-----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, PD2JDTPPUdg6SmKpe1n/OrZOtxWJJT2tHLPpbQlqFvJjbJqzw08uph6/E98Amoro aImhH/NUP4h/WPuSXixLzQ== 0001005150-97-000221.txt : 19970401 0001005150-97-000221.hdr.sgml : 19970401 ACCESSION NUMBER: 0001005150-97-000221 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADVANCED HEALTH CORP CENTRAL INDEX KEY: 0001002628 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MISC HEALTH & ALLIED SERVICES, NEC [8090] IRS NUMBER: 133832365 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-21209 FILM NUMBER: 97571834 BUSINESS ADDRESS: STREET 1: 555 WHITE PLAINS RD CITY: TARRYTOWN STATE: NY ZIP: 10591 BUSINESS PHONE: 9145244200 MAIL ADDRESS: STREET 1: 560 WHITE PLAINS RD STREET 2: 2ND FLOOR CITY: TARRYTOWN STATE: NY ZIP: 10591 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1996 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ____________ to________________ Commission File Number 0-21209 ADVANCED HEALTH CORPORATION (Exact name of registrant as specified in its charter) Delaware 13-3893841 (State or other jurisdiction (IRS employer of incorporation or organization) identification number) 560 White Plains Road 10591 Tarrytown, New York (Zip code) (Address of principal executive offices) Registrants' telephone number, including area code: (914) 524-4200 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 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K: [ ] The aggregate market value of the shares of Common Stock held by non-affiliates of the registrant is $90,233,257, based on the closing price of the Common Stock on March 25, 1997. As of March 25, 1997, there were 7,166,941 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement for the 1997 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, are incorporated by reference in Part III hereof. ADVANCED HEALTH CORPORATION FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 Table of Contents
Page ---- PART I Item 1. Business 3 Item 2. Properties 14 Item 3. Legal Proceedings 14 Item 4. Submission of Matters to a Vote of Security Holders 15 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 16 Item 6. Selected Financial Data 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 8. Financial Statements and Supplementary Data 19 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 20 PART III Item 10. Directors and Executive Officers of the Registrant 21 Item 11. Executive Compensation 21 Item 12. Security Ownership of Certain Beneficial Owners and Management 21 Item 13. Certain Relationships and Related Transactions 21 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 22 Signatures 23 Financial Statements F-1
-2- PART I ITEM 1. BUSINESS - ------ Overview Advanced Health Corporation (the "Company") provides a full range of integrated management services and clinical information systems to physician group practices, single legal entities comprised of multiple physicians, and physician networks, aggregations of individual physicians and physician groups formed for the purpose of entering into contracts with third-party payors. The management services provided by the Company include physician practice and network development, marketing, payor contracting, financial and administrative management, clinical information management, human resource management and practice and network governance. The Company developed its clinical information systems to provide physicians, at the point of care and on a real-time basis, with patient-specific clinical and payor information and the ability to generate patient medical orders and facilitate the implementation of disease management programs. Through the management of multi-specialty and single-specialty physician group practices and networks, the Company focuses its management efforts on high-cost, high-volume disease specialties, such as cardiology, oncology and orthopedics. The Company currently manages four multi-specialty physician group practices and four single-specialty physician group practices comprised of more than 170 physicians in the New York metropolitan area and 11 physician networks with approximately 1,500 physicians in the greater New York, Philadelphia and Atlanta metropolitan areas, and provides physician group consulting services to more than 100 physicians. The Company believes its management services and clinical information systems will enable physicians to enhance the quality and reduce the cost of health care. The Company's predecessor, Med-E-Systems Corporation ("MES"), was incorporated on August 27, 1993 as a clinical information systems development company. Effective August 23, 1995, MES became a subsidiary of the Company through a tax-free reorganization. The Company was subsequently merged with and into Majean, Inc., a Delaware corporation, and the surviving corporation changed its name to Advanced Health Corporation. On October 2, 1996, the Company consummated the initial public offering (the "IPO") of its Common Stock (including the exercise of the underwriters' over-allotment option). In the IPO, the Company sold 2,645,000 shares of Common Stock at an initial public offering price of $13.00 per share. Industry Increasing concern over the rising cost of health care in the United States has led to the development of managed care organizations and programs. Under such programs, managed care payors typically govern the provision of health care with the objective of ensuring delivery of quality care in a cost-effective manner. The traditional fee-for-service method of compensating health care providers offers few incentives for the efficient utilization of resources and is generally believed to contribute to health care cost increases at rates significantly higher than inflation. Consequently, fee-for-service reimbursement is rapidly being replaced by alternative reimbursement models, including capitated and other fixed-fee arrangements. The growth in enrollment in these new reimbursement models is shifting the financial risk of delivering health care from payors to providers. As a result of this changing health care environment, health care cost containment pressures have increased physician management responsibilities while lowering reimbursement rates to physicians. Consequently, physician compensation has declined. Because the majority of all physicians currently practice individually or in two-person groups, their ability to lower costs and to negotiate with payors is limited. Individual physicians and small group practices also tend to have limited administrative capacity, limited ties to other health care providers (restricting their ability to coordinate care across a variety of specialties), limited capital to invest in new clinical equipment and - ---------- Med-E-Practice(TM), Smart Scripts(TM), Internet Script Writer(TM), Med-E-Visit(TM), Practice Management Integrator(TM), Med-E-Network(TM), Med-E-Net Central(TM), Med-E-Net Office(TM), Med-E-Net Integrator(TM) and Med-E-Net Cardiology(TM) are trademarks of the Company. -3- technologies and limited purchasing power with vendors of medical supplies. In addition, individual physicians and small group practices typically lack the information systems necessary to enter into and manage risk-sharing contracts with payors and to implement disease management programs efficiently. In response to the foregoing factors, individual physicians and small group practices are increasingly affiliating with larger group practices and physician practice management companies ("PPMs"). By acquiring physician practices, PPMs are successfully providing physicians with lower administrative costs, leverage with vendors and payors and economies of scale necessary to attract capital resources. In addition, management companies and consultants are organizing independent physician practices, independent physician associations, physician hospital organizations and other physician organizations for the purpose of enabling physicians to contract with managed care payors. The Company believes that significant opportunities exist, in the consolidating health care industry, to assist physicians in managing the administrative aspects of group practices and networks. More importantly, the Company believes that even greater opportunities exist to assist physicians in managing the clinical aspects of group practices and networks. The Company believes its integrated physician practice and network management services and clinical information systems will enable physicians to more effectively control both the quality and cost of health care. Strategy The objective of the Company is to become a leading provider of integrated management services and clinical information systems to physician organizations. By enabling physicians to develop and efficiently manage group practices and networks, the Company seeks to assist physicians in facilitating risk-based managed care contracts, developing and implementing disease management programs and monitoring and controlling health care outcomes and costs. The Company's strategy includes (i) establishing long-term contractual alliances with physician organizations, (ii) managing high-cost, high-volume disease specialties such as cardiology, oncology and orthopedics, (iii) providing physicians with clinical information at the point of care, (iv) focusing on selected geographic markets that offer concentrations of physicians seeking the company's services and (v) continuing to develop relationships with key industry participants. Physician Practice and Network Services The Company provides physicians with a full range of integrated services to form and develop group practices and networks, to manage group practice and network operations, to develop disease management programs and to manage medical risk. These integrated services include clinical support and administrative and marketing services as well as point-of-care information systems and support. The Company often initially provides physician practice and network services pursuant to a consulting arrangement. The Company believes that its point-of-care information systems provide physicians with the information needed to improve the quality and reduce the cost of health care. In addition to providing administrative management services to physician organizations, the Company seeks to differentiate itself by assisting physicians in managing the clinical aspects of their practices. The Company believes that its integrated management services and clinical information systems will enhance the ability of physician group practices and networks to implement disease management programs and to manage practices under risk-based contracts. The Company is working to assist physicians in developing disease-specific clinical practice guidelines and in practicing in accordance with applicable standards of care. The Company has initially focused the implementation of its single-specialty disease management strategy on the creation of an integrated comprehensive cardiovascular care program, which includes physician group practices, networks and medical support services. It is anticipated that this disease management program will be delivered through linked practices and networks of cardiovascular specialists under management and/or development by the Company who will provide integrated, high-quality care for patients based on clinical care guidelines developed by the physician networks. The -4- Company anticipates that the physicians within these practices and networks will be linked together by the Company's clinical information systems. The Company markets its physician practice management and network management services through (i) direct sales methods, (ii) consultative sales that include providing advice on the development, consolidation and financing of group practices and networks and (iii) cross-selling to customers of its clinical information systems. The Company offers a comprehensive set of physician practice management services, including practice formation, operations development and strategic planning, marketing, payor contracting and management, financial