costs, or liabilities resulting from the acts or omissions of the Provider Indemnitees or such other party. 3.7 Provider Designee to Manager's Board of Directors. The Manager's Charter and Bylaws shall provide that one of the Manager's Directors shall be a person designated by the Provider's Board of Directors. 3.8 Approval of Subsequent Amendments of Manager's Charter and Bylaws. The Manager's Charter and Bylaws shall provide that the provisions in the Charter and Bylaws regarding the appointment of one member of the Manager's Board of Directors by Provider shall not be amended without the prior approval of the Provider's Board of Director's, which approval shall not be unreasonably withheld. IV. OBLIGATIONS OF PROVIDER. 4.1 Execution and Delivery of Services Agreement. Provider agrees to execute and deliver simultaneously with this Agreement a Services Agreement in substantially the form of Exhibit B attached hereto. Pursuant to the Services Agreement, Provider shall provide the Covered Services described therein, including the following services, at each Provider facility serving the various Tennessee markets jointly identified by Manager and Provider. -11- 18 4.1.1 Case Management. Provider shall provide case management of the services provided to eligible patients pursuant to the terms and conditions of the Payer Plan Agreements among Manager, Provider, and the Payers. In the provision of such case management services at each Provider location, Provider shall employ or otherwise engage the services of a Case Management Director, Administrative Assistant, Housing Developer, Team Leader, appropriate Case Managers, and an Assessment Team (composed of a minimum of 2 members). 4.1.2 Crisis Services for Children and Adolescents. Provider shall provide crisis services for children and adolescents covered by the Payers pursuant to the terms and conditions of the Payer Plan Agreements. 4.1.3 Respite Care. Provider shall provide respite services to eligible patients, including the identification and provision of temporary housing for such patients. In providing such services, Provider shall employ or otherwise engage a Respite Coordinator and have appropriate agreements with respite providers. 4.1.4 Crisis Service. Provider shall operate a twenty-four (24) crisis hot-line and crisis services. In providing such services, Provider shall employ or otherwise engage a Director of Crisis Services, an appropriate number of Counselors (including, lead counselors, regular shift counselors, and night shift counselors), and a Triage Coordinator. Each of such persons shall possess the appropriate qualifications, credentials, training, etc. to provide such services. 4.1.5 Clinical Operations. Provider shall provide appropriate clinical services and treatment to eligible patients. In providing such services, Provider shall employ or otherwise engage a Medical Director and an appropriate number of Health Professionals defined in the Services Agreement. Each of such persons shall possess the appropriate qualifications, credentials, training, etc. to provide such services. 4.1.6 Other Psychiatric Services. Provider shall also provide the following "other psychiatric services" in addition to the case management and other services described in subparagraphs 4.1.1 through 4.1.5 above: (a) rehab/crisis services (b) rehab/clinic services (c) grant revenue/housing (d) grant revenue/TDMHMR (e) grant revenue/crisis (f) grant revenue/homeless outreach (g) grant revenue/respite (h) grant revenue/medical doctors All agreements of Provider described in subparagraphs 4.1.1 through 4.1.6 above shall receive the prior written consent of Manager, which consent shall not be unreasonably withheld. -12- 19 4.2 Amendment of Provider Charter and Bylaws. As a condition subsequent to the continued effectiveness of this Agreement, Provider shall also agree to amend its Charter and Bylaws within thirty (30) days after the execution of this Agreement to provide for the following: 4.2.1 Provider's Board Positions. The Provider's Charter and Bylaws shall provide that (i) the maximum number of members of the Provider's Board of Directors shall be fifteen (15) Directors, (ii) one of the Provider's Directors shall be the person then acting as the Manager's Chief Executive Officer, and (iii) Manager shall be permitted to designate two (2) additional members of the Provider's Board of Directors, which persons may or may not be employees or affiliates of Manager or PMR. 4.2.2 Management Advisory Committee. The Provider's Charter and Bylaws shall provide for a committee to be called the "Management Advisory Committee." The Management Advisory Committee shall be composed of six (6) members, three of which shall be appointed by Manager's Board of Directors and three of which shall be appointed by Provider's Board of Directors. The Management Advisory Committee shall review all financial information and administrative reports and make recommendations to the Provider's Board of Directors in matters involving the management, administration, operation, and financial affairs of the Provider. 4.2.3 Approval of Subsequent Amendments of Charter and Bylaws. The Provider's Charter and Bylaws shall provide that the provisions in the Charter and Bylaws regarding (i) the number and appointment of members of the Provider's Board of Directors, and (ii) the composition, purpose, and authority of the Management Advisory Committee shall not be amended without the prior approval of each of the three members of the Provider's Board of Directors that have been designated by Manager. 4.3 Certifications, Licenses, Etc. The Provider shall ensure that its case management and psychiatric service programs shall be certified, licensed, and/or otherwise appropriately qualified in the name of Provider with all appropriate authorities. Provider shall, at all times, be the owner and holder of all licenses and accreditations with respect to the Provider's case management and other psychiatric program services. 4.4 Provider to be "Provider of Services". Provider shall be the "provider" within the meaning of all contracts and agreements with all third-party payers for case management and other psychiatric program services described in subparagraph 4.1 above. As the "provider of services," Provider has the duty to verify with Manager the Payer for each patient and the program coverage for such patient. 4.5 Program Facilities. Provider shall permit Manager to utilize Provider's current facilities, equipment, and supplies in Davidson County in connection with the services to be provided by the parties pursuant to this Agreement. Provider shall timely review and approve Manager's choice of premises and related build-out for additional facilities in the new markets identified by Manager for expansion of Provider's programs. Provider shall provide case management and other psychiatric program services in all such markets and -13- 20 at all such facilities pursuant to the terms and conditions of this Agreement and the Services Agreement. 4.6 Medical Records. Provider shall maintain all medical and patient records in the manner and for the period of time required by law and industry practice. All patient medical records shall be the property of Provider. Provider will promptly notify Manager of any Payer request for records or information from a third party regarding a patient in a Provider program. 4.7 Insurance. 4.7.1 Provider Insurance. For the Term of this Agreement, Provider shall procure and maintain at its own cost comprehensive general and professional liability insurance with elements of self-insurance or deductibles common to the industry covering personal injury, bodily injury, and property damage in the following amounts: (a) Personal/bodily injury: One Million and No/100ths Dollars ($1,000,000.00) per claimant and Three Million and No/100ths Dollars ($3,000,000.00) annual aggregate. (b) Property damage: Five Hundred Thousand and No/100ths Dollars ($500,000.00) per occurrence and Five Hundred Thousand and No/100ths Dollars ($500,000.00) annual aggregate. 4.7.2 Other Policy Requirements. Such insurance shall be written on an occurrence basis by an insurance company authorized to transact insurance business in the state in which Provider is located; provided, however, such insurance may be written on a claims-made basis if tail coverage is guaranteed at the time the primary insurance policy is written and Provider purchases and maintains such tail coverage upon the termination of Agreement for the maximum reporting period available or five (5) years, whichever is longer. 4.7.3 Risk Management Program. Provider shall create and manage, in cooperation with Manager, a risk management program designed to monitor and minimize all insurable risks related to the Provider's case management program. Risk management techniques and discussions shall be a regular part of the procedures implemented pursuant to the Policy Manual approved by Provider pursuant to subparagraph 3.3. 4.8 Indemnification. Provider agrees to indemnify and hold harmless Manager and Manager's directors, officers, employees, independent contractors, and agents ("Manager Indemnitees") from and against any and all claims, demands, causes of action, costs, and liabilities (including, without limitation, reasonable attorneys' fees), caused by, resulting from, or attributable to the grossly negligent or intentional acts or omissions of the Provider and/or the Provider's directors, officers, employees, independent contractors, and agents with respect to the duties and obligations imposed on the Provider hereunder. Provider shall have the right, at Provider's sole expense, of defending any such third party claim. -14- 21 Notwithstanding anything to the contrary herein, Provider is not obligated to indemnify the Manager Indemnitees or any other party for any claims, demands, causes of action, costs or liabilities, resulting from the acts or omissions of the Manager Indemnitees or such other party. 4.9 Employment of Provider Personnel. Manager will advise Provider of Manager's recommendations regarding employment of all personnel for the Provider's programs and facilities, and Provider shall timely review such recommendations and the qualifications of all such personnel. Provider shall employ or hire as independent contractors persons for those positions necessary for the staffing of Provider's programs and facilities. Provider shall, in its sole discretion, select the persons who will serve in each of those positions for Provider; provided, however, all such personnel shall be reasonably satisfactory to Manager. Provider agrees that all Provider personnel will be available to Manager when required for issues related to the operation and management of the Provider's facilities and case management programs. Provider is responsible for payment of Provider's employees and independent contractors and the provision of funds for such payments. Provider's employees shall not be eligible for nor participate in any of the health or benefit plans of Manager or PMR; Provider shall be totally responsible for providing any and all health or other benefits for its employees. 4.9.1 Employment Practices. Employment practices of Provider shall comply with all applicable federal and state laws, rules, regulations, and guidelines and the rules, regulations, and guidelines of regulatory agencies having appropriate jurisdiction over such matters. 4.9.2 Supervision and Control. Provider shall be responsible for the direction and control of all of Provider's employees and independent contractors and shall cause all personnel to comply to the extent applicable with all terms and conditions of this Agreement and with the protocols, as amended and as approved by Manager and Provider pursuant to subparagraph 3.2.2, and the Policy Manual, as amended and approved pursuant to subparagraph 3.3. 4.10 Supervision of Case Management Programs. Provider shall be responsible for the operation of the Provider's case management programs and the implementation of policies with respect thereto. Notwithstanding the authority granted to Manager hereunder, Provider shall retain and at all times exercise ultimate control over the affairs of Provider, and shall be accountable and responsible for all duties of Provider and Provider's services and programs. Provider shall have final authority to approve the Policy Manual and staffing plans for Provider's facilities. Provider shall establish a chain of command for each program through which Provider provides case management and related psychiatric services hereunder and shall supervise and bear the responsibility for all medical services provided through the Programs. The foregoing reporting relationships shall be in addition to any relationships established by Manager with respect to the administrative management of the programs. -15- 22 V. MANAGEMENT FEE, EXPENSES, AND DISBURSEMENT OF FUNDS. 5.1 General Parameters for Financial Arrangements. In determining the amount of the various payments that are to be made to each party pursuant to this Agreement and the related Services Agreement, Manager and Provider have agreed that the following are: (i) the parties to be involved in such financial arrangements and (ii) the components of the funds to be received by Manager and the payments that are to be made to each party: 5.1.1 Case Management Activities. Manager and Provider acknowledge and agree that the monies available for distribution to Manager and Provider pursuant to this Agreement and the related Services Agreement are based upon the Manager's receipts, revenues, expenditures, and payments related to the case management and other psychiatric services provided in Tennessee by Manager and every Case Manager (defined in subparagraph 2.2 above). The case management activities of Manager and the Case Managers are governed by the management and affiliation agreements between Manager and each Case Manager (in substantially the form of this Agreement and referred to herein collectively as the "Management Agreements" and individually as a "Management Agreement"), and the provider services agreement between Manager and each Case Manager (in substantially the form of the Services Agreement). 5.1.2 Capital Investments. Manager shall make capital investments for the operations of Provider and the other Case Managers as described in subparagraph 3.1 above, which shall be repaid as described below. In the event that a Case Manager desires to make capital investments for expansion of their respective facilities and operations, and Manager approves of such investment (which approval shall not be unreasonably withheld), then such Case Manager's capital investment shall be repaid in the same manner and according to the same priority that Manager's capital investment shall be repaid. The cost associated with borrowing any funds to make such capital investment (e.g., interest, loan origination fees, etc.) shall be the sole cost of Manager or a Case Manager, as the case may be, and such costs of borrowing shall not be reimbursed pursuant to this Agreement. 5.1.3 Capitated, Case Rate, and Other Payments. With respect to each contract (i.e., a Payer Plan Agreement defined in the Services Agreement) between a Payer and Manager for the provision of case management and other psychiatric services to Covered Persons in accordance with the Payer's respective Payer Plan (as those terms are defined in the Services Agreement), Manager shall receive (directly or by assignment from the Case Managers) (i) a monthly fee that is equal to a specific capitated amount per member per month ("PMPM") multiplied times the number of that Payer's Covered Persons, (ii) a specific case rate payment, and/or (iii) some other type of payment. These monthly capitated, case rate, and/or other payments from a Payer to Manager for case management services described in this Agreement are collectively referred to herein as the "Capitated Payment," and the Capitated Payment may vary for each Payer, depending upon the terms of the particular Payer Plan Agreement with a Payer for case management services. -16- 23 5.1.4 State Grants. In some instances, the State of Tennessee through grant programs ("Grants"), rather than the TennCare program and its participating Payers, will be the source of funding for the case management and other psychiatric services to be provided by Manager and the Case Managers to eligible Tennessee beneficiaries. In those instances where Grants provide the funding for case management activities, the Grants shall be received by Manager, either directly from the State agency making such Grant or by assignment from the Case Manager receiving such Grant. To the extent permitted by the terms and conditions of the Grant, such Grant shall be administered by Manager in the same manner and according to the same procedures as a Capitated Payment. If the terms of a Grant do not permit the Grant to be utilized by the parties in the same manner as a Capitated Payment, then the parties agree to use their best efforts to meet and agree upon the manner in which the services that are the subject of such Grant shall be provided and reimbursed. With the exception of capital investments by Manager and the Case Managers described in subparagraph 5.1.2 above, the cumulative Capitated Payments and Grants received by Manager (either directly or by assignment from the Case Managers) provide the funds for the case management and related psychiatric service activities of Manager and the Case Managers and provide the funds that eventually result in the accumulation of the Retained Reserves (defined below). The parties acknowledge and agree that Manager and the Case Managers shall be permitted to and may provide other health and psychiatric services in Tennessee besides the case management and other psychiatric services that are the subject of this Agreement, the other Management Agreements, and the services agreements, and the financial distributions described in this Agreement do not include any monies received by Manager or the Case Managers for such other activities not related to the case management and other psychiatric services described herein or in the other Management Agreements. 5.1.5 Subcapitated Payment. Manager shall pay each Case Manager from the Capitated Payments and the Grants an amount, referred to herein as the "Subcapitated Payment," for the case management and other psychiatric services provided by the respective Case Manager at its various facilities in accordance with its applicable provider service agreement. Each Case Manager shall pay for all of the costs associated with its case management and other psychiatric service obligations (e.g., the case manager's costs described in the consolidated pro forma budgets appearing behind Tab 1 of the Model defined below) from its Subcapitated Payment. 5.1.6 Payment for Old Asset Depreciation. Manager shall also pay to each Case Manager from the Capitated Payments and the Grants an amount equal to the depreciation of each Case Manager's facilities and equipment that are in existence on the date of the Case Manager's respective Management Agreement and utilized in accordance with the terms and conditions of the Case Manager's respective Management Agreement and provider services agreement. Such payment for depreciation is referred to herein as a payment for "Old Asset Depreciation." 5.1.7 Management Fee. Manager shall pay itself from the Capitated Payments and the Grants an amount, referred to herein as the "Management Fee," to reimburse Manager for the cost of the management and administrative services provided -17- 24 pursuant to this Agreement and the other Management Agreements with other Case Managers (net of depreciation of capital assets acquired by Manager in connection with the case management activities of Manager and the Case Managers and net of the repayment of Manager's capital investments). Such costs of Manager shall include the Manager's home office expenses described in the pro forma budgets behind Tab 2 of the Model (defined below). The parties intend that the Management Fee shall reimburse Manager for its costs for management and administrative services described herein in the amount budgeted in the Model. To the extent that the Management Fee does not cover Manager's actual costs or the budgeted amount exceeds Manager's actual costs, the Management Fee shall be adjusted as described in subparagraph 5.5 below. 5.1.8 Payment for New Asset Depreciation. Manager shall then pay itself from the Capitated Payments and Grants an amount equal to the depreciation of the capital assets (e.g., build-out of new case manager facilities, furniture, and equipment) that are acquired by Manager with its capital investments for case management activities. To the extent that a Case Manager, rather than Manager, has made such a capital investment for the Case Manager's case management activities, then Manager shall pay such Case Manager an amount equal to the depreciation of the capital assets (e.g., build-out of new Case Manager facilities, furniture, and equipment) that are acquired with the Case Manager's capital investments for case management activities. Such depreciation shall be computed in accordance with generally accepted accounting principles based on the depreciable capital assets' useful lives using the straight line method. Such payment for depreciation is referred to herein as a payment for "New Asset Depreciation." 5.1.9 Retained Reserves. Subtraction of the cumulative Subcapitated Payments, payments for Old Asset Depreciation, the Management Fee, and payments for New Asset Depreciation from the cumulative amount of the Capitated Payments and Grants results in an amount referred to herein as the "Retained Reserves." 5.1.10 Return of Capital Investments. The Retained Reserves shall first be utilized by Manager to pay Manager and each Case Manager, which made a capital investment described in subparagraph 5.1.2 above, a thirty-five percent (35%) annual return of Manager's and the Case Managers' respective capital investments (the "Investment Return") until such time as all such capital investments have been repaid (i.e., 35% of the amount of a party's capital investment shall be repaid each year until such time as the full amount of such capital investments are repaid). In the case of subsequent capital investments by Manager and the Case Managers, the amount of such subsequent capital investment shall be added to the amount of the original and any subsequent capital investments and 35% of such cumulative amount of original and subsequent capital investments shall be repaid on an annual basis until such time as all capital investments have been repaid. No interest is paid with respect to any of the capital investments. 5.1.11 Distribution of Remaining Retained Reserves. The remainder of the Retained Reserves shall be paid to Manager and the Case Managers as follows: -18- 25 (a) The remaining Retained Reserves shall be paid seventy percent (70%) to the Case Managers and thirty percent (30%) to Manager until such time as the Case Managers have received payments that cumulatively equal seventy percent (70%) of the cumulative Investment Return. (b) After such time as the payments received by the Case Managers pursuant to subparagraph 5.1.11(a) above cumulatively equal seventy percent (70%) of the cumulative Investment Return, the remainder of the Retained Reserves shall be paid fifty percent (50%) to Manager and fifty percent (50%) to the Case Managers. (c) Amounts to be received by the Case Managers pursuant to these distributions of the remaining Retained Reserves shall be made to each Case Manager on a pro rata basis based upon the percentage of Manager's gross revenues attributable to the case management and other psychiatric services of each respective Case Manager to Manager's total gross revenues that result from the case management and other psychiatric services of Manager and all Case Managers. (d) Distributions of the Retained Reserves in the manner described herein shall be made within thirty (30) days of the end of each calendar quarter after the parties have completed the quarterly review of financial arrangements described in subparagraph 5.5 below. 5.1.12 Example of Financial Distributions. Attached hereto as Exhibit K is a hypothetical example of the manner in which the distribution of funds will be made to Manager, Provider, CMI and other approved Case Managers for the various financial components described herein. The parties acknowledge and agree that (i) the example is purely hypothetical, (ii) the example is only intended to be used for clarification of the manner in which the various distributions will be made to the parties, and (iii) the example is not a representation or estimation of the actual funds that will be received or distributed. 5.2 The Model. In connection with the negotiation and preparation of this Agreement, Manager and Provider have prepared a budgetary analysis (referred to herein as the "Model," a copy of which is attached hereto as Exhibit G) of the expected revenues and expenses, which are involved in the case management activities contemplated by this Agreement, the other Management Agreements, and the related provider services agreements, and the payment of those expenses and distribution of funds. The Model analyzes the expected management and administrative costs (net of depreciation and interest on Manager's capital investments) for the Manager's home office (See Tab 2 of the Model). The Model also analyzes the estimated lives, revenues, expenses, and other applicable financial factors for the ten projected markets for case management services to be provided by the Case Managers (See Tabs 3 through 12 of the Model). The Model then analyzes the lives, incremental depreciation, program costs, and Capitated Payments expected for the Manager's home office and the ten projected markets on a consolidated basis (See Tab 1 of the Model). -19- 26 5.2.1 Projected Payments. Based upon the estimated Capitated Payment and Subcapitated Payment, the parties have projected the amounts that would be paid for Old Asset Depreciation, the Management Fee, and New Asset Depreciation. The Parties have also estimated the remaining Retained Reserves and the payments to be made from the Retained Reserves to Manager for its Investment Return, as well as the 70/30 and 50/50 distributions of the final amount of the Retained Reserves. (See page 1 of the Model.) 5.3 Actual Payments of Compensation. The parties acknowledge and agree that the Model determines the Subcapitated Payment and Management Fee, based upon the parties' current estimates of costs and other relevant factors, and the Capitated Payment, based upon the parties' current estimate of such payment after discussions with Payers. The actual Capitated Payments, Grants, any withholds by the Payers for risk pools, Subcapitated Payments and Management Fee, shall be set forth on Exhibit H to be attached hereto, which exhibit shall be amended from time to time to reflect the actual amounts for those financial components. The time and manner of making such payments to Manager, Provider, CMI, and other Case Managers shall also be set forth in Exhibit H. The parties also acknowledge and agree that the actual costs and other relevant data, as well as the amount of the Capitated Payment and Management Fee, may change; therefore, in accordance with subparagraph 5.5 below, the parties agree that they shall make appropriate adjustments of the payments to be made to the parties for the compensation components described in subparagraph 5.1 above by utilizing the compensation components described in subparagraph 5.1 above and the same methodology that they originally utilized in preparing the (i) budgetary pro formas of the Model and (ii) the hypothetical example of financial distributions (Exhibit K). To the extent that sufficient funds are not available for Manager to make each of the payments described herein, Manager shall make the payments in the priority set forth in Section 5.4 below. 5.4 Priority of Payments. In the event that sufficient funds are not available for Manager to make each of the payments described herein, Manager shall make the payments in the following order of priority: 5.4.1 the Subcapitated Payments to the Case Managers; 5.4.2 the payment for Old Asset Depreciation to the Case Managers for assets existing on the Effective Date of this Agreement; 5.4.3 the Management Fee to Manager; 5.4.4 the payment for New Asset Depreciation to Manager (and to the Case Managers to the extent that they make capital investments for acquisition of capital assets subsequent to the Effective Date); 5.4.5 the thirty-five percent (35%) Investment Return to Manager (and to the Case Managers to the extent that they make capital investments for acquisition of capital assets subsequent to the Effective Date); and -20- 27 5.4.6 the 70/30 or, if applicable, the 50/50 distribution of Retained Reserves to the Case Managers and Manager, respectively. In making the Subcapitated Payments to the Case Managers for their costs, Manager shall pay for (i) all costs of the Case Managers that are equal to or less than the budgeted amount for each cost category set forth specifically in the Model and (ii) all costs that are in excess of the budgeted amount for a cost category specifically set forth in the Model, provided that Manager has specifically approved in writing in advance such excess expenditure. 5.5 Quarterly Review of Financial Arrangements. 5.5.1 Within ten (10) days at the end of each quarter of the Term of this Agreement, Manager shall prepare for itself and for each Case Manager the unaudited financial statements for such prior quarter. Within ten (10) days after such quarterly financial statements have been prepared, the parties shall review the fees and other compensation paid in accordance with this Agreement and shall make appropriate adjustments that are approved by Manager and the Case Managers. Such adjustments shall be effective from and after the date that the parties agree to such an adjustment. Any such adjustments shall be made in accordance with the methodology originally utilized in preparing the budgetary pro formas in the Model with good faith recognition of (i) cost increases which have occurred in each Case Manager's local market areas, (ii) the Manager's actual costs for the management and administrative costs described herein, (iii) the actual Capitated Payments received from Payers and the Grants received from the State of Tennessee or its agencies, and (iv) other factors deemed relevant by the parties since any prior adjustment. In the event the parties cannot reach an agreement regarding an adjustment of the fees and other compensation paid hereunder, the provisions of Article XII shall apply. 5.5.2 If the Subcapitated Payments are not sufficient to reimburse the Case Managers for their actual costs that were budgeted in the Model or preapproved by Manager for the prior quarter, then the quarterly adjustment of the Subcapitated Payments for the next quarter shall include an adjustment to reimburse the Case Managers for the shortfall in reimbursement for the budgeted or preapproved expenses for the prior quarters. Such shortfalls in reimbursement for the budgeted or preapproved expenses for the prior quarters shall have the same priority of payment as the Subcapitated Payments to the Case Managers. In the event that funds are not available in a particular quarter to reimburse the Case Managers for such shortfalls, the shortfalls in such unreimbursed expenses shall be accumulated and reimbursed at the end of the next quarter in which such funds are available. 5.5.3 If the Management Fee is not sufficient to reimburse the Manager for its actual costs that were budgeted in the Model, then the quarterly adjustment of the Management Fee for the next quarter shall include an adjustment to reimburse Manager for the shortfall in reimbursement for the budgeted management and administrative expenses for the prior quarters. Such shortfalls in reimbursement for the budgeted -21- 28 management or administrative expenses for the prior quarters shall have the same priority of payment as the Management Fee to the Manager. In the event that funds are not available in a particular quarter to reimburse the Manager for such shortfalls, the shortfalls in such unreimbursed expenses shall be accumulated and reimbursed at the end of the next quarter in which such funds are available. 5.6 Accumulation and Payment of Shortfalls. In the event that there are shortfalls in the payment of any Subcapitated Payments, payments for Old Asset Depreciation, the Management Fee, payments for New Asset Depreciation, or the Investment Return, and such shortfalls cannot be paid during the next quarter after the quarterly adjustment, then each such shortfall shall be accumulated and paid at the end of the next quarter for which funds are available for such payment. The payment of such accumulated shortfalls shall be made in the same priority as payments for such financial components as set forth in subparagraph 5.4 above until such time as all such shortfalls have been reimbursed. There shall not be any 70/30 or 50/50 distributions of Retained Reserves until such time as all such accumulated shortfalls have been repaid. 5.7 Fair Market Value of Compensation. The parties agree that, to the best of their knowledge, the compensation and other payments set forth above (based on the assumptions of the Model) are consistent with the fair market value of the services for which such fees are paid and are reasonable and customary within the industry and within the areas served by Manager and the Case Managers. 5.8 Receipt of Capitated Payments and Grants by Remittance Clearinghouse. The parties agree that all Capitated Payments shall be received by and processed through a national remittance clearinghouse. Such processing of Capitated Payments and Grants shall be organized so that all Capitated Payments and Grants for case management and related psychiatric services shall be received by the clearinghouse and deposited into an account established with a national money center bank and that withdrawals from such account require the authorization of Manager and the Case Managers. The clearinghouse shall be given standing instructions to advise Manager and the Case Managers of each deposit within one (1) business day thereof; and, within ten (10) business days of the date of each such deposit, Manager and the Case Managers shall jointly prepare and deliver to the clearinghouse an authorization to make payment from such receipts to the parties in accordance with the terms and conditions of this Article V. For such purposes, each party shall designate a readily available representative and alternate representative so that such authorizations can be obtained and delivered to the clearinghouse in a timely manner. In the event of a dispute among the parties as to the distribution of funds from the clearinghouse account, undisputed payments shall be made to the parties not involved in such dispute. If a dispute is of such a nature that it involves all parties or all funds, then to the extent possible payments shall be made to the parties in the priority set forth in subparagraph 5.4 above to provide sufficient funds for the parties to cover their expense and continue to operate until the dispute is resolved. All such disputes shall be resolved in the manner set forth in Article XII. Funds that are not to be paid immediately to the parties (e.g., the Retained Reserves or funds related to disputed payments) shall be invested in the permitted investments set forth in Exhibit I attached hereto. The agreements with the -22- 29 clearinghouse and bank shall be in form and substance acceptable to those parties, Manager and the Case Managers. VI. REPRESENTATIONS AND WARRANTIES. 6.1 Provider's Representations and Warranties. Provider represents and warrants to Manager the following: 6.1.1 Corporate Capacity. Provider is a Tennessee non-profit corporation validly existing in good standing under the laws of the State of Tennessee. Provider has the requisite power and authority to enter into the Management Agreement, to perform its obligations thereunder, and to conduct its businesses as now being conducted. Provider is duly authorized, qualified, and licensed under all applicable laws, regulations, ordinances, and orders of governmental authorities having jurisdiction to own its properties and conduct its business in the place and in the manner now conducted. 6.1.2 Corporate Powers; Consents; Absence of Conflicts With Other Agreements, Etc. The execution, delivery, and performance of this Agreement by Provider and the consummation of the transactions contemplated herein by Provider: (a) are within Provider's corporate powers and the terms of Provider's Charter or Articles of Incorporation, Bylaws, and any amendments thereto, and have been duly and properly authorized by all appropriate corporate action; (b) to the best of Provider's knowledge, will neither conflict with nor result in any breach or contravention of, nor permit the acceleration of the maturity of, or the creation of any lien under, any indenture, mortgage, agreement, lease, contract, instrument, or understanding to which Provider is a party or by which Provider is bound, including without limitation the Basic Grants from the Tennessee Department of Mental Health and Mental Retardation and other grants that Provider receives from the State of Tennessee or its agencies; (c) will not violate any judgment, decree, order, writ, or injunction of any court or governmental authority to which Provider may be subject; and (d) are and will constitute the valid and legally binding obligation of Provider, enforceable in accordance with the terms of this Agreement, except as enforceability may be restricted, limited, or delayed by applicable bankruptcy or other laws affecting creditors' rights generally and except as enforceability may be subject to general principles of equity. 