and administrative management, clinical information management, human resource management and practice governance. The Company's physician network management services include network development and strategic planning, disease management program development, payor marketing and contracting, financial and administrative management, clinical information management and network governance. Clinical Information Systems The Company has developed clinical information systems that link physician users at the point of care and on a real-time basis with patient data and clinical guidelines maintained by the Company and third parties. The Company's clinical information systems consist of proprietary software, third-party hardware, proprietary and third-party databases and related support services. The Company's clinical information systems are designed to allow physicians (i) to access patient-specific clinical and payor information, (ii) to generate patient instructions, prescriptions and orders for tests, specialty referrals and specialty procedures and (iii) to access databases containing managed care and disease management guidelines, diagnostic/treatment preferences and guidelines affecting medical orders. The Company's clinical information systems are designed to complement existing health care information systems and to function with third-party applications. The clinical information system connects to physician users either through the use of a hand-held computer equipped with a wireless modem or a desktop computer using a standard wireline modem. It is anticipated that access to the Company's clinical information systems will be delivered to physician users and other health care professionals via both private and public networks, including the Internet. The Company's product suites operate within a client/server-based open architecture. The Company's products support HL-7 interfaces, incorporate TCP/IP protocols for real-time data transmission and run on the Microsoft Windows operating system and standard hardware platforms. The Company employs proprietary processes and standard commercial security measures to ensure the privacy of the data communication paths within its products. The Company has made only limited commercial sales of its clinical information systems to date. In addition to providing its clinical information systems to its affiliated physicians, the Company intends to continue licensing its clinical information systems to third-party health care organizations. In addition, the Company markets its clinical information systems to physician group practices and networks together with its management services. On September 27, 1995, the Company entered into a software license and integration agreement with Merck Medco Managed Care, Inc. for the Company's prescription writing software, which provides formulary management, drug utilization and review ("DUR") edits and linkage to drug therapy protocols. On August 1, 1995, the Company signed an agreement to provide disease management information systems and software to an affiliate of PCS Health Systems, Inc., the managed care unit of Eli Lilly & Company. The Eli Lilly & Company affiliate has agreed to sponsor two pilot programs involving the software applications developed by the Company. The Company continues to pursue strategic relationships with health care providers as well as hospital information systems companies, physician practice management systems companies and on-line services companies for the purpose of further developing and marketing its information systems. -5- The Company offers a broad range of clinical information systems for physician users, presently through two suites of applications, Med-E-Practice and Med-E-Network. Med-E-Practice is designed to be used directly by physician group practices in support of clinical decision making, clinical ordering and administrative management. Med-E-Network is designed to support administrative and clinical decision making for physician networks engaged in capitated and other fixed-fee arrangements under managed care contracts. These systems have only been developed by the Company recently, and the initial limited commercial installations of the Med-E-Practice suite of applications occurred in June 1996 and of the Med-E-Network suite of applications in February 1997. The following table summarizes the two suites of applications presently offered and being developed by the Company: Product Name Product Description Med-E-Practice Smart Scripts Pharmaceutical prescription writing applications providing formulary management, DUR edits and diagnostic coding linkage to drug therapy protocols. Med-E-Visit Patient encounter application generating a Superbill with fully qualified diagnostic coding linked to appropriate billing codes required to support outcomes analysis. Referral Supports multiple referral networks by recording referral information and providing both network-specific referral rules and appropriate network specialists. Conditions Editor Tracks and maintains an active conditions list by patient. Allergies Editor Maintains active and inactive allergy conditions by patient, supporting charting and DUR editing. Practice Management Allows Med-E-Practice applications to integrate Integrator with third-party physician practice management systems using industry standard HL-7 records. Clinical Note Allows physicians to complete clinical notes at the point of care. Currently in development. Med-E-Network Med-E-Net Central Provides centralized administrative functions necessary to manage risk-taking specialty networks. Med-E-Net Office Integrates physicians in geographically dispersed networks. Med-E-Net Integrator Provides integration and connectivity between the applications in the Med-E-Network suite and third-party databases. Med-E-Net Cardiology Provides cardiology-specific extensions to Med-E-Network for managing risk-taking cardiology networks. Med-E-Practice provides administrative and clinical support for physician group practices. The Med-E-Practice suite is designed for use by physicians at the point of care and on a real-time basis and is intended to allow better care decisions by providing better information. All of the applications in the Med-E-Practice suite are designed to be run on a pen-based, portable, wireless computer for use in a busy ambulatory practice. Med-E-Network is a suite of network management applications supporting physician networks engaged in risk-based contracts with payors. Med-E-Network automates network configuration, maintenance of network rules, referral management, utilization review management, claims and encounter submissions and financial and clinical reporting. Med-E-Network utilizes a relational database engine which integrates various sources of information and provides a flexible repository for developing administrative, financial and clinical reports. -6- The Company believes that the timely development of new clinical information applications and the enhancement of existing clinical information systems are important to its competitive position. The Company's current activities are directed toward this type of product development. The Company's product development strategy is directed toward creating new applications that (i) increase the functionality of current products by providing enhanced interfaces to third-party systems and data repositories, (ii) expand coverage along the continuum of clinical care, (iii) increase coverage to additional disease and procedure groups and (iv) provide customers with a range of decision support systems at various price points. The Company has approximately 30 professionals dedicated to systems development. Concentration of Revenues In the year ended December 31, 1995, Madison Medical -- The Private Practice Group of New York, L.L.P. ("Madison") accounted for approximately 36% of the Company's revenues. In the year ended December 31, 1996, Madison and the Advanced Heart Physicians & Surgeons Network, P.C. ("AHP&S") accounted for approximately 47% and 19% of revenues, respectively. The Company's management services agreements generally have an initial term of five to 20 years and may be terminated only for cause. The management services agreement with AHP&S restricts the Company's ability to provide management services to certain cardiology physician groups in the New York metropolitan area. In addition, in the year ended December 31, 1995, the Company's disease management software license and integration agreement with an affiliate of PCS Health Systems, Inc., the managed care unit of Eli Lilly & Company, accounted for approximately 32% of the Company's revenues. Although such affiliate of PCS Health Systems has agreed to sponsor two pilot programs involving the software applications developed by the Company, it has no obligation thereafter to use or distribute the Company's software. Although the Company seeks to build long-term customer relationships, no assurance can be given that such relationships will continue. Any termination or significant deterioration of the Company's relationships with its principal customers could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, a deterioration in the financial condition of any of its principal customers would materially adversely affect the Company's financial condition and results of operations. Contractual Relationships with Affiliated Physicians The Company typically establishes a majority-owned management service organization ("MSO") for each physician organization it manages. The MSO is a joint venture between the physician organization and the Company, with the Company owning at least 51% of the equity in the MSO. The MSO enters into a long-term management services agreement with the physician organization pursuant to which the MSO provides group practice management or network management services that provide both administrative and clinical support to members of the physician organization. The MSO concurrently enters into a services agreement with the Company pursuant to which it gains access to management services and clinical information systems from the Company. The MSO's assets consist primarily of its management service contracts with the physician group or network served and its liabilities consist primarily of its obligations under its agreement with the Company and its obligations to its employees. For certain MSOs, a stockholders agreement is entered into among the MSO, the physician organization and the Company. The stockholders agreement, among other things, (i) restricts the transfer of MSO equity, (ii) provides the terms upon which, after the occurrence of the Trigger Event (as hereinafter defined), the MSO can, at the Company's option, be merged with and into a wholly-owned subsidiary of the Company in a transaction in which interests of the physician groups and networks in such MSO would be exchanged for Common Stock (the "Roll Up Transaction") and (iii) grants to the physician organization the right to put its equity in the MSO to the Company at a price equal to 110% of the then-current fair market value of the shares of Common Stock that would have otherwise been issued in the Roll Up Transaction if the Company does not exercise its option to cause the Roll Up Transaction to occur within one year after the occurrence of the Trigger Event. In the case of each such MSO, a Trigger Event will occur at such time as (i) the Company is providing physician practice management services to at least 300 physicians, (ii) the Company is providing physician network management services to at least 2,000 physicians, (iii) the Company has at least $75,000,000 in stockholders' equity and (iv) the Company's Common Stock is publicly traded. The Company has reserved 548,224 shares of Common Stock for issuance upon the merger of such MSOs into the Company. -7- Physician Practices. The management services agreements between the MSO and a physician practice group generally have an initial term of five to 20 years and are automatically renewable for additional terms. Such agreements typically are