6.1.3 Securities Representations. (a) The Provider recognizes that the PMR Common Stock (the "Common Stock") that will be issued to Provider in connection with the transactions -23- 30 described in this Agreement is issued upon its representations and warranties contained in this Agreement, and Provider agrees to indemnify and hold harmless Manager and PMR against any misrepresentation, breach, or failure on its part to fulfill any covenants or agreements set forth in this Agreement with respect to the transfer of such Common Stock. (b) The Provider is the sole party in interest, is not acquiring the shares of Common Stock as an agent or otherwise for any other person, and the Provider is acquiring the shares of Common Stock for investment and not with a view to their resale or distribution. (c) The Provider has received copies of the materials described on Exhibit C hereto (the "Materials") and has read carefully and understands those materials. (d) The Provider is familiar with the business and financial condition, properties, operations and prospects of PMR, all as generally described in the Materials, and, at a reasonable time prior to the execution of this Agreement, has been afforded the opportunity to ask questions of and receive satisfactory answers from PMR's officers and directors, or other persons acting on PMR's behalf, concerning the business and financial condition, properties, operations and prospects of PMR and concerning the terms and conditions of the offering of the shares of Common Stock and has asked such questions as Provider desires to ask, and all such questions have been answered to the full satisfaction of the Provider. (e) The Provider has carefully reviewed the Materials, and based upon the contents thereof, understands and acknowledges that the acquisition of the shares of Common Stock and Common Stock purchase warrants of PMR set forth within this Agreement may involve various risks and that Provider has the requisite knowledge and experience in business and financial matters that it is capable of evaluating these risks and in making an informed investment decision has elected to assume such risks. In making an informed investment decision hereunder, Provider has relied solely upon the information contained within the Materials. (f) The Provider is relying solely on the information contained in the Materials and the answers to questions with respect thereto furnished to it by PMR. No representations or warranties have been made to the Provider by PMR as to the tax consequences of this investment or as to profits, losses, or cash flow that may be received or sustained as a result of this investment, other than those contained in the Materials. (g) All documents, records and books pertaining to a proposed investment in the shares of Common Stock that the Provider has requested, have been made available to the Provider. -24- 31 (h) The Provider represents that, if it is not an "Accredited Investor" (as that term is defined in Exhibit D hereto) Provider's representatives personally have such knowledge of finance, securities, and investments, generally, and experience and skill in investments based on actual participation, that Provider's representatives are capable of evaluating the merits and risks of Provider's prospective investment in PMR. (i) The Provider is acquiring the shares of Common Stock solely for the Provider's own beneficial account, for investment purposes, and not with a view to, or for resale in connection with, any distribution of the shares of Common Stock. The Provider understands that the offer and sale of the shares of Common Stock pursuant to this Agreement have not been registered under the Securities Act of 1933, as amended (the "Securities Act"), or any state securities laws by reason of specific exemptions under the provisions thereof that depend in part upon the investment intent of the Provider and of the other representations made by the Provider in this Agreement. The Provider understands that PMR and Manager are relying upon the representations, covenants, and agreements contained in this Agreement for the purpose of determining whether this transaction meets the requirements for such exemptions. (j) The Provider understands that the shares of Common Stock are "restricted securities" under applicable federal securities laws and that the Securities Act and the rules of the Securities and Exchange Commission ("SEC") provide in substance that the Provider may dispose of the shares of Common Stock only pursuant to an effective registration statement under the Securities Act or an exemption therefrom, and, except as provided in Section 11.2 below, the Provider understands that PMR has no obligation to register any of the shares of Common Stock purchased by the Provider thereunder, or to take action so as to permit sales pursuant to the Securities Act (including Rule 144 thereunder). As a consequence, the Provider understands that the Provider must bear the economic risks of the investment in the shares of Common Stock for an indefinite period of time. The Provider understands that the Provider may not at any time demand the purchase by PMR of the Provider's shares of Common Stock. (k) The Provider agrees: (A) that the Provider will not sell, assign, pledge, give, transfer, or otherwise dispose of the shares of Common Stock or any interest therein, or make any offer or attempt to do any of the foregoing, except pursuant to a registration of the shares of Common Stock under the Securities Act and all applicable state securities laws or in a transaction that is exempt from the registration provisions of the Securities Act and all applicable state securities laws; (B) that PMR and any transfer agent for the shares of Common Stock shall not be required to give effect to any purported transfer of any of the shares of Common Stock except upon compliance with the foregoing restrictions; and (C) that a legend in substantially the following form will be placed on the certificates representing the shares of Common Stock transferred to Provider: -25- 32 THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE BEEN TAKEN WITHOUT A VIEW TO THE DISTRIBUTION THEREOF WITHIN THE MEANING OF THE SECURITIES ACT OF 1933, AS AMENDED, AND MAY NOT BE SOLD, PLEDGED, TRANSFERRED OR OTHERWISE DISPOSED OF EXCEPT IN ACCORDANCE WITH SUCH ACT AND THE RULES AND REGULATIONS THEREUNDER AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS. PMR WILL NOT TRANSFER SUCH SHARES EXCEPT UPON RECEIPT OF A FAVORABLE OPINION OF ITS COUNSEL AND/OR EVIDENCE SATISFACTORY TO PMR THAT THE REGISTRATION PROVISIONS OF SUCH ACT HAVE BEEN COMPLIED WITH OR THAT SUCH REGISTRATION IS NOT REQUIRED AND THAT SUCH TRANSFER WILL NOT VIOLATE ANY APPLICABLE STATE SECURITIES LAWS. (l) The Provider has not offered or sold any portion of the subscribed for shares of Common Stock and has no present intention of dividing such shares of Common Stock with others or of reselling or otherwise disposing of any portion of such shares of Common Stock either currently or after the passage of a fixed or determinable period of time or upon the occurrence or non-occurrence of any pre-determined event or circumstance. 6.1.4 Manager's Name. Provider has requested that PMR's subsidiary, which is a party to this Agreement, be named "Tennessee Mental Health Cooperative, Inc.," a name that is substantially similar to Provider's name. Provider has consented to PMR's and Manager's use of that name, and Provider has agreed that neither PMR nor Manager shall pay a license or use fee in connection with the use of that name. 6.2 Manager's Representations and Warranties. Manager shall represent and warrant to Provider the following: 6.2.1 Corporate Capacity. Manager is a Tennessee corporation validly existing in good standing under the laws of the State of Tennessee. Manager has the requisite power and authority to enter into this Agreement, to perform its obligations hereunder, and to conduct its businesses as now being conducted. Manager is duly authorized, qualified, and licensed under all applicable laws, regulations, ordinances, and orders of governmental authorities having jurisdiction to own its properties and conduct its business in the place and in the manner now conducted. 6.2.2 Corporate Powers; Consents; Absence of Conflicts With Other Agreements, Etc. The execution, delivery, and performance of this Agreement by Manager and the consummation of the transactions contemplated therein by Manager: -26- 33 (a) are within Manager's corporate powers and the terms of Manager's Charter or Bylaws or any amendments thereto, and have been duly and properly authorized by all appropriate corporate action; (b) to the best of Manager's knowledge, will neither conflict with nor result in any breach or contravention of, nor permit the acceleration of the maturity of, or the creation of any lien under, any indenture, mortgage, agreement, lease, contract, instrument, or understanding to which Manager is a party or by which Manager is bound; (c) will not violate any judgment, decree, order, writ, or injunction of any court or governmental authority to which Manager may be subject; and (d) are and will constitute the valid and legally binding obligation of Manager, enforceable in accordance with the terms of this Agreement, except as enforceability may be restricted, limited, or delayed by applicable bankruptcy or other laws affecting creditors' rights generally and except as enforceability may be subject to general principles of equity. VII. STANDARDS OF SERVICES. Manager and Provider each agree, in connection with the operation of Provider and its programs, to comply with all laws, rules, and regulations of all governmental authorities having jurisdiction over each, and any recommendations and policies resulting from Manager's and Provider's respective quality assurance programs and their general policies and procedures regarding quality assurance matters, which recommendations are designed to comply with applicable laws, rules, or regulations. The parties hereto acknowledge that a material part of the consideration for this Agreement is the other party's compliance with the provisions of this Article VII. The parties further acknowledge that the non-compliance by either with any of the applicable laws, rules, and regulations applicable to such party may have a material adverse effect on the other party. The parties therefore agree to cooperate in good faith with each other to monitor and ensure such compliance. 7.1 Ongoing Quality and Compliance Reviews. The performance of all services rendered hereunder shall be reviewed as part of Provider's ongoing quality assurance program by Manager's quality assurance personnel pursuant to the provisions of subparagraph 3.2.7 above. In the event of non-compliance with any standards for service set forth herein or applicable laws, rules, or regulations by either party hereto, the other party shall give the non-complying party notice thereof, and such party shall so comply or cause such compliance as soon as practicable thereafter, but in any event within thirty (30) days after such notice. 7.2 Change in Laws or Regulations. The parties acknowledge that applicable laws, rules, and regulations including, but not limited to, Medicaid or TennCare billing guidelines and related or included fee structures, may change at any time during the Term of this Agreement or any extensions thereof and that such change may require a -27- 34 modification of this Agreement. The parties hereby agree to give each other immediate notice of such change in applicable laws, rules, or regulations, whereupon the parties shall meet in good faith to negotiate a modification of this Agreement such that it complies with such changes in applicable laws, rules, regulations, guidelines, or fee structures. 7.3 Notice from Governmental/Regulators Entities. The parties hereby agree to give each other a copy of any notice or contact received from any governmental or regulatory entity, having jurisdiction thereof with respect to the case management programs, that any activity of such party is in violation of any applicable law, rule, or regulation and to continue to promptly inform the other party of all responses and procedures taken as a result of such notice or contact until the alleged violation is cured, and to provide such other party with evidence of the successful conclusion of the event. VIII. INDEPENDENT CONTRACTOR. No relationship of employer and employee or of joint venture between Manager and Provider is created by this Agreement, it being mutually understood and acknowledged that Manager is at all times acting and performing as an independent contractor hereunder. No employee or independent contractor of one party shall have any claim under this Agreement or otherwise against the other party for salary or other compensation, vacation or sick pay, sick leave, retirement benefits, social security, workers' compensation, disability or unemployment insurance benefits or any other employee benefits of any kind. IX. COVENANT NOT TO COMPETE. 9.1 Noncompetition. In consideration of the delivery of fifty thousand (50,000) shares of Common Stock of PMR and the covenants of Manager hereunder, Provider agrees that, during the term of this Agreement, neither Provider, nor any subsidiary or affiliate of Provider, nor any of their officers, directors, employees, or agents shall directly or indirectly, in any capacity, own, manage, operate, control, participate in the management or control of, be employed by, contract with, consult with, lend Provider's name to, receive any remuneration or maintain or continue any interest whatsoever in, any enterprise or medical practice, whether private or otherwise, providing case management and related psychiatric services of the type described in this Agreement or the Services Agreement to patients within the State of Tennessee (including, but not limited to, the execution of a Payer Plan Agreement with any Payer); provided, however, if this Agreement is terminated by Manager prior to the end of the Term due to an uncured default by Provider, then the term of this covenant of Provider not to compete shall extend for the duration of the unexpired Term of this Agreement plus six (6) months. In the event that this Agreement is terminated by Provider for cause as set forth in subparagraph 1.3 above, then this covenant of Provider not to compete shall terminate on the date that this Agreement is so terminated. This covenant not to compete does not apply to (i) Provider's ownership of (a) shares in publicly traded companies (so long as such ownership percentage is less than one percent), and (b) shares of PMR stock; (ii) Provider's current Directors that on the Effective Date of this Agreement already have an interest in an organization that competes with Provider; or (iii) arrangements for the provision of case management and related psychiatric services -28- 35 described in this Agreement to patients within Davidson County and the Tennessee counties contiguous to Davidson County, so long as Provider has given Manager the right of first refusal to participate in each such arrangement by the notice described below and Manager has declined to participate in such arrangement. In the event that Provider desires to participate in any such competitive arrangement in Davidson County or any county contiguous to Davidson County, Provider shall give Manager written notice specifying all of the material terms and conditions of such arrangement. Within thirty (30) days thereafter, Manager shall notify Provider in writing whether Manager desires to participate in that arrangement. In the event that Manager declines to participate in such arrangement or fails to submit such notice of Manager's intent within such thirty (30) day period (in which case Manager shall be deemed to have declined to participate), then Provider shall be permitted within one (1) year thereafter to enter into such arrangement on substantially the same terms and conditions presented to Manager at Provider's sole cost and expense. In the event, that Provider does not enter into such arrangement with the one (1) year period or the terms and conditions are substantially different, then Provider must again provide Manager the right of first refusal to participate in such arrangement. 9.2 Anti-Raiding. Provider also agrees that, during the Term of this Agreement, and for a period of six (6) months after the expiration or sooner termination of this Agreement by Manager due to an uncured default by Provider, neither Provider, nor any subsidiary or affiliate of Provider, nor any of their officers, directors, employees, or agents will directly or indirectly, in any capacity, (a) solicit or otherwise attempt to contact any person, or an immediate family member of any person, who has been a patient of a Payer or Provider in connection with this Agreement or the Services Agreement for purposes of inducing such person to become a patient of Provider or another medical practice or case management organization in which Provider provides such services or otherwise has an interest, or (b) solicit for employment or employ any person who has been an employee of Provider or Manager. 9.3 Severability of Non-Compete Covenants. Provider further agrees that if any restriction contained in this Article IX is held by any court of competent jurisdiction to be unenforceable or unreasonable, a lesser restriction shall be severable therefrom and shall be enforced in its place, and the remaining restrictions contained herein shall be enforceable independently of each other. In the event of a threatened breach of this covenant by Provider, Manager shall be entitled to injunctive relief, without the necessity of posting a bond, cash or otherwise and without precluding any other remedies as may be available at law or in equity for the breach of this covenant. X. CONFIDENTIALITY AGREEMENT. 10.1 Confidentiality of Agreements. Except for disclosure required by law, Provider and Manager shall agree to keep confidential the terms and conditions of this Agreement, the Stock Warrant Agreement, the Registration Rights Agreement, the Services Agreement, and Manager's and Provider's proprietary or confidential information (both documentary and software). Additionally, Provider agrees to use its best efforts to circulate to its agents, employees, officers and others who have knowledge of any part of this -29- 36 Agreement or the operations of the Provider and Manager hereafter an insider trading memorandum which highlights and addresses the concerns of insider trading to the extent prohibited under relevant federal securities laws. Provider shall take all reasonable efforts to prevent the dissemination of confidential nonpublic information, including, but not limited to, strict adherence to Section 10.1 of this Agreement and the distribution of an insider trading memorandum, as set forth above. 10.2 Confidential Information. Provider and Manager agree that some information received by one party from the other pursuant to this Agreement shall be confidential. Except as may otherwise be required by law or legal process, it is therefore agreed that any information received by one party from the other, and clearly designated in writing as "CONFIDENTIAL," or in any other matter which indicates its confidential nature (hereinafter referred to as "Confidential Information"), shall not be disclosed by the other party and shall not be used by the other party for purposes other than those contemplated by this Agreement. Confidential Information also includes, without limitation, information as to any patient as well as information relating to business practices, costs, users or purchasers of either party's services, research or services. Confidential Information does not include: (a) information that has become known to third parties or has become publicly known through no fault of the receiving party; or (b) information already in the receiving party's possession prior to the disclosure of said information to the receiving party; or (c) information subsequently disclosed to the receiving party by a third party who is not under any obligation or confidentiality to the disclosing party; or (d) information approved for disclosure by prior written consent of the disclosing party; or (e) information that the parties have agreed is necessary to disclose. 10.3 Proprietary Information of Manager. 10.3.1 Acknowledgment of Proprietary Interest. Provider recognizes the proprietary interest of Manager in any Trade Secrets of Manager. As used herein, the term "Trade Secrets" includes all of Manager's confidential or proprietary information, including without limitation any confidential information of Manager encompassed in any reports, protocols, plans, proposals, codes, marketing and sales programs, financial projections, cost summaries, pricing formulae, client contracts, client lists, and all concepts, ideas, materials, or information related to the business of Manager or Manager's clients which have not previously been released to the public at large by duly authorized representatives of Manager, whether or not such information would be protectable as a Trade Secret or the copying of which would be enjoined or restrained by a court as constituting unfair -30- 37 competition. Provider acknowledges and agrees that any and all Trade Secrets of Manager learned by Provider during the course of its engagement by Manager or otherwise, whether developed by Manager alone or in conjunction with others, shall be and are the property of Manager. 10.3.2 Covenant Not to Divulge Trade Secrets. Provider acknowledges and agrees that Manager is entitled to prevent the disclosure of Trade Secrets of Manager. As a portion of the consideration for the continuing engagement of Provider hereunder and for the compensation being paid to Provider by Manager, Provider agrees at all times during the term of said engagement by Manager, and thereafter, to hold said Trade Secrets in strictest confidence and not to disclose same or allow them to be disclosed to any person, firm, or corporation, other than to persons engaged by Manager to further the business of Manager, and not to use the same, except in the pursuit of the business of Manager, without the prior written consent of Manager. 10.3.3 Return of Materials at Termination. In the event of any termination of this Agreement, with or without cause, Provider shall promptly deliver to Manager all materials, property, documents, data, and other information belonging to Manager or pertaining to Trade Secrets. Provider shall not take any materials, property, documents, or other information or any reproduction or excerpt thereof, belonging to Manager or containing or pertaining to Trade Secrets. 10.3.4 Application to Provider Representatives. This Article X shall apply to Provider and any director, officer, employee, independent contractor, or agent of Provider and shall survive the termination of this Agreement. XI. STOCK TRANSACTIONS. 11.1 Stock Warrant Agreement. As part of the consideration for the transactions contemplated in this Agreement and the CMI Management Agreement, Manager has agreed to cause PMR to grant to Provider and CMI the option to purchase additional shares of Common Stock of PMR in the event that Manager obtains certain levels of profitability as a result of the case management activities relating to this Agreement and the CMI Management Agreement. In connection therewith, Manager agrees to cause PMR to execute and deliver to Provider and to CMI, one or more stock warrant agreements in substantially the form of Exhibit E hereto (each a "Stock Warrant Agreement"), which provides that for five (5) years Provider and CMI shall have the right to purchase at the then-current market rate (defined below) their pro rata portion of ten thousand (10,000) shares of Common Stock of PMR for every Four Hundred Twenty-Five Thousand and No/100ths Dollars ($425,000.00) of pre-tax net income of Manager that was generated during each fiscal period ending April 30 as a result of (i) the case management activities of Manager and Provider pursuant to this Agreement and the Services Agreement and (ii) the case management activities of Manager and CMI pursuant to the CMI Management Agreement and the Provider Services Agreement between Manager and CMI (the "CMI Services Agreement"). The pro rata portion of Provider and CMI shall be determined on the basis of the percentage of Manager's gross revenues attributable to the case -31- 38 management and other psychiatric services of Provider and CMI, respectively, to Manager's total gross revenues that result from the case management and other psychiatric service activities of Manager, Provider, and CMI. The then-current market rate for purposes of determining the purchase price upon exercising the warrant shall be the average closing price of the Common Stock of PMR on the principal exchange on which it trades (including for this purpose, NASDAQ) for the ten (10) trading days prior to the end of the Manager's fiscal year end of April 30 for the year of determination. The parties agree that Manager's pre-tax net income for purposes of these calculations shall not include the Manager's income from other sources or other activities nor the costs from such other activities or categories of cost not included in the Model. The determination of Manager's pre-tax net income shall be made within ninety (90) days of the end of each fiscal year of Manager in connection with the audit of Manager by Manager's independent certified public accountants. Notwithstanding anything to the contrary contained herein, Manager, Provider, and CMI agree that the maximum aggregate number of shares of Common Stock that may be purchased by Provider and CMI cumulatively pursuant to the Stock Warrant Agreements shall not exceed five hundred fifty thousand (550,000) shares of Common Stock. 11.2 Registration Rights. The Manager agrees to grant certain incidental registration rights to the Provider and CMI pursuant to which the Manager will, under those terms and conditions set forth in a Registration Rights Agreement, in substantially the form of Exhibit F hereto, cause the resale of the shares of Common Stock issued as consideration for the covenant not to compete pursuant to Section 9.1 of this Agreement and shares of Common Stock issuable upon exercise of the Stock Warrant Agreements issued pursuant to Section 11.1 of this Agreement, to be the subject of a Registration Statement filed with the SEC. Notwithstanding the foregoing, neither Manager nor PMR have any obligation to provide for or guarantee the resale of such stock. 11.3 Provider's Covenants Regarding Stock Transactions. The Provider recognizes and agrees that the Common Stock purchased pursuant to the Stock Warrant Agreement will be issued to Provider based upon Provider's representations and warranties contained herein and in the Stock Warrant Agreement, and Provider agrees to indemnify and hold PMR and Manager harmless against any misrepresentation, breach, or failure on its part to fulfill any covenants or agreements set forth in this Agreement or the Stock Warrant Agreement. Provider agrees to furnish any additional information reasonably requested by Manager or PMR to assure compliance with applicable federal and state securities laws in connection with the purchase and issuance of the shares of Common Stock. Provider agrees to notify Manager, PMR, and PMR's legal counsel, if there is any change in the status of Provider prior to the consummation of the purchase or issuance of shares of Common Stock to Provider pursuant to this Agreement and the Stock Warrant Agreement. Finally, Provider agrees to execute and deliver such documents as PMR and Manager may reasonably require in connection with the issuance of the Stock Warrant Agreement and the Common Stock to be purchased and transferred in connection with this Agreement and the Stock Warrant Agreement. The form and substance of all such documentation shall be approved by PMR and Provider. -32- 39 XII. ARBITRATION. In the event that a dispute arises with respect to this Agreement, then either party may request binding arbitration in order to resolve such dispute. In such event, the party requesting arbitration shall do so by giving notice to that effect to the other party, specifying in said notice, in reasonable detail, the nature of the dispute and designating one of the arbitrators. Within thirty (30) days after such notice is given, the other party shall designate one of the arbitrators by notice given to the party requesting arbitration. The determination of the two designated arbitrators shall be binding and conclusive upon the parties. However, if the two designated arbitrators shall fail to make such determination within thirty (30) days after both have been designated, then they shall select a third arbitrator. The determination of the majority of the three arbitrators shall be binding and conclusive on the parties. If a party shall fail or refuse to designate an arbitrator within the time period provided above, then such arbitrator shall be appointed by the application of the other party by the Middle Tennessee Chapter of the American Arbitration Association. If the two arbitrators designated as set forth above shall fail to make such determination within such thirty (30) day period, and shall fail to designate a third arbitrator within thirty (30) days thereafter, then such third arbitrator shall be appointed upon application of either party by the Middle Tennessee Chapter of the American Arbitration Association. Each party shall bear the expenses of the arbitrator appointed by such party or on behalf of such party. Expenses of the third arbitrator, if necessary, shall be shared equally by the parties. The decision in any such arbitration may be enforced, on the application of either party thereto, by the order or judgment of a court of competent jurisdiction sitting in Davidson County, Tennessee. Any arbitration will be conducted during the arbitration proceeding. In the event the parties cannot agree on rules to govern discovery, the arbitrators shall designate what, if any, discovery shall be authorized. The parties may, by agreement, jointly appoint one arbitrator to decide any dispute. In such event, the parties shall share the expense of the arbitrator. The prevailing party in any such arbitration conducted pursuant to this Agreement shall be entitled to recover from the losing party reasonable expenses, attorneys' fees, and costs incurred in connection therewith in the manner set forth in subparagraph 13.12 below. XIII. MISCELLANEOUS. 13.1 Service of Notices. All notices and other communications and all legal process in regard hereto shall be validly given or served if in writing and delivered personally or sent certified mail, postage prepaid, return receipt requested in the case notices to Manager, to the address set forth below or such address as either party may designate to the other in writing: -33- 40 If to Provider: Mental Health Cooperative, Inc. 275 Cumberland Bend Nashville, Tennessee 37228 Attention: Executive Director Phone number: (615) 726-3340 With a copy to: Boult Cummings Conners & Berry 414 Union Street, Suite 1600 Nashville, Tennessee 37219 Attention: Mr. E. Berry Holt, III Phone number: (615) 252-2312 If to Manager: Tennessee Mental Health Cooperative, Inc. 275 Cumberland Bend Nashville, Tennessee 37228 Attention: Mr. Allen Tepper Phone number: -------------------------------- With a copy to: PMR Corporation Cabillo Plaza 3990 Old Town Avenue, Suite 206A San Diego, California 92110 Attention: Mr Allen Tepper, President 13.2 Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their successors and permitted assigns. 13.3 Choice of Law. The validity, enforceability and interpretation of any of the clauses of this Agreement shall be determined and governed by the laws of the State of Tennessee. 13.4 Entire Agreement. This Agreement constitutes the entire agreement between the parties hereto with respect to the subject matter hereof and supersedes all prior and contemporaneous agreements, understanding, negotiations and discussions of the parties whether written or oral. 13.5 Amendments. No amendment, modification or supplement of any provision of this Agreement shall be effective unless in writing, signed by the parties hereto; and no -34- 41 waiver of any party's obligations under this Agreement, or consent to any departure therefrom, shall be effective unless in writing, signed by the parties hereto and then only in the specific instance and for the specific purpose given. 13.6 Severability. If any provision of this Agreement is held to be inoperative, unenforceable, or invalid under present or future laws effective during the Term of this Agreement, such shall be inoperative, unenforceable or invalid without affecting the remaining provisions. This Agreement shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part of this Agreement, and, to that end, the provisions of this Agreement are declared to be severable. Notwithstanding the foregoing, however, the parties agree to negotiate a modification of this Agreement pursuant to the provisions of subparagraph 13.5 in the event any provision of this Agreement is believed by a party in good faith to be invalid under applicable laws, rules, or regulations. 13.7 Number and Gender. Whenever the context of this Agreement requires, the singular shall include the plural and the masculine gender shall include the feminine. 13.8 Joint Negotiations. This Agreement is the product of negotiations between the parties and is not to be interpreted more strongly in favor of one party or the other in the interpretation or enforcement thereof. 13.9 Headings. Headings in this Agreement are included for convenience of reference only and are not part of this Agreement for any other purpose. 13.10 Assignment. Neither party shall assign, sell or transfer this Agreement or any interest herein without the prior written consent of the other party, which consent shall not be unreasonably withheld. In the event that the primary business and/or substantially all of the assets of Manager is transferred to an affiliate of Manager, Manager shall have the right to assign all of its rights under Agreement to any such affiliate during the Term of Agreement, and any such assignee/affiliate shall acquire all of the rights and assume all of the obligations of Manager under this Agreement. 13.11 Counterparts. This Agreement may be executed in counterparts and either party hereto may execute any counterpart, each of which, when executed and delivered, will be deemed to be an original, and all of which counterparts taken together will be deemed to be but one and the same instrument. The execution of this Agreement by any party hereto will not become effective until a counterpart hereof has been executed by each other party hereto. 13.12 Attorneys Fees. In the event of any litigation or arbitration concerning any controversy, claim, or dispute between the parties hereto, the prevailing party shall be entitled to recover from the losing party reasonable expenses, attorneys' fees, and costs incurred therein or in the enforcement or collection of any judgment or award rendered therein. The "prevailing party" means the party determined by the court or arbitrator to have most nearly prevailed, even if such party did not prevail in all matters, not necessarily -35- 42 the one in whose favor a judgment is rendered. Further, in the event of any default by a party under this Agreement, such defaulting party shall pay all the expenses and attorneys' fees incurred by the other party in connection with such default, whether or not any litigation or arbitration is commenced. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the Effective Date first written above. PROVIDER: MENTAL HEALTH COOPERATIVE, INC. By: /s/ PAM WOMACK ----------------------------------- Name: Pam Womack --------------------------------- Title: --------------------------------- By: /s/ WILLIAM F. MOYNIHAN ----------------------------------- Name: William F. Moynihan --------------------------------- Title: President of the Board --------------------------------- MANAGER: TENNESSEE MENTAL HEALTH COOPERATIVE, INC. By: /s/ ALLEN TEPPER ----------------------------------- Name: Allen Tepper --------------------------------- Title: --------------------------------- -36- 43 [EXHIBITS EXCLUDED] 44 10.17 ADDENDUM TO MANAGEMENT AND AFFILIATION AGREEMENT This ADDENDUM TO MANAGEMENT AND AFFILIATION AGREEMENT ("Addendum") is made this 25th day of August, 1995, by and between Mental Health Cooperative, Inc., a Tennessee not-profit corporation ("Provider"), and Tennessee Mental Health Cooperative, Inc., a Tennessee for-profit corporation ("Manager"). RECITALS A. Provider and Manager entered into a Management and Affiliation Agreement ("Agreement") and a Provider Services Agreement ("Services Agreement") as of April 13, 1995. B. Provider and Manager entered into the Agreement and Services Agreement in the anticipation of the expansion of the TennCare program to include the provision of certain covered services to patients who suffer from serious and persistent mental illness ("SPMI"). C. The expansion of the TennCare program to the SPMI patients has been delayed by the State of Tennessee but the parties hereto wish to implement the Agreement and Services Agreement as hereinafter provided. NOW, THEREFORE, Manager and Provider, intending to be legally bound hereby, agree as follows: AGREEMENT 1. Effective Date. The effective date of the Agreement and Services Agreement shall be September 1, 1995 ("Effective Date"). Section 1.1.1 of the Agreement entitled "Conditions Precedent" is hereby declared null and void and of no force and effect whatsoever. 2. Letter of Credit. Section 3.1 of the Agreement requires Manager to obtain an irrevocable letter of credit ("Letter of Credit") on or before the Effective Date of the Agreement. The parties hereto agree that the obligation to obtain the Letter of Credit shall be deferred until otherwise mutually agreed to by the parties. In lieu of the Letter of Credit, upon the Effective Date, PMR shall loan $500,000 to Manager for 1 year and shall provide a Line of Credit to Manager in the amount of $500,000. PMR shall secure the Line of Credit by maintaining $500,000 in cash or cash equivalents in its bank accounts or by having $500,000 available on PMR's Line of Credit from its banks or any combination thereof totaling $500,000. PMR's Line of Credit to Manager shall terminate on the latter of the first anniversary of the Agreement or the implementation of the expansion of the TennCare Program to SPMI patients. The $500,000 loan and $500,000 Line of Credit from PMR to Manager shall be available to pay Subcapitated Payments to Case Managers under paragraph 5.4.1 of the Agreement. 45 3. Other Case Managers. Section 2.2 of the Agreement allows Manager to contract with other Case Managers other than Provider so long as Provider gives its prior written approval. The parties hereto agree that such prior written approval shall only be needed for Case Managers providing services in the State of Tennessee and no such prior written approval shall be required for contracts which Manager enters into with Case Managers who provide services exclusively outside of the State of Tennessee. 4. Provider's Board Positions. Paragraph 4.2.1 (iii) of the Agreement is hereby amended to read, "Manager shall be permitted to designate two (2) additional members of the Provider's Board of Directors (not to exceed a total of three (3) directors, including the director to be designated under Paragraph 4.2.1(ii) hereof), which persons may or may not be employees or affiliates of Manager or PMR, provided, however, that Provider shall have the right to approve each designee, which approval shall not be unreasonably withheld by Provider." 5. Independent Annual Audit. Manager shall cause its financial records to be independently audited on an annual basis, the cost of which shall be paid for by Manager. 6. Case Management Network. Manager shall use its best efforts to create a network of entities to provide case management services, both inside and outside of the State of Tennessee, and to have these entities become Case Managers under the terms of the Agreement. 7. Effect of Addendum, Definitions. All other terms and conditions of the Agreement shall remain in full force and effect except as modified herein. The definitions of the Agreement shall apply to this Addendum. 7.1 Wherever in the Agreement the phrase "related psychiatric services" appears, it shall mean "other psychiatric services." 7.2 In Paragraph 5.1.3 of the Agreement, it is agreed that the "Capitated Payment" shall include payments received for other psychiatric services rendered by Provider. 8. Establishing Present Book Value for Old Asset Depreciation. Pursuant to Paragraph 5.1.6 of the Agreement, each Case Manager shall be paid certain amounts from the Capitated Payments and the Grants for depreciation of certain assets. Within twenty (20) days of the Effective Date, Case Manager shall submit to Manager a schedule of all assets eligible for payments for Old Asset Depreciation and the schedule shall include (1) the initial book value of each asset, (2) the dollar amount which each asset has been depreciated by Case Manager through the Effective Date and (3) the difference thereof, which is the present book value, shall be eligible for Old Asset Depreciation over the asset's remaining useful life as originally determined at the time of acquisition by Case Manager. 2 46 9. Quarterly Review of Financial Arrangements. The following shall be added as Paragraph 5.5.4 to the Agreement: "A breach of this Paragraph 5.5 shall be subject to Paragraph 1.3.9 hereof." SIGNATURES TO FOLLOW ON PAGE FOUR 3 47 IN WITNESS WHEREOF, the parties hereto have caused this Addendum to be executed on the day and year first written above. PROVIDER: MENTAL HEALTH COOPERATIVE, INC., a Tennessee not-profit corporation, By: /S/ PAM WOMACK Name: Pam Womack Title: Executive Director By: _______________________________ Name: ________________________ Title: _______________________ MANAGER: TENNESSEE MENTAL HEALTH COOPERATIVE, INC., a Tennessee for-profit corporation By: /S/ ALLEN TEPPER Name: Allen Tepper Title: _______________________ EX-10.15 18 EXHIBIT 10.15 1 EXHIBIT 10.15 PROVIDER SERVICES AGREEMENT BETWEEN TENNESSEE MENTAL HEALTH COOPERATIVE, INC. AND MENTAL HEALTH COOPERATIVE, INC. 2 TABLE OF CONTENTS