subject to early termination for cause. The management services agreements generally obligate an MSO to provide certain non-medical practice management services to the physician practice group for a monthly fee. The fee paid to the MSO is generally a combination of fixed fees for certain services and percentage fees for certain services. For risk-based contracts that the physician practice group enters into, the management services agreement will generally provide for additional management fees based upon savings recognized by the physician practice group because of any cost efficiencies resulting from the MSO's performance. The fees are set to be competitive within the geographic area in which the physician practice group is located. A provision restricting the physician practice group from competing against the MSO or employing the MSO's employees is generally included in the agreement. Physician Networks. The management services agreements between the MSO and a physician network generally have an initial term of at least five years and are automatically renewable for additional terms. Such agreements typically are subject to early termination for cause. The management services agreements generally obligate an MSO to provide certain non-medical practice management services to the physician network for a fee. The fee paid to the MSO for risk-based or capitated contracts is generally a service fee equal to the actual cost, not to exceed a specified percentage of capitated revenues, for providing the non-medical management services plus an incentive based on savings generated by the network. The fee paid to the MSO for fee-for-service contracts is generally equal to the administrative fees included in the managed care contract plus a management processing fee agreed upon by the MSO and the physician network. The fees are set to be competitive within the geographic area in which the physician network is located. In the agreement, the physician network agrees that the MSO will be the exclusive provider of non-medical management services to the physician network. Capitated and Other Fixed-Fee Arrangements. In the future, the Company anticipates entering into managed care or capitated arrangements, either indirectly through the assignment of managed care contracts entered into between its affiliated physicians and third-party payors or directly through the formation of an independent physician association ("IPA"). The Company does not now have capitated contracts (although the Company does provide management services to physician groups and networks that have entered into such capitated contracts). The Company has little experience in managing capitated-risk arrangements and has no experience in forming or managing an IPA. With respect to the assignment of capitated revenues to the Company, the Company will be dependent on the physician group practices and networks entering into such agreements, the terms and conditions of which are determined by the physicians in their sole discretion, and providing medical services thereunder. In addition, the Company is dependent upon the continued alliance of the physicians with the group practice and network clients of the Company. The Company had previously reported, at the insistence of the accounting staff of the Securities and Exchange Commission (the "SEC"), that it would recognize in its financial statements only those assigned revenues associated with the provision of its management services (typically expected to be approximately 10% of the capitated payments made), with the balance of such payments being paid over to the physicians providing the services pursuant to such agreements. Subsequently, but prior to the Company either earning, recording or reporting any such revenues, SEC accounting releases have indicated that because of the increased risk-sharing relationships, revenues for the full amount of the capitated fee should be reflected in full in the Company's statement of operations when earned. The Company has not earned, recognized or recorded any such revenue through December 31, 1996. Revenues under any managed care or capitated arrangements entered into directly by the Company will generally be a fixed amount per enrollee. Under such an arrangement, the Company would contract with affiliated physicians for the provision of health care services and the Company would be responsible for the provision of all or a portion of the health care requirements of such enrollees. To the extent that enrollees require more care than is anticipated by the Company upon entering into such a contract, the Company's revenues under such contracts may be insufficient to cover its costs, in which event the Company would suffer a loss. The Company expects to enter into reinsurance agreements with third-party insurers in respect of a portion of such risk. -8- Proprietary Rights The Company is relying upon the effectiveness of protection provided by a combination of patent, trade secret and copyright laws, nondisclosure and other contractual provisions and technological measures to protect its proprietary position in its methodologies, databases and software. The Company has two U.S. patent applications and a foreign patent application having subject matter common with both U.S. applications, but no issued patents. The patent applications are directed to the Company's Smart Scripts prescription management system and related technologies. No assurance can be provided that a patent or patents will be issued or will provide the Company with adequate protection. Nor can any assurance be given that patent, trade secrets, copyright or other intellectual property rights can be successfully asserted in any court action. The Company also has copyrights in its software, user documentation and databases. The copyright protection accorded to databases, however, is fairly limited. While the arrangement and selection of data are protectable, the actual data are not, and others are free to create databases that perform the same function. The Company distributes its clinical information systems products under agreements that grant customers non-exclusive licenses and generally contain terms and conditions restricting the disclosure and use of the Company's systems. In addition, the Company attempts to protect the secrecy of its proprietary databases and other trade secrets and proprietary information through confidentiality agreements with employees, consultants and third parties. The Company believes that, aside from the various legal protections of its proprietary information and technologies, factors such as the technological and creative skills of its personnel and product maintenance and support are integral to establishing and maintaining its position within the health care industry. Although the Company believes that its products do not infringe upon the proprietary rights of third parties, there can be no assurance that third parties will not assert infringement claims against the Company in the future. Competition The provision of physician practice and network management services is a highly competitive business in which the Company competes for contracts with several national and many regional and local companies. The Company also competes with traditional managers of health care services that directly recruit and manage physicians. In addition, certain of the Company's competitors are dedicated to or specialize in the management of single-specialty practices focused on diseases such as cardiology, oncology and orthopedics, specialties on which the Company intends to focus. Certain of the Company's competitors have access to substantially greater financial resources than the Company. The Company believes that competition in this industry is generally based on cost and quality of services. The market for health care information systems and services is highly competitive and rapidly changing. The Company believes that the principal competitive factors for clinical information systems are the proprietary nature of methodologies, databases and technical resources, the usefulness of the data and reports generated by the software, customer service and support, compatibility with the customer's existing information systems, potential for product enhancement, vendor reputation, price and the effectiveness of marketing and sales efforts. The Company's competitors include other providers of clinical information systems and practice management systems. Many of the Company's competitors and potential competitors have greater financial, product development, technical and marketing resources than the Company, and currently have, or may develop or acquire, substantial installed customer bases in the health care industry. In addition, as the market for clinical information systems and practice management systems develops, additional competitors may enter the market and competition may intensify. While the Company believes that it will successfully differentiate its clinical information systems from those of its competitors, there can be no assurance that future competition will not have a material adverse effect on the Company. -9- Government Regulation As a participant in the health care industry, the Company's operations and relationships are subject to extensive and increasing regulation by a number of governmental entities at the federal, state and local levels. The Company believes its operations are in material compliance with applicable laws. Nevertheless, because of the nature of the Company's relationship with physician organizations, many aspects of the Company's business operations have not been the subject of state or federal regulatory interpretations and there can be no assurance that a review by courts or regulatory authorities of the Company's business or that of its affiliated physician organizations will not result in a determination that could adversely affect the operations of the Company or that the health care regulatory environment will not change so as to restrict the Company's or the affiliated physicians' existing operations or their expansion. Reimbursement. Inasmuch as a portion of the revenues of the Company's affiliated physician group practices is derived from payments made by government-sponsored health care programs (principally, Medicare, Medicaid and state reimbursed programs), any change in reimbursement regulations, policies, practices, interpretations or statutes could adversely affect the operations of the Company. The federal Medicare program adopted a system of reimbursement of physician services, a resource-based relative value scale ("RBRVS") payment methodology, which took effect in 1992 and was fully implemented by December 31, 1996. The Company expects that the RBRVS fee schedule and other future changes in Medicare reimbursement will result, in some cases, in a reduction and, in some cases, in an increase from historical levels in the per-patient Medicare revenue received by certain of the physician organizations with which the Company contracts. Although the Company does not believe such reductions will have a material adverse effect on the Company's operating results, the RBRVS fee schedule may be adopted by other payors, which could have a material adverse effect on the Company. Billing. There are also state and federal civil and criminal statutes imposing substantial penalties, including civil and criminal fines and imprisonment, on health care providers that fraudulently or wrongfully bill governmental or other third-party payors for health care services. The federal law prohibiting false billings allows a private person to bring a civil action in the name of the U.S. government for violations of its provisions. The Company believes it is in material compliance with such laws, but there is no assurance that the Company's activities will not be challenged or scrutinized by governmental authorities. Moreover, technical Medicare and other reimbursement rules affect the structure of physician billing arrangements. The Company believes it is in material compliance with such regulations, but