PAGE ---- ARTICLE I DEFINITIONS 1.1 Capitation................................................................. 2 1.2 Covered Persons............................................................ 2 1.3 Covered Services........................................................... 2 1.4 Emergency Care............................................................. 2 1.5 Health Professional........................................................ 2 1.6 Management Agreement....................................................... 2 1.7 Necessary.................................................................. 2 1.8 Participating Provider .................................................... 2 1.9 Payer...................................................................... 3 1.10 Payer Plan................................................................. 3 1.11 Payer Plan Agreements...................................................... 3 1.12 Preauthorization........................................................... 3 1.13 TennCare................................................................... 3 ARTICLE II PAYER PLAN AGREEMENTS 2.1 Contract Authority......................................................... 3 2.2 Agreement Compliance....................................................... 4 2.3 Policies................................................................... 4 2.4 Copies..................................................................... 4 ARTICLE III DUTIES AND OBLIGATIONS OF PROVIDER 3.1 Participation in Payer Plan................................................ 4 3.2 Cooperation with Utilization Management, Quality Improvement, and Other Managed Care Requirements........................... 4 3.3 Managed Care Efforts....................................................... 5 3.4 No Guarantee of Utilization................................................ 5 3.5 Referrals.................................................................. 5 3.6 Provider Services.......................................................... 5 3.7 Confidentiality............................................................ 5 3.7.1 Acknowledgment of Proprietary Interest......................... 5 3.7.2 Covenant Not to Divulge Trade Secrets.......................... 6 3.7.3 Return of Materials at Termination............................. 6 3.7.4 Application to Provider Representatives........................ 6 3.8 Reporting Changes of Provider Information.................................. 6 3.9 Changes in Services........................................................ 6 3.10 Notice of Lawsuit.......................................................... 6 3.11 Site Visits................................................................ 6 3.12 Preauthorization of Services............................................... 7 3.13 Emergency Services......................................................... 7
-i- 3 ARTICLE IV DUTIES AND OBLIGATIONS OF TMHC 4.1 General.................................................................... 7 4.2 Administrative Services.................................................... 7 4.3 Compensation............................................................... 7 4.4 Utilization Management and Quality Improvement............................. 7 4.5 Participating Payer List................................................... 7 4.6 Medical Records............................................................ 7 4.7 Marketing Materials........................................................ 7 4.8 Provider-Patient Relationship.............................................. 8 4.9 Verification of Coverage................................................... 8 4.10 Liaison.................................................................... 8 4.11 Reports.................................................................... 8 ARTICLE V REPRESENTATIONS AND WARRANTIES 5.1 Provider Representations and Warranties.................................... 8 5.1.1 Certifications................................................. 8 5.1.2 Corporate Capacity............................................. 8 5.1.3 Corporate Powers............................................... 8 5.2 TMHC Representations and Warranties........................................ 9 5.2.1 Corporate Capacity............................................. 9 5.2.2 Power and Authority............................................ 9 ARTICLE VI CAPITATED SERVICES AND COMPENSATION 6.1 Responsibility for Capitated Services...................................... 10 6.2 Accessibility of Services.................................................. 10 6.3 Employment of Health Professionals......................................... 10 6.4 Subcontracting Prohibited.................................................. 10 6.5 Disciplinary Action........................................................ 11 6.6 Identification of Covered Persons.......................................... 11 6.7 Calculation of Capitation.................................................. 11 6.8 Payment of Capitation...................................................... 11 6.9 Payment Adjustments........................................................ 12 6.10 Compensation of Provider Employees......................................... 12 6.11 No Additional Payments..................................................... 12 6.12 Hold Harmless.............................................................. 12 ARTICLE VII REGULATORY COMPLIANCE 7.1 Licenses................................................................... 12 7.2 Notice..................................................................... 12
-ii- 4 ARTICLE VIII QUALITY MANAGEMENT AND UTILIZATION REVIEW 8.1 Quality Management Program................................................. 13 8.2 Quality Studies............................................................ 13 8.3 Utilization Management..................................................... 13 8.4 Coordination of Programs................................................... 13 8.5 Data Reports............................................................... 13 ARTICLE IX MEDICAL RECORDS AND CONFIDENTIALITY 9.1 Maintenance of Medical Records............................................. 13 9.2 Transferability............................................................ 13 9.3 Access to Medical Records.................................................. 14 9.4 Confidentiality of Medical Records......................................... 14 ARTICLE X INDEPENDENT RELATIONSHIP 10.1 Status of Parties.......................................................... 14 10.2 Third Parties.............................................................. 14 ARTICLE XI INSURANCE AND INDEMNITY 11.1 No Liability............................................................... 14 11.2 Indemnification............................................................ 14 11.3 Insurance.................................................................. 15 ARTICLE XII COVERED PERSON COMPLAINTS AND GRIEVANCES ARTICLE XIII PARTICIPATION IN ALTERNATIVE HEALTH CARE PROGRAMS ARTICLE XIV TERM AND TERMINATION 14.1 Termination Date........................................................... 16 14.2 Termination by Agreement................................................... 16 14.3 Termination for Cause...................................................... 16 14.4 Adverse Effect Upon Tax-Exempt Status...................................... 17 14.5 Termination Due to Legislative or Administrative Changes................... 17 14.6 Continuation............................................................... 18 14.7 Post-Termination Matters................................................... 18 14.8 Other Remedies............................................................. 18 14.9 Avoidance of Termination................................................... 18
-iii- 5 ARTICLE XV ARBITRATION 15.1 Arbitration................................................................ 18 ARTICLE XVI MISCELLANEOUS 16.1 Exhibits................................................................... 19 16.2 Entire Agreement........................................................... 19 16.3 Modification of this Agreement............................................. 20 16.4 Assignment................................................................. 20 16.5 Notice..................................................................... 20 16.6 Attorneys Fees............................................................. 21 16.7 Severance of Invalid Provisions............................................ 21 16.8 Waiver..................................................................... 21 16.9 Captions................................................................... 21
EXHIBIT 1.3 - COVERED SERVICES -iv- 6 PROVIDER SERVICES AGREEMENT BETWEEN TENNESSEE MENTAL HEALTH COOPERATIVE, INC. AND MENTAL HEALTH COOPERATIVE, INC. THIS PROVIDER SERVICES AGREEMENT (the "Agreement") is made and entered into as of the 13th day of April, 1995 (the "Effective Date"), by and between TENNESSEE MENTAL HEALTH COOPERATIVE, INC., a Tennessee corporation (hereinafter referred to as "TMHC"), and MENTAL HEALTH COOPERATIVE, INC., a Tennessee nonprofit corporation (hereinafter referred to as "Provider"), which are collectively referred to hereinafter as "the Parties." W I T N E S S E T H WHEREAS, TMHC is organized for the primary purpose of developing and promoting a coordinated and cost effective program for the distribution and delivery of mental health care to the residents of Tennessee who suffer from serious and permanent mental illness ("SPMI") through contracts with providers; WHEREAS, TMHC and Provider will contract with managed care organizations, health maintenance organizations, and other payers to provide mental health services for SPMI individuals covered by the payers' health care plans; WHEREAS, TMHC desires to enter agreements with providers of case management and other mental health care services who will agree to (i) comply with the compensation and utiliza tion management mechanisms established by TMHC, (ii) participate in and comply with the protocols, policies, and procedures that may be adopted from time to time by TMHC and contracted payers, and (iii) join TMHC in its commitment to satisfy needs of individuals with SPMI in such provider's service area, through a cost-effective, case management system of mental health care services; WHEREAS, Provider is duly certified, licensed, and otherwise qualified to provide case management services in the State of Tennessee, whose licenses, certifications, and qualifications are without limitation or restriction, and who desires to provide services as described herein; and WHEREAS, Provider desires to enter into an agreement with TMHC to cooperate with TMHC in providing case management and other mental health care services to SPMI individuals covered by the contracted payers upon the terms and conditions set forth in this Agreement. NOW, THEREFORE, for and in consideration of the promises and mutual covenants herein contained and other good and valuable consideration, it is mutually agreed by and between the parties hereto as follows: 7 ARTICLE I DEFINITIONS 1.1 Capitation shall mean the compensation paid Provider by TMHC under this Agreement for providing or arranging for the provision of Covered Services. The term "Capitation" shall include capitated, case rate, and other payments. 1.2 Covered Persons shall mean those persons who are eligible to receive case management and other mental health care services pursuant to enrollment in a Payer Plan. 1.3 Covered Services shall mean the case management and other mental health care services described in Exhibit 1.3. 1.4 Emergency Care shall mean bona fide emergency services provided after the sudden onset of a condition manifesting itself by acute symptoms of sufficient severity, including severe pain, such that the absence of immediate medical, psychiatric, and case management attention could reasonably be expected to result in: 1.4.1 placing the person's health in serious jeopardy; 1.4.2 serious impairment to bodily functions; or 1.4.3 serious dysfunction of any bodily organ or part. 1.5 Health Professional means any physician, psychiatrist, psychologist, clinical social worker, case manager, licensed counselor, nurse, physician extender (e.g., nurse practitioner, physician assistant), or other allied health professional, who is an employee or independent contractor of Provider and provides certain Covered Services to Covered Persons pursuant to an agreement with Provider or a Payer. 1.6 Management Agreement shall mean that certain Management and Affiliation Agreement dated the date of this Agreement between TMHC and Provider, pursuant to which TMHC shall provide full management services for Provider. 1.7 Necessary services and/or supplies shall mean the use of services or supplies as provided by a Provider required to identify or treat a Covered Person's SPMI Condition and which, as determined by TMHC or Payer are: (1) consistent with the symptoms or diagnosis and treatment of SPMI patients; (2) appropriate with regard to standards of good mental health practice established by the organized community of mental health and case management providers; (3) not solely for convenience of such Covered Person, his or her physician, hospital, or another health care provider; and (4) the most appropriate supply or level of service needed to provide Covered Services to such Covered Persons. 1.8 Participating Provider shall mean a Health Professional that has entered into a written agreement with a Payer and/or Payer Plan to participate in a health care provider -2- 8 panel established by Payer and/or Payer Plan and to comply with the reimbursement mechanisms and utilization management procedures established by Payer and/or Payer Plan. 1.9 Payer shall mean any entity, including, but not limited to, health maintenance organizations and other managed care organizations, that has contracted with TMHC and/or Provider to obtain Covered Services for its enrollees and that is responsible for paying the cost of such Covered Services. 1.10 Payer Plan shall mean the health care programs established by any Payer that include the delivery of Covered Services to Covered Persons. 1.11 Payer Plan Agreements shall mean those certain agreements between (i) TMHC and/or Provider, and (ii) Payers that describe the terms and conditions for the provision of Covered Services to Covered Persons by TMHC and/or Provider in accordance with each Payer's Payer Plan. 1.12 Preauthorization shall mean the authorization granted to Provider by TMHC to provide specific Covered Services to a Covered Person. TMHC shall supply Provider with protocols that set forth those Covered Services for which Preauthorization must be obtained and the procedures for obtaining such Preauthorization. 1.13 TennCare shall mean the medical assistance program for individuals who are eligible for Medicaid or are uninsured that is administered by the State of Tennessee pursuant to section 1115(a) of the Social Security Act. ARTICLE II PAYER PLAN AGREEMENTS 2.1 Contract Authority. TMHC and Provider shall jointly develop contracts with Payers for the provision of Covered Services to Covered Persons (referred to herein as "Payer Plan Agreements") that are mutually acceptable to TMHC and Provider. If TMHC, Provider, and the applicable Payer determine that Provider will not directly execute a Payer Plan Agreement, then TMHC shall have the authority on behalf of Provider to execute, deliver, and amend those Payer Plan Agreements that have received the prior written approval of Provider. TMHC shall notify Provider not less than fourteen (14) days in advance of the effective date of any such Payer Plan Agreement and provide Provider with a summary of its terms and conditions. TMHC shall use its best efforts to ensure that the Payer Plan Agreements are assignable to the provider(s) of case management services. To the extent required by TMHC, Provider, or any Payer, Provider shall execute, deliver, and thereby become a direct party to any Payer Plan Agreement that is mutually acceptable to and has been approved by TMHC, Provider, and the Payer. If Provider executes a Payer Plan Agreement directly with a Payer, then Provider shall assign to TMHC the Capitation payments to be received from the Payer for distribution in accordance with Article V of the Management Agreement. -3- 9 If TMHC negotiates a Payer Plan Agreement with a Payer that has not been approved by Provider, TMHC shall notify Provider not less than sixty (60) days in advance of the effective date of any such proposed Payer Plan Agreement and provide Provider with a summary of the terms and conditions of such Payer Plan Agreement. Provider shall notify TMHC of Provider's acceptance or rejection of such Payer Plan Agreement on or before thirty (30) days after Provider's receipt of such summary materials. Rejection of such a proposed Payer Plan Agreement shall not terminate Provider's obligations under this Agreement with respect to Covered Services to be provided to Covered Persons of other Payers under Payer Plan Agreements previously or subsequently provided and/or executed by Provider. 2.2 Agreement Compliance. Provider agrees to comply with all operational and procedural rules and regulations promulgated by those Payers whose Payer Plan Agreements Provider has approved and/or executed pursuant to Section 2.1 hereto or that are otherwise applicable pursuant to regulations promulgated by the State of Tennessee. TMHC shall notify Provider in writing of any changes that such Payers or the State of Tennessee may make to such operational or procedural rules and regulations. 2.3 Policies. Provider agrees to be bound by all of the policies, rules, and regulations adopted by TMHC and/or Payer from time to time in connection with Payer Plans, as they relate to Payer Plan Agreements and this Agreement. TMHC or Payer shall notify Provider of such policies, rules, regulations, and amendments thereto. 