regulatory authorities may differ and in such event the Company may have to modify its relationship with physician organizations. Noncompliance with such regulations may adversely affect the business, financial condition and results of operations of the Company and subject it and affiliated physician groups to penalties and additional costs. Corporate Practice of Medicine. The laws of many states prohibit business corporations such as the Company from practicing medicine and employing physicians to practice medicine. These laws forbid both direct control over medical decisions and indirect interference such as splitting medical fees' with physicians or controlling budgetary allotments for patient care. Laws regarding the corporate practice of medicine vary from state to state and are enforced by the courts and by regulatory authorities. New York State, for example, prohibits percentage payments from physicians or physician groups to management entities for services other than billing and collecting and prohibits management entities from engaging in the delivery of medical services. All of the management service agreements ("MSAs") between the Company's majority-owned MSOs and the physician groups and networks they serve specifically address this issue. First, each explicitly provides that the physician organization retains complete control over medical decision making, and that the MSO may neither interfere with the professional judgment of medical personnel nor control, direct or supervise the provision of medical services. Furthermore, the MSAs make it clear that the MSO may not perform any services or activities which constitute the practice of medicine. For instance, the MSO has no responsibility in decisions regarding level of patient care, credentialing or quality monitoring. Administrative policies, budgets and fee schedules affecting the delivery of medical services are developed by a Joint Management Advisory Board, which is at all times controlled by medical group physicians. In contrast, each MSO controlled by the Company is a management organization whose role is to assist with and coordinate administrative functions and to advise the physician group as to the relationship between its performance -10- of medical activities and the administrative and business functioning of its practice. The Company believes it is in material compliance with regulations regarding the corporate practice of medicine, but regulatory authority may differ and in such event expansion of the operations of the Company to certain jurisdictions may require it to comply with such jurisdictions' regulations which could lead to structural and organizational modifications of the Company's form of relationships with physician organizations. Such changes, if any, could have a material adverse effect on the Company. Anti-Kickback Statutes. Certain provisions of the Social Security Act, commonly referred to as the "Antikickback Statute," prohibit the offer, payment, solicitation or receipt of any form of remuneration in return for the referral of Medicare or state health program patients or patient care opportunities, or in return for the recommendation, arrangement, purchase, lease or order of items or services that are covered by Medicare or state health programs. The Anti-kickback Statute is broad in scope and has been broadly interpreted by courts in many jurisdictions. Read literally, the statute places at risk many legitimate business arrangements, potentially subjecting such arrangements to lengthy, expensive investigations and prosecutions initiated by federal and state governmental officials. Many states, including those in which the Company does business, have adopted similar prohibitions against payments intended to induce referrals of Medicaid and other third-party payor patients. The Company believes that, although it is receiving remuneration under the management services agreements for management services, it is not in a position to make or influence the referral of patients or services reimbursed under government programs to the physician groups and, therefore, believes it has not violated the Anti-kickback Statute. The Company also is not a separate provider of Medicare or state health program reimbursed services. To the extent the Company is deemed to be either a referral source or a separate provider under its management services agreements and to receive referrals from physicians, the financial arrangements under such agreements could be subject to scrutiny and prosecution under the Anti-kickback Statute. Violation of the Anti-kickback Statute is a felony, punishable by fines up to $25,000 per violation and imprisonment for up to five years. In addition, the Department of Health and Human Services may impose civil penalties excluding violators from participation in Medicare or state health programs. In July 1991, in part to address concerns regarding the Anti-kickback Statute, the federal government published regulations that provide exceptions, or "safe harbors," for transactions that will be deemed not to violate the Anti-kickback Statute. Among the safe harbors included in the regulations were provisions relating to the sale of practitioner practices, management and personal services agreements and employee relationships. Additional safe harbors were published in September 1993 offering new protections under the Anti-kickback Statute to eight activities, including referrals within group practices consisting of active investors. Proposed amendments to clarify these safe harbors were published in July 1994 which, if adopted, would cause substantive retroactive changes to the 1991 regulations. Although the Company believes that it is not in violation of the Anti-kickback Statute, its operations may not fit within any of the existing or proposed safe harbors. Significant prohibitions against physician referrals were enacted by Congress in the Omnibus Budget Reconciliation Act of 1993. These prohibitions, commonly known as "Stark II," amended prior physician self-referral legislation known as "Stark I" by dramatically enlarging the field of physician-owned or physician-interested entities to which the referral prohibitions apply. Effective January 1, 1995, Stark II prohibits, subject to certain exemptions, a physician or a member of his immediate family from referring Medicare patients to an entity providing "designated health services" in which the physician has an ownership or investment interest, or with which the physician has entered into a compensation arrangement including the physician's own group practice. The designated health services include radiology and other diagnostic services, radiation therapy services, physical and occupational therapy services, durable medical equipment, parenteral and enteral nutrients, equipment and supplies, prosthetics, orthotics, outpatient prescription drugs, home health services and inpatient and outpatient hospital services. The penalties for violating Stark II include a prohibition on payment by these government programs and civil penalties of as much as $15,000 for each violative referral and $100,000 for participation in a "circumvention scheme." The Company believes that its activities are not in violation of Stark I or Stark II. However, the Stark legislation is broad and ambiguous. Interpretative regulations clarifying the provisions of Stark II have not been issued. While the Company believes it is in compliance with the Stark legislation, future regulations could require the Company to modify the form of its relationships with physician organizations. Moreover, the violation of Stark -11- I or II by the Company's affiliated physician organizations could result in significant fines and loss or reimbursement which could materially adversely affect the Company. Many states in which the Company conducts business have enacted similar laws applicable to all services. PIP Regulations. The Health Care Finance Administration ("HCFA") has issued final regulations (the "PIP regulations") covering the use of physician incentive plans ("PIPs") by health maintenance organizations ("HMOs") and other managed care contractors and subcontractors ("Organizations"), potentially including the Company. Any Organization that contracts with a physician group that places the individual physician members of the group at substantial financial risk for the provision of services (e.g., if a primary care group takes risk but subcontracts with a specialty group to provide certain services) must satisfy certain disclosure, survey and stop-loss requirements. Under the PIP regulations, payments of any kind, direct or indirect, to induce providers to reduce or limit covered or medically necessary services ("Prohibited Payments") are prohibited. Further, where there are no Prohibited Payments but there is risk sharing among participating providers related to utilization of services by their patients, the regulations contain three groups of requirements: (i) requirements for physician incentive plans that place physicians at "substantial financial risk;" (ii) disclosure requirements for all Organizations with PIPs; and (iii) requirements related to subcontracting arrangements. In the case of substantial financial risk (defined in the regulations according to several methods, but essentially risk in excess of 25% of the maximum payments anticipated under a plan with less than 25,000 covered lives), Organizations must: (1) conduct enrollee surveys and (2) ensure that all providers have specified stop-loss protection. The violation of the requirements of the PIP regulations may result in a variety of sanctions, including suspension of enrollment of new Medicaid or Medicare members, or a civil monetary penalty of $25,000 for each determination of noncompliance. In addition, because of the increasing public concerns regarding PIPs, the PIP regulations may become the model for the industry as a whole. The new regulations could have an affect on the ability of the Company to effectively reduce the costs of providing services by limiting the amount of risk that may be imposed upon physicians. Anti-Trust. Because the affiliated physician organizations remain separate legal entities, they may be deemed competitors subject to a range of antitrust laws which prohibit anti-competitive conduct, including price fixing, concerted refusals to deal and division of market. The Company intends to comply with such state and federal laws as may affect its development of integrated health care delivery networks, but there can be no assurance that a review of the Company's business by courts or regulatory authorities will not result in a determination that could adversely affect the operation of the Company and its affiliated physician groups. Insurance Regulations. Laws in all states regulate the business of insurance and the operation of HMOs. Many states also regulate the establishment and operation of networks of health care providers. There can be no assurance that regulatory authorities of the states in which the Company operates would not apply these laws to require licensure of the Company's operations as an insurer, as an HMO or as a provider network. On August 10, 1995, the National Association of Insurance Commissioners (the "NAIC") issued a report opining that certain risk-transferring arrangements may entail the business of insurance, to which state licensure laws apply, but that licensure laws would not apply where an unlicensed entity contracts to assume "downstream risk" from a duly licensed health insurer or HMO for health care provided to that carrier's enrollees. The NAIC's conclusions are not binding on the states. The Company does not now have capitated contracts and will enter into such contracts only with licensed insurance companies and HMOs, and only if allowed by state law. The Company believes that it is in compliance with these laws in the states in which it does business, but there can be no assurance that future interpretations of insurance laws and health care network laws by the regulatory authorities in these states or in the states into which the Company may expand will not require licensure or a restructuring of some or all of the Company's operations. Health Care Reform. As a result of the continued escalation of health care costs and the inability of many individuals to obtain health insurance, numerous proposals have been or may be introduced in the U.S. Congress and state legislatures relating to health care reform. There can be no assurance as to the ultimate content, timing or effect of any health care reform legislation, nor is it possible at this time to estimate the impact of potential legislation, which may be material, on the Company. -12- Confidentiality of Patient Records. The confidentiality of patient records and the circumstances under which such records may be released is subject to substantial regulation under state and federal laws and regulations. To protect patient confidentiality, data entries to the Company's databases delete any patient identifiers, including name, address, hospital and physician. The Company believes that its procedures comply with the laws and regulations regarding the collection of patient data in substantially all jurisdictions, but regulations governing patient confidentiality rights are evolving rapidly and are often difficult to apply. Additional legislation governing the dissemination of medical record information has been proposed at both the state and federal level. This legislation may require holders of such information to implement security measures that may be of substantial cost to the Company. There can be no assurance that changes to state or federal laws would not materially restrict the ability of the Company to obtain patient information originating from records. FDA Regulation. Certain products, including software applications, intended for use in the diagnosis of disease or other conditions, or in the cure, treatment, mitigation or prevention of disease, are subject to regulation by the United States Food and Drug Administration (the "FDA") under the Federal Food, Drug and Cosmetic Act of 1938, as amended (the "FDCA"). The FDCA imposes substantial regulatory controls over the manufacturing, testing, labeling, sale, distribution, marketing and promotion of medical devices and other related activities. These regulatory controls can include, for example, compliance with the following: manufacturer establishment registration and device listing; current good manufacturing practices; FDA clearance of a premarket notification submission or FDA approval of a premarket approval application; medical device adverse event reporting; and general prohibitions on misbranding and adulteration. Violations of the FDCA can result in severe criminal and civil penalties, and other sanctions, including, but not limited to, product seizure, recall, repair or refund orders, withdrawal or denial of premarket notifications or premarket approval applications, denial or suspension of government contracts and injunctions against unlawful product manufacture, labeling, promotion and distribution or other activities. In its 1989 Draft Policy for the Regulation of Computer Products (the "1989 Draft Policy Statement"), the FDA stated that it intended to exempt certain clinical decision support software products from a number of regulatory controls. Under the 1989 Draft Policy Statement, the FDA stated that it intended to exempt decision support software products that involve "competent human intervention before any impact on human health occurs (e.g., where clinical judgment and experience can be used to check and interpret a system output)" from the following controls: manufacturer establishment registration and device listing, premarket notification and compliance with the medical device reporting and current good manufacturing practice regulations. In the 1989 Draft Policy Statement, the FDA stated that until it formally exempted decision support software products from these requirements, manufacturers of eligible decision support software products would be required to comply with those controls. Since issuing the 1989 Draft Policy Statement, the FDA has not issued a final policy on this issue and has not formally exempted any products as discussed in the 1989 Draft Policy Statement. The FDA has referred to the 1989 Draft Policy Statement in official presentations regarding software regulation and in decisions and opinions regarding the regulatory status of various products. Over the last few years, however, the FDA has stated that it intends to issue a new policy concerning computer products and has been increasing its efforts to develop this policy in recent months. Under this new policy, exemptions from regulatory controls, if any, would be based upon a product specific "risk factor" analysis. For purposes of this analysis, the FDA has considered, among other things, the following: (i) seriousness of the disease to be diagnosed or treated; (ii) time frame for use of the information; (iii) whether the data output is provided or manipulated in a novel or non-traditional manner; (iv) whether the software provides individualized patient care recommendations; (v) whether the mechanism by which the software arrives at a decision is hidden or transparent; and (vi) whether the product provides new capabilities for the user. Given the FDA's intent to issue a new policy concerning the regulation of computer software, there can be no assurance as to the effect of such a policy, if any, upon the regulatory status of the Company's products. The Company's clinical information systems are intended to assist health care providers in analyzing economic and quality data related to patient care and expected outcomes in order to maximize the cost-effectiveness of general treatment plans and practice protocols. These products are not intended to provide specific diagnostic data or results or affect the use of specific therapeutic interventions for individual patients. As such, the Company -13- believes that its clinical information systems are not medical devices under the FDCA and, thus, are not subject to the controls imposed on manufacturers of medical devices and do not fall within the scope of the 1989 Draft Policy Statement. The Company further believes that to the extent that its products are determined to be medical devices, they fall within the exemptions for decision support systems provided by the 1989 Draft Policy Statement. The Company has not taken action to comply with the requirements that would otherwise apply if the Company's products were determined to be non-exempt medical devices. There can be no assurance that the FDA will not make a request or take other action to require the Company to comply with any or all current or future controls applicable to medical devices under the FDCA. There can be no assurance that, if such a request were made or other action were taken, the Company could comply in a timely manner, if at all, or that any failure to comply would not have a material adverse effect on the Company's business, financial condition or results of operations, or that the Company would not be subjected to significant penalties or other sanctions. There can be no assurance that the FDA will continue to permit any or all of the exemptions provided in the 1989 Draft Policy Statement, or in a new policy statement, if any, or that the FDA will promulgate regulations formally implementing such exemptions. There can be no assurance that the Company's current or future clinical information systems will qualify for future exemptions, if any, nor can there be any assurance that any future requirements will not have a material adverse effect on the Company's business, financial condition or results of operations. The health care industry is subject to changing political, economic and regulatory influences that may affect the procurement practices and operations of health care industry participants. During the past several years, government regulation of reimbursement rates in the United States health care industry has increased. Lawmakers continue to propose programs to reform the United States health care system, which may contain proposals to increase governmental involvement in health care, lower reimbursement rates and otherwise change the operating environment for the Company's customers. Health care industry participants may react to these proposals by curtailing or deferring investments, including investments in the Company's products. The Company cannot predict what impact, if any, such factors may have on its business, financial condition and results of operations. Employees As of December 31, 1996, the Company had a total of approximately 110 employees, approximately 30 of whom were employed in the Company's information systems subsidiary. None of the Company's employees is subject to a collective bargaining agreement. The Company has never experienced a work stoppage and believes that its employee relations are satisfactory. ITEM 2. PROPERTIES - ------ The Company currently occupies 26,302 square feet of leased office space in Tarrytown, New York, 4,065 square feet of leased office space in Marietta, Georgia, 1,180 square feet of leased office space in Wayne, Pennsylvania and 10,742 square feet of leased office and data center space in Chicago, Illinois. The current lease for the Tarrytown office has an annual rental of approximately $500,000 and expires in March 2002. The lease for the Marietta office expires in January 2001 and has an annual rental of approximately $50,000. The lease for the Wayne office expires in October 1997 and has an annual rental of approximately $20,000. The lease for the Chicago office expires in March 2001 and has an annual rental of $184,000 for the current year. The Company believes that these facilities are adequate for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS - ------ The Company is not a party to any litigation that would have a material adverse effect on its business, results of operations or financial condition. -14- Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS None. -15- PART II Item 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock began trading over-the-counter on the Nasdaq National Market under the symbol "ADVH" on October 3, 1996. The high and low closing prices for the period from such date through December 31, 1996 were $16.87 and $12.50, respectively. As of March 25, 1997, there were approximately 170 registered holders of the Common Stock. The Company has not declared or paid any cash dividends on its capital stock since inception and does not expect to pay dividends in the foreseeable future. The Company presently intends to retain future earnings, if any, to finance the expansion of its business. The payment of any cash dividends in the future will depend on the Company's earnings, financial condition, results of operations, capital needs and other factors deemed pertinent by the Company's Board of Directors, subject to laws and regulations then in effect. Item 6. SELECTED FINANCIAL DATA The selected consolidated statement of operations data for the years ended December 31, 1994, 1995 and 1996, and the balance sheet data as of December 31, 1995 and 1996, are derived from the Consolidated Financial Statements of the Company included elsewhere in this Annual Report on Form 10-K, which have been audited by Arthur Andersen LLP, independent public accountants. The selected consolidated statement of operations data for the period from inception (August 27, 1993) to December 31, 1993 and the selected consolidated balance sheet data as of December 31, 1993 and 1994 are derived from the consolidated financial statements of the Company which have been audited by Arthur Andersen LLP, independent public accountants, but which are not included in this Annual Report on Form 10-K. The selected consolidated financial data set forth below is qualified by reference to, and should be read in conjunction with, the Company's Consolidated Financial Statements and the Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained elsewhere in this Annual Report on Form 10-K.