2.4 Copies. Copies of TMHC and Payer policies, rules, and regulations and any other pertinent documents pertaining to the Payer Plan Agreements and related Payer Plans shall be provided to and be available for examination by Provider upon request. ARTICLE III DUTIES AND OBLIGATIONS OF PROVIDER 3.1 Participation in Payer Plan. Pursuant to Payer Plan Agreements executed by TMHC and/or Provider in accordance with Section 2.1 hereof, Provider shall participate in Payer Plans and shall provide or arrange for the provision of Covered Services to Covered Persons. Provider and Provider's staff and administrative personnel shall treat Covered Persons promptly, fairly, and courteously. TMHC and Provider shall portray each other in a positive light to Covered Persons and the public. Provider shall, consistent with the managed care, peer review, and quality assurance programs of TMHC and Payers, provide a level of care that is both Necessary and consistent with the quality of care established by TMHC protocols and guidelines. 3.2 Cooperation with Utilization Management, Quality Improvement, and Other Managed Care Requirements. Provider shall comply with the utilization management and quality improvement plan and managed care requirements, procedures, and protocols established by TMHC and/or Payer, including, but not limited to, Preauthorization of Covered Services, admissions for inpatient and outpatient hospital services, concurrent review and discharge planning of patients receiving Covered Services, prior authorization -4- 10 of referrals, claims review, peer review, and complaint resolution as TMHC or Payer may from time to time notify Provider. 3.3 Managed Care Efforts. Provider shall utilize managed care methods and practices consistent with sound medical and case management practice as determined in accordance with accepted community professional standards for rendering quality care. Provider shall abide by the procedures and criteria adopted by TMHC and Payer to monitor the necessity and quality of Covered Services provided to Covered Persons and cooperate fully with TMHC and Payer in the development of appropriate approaches to managed care consistent with sound medical practice. 3.4 No Guarantee of Utilization. Provider acknowledges that TMHC does not warrant or guarantee that Provider shall be utilized by a Covered Person or any number of Covered Persons within any Payer Plan. 3.5 Referrals. Consistent with the direction and Preauthorization by TMHC and with sound medical practice and in accordance with accepted community professional standards for rendering quality medical care and case management services, Provider shall use Provider's best effort to make referrals of Covered Persons to other Participating Providers in the Payer Plans. TMHC shall provide a list of Participating Providers to Provider. 3.6 Provider Services. Provider shall provide Covered Services to Covered Persons in accordance with the terms set forth in this Agreement, the applicable Payer Plan Agreement, and in the same manner, in accordance with the same standards, and within the same time availability as provided to any of Provider's patients that are not Covered Persons. Provider shall not refuse to accept any Covered Person as a patient on the basis of race, color, religion, sex, national origin, Payer Plan, health status, or medical condition of such patient, except with the prior approval of TMHC. Provider shall assist TMHC in monitoring accessibility to care for Covered Persons, including scheduling of appointments and waiting times. Provider shall provide only those Covered Services that are Necessary. 3.7 Confidentiality. 3.7.1 Acknowledgment of Proprietary Interest. Provider recognizes the proprietary interest of TMHC in any Trade Secrets of TMHC. As used herein, the term "Trade Secrets" includes all of TMHC's confidential or proprietary information, including without limitation any confidential information of TMHC encompassed in any reports, protocols, plans, proposals, codes, marketing and sales programs, financial projections, cost summaries, pricing formulae, client contracts, client lists, and all concepts, ideas, materials, or information related to the business of TMHC or TMHC's clients that have not previously been released to the public at large by duly authorized representatives of TMHC, whether or not such information would be protectable as a trade secret or the copying of which would be enjoined or restrained by a court as constituting unfair competition. Provider acknowledges and agrees that any and all Trade Secrets of TMHC learned by Provider during the -5- 11 course of its engagement by TMHC or otherwise, whether developed by TMHC alone or in conjunction with others, shall be and are the property of TMHC. 3.7.2 Covenant Not to Divulge Trade Secrets. Provider acknowledges and agrees that TMHC is entitled to prevent the disclosure of Trade Secrets of TMHC. As a portion of the consideration for the continuing engagement of Provider hereunder and for the compensation being paid to Provider by TMHC, Provider agrees at all times during the term of said engagement by TMHC, and thereafter, to hold said Trade Secrets in strictest confidence and not to disclose same or allow them to be disclosed to any person, firm, or corporation, other than to persons engaged by TMHC to further the business of TMHC, and not to use the same, except in the pursuit of the business of TMHC, without the prior written consent of TMHC. 3.7.3 Return of Materials at Termination. In the event of any termination of this Agreement, with or without cause, Provider shall promptly deliver to TMHC all materials, property, documents, data, and other information belonging to TMHC or pertaining to Trade Secrets. Provider shall not take any materials, property, documents, or other information or any reproduction or excerpt thereof, belonging to TMHC or containing or pertaining to Trade Secrets. 3.7.4 Application to Provider Representatives. This Section 3.7 shall apply to Provider and any director, officer, employee, independent contractor, or agent of Provider and shall survive the termination of this Agreement. 3.8 Reporting Changes of Provider Information. Provider shall use Provider's best efforts to notify TMHC in writing, at least thirty (30) calendar days prior to any change in Provider's business address, business telephone number, office hours, tax identification number, malpractice insurance carrier or coverage, State of Tennessee license number, or any DEA registration number. 3.9 Changes in Services. If Provider must involuntarily limit or discontinue any Covered Services, it will provide TMHC with written notice as soon as possible upon Provider's learning of the limitation or discontinuation. 3.10 Notice of Lawsuit. Provider agrees to notify TMHC of any suits or claims filed against Provider by or relating to a Payer or a Covered Person, within five working days of Provider's receipt of notice of such claim having been filed or such action having been brought. Provider shall provide TMHC with any information regarding such claims or actions reasonably requested by TMHC, subject to the law regarding confidentiality of patient records, and not including any information that would otherwise be privileged under law. 3.11 Site Visits. Provider shall permit TMHC or Payer to conduct on-site inspections of Provider's facilities to review the site and Provider's record keeping practices in order to ensure conformance with standards of TMHC or Payer. -6- 12 3.12 Preauthorization of Services. For all non-Emergency Services for which verification of eligibility or Preauthorization is required, Provider shall secure TMHC's authorization before providing Covered Services pursuant to the requirements set forth in TMHC protocols, this Agreement and the Payer Plan Agreements. If Preauthorization cannot be obtained due to a holiday, weekend, or after hours, Provider agrees to notify TMHC the first working day after rendering the Covered Services. 3.13 Emergency Services. Provider shall use its best efforts to notify TMHC within 48 hours of providing Emergency Services or providing Covered Services to a Covered Person with an emergency. Provider shall provide Emergency Services when Necessary and shall not be required to first obtain Preauthorization from TMHC. ARTICLE IV DUTIES AND OBLIGATIONS OF TMHC 4.1 General. TMHC shall develop, execute, and deliver Payer Plan Agreements with Payers that meet the requirements of Section 2.1. Pursuant to such Payer Plan Agreements, Provider shall provide or arrange for the provision of Covered Services to Covered Persons. TMHC shall furnish Provider with a written summary of the terms and conditions of each proposed Payer Plan Agreement. The summaries of all Payer Plan Agreements approved and/or executed by Provider pursuant to Section 2.1 shall become appendices to this Agreement. 4.2 Administrative Services. TMHC shall perform the administrative, claims processing, marketing, advertising, member services, quality management, and utilization management services as described more fully in the Management Agreement. 4.3 Compensation. TMHC shall compensate Provider for Covered Services, in accordance with the provisions of Article VI. 4.4 Utilization Management and Quality Improvement. TMHC shall provide Provider with written information concerning utilization management, quality improvement, and complaint resolution plans administered by TMHC or a Payer and any modifications thereto. 4.5 Participating Payer List. TMHC shall provide Provider with a current list of Payers who have executed Payer Plan Agreements under which Provider is obligated to provide Covered Services to Covered Persons and periodically shall update such list. 4.6 Medical Records. TMHC shall, and shall seek Payer's agreement to, maintain any medical records to which it or Payer has access under this Agreement in confidence and in accordance with applicable law. 4.7 Marketing Materials. TMHC shall arrange for Payers to list Provider as a Participating Provider in the specialty area(s) designated by Provider in marketing and -7- 13 informational materials developed and distributed by those Payers whose contracts Provider has approved and/or executed pursuant to Section 2.1. 4.8 Provider-Patient Relationship. TMHC shall not intervene in any way or manner with the rendition of services by Provider, it being understood and agreed that the traditional relationship between mental health care provider and patient shall be maintained. 4.9 Verification of Coverage. TMHC shall provide Provider adequate and timely verification of eligibility of Covered Persons and Preauthorization of Covered Services to be provided to Covered Persons. In order that Provider may verify coverage for particular Covered Persons, TMHC shall establish a system for verification and Preauthorization. 4.10 Liaison. TMHC shall maintain continuing liaison and close cooperation between TMHC, Provider, and Payers. 4.11 Reports. TMHC shall provide Provider with utilization reports that it prepares in relation to Provider and Covered Persons that have utilized Provider pursuant to this Agreement in order that Provider may better manage the cost of services utilized by Covered Persons. ARTICLE V REPRESENTATIONS AND WARRANTIES 5.1 Provider Representations and Warranties. 5.1.1 Certifications. Provider represents and warrants that it has all certifications, licenses, permits, and other qualifications required by federal and state law to operate its facilities and provide Covered Services, and all certifications and accreditations necessary for Provider to participate as a provider of services in TennCare. 5.1.2 Corporate Capacity. Provider represents and warrants that it is a Tennessee non-profit corporation validly existing in good standing under the laws of the State of Tennessee. Provider has the requisite power and authority to enter into this Agreement, to perform its obligations hereunder, and to conduct its businesses as now being conducted. Provider is duly authorized, qualified, and licensed under all applicable laws, regulations, ordinances, and orders of governmental authorities having jurisdiction to own its properties and conduct its business in the place and in the manner now conducted. 5.1.3 Corporate Powers. Provider represents and warrants that the execution, delivery, and performance of this Agreement by Provider and the consummation of the transactions contemplated herein by Provider: -8- 14 (1) are within Provider's corporate powers and the terms of Provider's Charter or Articles of Incorporation, Bylaws or any amendments thereto, and have been duly and properly authorized by all appropriate corporate action; (2) to the best of Provider's knowledge, will neither conflict with nor result in any breach or contravention of, nor permit the acceleration of the maturity of, or the creation of any lien under, any indenture, mortgage, agreement, lease, contract, instrument, or understanding to which Provider is a party or by which Provider is bound, including without limitation the Basic Grants from the Tennessee Department of Mental Health and Mental Retardation; (3) will not violate any judgment, decree, order, writ, or injunction of any court or governmental authority to which Provider may be subject; and (4) are and will constitute the valid and legally binding obligation of Provider, enforceable in accordance with the terms of this Agreement, except as enforceability may be restricted, limited, or delayed by applicable bankruptcy or other laws affecting creditors' rights generally and except as enforceability may be subject to general principles of equity. 5.2 TMHC Representations and Warranties. 5.2.1 Corporate Capacity. TMHC represents and warrants that it is a Tennessee corporation validly existing in good standing under the laws of the State of Tennessee. TMHC has the requisite power and authority to enter into this Agreement, to perform its obligations thereunder, and to conduct its businesses as now being conducted. TMHC is duly authorized, qualified, and licensed under all applicable laws, regulations, ordinances, and orders of governmental authorities having jurisdiction to own its properties and conduct its business in the place and in the manner now conducted. 5.2.2 Power and Authority. TMHC represents and warrants that the execution, delivery, and performance of this Agreement by TMHC and the consummation of the transactions contemplated herein by TMHC: (1) are within TMHC's corporate powers and the terms of TMHC's Charter or Articles of Incorporation, Bylaws or any amendments thereto, and have been duly and properly authorized by all appropriate corporate action; -9- 15 (2) to the best of TMHC's knowledge, will neither conflict with nor result in any breach or contravention of, nor permit the acceleration of the maturity of, or the creation of any lien under, any indenture, mortgage, agreement, lease, contract, instrument, or understanding to which TMHC is a party or by which TMHC is bound; (3) will not violate any judgment, decree, order, writ, or injunction of any court or governmental authority to which TMHC may be subject; and (4) are and will constitute the valid and legally binding obligation of TMHC, enforceable in accordance with the terms of this Agreement, except as enforceability may be restricted, limited, or delayed by applicable bankruptcy or other laws affecting creditors' rights generally and except as enforceability may be subject to general principles of equity. ARTICLE VI CAPITATED SERVICES AND COMPENSATION 6.1 Responsibility for Capitated Services. Subject to verification of eligibility, Preauthorization, and applicable utilization management procedures, it is agreed by the parties hereto that all Covered Services required by Covered Persons pursuant to a Payer Plan Agreement are to be provided by Provider. Provider shall be responsible for the total costs of Covered Services when they are provided to Covered Persons for whom Provider is entitled to a Capitation payment. 6.2 Accessibility of Services. Provider shall make readily available and accessible Covered Services to Covered Persons at the locations designated by TMHC in accordance with the Management Agreement during normal business hours, and Provider shall be reasonably available to provide Covered Services after hours. Emergency Services shall be available on a twenty-four hours a day/seven days a week basis. 6.3 Employment of Health Professionals. Provider shall employ or contract with such employees, Health Professionals, and suppliers as shall be necessary to provide Covered Services to Covered Persons. Provider shall be responsible for paying employees, Health Professionals, and suppliers for Covered Services rendered. TMHC shall assist Provider in the recruitment, retention, and evaluation of such employees, Health Professionals, and suppliers in accordance with the Management Agreement. 6.4 Subcontracting Prohibited. Provider shall not contract or subcontract with other case management or psychiatric service organizations for the provision of Covered Services to Covered Persons pursuant to a Payer Plan, except with the prior written consent of TMHC which consent shall not unreasonably be withheld. -10- 16 6.5 Disciplinary Action. In the event an employee, Health Professional, or supplier fails to comply with the applicable provisions of this Agreement, TMHC shall so notify Provider. Provider shall use its best efforts to bring such individual or supplier into compliance with the applicable provisions of the Agreement. Provider agrees to reassign such individual or supplier from the activities pursuant to this Agreement or terminate such employment or arrangement in the event that such individual or supplier fails to comply with the applicable provisions of this Agreement within thirty (30) days of Provider providing such individual or supplier with notice of noncompliance. 6.6 Identification of Covered Persons. In order to identify Covered Persons and determine compensation under this Agreement, TMHC shall provide Provider with the following information regarding Covered Persons within two (2) days after receipt from the applicable Payer: (a) the names of the Covered Persons who are currently enrolled in a Payer Plan; (b) the names of Covered Persons who have terminated their enrollment in a Payer Plan and the effective date of such termination; (c) the Capitation rates payable to Provider for Covered Persons who are enrolled in a Payer Plan; (d) the names of new Covered Persons and copies of their enrollment forms; and (e) all other necessary and pertinent information regarding Covered Persons for whom Provider is responsible for providing Covered Services. For the purpose of calculating Capitation payments due under this Agreement, the number of Covered Persons will be determined when the necessary information is received from the applicable Payers. 6.7 Calculation of Capitation. Each month, TMHC shall pay a Capitation payment as payment in full for Covered Services to be provided or made available to Covered Persons who are eligible to receive Covered Services during such month. Capitation payments shall be calculated as set forth in Article V of the Management Agreement and Exhibit G thereto. 6.8 Payment of Capitation. Provided that the parties have given the remittance clearinghouse the appropriate instructions for such payments in the manner set forth in Article V of the Management Agreement, Capitation payments shall be made no later than two (2) days after receipt of the capitated or other payments from the Payer for each month during the term hereof in which the Provider provides or arranges for the provision of Covered Services for Covered Persons who are eligible to receive such Covered Services during such month. TMHC, however, may vary the time of payment in accordance with the terms of a particular Payer Plan. -11- 17 6.9 Payment Adjustments. TMHC shall make retroactive Capitation payment adjustments for Covered Persons found either to be eligible (additions) or not to be eligible (deletions) to receive Covered Services during the month to which the adjustments apply. Such adjustments shall be made in accordance with the applicable Payer Plan Agreement. Retroactive Capitation payment adjustments for deletions will not exceed ninety (90) days. Provider shall be responsible for seeking payment for services rendered directly from persons determined retroactively to be ineligible for Covered Services. 