Year Ended Period from Inception December 31, (August 27, 1993) to ------------------------------------------ December 31, 1993 1994 1995 1996 ---------------------- ------ ------ ------ (In thousands, except per share data) Statement of Operations Data: Revenues $ -- $ 379 $ 1,054 $19,136 Cost of revenues -- 12 340 9,707 ------- -------- -------- ------- Gross profit -- 367 714 9,429 Operating expenses 521 2,900 6,412 11,886 ------- -------- -------- ------- Operating loss (521) (2,533) (5,698) (2,442) Other income (expense) -- (15) (8) 15 ------- -------- -------- ------- Net loss before income taxes (521) (2,548) (5,706) (2,445) Income tax benefit -- -- -- 977 ------- -------- -------- ------- Net loss $ (521) $(2,548) $(5,706) $(1,465) ======= ======== ======== ======= Net loss per share $(0.23) $ (1.03) $ (1.47) $ (0.26) ======= ======== ======== ======= Weighted average number of common shares and common share equivalents outstanding 2,229 2,482 3,893 5,635 ======= ======== ======== =======
-16-
December 31, --------------------------------------------------- 1993 1994 1995 1996 ------ ------ ------ ------ (In thousands) Balance Sheet Data: Cash and cash equivalents $ 7 $ 7 $1,464 $12,086 Investments in marketable securities -- -- -- 7,390 Working capital (deficit) (435) (1,032) (741) 26,683 Total assets 27 913 6,462 35,400 Total debt -- 416 567 235 Total stockholders' equity (deficit) (416) (325) 2,675 31,884
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the results of operations and financial condition of the Company should be read in conjunction with the Consolidated Financial Statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. Overview The Company provides a full range of integrated management services and clinical information systems to physician group practices and physician networks. The Company generates revenues from (i) fees for managing and providing consulting services to physician group practices, (ii) fees for managing physician networks and (iii) fees for use and support of its clinical information systems, including recurring license, software installation, software integration, training and data conversion fees. The Company contracts with its physician practice and network management clients pursuant to long-term agreements with its MSOs, the results of which MSOs are consolidated in the Consolidated Financial Statements. To date, the Company has been dependent on a small number of contracts to generate the majority of its revenues. See "Business -- Concentration of Revenues." The Company expects that the concentration of its revenues will be reduced as the Company enters into additional contracts to provide management services and clinical information systems to physician organizations. The Company believes that its historical results of operations from period to period are not comparable and that such results are not necessarily indicative of results for any future periods because the Company was a development stage company investing in technology development and did not provide physician practice and network management services prior to December 11, 1995. Acquisitions On August 28, 1995, the Company acquired certain assets and assumed certain liabilities of Peltz Ventimiglia, Inc. ("Peltz"), a physician practice management consulting company with physician clients located throughout the East Coast of the United States, for 75,996 shares of Common Stock and contingent warrants to purchase 113,995 shares of Common Stock at $4.38 per share. The warrants are only exercisable, as contingent consideration, based on the achievement of targeted operating performance criteria. On September 1, 1995, the Company acquired U.S. Health Connections, Inc. ("Health Connections"), a network management company servicing the Southeastern United States and headquartered in Atlanta, Georgia, for $150,000 in cash, 30,193 shares of the Common Stock and $150,000 in notes payable. As of December 31, 1996, none of such notes payable remained outstanding. The purchase price also included an additional 56,611 shares of -17- Common Stock issued into escrow at closing. These escrowed shares represent contingent consideration that will be released from escrow based on the achievement of targeted operating performance criteria and accounted for based on the then fair market value. On April 1, 1996, the Company acquired certain assets of Benenson & Associates, Inc. ("Benenson"), a physician network development company with approximately 10 network clients located throughout the East Coast of the United States, for 8,937 shares of Common Stock and $45,000 in cash, payable in two installments of $22,500 each on the closing date and the first anniversary thereof. Results of Operations Year Ended December 31, 1996 and 1995 Total revenues for the year ended December 31, 1996 increased to $19.1 million from $1.1 million in the year ended December 31, 1995, primarily as a result of the increased activity in the Company's group practice and network management services. The provision of physician group practice management and related services and network management services accounted for approximately $15.1 million of the Company's net revenue for the year ended December 31, 1996 as compared to $.3 million in the year ended December 31, 1995. The Company earned fees for the use and support of its clinical information systems, including the recognition of license revenues and software, systems and training revenues, of approximately $4.0 million for the year ended December 31, 1996, as compared to $.7 million in the year ended December 31, 1995. Cost of revenues for the year ended December 31, 1996 increased to $9.7 million from approximately $.3 million for the year ended December 31, 1995. The increase in cost of revenues related primarily to the non-medical and system expenses outsourced to the Company from physician group practices under management. Operating expenses for the year ended December 31, 1996 increased to $11.9 million from $6.4 million for the year ended December 31, 1995. The increase in operating expenses reflected expenses related to the provision of physician group practice management services for the full year ended December 31, 1996, the Company did not begin to provide such services until December 1995. An income tax benefit of approximately $1.0 million was recorded in 1996 as a result of the Company's determination, based on profitable fourth quarter operations, that the related deferred income tax asset would be realized through the generation of taxable income in the future. No such benefit was recorded in 1995. The net loss for the year ended December 31, 1996 was $1.5 million compared to a loss of $5.7 million for the year ended December 31, 1995. Year Ended December 31, 1995 and 1994 Total revenues for the year ended December 31, 1995 increased to $1.1 million from $378,878 in the year ended December 31, 1994, primarily as a result of the initiation of the Company's physician group practice services to Madison in December 1995, which generated approximately $505,000 of the Company's net revenue for the year ended December 31, 1995. The Company began to provide physician network management services in September 1995, which accounted for approximately $163,000 of the Company's net revenue for the year ended December 31, 1995. The Company earned fees for the use and support of its clinical information systems, including the recognition of license revenues under its contract with an affiliate of PCS Health Systems, Inc., the managed care unit of Eli Lilly & Company, and software installation and training revenues, of approximately $386,000 for the year ended December 31, 1995, as compared to $378,878 of such revenues for the year ended December 31, 1994. Operating expenses for the year ended December 31, 1995 increased to $6.4 million from $2.9 million for the year ended December 31, 1994. The increase in operating expenses was due to the increases in staffing and general corporate expenses required to fund the Company's transition from a development stage company involved in the development of clinical information systems to a full service physician practice and network management company. The net loss for the year ended December 31, 1995 was $5.7 million compared to a loss of $2.5 million for the year ended December 31, 1994. -18- Liquidity and Capital Resources At December 31, 1996, the Company had cash and cash equivalents of $12.1 million and marketable securities of $7.4 million, compared to $1.5 million of cash at December 31, 1995. The Company's operations used net cash of $11.0 million and $4.3 million in 1996 and 1995, respectively. The increased use of cash in 1996 resulted primarily from the purchase of accounts receivable from a physician practice under Company management for an aggregate amount of $4.5 million and $1.1 million from the recognition of revenue deferred at December 31, 1995. Cash flows from investing activities increased, as a result of the investment of proceeds from the Company's IPO in marketable securities, to $8.6 million for the year ended December 31, 1996 compared with $1.0 million for the year ended December 31, 1995. Net cash provided by financing activities was $30.2 million for the year ended December 31, 1996 and related to the completion of the Company's IPO. Net cash provided by financing activities for the year ended December 31, 1995 was $6.8 million primarily attributable to the private placement of equity securities. See "-- Acquisitions" above. The Company's operating plan for 1997 includes continued development of the Company's integrated management services and clinical information systems. The principal categories of expenditures include further development of the Company's clinical information systems, as well as ongoing business development and marketing. The Company believes that the net proceeds of the IPO, cash and investments on hand, interest income and revenues from operations will be sufficient to fund planned operations of the Company through at least the end of 1998 During January and February 1997, the Company loaned $2 million to Madison, a physician practice it currently manages, secured by the physicians' 49% ownership interest in its MSO. The loan bears interest at prime plus 2 percent and is to be repaid in 12 equal monthly installments beginning January 1998. Furthermore, the Company provided a letter of credit on behalf of Madison that expires January 8, 1998, in the amount of $1.8 million by depositing restricted cash with the lending institution that issued the letter of credit. The Company has no other planned material capital expenditures or other capital commitments. From time to time in the ordinary course of its business, the Company evaluates possible acquisitions of businesses, products and technologies that are complementary to those of the Company. The Company currently has no agreements or understandings, and is not engaged in active negotiations, with respect to any such acquisition. Under certain specified circumstances, the Company has the option to cause certain MSOs to be merged with and into a wholly-owned subsidiary of the Company in a transaction in which the interests of the physician groups and networks in such MSOs would be exchanged for Common Stock of the Company. The Company has reserved 548,224 shares of Common Stock for issuance upon consummation of the Roll Up Transaction, all of which will be issued if the Company effects the Roll Up Transaction. In addition, certain of the physician groups and networks managed by the Company have rights to require the Company to purchase all or part of such physicians' interest in their respective MSO in the event that the Company does not consummate the Roll Up Transaction within one year after the satisfaction of specified conditions. There can be no assurance that the Company will have the financial resources to purchase such interests in accordance with its obligations at the time any such rights are exercised, or that the Company would be able to obtain financing on satisfactory terms or conditions, if at all, to purchase such interests. In addition, pursuant to its agreement with one of its physician group practice clients, the Company has agreed, under certain circumstances, to advance funds to such group practice to finance working capital. To date, the Company has not made any advances to such group practice under the agreement and it does not expect to do so in the future. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Financial Statements