6.10 Compensation of Provider Employees. Provider shall be responsible for compensating and shall compensate its Health Professionals and suppliers for Covered Services rendered to Covered Persons, regardless of whether the Capitation payments made hereunder are sufficient for such purposes. Notwithstanding any other provision of this Agreement, should Provider not pay its Health Professionals, or suppliers in a timely manner for Covered Services rendered, TMHC may, after conferring with Provider, make such payments and withhold such amounts paid from Provider's monthly Capitation payment. 6.11 No Additional Payments. Provider agrees to accept the monthly Capitation payment from TMHC as payment in full for Covered Services rendered and not to seek additional payments or compensation from Covered Persons regardless of whether or not payment is received from TMHC. 6.12 Hold Harmless. Provider agrees that in no event, including, but not limited to nonpayment by TMHC or TMHC's breach of this Agreement, shall any Covered Person be liable for any sums owed by TMHC, and neither Provider, nor its agents or trustees (including TMHC pursuant to the Management Agreement), shall bill, charge, collect a deposit or other sum, or seek compensation, remuneration, reimbursement from or maintain any action at law or have any other recourse against, or make any surcharge upon, a Covered Person or other person acting on a Covered Person's behalf to collect sums owed by TMHC. The obligations set forth in this Section 6.12 shall survive termination of this Agreement regardless of the cause giving rise to such termination and shall be construed to the benefit of Covered Persons, and the provisions of this Section 6.12 shall supersede any oral or written agreement to the contrary now existing or hereafter entered into between Provider and TMHC or any persons acting on their behalf. ARTICLE VII REGULATORY COMPLIANCE 7.1 Licenses. Provider agrees that it shall maintain all Licenses required by state or federal law to operate Provider's facilities and provide Covered Services, and all certifications and accreditations necessary for Provider to participate as a provider of services in TennCare. 7.2 Notice. Provider agrees to notify TMHC promptly in the event that any action is taken against any such certifications, licenses, permits, or accreditations required by state or federal law to operate Provider's facilities or to provide Covered Services and -12- 18 all certifications and accreditations necessary for Provider to participate as a provider of services in TennCare. ARTICLE VIII QUALITY MANAGEMENT AND UTILIZATION REVIEW 8.1 Quality Management Program. Provider shall abide by and comply with the requirements of and participate in TMHC's quality management program for services provided to Covered Persons. TMHC shall provide Provider with copies of the applicable quality management program documents and instructions. 8.2 Quality Studies. Provider shall participate in quality management studies conducted by TMHC and Provider regarding any procedure or problem identified by TMHC's quality management program. 8.3 Utilization Management. Provider agrees to comply with the requirements of and participate in TMHC's utilization review program. The express purpose of the TMHC's utilization review program shall be to ensure the delivery of Necessary services. TMHC shall provide Provider with copies of the applicable utilization review program documents and instructions. 8.4 Coordination of Programs. Provider shall coordinate its utilization review activities with TMHC's utilization review program instituted in accordance with the Management Agreement. 8.5 Data Reports. Provider agrees to provide TMHC with all encounter data with regard to Covered Services provided to Covered Persons, including utilization and cost data required to meet governmental regulatory requirements, and such other data as may be reasonably requested by TMHC. ARTICLE IX MEDICAL RECORDS AND CONFIDENTIALITY 9.1 Maintenance of Medical Records. Provider shall maintain, with respect to each Covered Person receiving Covered Services, a medical record in such form and containing such information as may be required by the laws, rules, and regulations of the State of Tennessee. Provider shall maintain for at least five (5) years after the date of delivery of services, and readily make available to TMHC, applicable Payers, and governmental agencies with regulatory authority, medical and all related administrative records of Covered Persons that receive Covered Services, as required by TMHC in accordance with this Agreement or pursuant to applicable law. 9.2 Transferability. Provider agrees, upon request of a Covered Person or such person's Participating Provider, subject to applicable disclosure and confidentiality laws, to transfer the medical records of the Covered Person to such primary Participating Provider. This Section shall survive the termination or expiration of this Agreement. -13- 19 9.3 Access to Medical Records. Provider shall provide TMHC with all records necessary to carry out TMHC's utilization management and quality improvement programs. Subject to applicable disclosure and confidentiality laws, Provider shall upon request, permit TMHC, each applicable Payer, or any duly designated third party to inspect and make copies of medical records, books, and other records of Provider relating to Covered Services provided to Covered Persons and the cost thereof during the term of this Agreement and thereafter for a period of time in conformance with state and federal law. TMHC and each applicable Payer shall be entitled to obtain copies of Covered Persons' medical records. The provisions of this paragraph shall not waive or limit any restriction on release or disclosure of patient records established in any other provision of this Agreement or as otherwise required by state or federal law. 9.4 Confidentiality of Medical Records. Provider agrees that information concerning Covered Persons shall be kept confidential and shall not be disclosed to any person except as authorized by Tennessee and federal law. This confidentiality provision shall remain in effect notwithstanding any subsequent termination or expiration of this Agreement. ARTICLE X INDEPENDENT RELATIONSHIP 10.1 Status of Parties. None of the provisions of this Agreement are intended to create nor shall be deemed or construed to create any relationship between TMHC and Provider other than that of independent entities contracting with each other hereunder solely for the purpose of effecting the provisions of this Agreement. Neither of the Parties, nor any of their respective officers, directors, or employees, shall be construed to be the agent, employee, or representative of the other, except to the extent specifically provided herein or in the Management Agreement. Neither party is authorized to represent the other for any purpose whatsoever without the prior consent of the other except as specifically provided in Articles II and IV hereof. 10.2 Third Parties. This Agreement shall not create, nor be deemed or construed to create, any rights in any third party, including any Payer or Covered Person. ARTICLE XI INSURANCE AND INDEMNITY 11.1 No Liability. Neither TMHC nor Provider, nor any of their respective officers, directors, agents, employees, or independent contractors, shall be liable to third parties for any act or omission of the other party or its respective officers, directors, agents, employees, or independent contractors. 11.2 Indemnification. Provider agrees to indemnify and hold harmless TMHC and TMHC's directors, officers, employees, independent contractors, and agents from and against any and all claims, demands, causes of action, costs, and liabilities (including, without limitation, reasonable attorneys' fees), caused by, resulting from, or attributable to -14- 20 the grossly negligent or intentional acts or omissions of the Provider and/or the Provider's directors, officers, employees, independent contractors, and agents with respect to the duties and obligations imposed on the Provider hereunder. TMHC agrees to indemnify and hold harmless Provider and Provider's directors, officers, employees, independent contractors, and agents from and against any and all claims, demands, causes of action, costs, and liabilities (including, without limitation, reasonable attorneys' fees), caused by, resulting from, or attributable to the grossly negligent or intentional acts or omissions of TMHC and/or TMHC's directors, officers, employees, independent contractors, and agents with respect to the duties and obligations imposed on TMHC hereunder. 11.3 Insurance. During the term of this Agreement, Provider agrees to maintain at its sole cost and expense, such policies of general and professional liability insurance coverage in amounts set forth in the Management Agreement, as shall be necessary to insure Provider and TMHC or named insured against any claim for damages arising in connection with Provider's responsibilities under this Agreement. Provider shall furnish TMHC with copies of such insurance policies and copies of all amendments and renewals to such policies so long as this Agreement is in effect. Provider also shall furnish TMHC with certificates reflecting such coverage and shall provide TMHC with prior written notice of the cancellation or proposed cancellation thereof for any cause. ARTICLE XII COVERED PERSON COMPLAINTS AND GRIEVANCES Notification. Provider shall notify TMHC of any complaints received by Provider with regard to Covered Services rendered by Provider within five (5) days of receipt of such complaint. Provider shall cooperate with TMHC in the investigation and resolution of any complaint under the protocols and procedures established by TMHC for resolution of such complaints. ARTICLE XIII PARTICIPATION IN ALTERNATIVE HEALTH CARE PROGRAMS Provider shall be precluded from participating in or contracting with any other Payer, health care provider organization, health maintenance organization, managed care organization, insurer, or otherwise to provide Covered Services in the State of Tennessee in accordance with the Provider's covenant not to compete that is contained in Section 9.1 of the Management Agreement. -15- 21 ARTICLE XIV TERM AND TERMINATION 14.1 Termination Date. This Agreement shall have an initial term that shall expire on the sixth (6th) anniversary of the Effective Date (the "Termination Date"). Unless terminated in accordance with the terms of this Agreement, this Agreement shall automatically renew for successive one (1) year terms thereafter. If either party intends not to renew the Agreement, the party must give the other party at least sixty (60) days' prior written notice of such intent not to renew. 14.2 Termination by Agreement. In the event Provider and TMHC shall mutually agree in writing, this Agreement may be terminated on the date specified in such written agreement. 14.3 Termination for Cause. Either party shall have the right, but not the obligation, to terminate this Agreement at any time for cause by giving written notice to the other party of such intent to terminate the Agreement. Cause for termination includes, but is not limited to: 14.3.1 the material breach of any of the representations and warranties set forth in Article V; 14.3.2 the failure of Provider to provide Covered Services pursuant to the terms of the Agreement and any Payer Plan Agreement; 14.3.3 the disciplining, loss of license, or loss of certification, accreditation, or qualification by any licensing, regulatory, or professional organization or agency with jurisdiction over Provider; 14.3.4 the commission or omission of any act or conduct by Provider that is detrimental to a Covered Person's health or safety; 14.3.5 the failure of Provider to maintain the required liability insurance coverage protection; 14.3.6 a finding by any licensing, regulatory, or professional organization having jurisdiction over the subject matter of this Agreement that the Agreement violates any state or federal law; 14.3.7 any change in federal or state law that causes this Agreement to be in violation of any federal or state law or regulation; 14.3.8 the habitual neglect or continued failure of either party to perform its duties and obligations under the Agreement; -16- 22 14.3.9 the initiation of bankruptcy, insolvency, dissolution, liquidation, or receivership proceedings by or against either party; 14.3.10 an admission by either party in writing that it is unable to pay its debts as they mature or the making by either party of a general assignment for the benefit of creditors; 14.3.11 the breach of any other material provision of this Agreement by either party if after sixty (60) days' written notice setting forth the details of the breach and the intent to terminate is given by the terminating party and the breach is not cured by the breaching party during such time period, unless such breach cannot reasonably be cured within such sixty (60) day period and the breaching party has begun to cure such breach during such sixty (60) day period and diligently pursues such remedial action until such breach is cured; 14.3.12 the material breach of the Management Agreement, the Stock Warrant Agreement or the Registration Rights Agreement of even date herewith between Provider and TMHC; or 14.3.13 the termination of the Management Agreement for any reason. 14.4 Adverse Effect Upon Tax-Exempt Status. In the event that (i) it is ever determined that any of the transactions contemplated by this Agreement shall have a material adverse effect upon the Provider's non-profit status under state law or Provider's tax-exempt status under IRC Section 501(c)(3), and (ii) an opinion letter stating such conclusion is delivered to the parties by legal counsel having recognized expertise in such matters, then both parties agree to negotiate in good faith to amend the Agreement to conform with the then-existing laws and regulations regarding such non-profit and tax-exempt status. If agreement cannot be reached with respect to such amendments within ninety (90) days of notice from Provider (including delivery of the above-referenced legal opinion) of such determination that the Agreement has an adverse effect upon Provider's non-profit or tax-exempt status (or such earlier time required by law), then this Agreement may be immediately terminated by Provider by written notice to Manager. 14.5 Termination Due to Legislative or Administrative Changes. In the event that there shall be a change in the statutes, regulations, or instructions relating to the Tennessee Medicaid or TennCare programs, the adoption of any new legislation or regulations applicable to this Agreement, a change in any applicable third party payer reimbursement system (including, without limitation, those of the Payers and the Payer Plan Agreements), or the initiation of an enforcement action with respect to legislation, regulations, or instructions applicable to this Agreement, any of which affects the continuing viability or legality of this Agreement or materially affects the compensation that Provider and TMHC will receive under the Management Agreement, then both parties agree to negotiate in good faith to amend the Agreement to conform with the then-existing laws and regulations. If agreement cannot be reached with respect to such amendments within -17- 23 ninety (90) days of such change, adoption, or enforcement (or such earlier time as may be required by such legislation or regulations), this Agreement may be terminated immediately by either party by written notice to the other party. 14.6 Continuation. If, upon termination of the Agreement by TMHC, Provider is obligated under any Payer Plan Agreement to provide Covered Services extending beyond the termination date of the Agreement, at TMHC's request, Provider shall continue to provide Covered Services to Covered Persons under the terms and conditions the Payer Plan Agreements in effect as of the termination date of this Agreement until the renewal date of such Payer Plan Agreements. Provider shall continue to provide Covered Services under such circumstances at the Capitation rates then in effect. Provider shall continue to provide Covered Services to Covered Persons under the care of Provider after the date a Payer Plan Agreement renews until such time as TMHC makes appropriate provision for assumption of such services by another provider. Provider shall provide such continuous services at the Capitation rates then in effect, and TMHC or the applicable Payers shall pay Provider for such services at the Capitation rate then in effect. 14.7 Post-Termination Matters. Notwithstanding termination of this Agreement, TMHC and Payer shall continue to have access to the records maintained by Provider in accordance with Article IX above for a period of three (3) years from the date of the provision of the Covered Services to Covered Persons to which the records refer for purposes consistent with their rights, duties, and obligations under this Agreement and any Payer Agreement. After the effective date of termination, this Agreement shall be deemed to remain in effect for the resolution of all matters unresolved at that date. Termination of this Agreement shall not effect the rights, obligations, and liabilities of the parties arising out of the transactions occurring prior to termination. 14.8 Other Remedies. Nothing contained herein shall be construed to limit either party's lawful remedies in the event of a material breach of this Agreement. 14.9 Avoidance of Termination. TMHC and Provider agree to use their best efforts promptly to give the other party notice of any breach of this Agreement and any other problem related to this Agreement that could lead to a termination of this Agreement. Within five (5) days of receipt of such notice, representatives of TMHC and Provider shall meet and use their best efforts to negotiate a solution to the problem with respect to which such notice was sent. Such good faith negotiations shall particularly be required with reference to notices given pursuant to Sections 14.2.12, 14.3, 14.4 and 14.5 above. Notwithstanding such meeting, the time period for termination of this Agreement as set forth in this Article XIV shall remain in effect unless otherwise agreed in writing. ARTICLE XV ARBITRATION 15.1 Arbitration. In the event that a dispute arises with respect to this Agreement, then either party may request binding arbitration in order to resolve such dispute. In such event, the party requesting arbitration shall do so by giving notice to that -18- 24 effect to the other party, specifying in said notice, in reasonable detail, the nature of the dispute and designating one of the arbitrators. Within thirty (30) days after such notice is given, the other party shall designate one of the arbitrators by notice given to the party requesting arbitration. The determination of the two designated arbitrators shall be binding and conclusive upon the parties. However, if the two designated arbitrators shall fail to make such determination within thirty (30) days after both have been designated, then they shall select a third arbitrator. The determination of the majority of the three arbitrators shall be binding and conclusive on the parties. If a party shall fail or refuse to designate an arbitrator within the time period provided above, then such arbitrator shall be appointed by the application of the other party by the Middle Tennessee Chapter of the American Arbitration Association. If the two arbitrators designated as set forth above shall fail to make such determination within such thirty (30) day period, and shall fail to designate a third arbitrator within thirty (30) days thereafter, then such third arbitrator shall be appointed upon application of either party by the Middle Tennessee Chapter of the American Arbitration Association. Each party shall bear the expenses of the arbitrator appointed by such party or on behalf of such party. Expenses of the third arbitrator, if necessary, shall be shared equally by the parties. The decision in any such arbitration may be enforced, on the application of either party thereto, by the order or judgment of a court of competent jurisdiction sitting in Davidson County, Tennessee. Any arbitration will be conducted during the arbitration proceeding. In the event the parties cannot agree on rules to govern discovery, the arbitrators shall designate what, if any, discovery shall be authorized. The parties may, by agreement, jointly appoint one arbitrator to decide any dispute. In such event, the parties shall share the expense of the arbitrator. The prevailing party in any such arbitration conducted pursuant to this Agreement shall be entitled to recover from the losing party reasonable expenses, attorneys' fees, and costs incurred in connection therewith in the manner set forth in subparagraph 16.6 below. ARTICLE XVI MISCELLANEOUS 16.1 Exhibits. All Exhibits and attachments referenced in this Agreement and attached hereto are incorporated herein by reference. 16.2 Entire Agreement. Except for the Management Agreement and Stock Warrant Agreement of even date herewith, this Agreement supersedes all previous agreements, promises, negotiations, or representations, between the parties, whether oral or written, and this Agreement constitutes the entire agreement regarding the subject matter hereof existing between the parties. No party shall be entitled to benefits other than those specified herein and in the Management Agreement and the Stock Warrant Agreement. As between or among the parties, no oral statements or prior written material not specifically incorporated herein shall be of any force and effect. The parties specifically acknowledge that in entering into and executing this Agreement, the parties rely solely upon the representation and agreements contained in this Agreement and in the Management Agreement and the Stock Warrant Agreement and no others. All prior representations or agreements, whether written or verbal, not expressly incorporated or referenced herein are -19- 25 superseded and no changes in or additions to this Agreement shall be recognized unless and until made in accordance with Section 17.4 below. 16.3 Modification of this Agreement. This Agreement may be amended or modified as mutually agreed by the parties in writing signed by both parties. 16.4 Assignment. This Agreement, being intended to secure the services of and be personal to the Provider, shall not be assigned, sublet, delegated, or transferred by Provider without the prior written consent of TMHC. TMHC may assign the Agreement to any entity that is controlled by, under common control with, or that controls TMHC, or that is formed as the result of an internal restructuring of TMHC and/or its affiliates without Provider's consent; provided, however, such assignment shall not release PMR of its obligations under the Stock Warrant Agreement or Registration rights Agreement. This Agreement shall inure to the benefit of and shall bind the successors and permitted assignees of TMHC and Provider. 16.5 Notice. Any notice required to be given pursuant to the terms and provisions hereof shall be sent by hand delivery, by certified mail, return receipt requested, postage prepaid, or by telefacsimile, to TMHC or to the Provider at the respective addresses or phone numbers indicated below. Notice shall be deemed to be effective when mailed or hand delivered, but notice of change of address shall be effective upon receipt. If to TMHC: Tennessee Mental Health Cooperative, Inc. 275 Cumberland Bend Nashville, Tennessee 37228 Attention: Mr. Allen Tepper Phone number: ---------------------------- With a copy to: PMR Corporation Cabrillo Plaza 3990 Old Town Avenue, Suite 206A San Diego, California 92110 Attention: Mr. Allen Tepper, President Phone number: (619) 295-2227 If to Provider: Mental Health Cooperative, Inc. 275 Cumberland Bend Nashville, Tennessee 37228 Attention: Executive Director Phone number: (615) 726-3340 -20- 26 With a copy to: Boult Cummings Conners & Berry 414 Union Street, Suite 1600 Nashville, Tennessee 37219 Attention: Mr. E. Berry Holt, III Phone number: (615) 252-2312 16.6 Attorneys Fees. In the event of any litigation or arbitration concerning any controversy, claim, or dispute between the parties hereto, the prevailing party shall be entitled to recover from the losing party reasonable expenses, attorneys' fees, and costs incurred therein or in the enforcement or collection of any judgment or award rendered therein. The "prevailing party" means the party determined by the court or arbitrator to have most nearly prevailed, even if such party did not prevail in all matters, not necessarily the one in whose favor a judgment is rendered. Further, in the event of any default by a party under this Agreement, such defaulting party shall pay all the expenses and attorneys' fees incurred by the other party in connection with such default, whether or not any litigation or arbitration is commenced. 16.7 Severance of Invalid Provisions. In the event that any one or more of the provisions of this Agreement shall, for any reason, be held to be invalid, illegal, or unenforceable in any respect by a court of competent jurisdiction, the parties agree that such court may interpret this Agreement without reference to such invalid, illegal, or unenforceable provision; provided, however, that wherever possible such court shall modify or restrict the meaning of such provision so that, as modified, it shall be enforceable. 16.8 Waiver. The waiver by either party of any breach of any provision of this Agreement or warranty representation herein set forth shall not be construed as a waiver of any subsequent breach of the same or any other provision. The failure to exercise any right hereunder shall not operate as a waiver of such right. All rights and remedies provided herein are cumulative. 16.9 Captions. The captions contained herein are for reference purposes only and shall not affect the meaning of this Agreement. 16.10 Governing Law. This Agreement shall be construed and enforced in accordance with the laws of the State of Tennessee, and venue shall be in Davidson County. -21- 27 IN WITNESS WHEREOF, the foregoing Agreement between TMHC and Provider is entered into by and between the undersigned parties, to be effective as of the date first written above. TMHC: TENNESSEE MENTAL HEALTH COOPERATIVE, INC. By: /s/ ALLEN TEPPER --------------------------------- Name: Allen Tepper ------------------------------- Title: ------------------------------ PROVIDER: MENTAL HEALTH COOPERATIVE, INC. By: /s/ PAM WOMACK --------------------------------- Name: Pam Womack ------------------------------- Title: ------------------------------ By: /s/ WILLIAM F. MOYNIHAN --------------------------------- Name: William F. Moynihan ------------------------------- Title: ------------------------------ -22- 28 EXHIBIT 1.3 COVERED SERVICES The following are the Covered Services to be provided by Provider: (1) A highly accessible, but managed point of entry into the local treatment and service system. This includes availability of twenty-four hour crisis and assessment services provided in the Covered Person's home, in the streets, in the jails, or in hospital emergency rooms. (2) Initial CRG determinations on Covered Persons first entering the system for mental health services, and completion of the required, semi-annual CRG re-assessments. (3) Twenty-four hour, full support case management and continuous treatment team services where case managers provide a full range of community support services. These include assisting with living arrangements; securing entitlements; assisting with health issues, medication and symptom monitoring, and other basic survival supports; and assessing and developing rehabilitation readiness. All of these services are aimed at decreasing the Covered Person's use of emergency rooms and inpatient services and at helping the Covered Person to manage his/her mental illness on a daily basis with increasing independence and decreased reliance on paid care-givers to the extent possible. (4) Out-of-home crisis respite services with a crisis companion for Covered Persons who might otherwise have been admitted to inpatient care. Through the crisis unit, "bridge" case management services are also available for Covered Persons first entering the system, until such time as a regular case management connection is established. (5) Psychiatric services where psychiatric and nursing staff provide medication, administration, and monitoring. Psychiatric and nursing staff coordinate with case management teams so that Covered Persons receive continuous care from the same team of staff on an ongoing basis, across all inpatient and outpatient episodes of care. (6) Representative payee service for Covered Persons who need someone to be payee of their SSI/SSDI check. Representative payee assists with budgeting monthly income and insuring that bills, such as rent and utilities, are paid monthly. This helps insure community stability for Covered Persons. Exhibit 1.3 - Page 1 EX-10.16 19 EXHIBIT 10.16 1 EXHIBIT 10.16 MANAGEMENT AND AFFILIATION AGREEMENT DATED APRIL 13, 1995 between CASE MANAGEMENT, INC. and TENNESSEE MENTAL HEALTH COOPERATIVE, INC. [This agreement is substantially identical in all material respects to the Management and Affiliation Agreement dated April 13, 1995 between Mental Health Cooperative, Inc. and Tennessee Mental Health Cooperative, Inc. filed herewith as Exhibit 10.14, except for the name of the party contracting with Company's subsidiary is Case Management, Inc. and except that this agreement is not subject to the addendum filed as part of Exhibit 10.14 but is modified pursuant to the Addendum to Management and Affiliation Agreement which is filed as part of this exhibit.] 2 ADDENDUM TO MANAGEMENT AND AFFILIATION AGREEMENT This ADDENDUM TO MANAGEMENT AND AFFILIATION AGREEMENT ("Addendum") is made this 6th day of September, 1995, by and between Case Management, Inc., a Tennessee not-profit corporation ("Provider"), and Tennessee Mental Health Cooperative, Inc., a Tennessee for-profit corporation ("Manager"). RECITALS A. Provider and Manager entered into a Management and Affiliation Agreement ("Agreement") and a Provider Services Agreement ("Services Agreement") bearing even date herewith. B. Provider and Manager entered into the Agreement and Services Agreement in the anticipation of the expansion of the TennCare program to include the provision of certain covered services to patients who suffer from serious and persistent mental illness ("SPMI"). C. The expansion of the TennCare program to the SPMI patients has been delayed by the State of Tennessee but the parties hereto wish to implement the Agreement and Services Agreement as hereinafter provided. NOW, THEREFORE, Manager and Provider, intending to be legally bound hereby, agree as follows: AGREEMENT 1. Effective Date. The effective date of the Agreement and Services Agreement shall be October 1, 1995 ("Effective Date"). Section 1.1.1 of the Agreement entitled "Conditions Precedent" is hereby declared null of void and of no force and effect whatsoever. 2. Letter of Credit. Section 3.1 of the Agreement requires Manager to obtain an irrevocable letter of credit ("Letter of Credit") on or before the Effective Date of the Agreement. The parties hereto agree that the obligation to obtain the Letter of Credit shall be deferred until otherwise mutually agreed to be the parties. In lieu of the Letter of Credit, PMR has loaned $500,000 to Manager for one (1) year and has provided a Line of Credit to Manager in the amount of $500,000. PMR shall secure the Line of Credit by maintaining $500,000 in cash or cash equivalents in its bank accounts or by having $500,000 available on PMR's Line of 3 Credit from its banks or any combination thereof totaling $500,000. PMR's Line of Credit to Manager shall terminate on the latter of the first anniversary of the Agreement or the implementation of the expansion of the TennCare Program to SPMI patients. The $500,000 loan and $500,000 Line of Credit from PMR to Manager shall be available to pay Subcapitated Payments to Case Managers under paragraph 5.4.1 of the Agreement. 3. Other Case Managers. Section 2.2 of the Agreement allows Manager to contract with other Case Managers other than Provider so long as Provider gives its prior written approval. The parties hereto agree that such prior written approval shall only be needed for Case Managers providing services in the State of Tennessee and no such prior written approval shall be required for contracts which Manager enters into with Case Managers who provide services exclusively outside of the State of Tennessee. 4. Provider's Board Positions. Paragraph 4.2.1(iii) of the Agreement is hereby amended to read, "Manager shall be permitted to designate two (2) additional members of the Provider's Board of Directors (not to exceed a total of three (3) directors, including the director to be designated under Paragraph 4.2.1(ii) hereof), which persons may or may not be employees or affiliates of Manager of PMR, provided, however, that Provider shall have the right to approve each designee, which approval shall not be unreasonably withheld by Provider." 5. Independent Annual Audit. Manager shall cause its financial records to be independently audited on an annual basis, the cost of which shall be paid for by Manager. 6. Case Management Network. Manager shall use its best efforts to create a network of entities to provide Case Management services, both inside and outside of the State of Tennessee, and to have these entities become Case Managers under the terms of the Agreement. 7. Written Agreement with Mental Health Cooperative, Inc. Manager shall use its best efforts to assist in the consummation of a formal affiliation agreement between provider and Mental Health Cooperative, which efforts shall be to obtain consummation of an agreement within ninety (90) days of the effective date of the agreement. 8. Employment Agreements. Due to accrued employment benefits payable to Provider's employees, and for other business reasons, Manager shall agree that Provider shall become a party to any employment agreement(s) that Manager may enter into with individuals employed by Provider who shall become employees of Manager under the terms of the agreement. -2- 4 9. Case Management Activities and State Grants. Sections 5.1.1. and 5.1.4, respectively, shall be revised, as needed, to insure that the language setting forth the scope of the agreement is not restricting the participation or effect of Provider's involvement in the agreement to the state of Tennessee. 10. Quarterly Review of Financial Arrangements. The following shall be added as Paragraph 5.5.4 to the Agreement. "A breach of this Paragraph 5.5 shall be subject to paragraph 1.3.9 hereof." 11. Establishing Present Book Value for Old Asset Depreciation. Pursuant to Paragraph 5.1.6 of the Agreement, each Case Manager shall be paid certain amounts from the Capitated Payments and the Grants for depreciation of certain assets. Within twenty (20) days of the Effective Date, Case Manager shall submit to Manager a schedule of all assets eligible for payments for Old Asset Depreciation and the schedule shall include (1) the initial book value of each asset, (2) the dollar amount which each asset has been depreciated by Case Manager through the Effective Date and (3) the difference thereof, which is the present book value, shall be eligible for Old Asset Depreciation over the asset's remaining useful life as originally determined at the time of acquisition by Case Manager. 12. Effect of Addendum, Definitions. All other terms and conditions of the Agreement shall remain in full force and effect except as modified herein. The definitions of the Agreement shall apply to this Addendum. 13.1 Wherever in the Agreement the phrase "related psychiatric services" appears, it shall mean "other psychiatric services." 13.2 In Paragraph 5.1.3 of the Agreement, it is agreed that the "Capitated Payment" shall include payments received for other psychiatric services rendered by Provider. -3- 5 IN WITNESS WHEREOF, the parties hereto have caused this Addendum to be executed on the day and year first written above. PROVIDER: CASE MANAGEMENT, INC. a Tennessee non-profit corporation BY: /s/ W. R. C. SMITH ------------------------------- NAME: W. R. C. Smith -------------------------- TITLE: President ------------------------- MANAGER: TENNESSEE MENTAL HEALTH COOPERATIVE, INC., a Tennessee for-profit corporation BY: /s/ ALLEN TEPPER ------------------------------- NAME: Allen Tepper -------------------------- TITLE: Chief Executive Officer ------------------------- -4- EX-10.17 20 EXHIBIT 10.17 1 EXHIBIT 10.17 PROVIDER SERVICES AGREEMENT DATED APRIL 13, 1995 between TENNESSEE MENTAL HEALTH COOPERATIVE, INC. and CASE MANAGEMENT, INC. [This agreement is substantially identical in all material respects to the Provider Services Agreement dated April 13, 1995 between Tennessee Mental Health Cooperative, Inc. and Mental Health Cooperative, Inc. filed herewith as Exhibit 10.15, except that the party contracting with the Company's subsidiary is Case Management, Inc. and except that this agreement is modified by the Addendum to Management and Affiliation Agreement filed as part of Exhibit 10.16 (including an amended effective date of October 1, 1995).] EX-21 21 EXHIBIT 21 1 EXHIBIT 21 The following is a list of the subsidiaries of PMR Corporation: NAME: JURISDICTION OF ORGANIZATION: - ------------------------------------------------------------------------------- Psychiatric Management Resources, Inc. California Collaborative Care, Inc. California PMR-CD, Inc. California Aldine-DC, Inc. California Twin Town Outpatient, a general partnership California Collaborative Care Corporation Tennessee EX-23.1 22 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/S-3 No. 33-72664) pertaining to the Employees' Incentive Stock Option Plan of 1990 and the Outside Directors' Non-Qualified Stock Option Plan of 1992 and the Registration Statement (Form S-3 No. 33-77848) pertaining to the registration of 554,272 shares of common stock and the Registration Statement (Form S-3 No. 33-97202) pertaining to the registration of 1,388,087 shares of common stock of our report dated June 13, 1997, with respect to the consolidated financial statements and schedule of PMR Corporation included in the Annual Report (Form 10-K) for the year ended April 30, 1997. ERNST & YOUNG LLP July 28, 1997 San Diego, California EX-27 23 EXHIBIT 27
5 YEAR APR-30-1997 MAY-01-1996 APR-30-1997 10,048,203 0 16,350,139 5,081,177 0 27,958,301 1,263,743 1,175,980 33,084,538 7,317,237 0 50,334 0 0 16,197,217 33,084,538 0 56,636,902 0 41,423,157 700,734 3,084,166 (217,297) 5,296,041 2,172,000 3,124,041 0 0 0 3,124,041 0.54 0.54
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