Page ---- Report of Independent Public Accountants F-1 Consolidated Balance Sheets as of December 31, 1995 and 1996 F-2 Consolidated Statements of Operations for the years ended December 31, 1994, 1995 and 1996 F-3 Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1994, 1995 and 1996 F-4 Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1995 and 1996 F-5 Notes to Consolidated Financial Statements F-6
Financial Statement Schedules All schedules have been omitted because they are not applicable or not required or because the required information is included in the Consolidated Financial Statements or notes thereto. -19- Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. -20- PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information called for by this item is incorporated herein by reference to the sections of the definitive Proxy Statement to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1996, and delivered to stockholders in connection with the 1997 Annual Meeting of Stockholders, captioned "Election of Directors," "Executive Officers" and "Disclosure Pursuant to Section 16 of the Exchange Act." ITEM 11. EXECUTIVE COMPENSATION The information called for by this item is incorporated herein by reference to the sections of the definitive Proxy Statement to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1996, and delivered to stockholders in connection with the 1997 Annual Meeting of Stockholders, captioned "Meetings of the Board of Directors and Committees of the Board of Directors; Compensation of Directors" and "Executive Compensation and Related Information." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information called for by this item is incorporated herein by reference to the section of the definitive Proxy Statement to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1996, and delivered to stockholders in connection with the 1997 Annual Meeting of Stockholders, captioned "Security Ownership of Certain Beneficial Owners, Directors and Management." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information called for by this item is incorporated herein by reference to the section of the definitive Proxy Statement to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1996, and delivered to stockholders in connection with the 1997 Annual Meeting of Stockholders, captioned "Certain Transactions." -21- PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents Filed as Part of the Report 1. Financial Statements The financial statements listed under Item 8 are filed as part of this report. 2. Financial Statement Schedules Schedules have been omitted because they are either not applicable or the required information has been disclosed in the financial statements or notes thereto. 3. Exhibits The exhibits listed on the accompanying Exhibit Index are filed as part of this report or incorporated by reference herein. (b) Reports on Form 8-K No Current Reports on Form 8-K were filed by the registrant during the fourth quarter of the year ended December 31, 1996. -22- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 30th day of March, 1997. ADVANCED HEALTH CORPORATION By /s/ Jonathan Edelson ------------------------ Jonathan Edelson, M.D. Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
Signature Title Date - ------------ ------- ------ /s/ Jonathan Edelson Chairman of the Board, Chief Executive March 30, 1997 - ----------------------- Officer and Director (Principal Executive Jonathan Edelson, M.D. Officer) /s/ Steven Hochberg President and Director March 30, 1997 - ----------------------- Steven Hochberg /s/ Alan B. Masarek Chief Operating Officer and Chief Financial March 30, 1997 - ----------------------- Officer (Principal Financial and Alan B. Masarek Accounting Officer) /s/ James T. Carney - ---------------------- Director March 30, 1997 James T. Carney /s/ Barry Kurokawa - ---------------------- Director March 30, 1997 Barry Kurokawa /s/ Jonathan Lieber - ---------------------- Director March 30, 1997 Jonathan Lieber
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Advanced Health Corporation: We have audited the accompanying consolidated balance sheets of Advanced Health Corporation (a Delaware corporation) and subsidiaries as of December 31, 1995 and 1996, and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows for the three years ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Advanced Health Corporation and subsidiaries as of December 31, 1995 and 1996, and the results of their operations and their cash flows for the three years ended December 31, 1996 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP New York, New York March 28, 1997 F-1 ADVANCED HEALTH CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, ASSETS 1995 1996 ------ -------------- ------------- CURRENT ASSETS: Cash and cash equivalents $ 1,464,427 $ 12,085,990 Investments in marketable securities (Note 5) - 7,389,971 Accounts receivable, net 1,020,558 8,636,696 Note receivable 125,000 - Prepaid expenses 278,305 182,027 Advances to affiliates (Note 4) - 646,738 Deferred income taxes, net (Note 11) - 976,792 --------------- --------------- Total current assets 2,888,290 29,918,214 PROPERTY AND EQUIPMENT, net (Note 6) 1,538,898 2,053,049 INTANGIBLE ASSETS, net (Note 7) 1,875,611 1,857,763 OTHER ASSETS (Notes 2 and 4) 159,112 1,570,536 --------------- --------------- Total assets $ 6,461,911 $ 35,399,562 =============== =============== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable $ 1,312,571 $ 1,968,203 Accrued expenses (Note 8) 407,241 912,764 Deferred revenue 1,500,000 200,000 Loan payable related to acquisition (Note 3) 150,000 22,500 Current portion of capital lease obligations (Note 12) 259,805 131,441 --------------- --------------- Total current liabilities 3,629,617 3,234,908 DEFERRED REVENUE - 200,000 CAPITAL LEASE OBLIGATIONS (Note 12) 157,254 80,775 --------------- --------------- Total liabilities 3,786,871 3,515,683 --------------- --------------- COMMITMENTS (Note 13) SHAREHOLDERS' EQUITY (DEFICIT): Preferred stock, $.01 par value; 5,000,000 shares authorized; 0 shares issued and outstanding - - Common stock, $.01 par value; 15,000,000 shares authorized; 4,491,270 and 7,166,941 shares issued and outstanding, respectively 44,913 71,669 Additional paid-in capital 11,481,478 42,068,864 Accumulated deficit (8,776,351) (10,241,539) Unrealized gain on marketable securities, net of deferred income taxes - 59,885 Less: Treasury stock, at cost; 8,937 shares, respectively (75,000) (75,000) --------------- --------------- Total shareholders' equity (deficit) 2,675,040 31,883,879 --------------- --------------- Total liabilities and shareholders' equity (deficit) $ 6,461,911 $ 35,399,562 =============== ===============
The accompanying notes are an integral part of these consolidated balance sheets. F-2 ADVANCED HEALTH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, ---------------------------------------------------- 1994 1995 1996 ---- ---- ---- REVENUE FROM MSOs $ -- $ 341,657 $ 15,124,806 REVENUE 203,878 712,292 4,011,420 REVENUE FROM RELATED PARTY 175,000 -- -- ------------ ------------ ------------ Total revenues 378,878 1,053,949 19,136,226 COST OF REVENUES 12,297 340,326 9,706,667 ------------ ------------ ------------ Gross profit 366,581 713,623 9,429,559 OPERATING EXPENSES 2,900,477 6,412,367 11,886,216 ------------ ------------ ------------ Operating loss (2,533,896) (5,698,744) (2,456,657) INTEREST EXPENSE (15,034) (7,863) (164,656) INTEREST INCOME -- -- 179,333 ------------ ------------ ------------ Net loss before income taxes (2,548,930) (5,706,607) (2,441,980) INCOME TAX BENEFIT (Note 11) -- -- 976,792 ------------ ------------ ------------ Net loss $ (2,548,930) $ (5,706,607) $ (1,465,188) ============ ============ ============ PER SHARE INFORMATION (Note 2): Net loss per share $ (1.03) $ (1.47) $ (0.26) ============ ============ ============ Weighted average common shares and common share equivalents outstanding 2,482,213 3,893,244 5,634,898 ============ ============ ============ The accompanying notes are an integral part of these consolidated statements. F-3 ADVANCED HEALTH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) Common Stock Subscriptions Common Stock Additional Receivable ---------------------------- Paid-in -------------------------- Accumulated Shares Par Value Capital Shares Amount Deficit ------------ ------------ ------------ ---------- ------------ ------------ BALANCE, January 1, 1994 1,773,389 $ 17,734 $ 90,611 185,893 $ (3,120) $ (520,814) Sale and issuance of common stock (Note 10a) 25,319 253 639,402 -- -- -- Issuance of Series B Convertible Preferred Stock (Note 10) 252,831 2,529 1,997,574 -- -- -- Net loss -- -- -- -- -- (2,548,930) ------------ ------------ ------------ ---------- ------------ ------------ BALANCE, December 31, 1994 2,051,539 20,516 2,727,587 185,893 (3,120) (3,069,744) Issuance of Common Stock (Note 10a) 50,641 506 (506) -- -- -- Issuance of Series C convertible Preferred Stock (Note 10) 178,743 1,787 1,498,213 -- -- -- Issuance of common stock in private placement (Note 10c) 79,780 798 624,261 -- -- -- Redemption of common stock subscriptions -- -- -- (185,893) 3,120 -- Exercise of stock options 885,279 8,853 10,864 -- -- -- Common stock issued for acquisitions 649,753 6,498 1,629,314 -- -- -- Issuance of Series D Convertible Preferred Stock (Note 10) 595,535 5,955 4,991,745 -- -- -- Repurchase of treasury stock -- -- -- -- -- -- Net loss -- -- -- -- -- (5,706,607) ------------ ------------ ------------ ---------- ------------ ------------ BALANCE, December 31, 1995 4,491,270 44,913 11,481,478 -- -- (8,776,351) Common stock issued for acquisition 8,937 89 44,911 -- -- -- Exercise of stock options (Note 10) 21,734 217 85,757 -- -- -- Issuance of common stock in public offering, net of expenses of $3,921,742 (Note 10c) 2,645,000 26,450 30,456,718 -- -- -- Unrealized gain on marketable securities, net of deferred income taxes of $39,924 -- -- -- -- -- -- Net loss -- -- -- -- -- (1,465,188) ------------ ------------ ------------ ---------- ------------ ------------ BALANCE, December 31, 1996 7,166,941 $ 71,669 $ 42,068,864 -- $ -- $(10,241,539) ============ ============ ============ ========== ============ ============
Unrealized Gain On Treasury Stock Marketable --------------------------- Securities Shares Amount Total ------------ ------------ ------------ ------------ BALANCE, January 1, 1994 $ -- -- $ -- $ (415,589) Sale and issuance of common stock (Note 10a) -- -- -- 639,655 Issuance of Series B Convertible Preferred Stock (Note 10) -- -- -- 2,000,103 Net loss -- -- -- (2,548,930) ------------ ------------ ------------ ------------ BALANCE, December 31, 1994 -- -- -- (324,761) Issuance of Common Stock (Note 10a) -- -- -- -- Issuance of Series C convertible Preferred Stock (Note 10) -- -- -- 1,500,000 Issuance of common stock in private placement (Note 10c) -- -- -- 625,059 Redemption of common stock subscriptions -- -- -- 3,120 Exercise of stock options -- -- -- 19,717 Common stock issued for acquisitions -- -- -- 1,635,812 Issuance of Series D Convertible Preferred Stock (Note 10) -- -- -- 4,997,700 Repurchase of treasury stock -- 8,937 (75,000) (75,000) Net loss -- -- -- (5,706,607) ------------ ------------ ------------ ------------ BALANCE, December 31, 1995 -- 8,937 (75,000) 2,675,040 Common stock issued for acquisition -- -- -- 45,000 Exercise of stock options (Note 10) -- -- -- 85,974 Issuance of common stock in public offering, net of expenses of $3,921,742 (Note 10c) -- -- -- 30,483,168 Unrealized gain on marketable securities, net of deferred income taxes of $39,924 59,885 -- -- 59,885 Net loss -- -- -- (1,465,188) ------------ ------------ ------------ ------------ BALANCE, December 31, 1996 $ 59,885 8,937 $ (75,000) $ 31,883,879 ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated statements. F-4 ADVANCED HEALTH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, --------------------------------------------- 1994 1995 1996 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (2,548,930) $ (5,706,607) $ (1,465,188) Adjustments to reconcile net loss to net cash used in operating activities- Depreciation and amortization 146,681 456,819 890,346 Deferred income taxes -- -- (976,792) Allowance for doubtful accounts -- -- 210,000 Changes in operating assets and liabilities- Accounts receivable -- (1,020,558) (7,826,138) Note receivable -- (125,000) 125,000 Prepaid expenses (7,134) (271,171) 96,278 Advances to affiliates -- -- (646,738) Other assets (125,711) (33,401) (1,439,934) Accounts payable 200,713 993,445 655,632 Accrued expenses 82,973 280,396 505,523 Due to affiliate 270,709 (375,825) -- Deferred revenue (175,000) 1,500,000 (1,100,000) ------------ ------------ ------------ Net cash used in operating activities (2,155,699) (4,301,902) (10,972,011) ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Issuance of note receivable from affiliate -- (500,000) -- Proceeds from repayment of note receivable from affiliate -- 500,000 -- Investments in marketable securities -- -- (7,290,162) Cash paid for acquisitions -- (150,000) -- Purchases of property and equipment, net (505,997) (881,531) (1,296,131) ------------ ------------ ------------ Net cash used in investing activities (505,997) (1,031,531) (8,586,293) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: (Repayment of) proceeds from loan payable related to acquisition 50,000 (50,000) (94,500) Net proceeds from sale and issuance of common stock 639,655 628,179 30,483,168 Net proceeds from exercise of stock options -- 19,717 85,974 Net proceeds from promissory notes -- -- 5,000,000 Repayment of promissory notes -- -- (5,000,000) Purchase of treasury stock -- (75,000) -- Net proceeds from issuance of Series B Convertible Preferred Stock (Note 10) 2,000,103 -- -- Net proceeds from issuance of Series C Convertible Preferred Stock (Note 10) -- 1,500,000 -- Net proceeds from issuance of Series D Convertible Preferred Stock (Note 10) -- 4,997,700 -- Repayment of capital lease obligations (28,435) (229,639) (294,775) ------------ ------------ ------------ Net cash provided by financing activities 2,661,323 6,790,957 30,179,867 ------------ ------------ ------------ Net change in cash and cash equivalents (373) 1,457,524 10,621,563 CASH AND CASH EQUIVALENTS, beginning of year 7,276 6,903 1,464,427 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS, end of year $ 6,903 $ 1,464,427 $ 12,085,990 ============ ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 3,267 $ 21,497 $ 160,477 ============ ============ ============ Income taxes $ 3,189 $ 14,854 $ 35,633 ============ ============ ============ SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES: Capital lease obligations incurred $ 394,481 $ 280,652 $ 58,017 ============ ============ ============ Fair market value of common stock issued for acquisitions $ -- $ 1,635,812 $ 45,000 ============ ============ ============ Unrealized gain on marketable securities $ -- $ -- $ 99,809 ============ ============ ============ Loan payable issued for acquisition $ -- $ 150,000 $ 22,500 ============ ============ ============
The accompanying notes are an integral part of these consolidated statements. F-5 ADVANCED HEALTH CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995 AND 1996 1. ORGANIZATION AND BUSINESS: The Company Advanced Health Corporation ("AHC") and subsidiaries (collectively, the "Company") provides physician groups and networks with professional practice and network management services and clinical information systems and services. The Company's wholly-owned subsidiary was incorporated on August 27, 1993 as Med-E-Systems Corporation, and was engaged at inception to design and develop clinical information systems for physician users. Effective August 1995, Med-E-Systems Corporation became a wholly-owned subsidiary of AHC, an entity incorporated in March 1995, through a stock-for-stock transfer in which preferred and common shareholders of Med-E-Systems Corporation exchanged their interests for the same amounts and classes of preferred and common stock in AHC as those then outstanding in Med-E-Systems Corporation. The Company was subsequently merged with and into Majean, Inc. (Note 3), a Delaware corporation, and the surviving corporation changed its name to Advanced Health Corporation. The Company operates in a highly-regulated environment in which its sources of revenues are dependent on the Company's ability to successfully negotiate with third parties for its various services. Currently, the Company depends on revenue generated by a limited number of customers, including physician groups and networks which are under long-term contracts. Formation of Management Service Organizations The Company has established Management Service Organizations ("MSOs") to facilitate the provision of management services to physician practice and network clients. In November 1995, the Company obtained a 51% interest in Uptown Physician Management , Inc. ("Uptown") a newly formed MSO. The Company acquired this interest as part of the formation of Uptown and concurrent with the signing of a long-term management services agreement between Uptown and Madison Medical - The Private Practice Group of New York, L.L.P.("Madison"), which is a multi-specialist group practice based in the State of New York. In June 1996, the Company obtained a 51% interest in Specialist Physicians Management, Inc. ("Specialist"), a newly formed MSO. The Company acquired this interest as part of the formation of Specialist and concurrent with the signing of a long-term management services agreement between Specialist and Cardiology First of New Jersey, P.A., which is a network of cardiologists based in the State of New Jersey. In June 1996, the Company obtained a 51% interest in Diamond Physician Management, Inc. ("Diamond"), a newly formed MSO. The Company acquired this interest as part of the formation of Diamond and concurrent with the signing of a long-term management services agreement between Diamond and Long Island Interventional Cardiology, which is a private cardiovascular physician practice based in Long Island, New York. F-6 In August 1996, the Company obtained a 51% interest in Millenium Physician Management, Inc. ("Millenium"), a newly formed MSO. The Company acquired this interest as part of the formation of Millenium and concurrent with the signing of a long-term management services agreement between Millenium and Millenium Medical Associates, P.C., which is a multi-specialist group practice based in the State of New Jersey. In November 1996, the Company obtained a 51% interest in Prime Health Physician Management, Inc. ("Prime"), a newly formed MSO. The Company acquired this interest as part of the formation of Prime and concurrent with the signing of a long-term management services agreement between Prime and Primary Care Associates, which is a multi-specialist group practice based in the State of Pennsylvania. In November 1996, the Company obtained a 51% interest in Mid-Atlantic Physicians Management, Inc. ("Mid-Atlantic"), a newly formed MSO. The Company acquired this interest as part of the formation of Mid-Atlantic and concurrent with the signing of a long-term management services agreement between Mid-Atlantic and Mid-Atlantic Cardiology, P.A., which is a cardiologist group practice based in the State of New Jersey. In forming these MSOs, the Company conveyed 49% interests (Note 3) to the physician practice or network in exchange for the execution of the long-term management services agreements described above. The Company records the fair value of these arrangements, which is, in the opinion of management, more readily determinable than the 49% MSO interest conveyed. These intangible assets, which are not material, will be amortized over the life of the related contracts. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Basis of Consolidation The accompanying consolidated financial statements include the accounts of AHC and its wholly-owned subsidiaries, Advanced Health Management Corporation ("AHM", formerly Advanced Clinical Networks Corporation) and Med-E-Systems Corporation ("MES"), and the MSOs discussed in Note 1. The consolidated financial statements for 1994 and 1995 include the results of operations of the Company, including other entities formed or acquired from their formation or acquisition during those years, through December 31, 1995. The structure of the Company's wholly or majority-owned MSOs presently provides for the Company to receive activity-based fee income from the MSOs for management services provided, and reimbursement from the MSOs for certain expenses incurred, with the result being that there are no profits in the MSO entity for which a minority interest is required to be calculated. Accordingly, the consolidated financial statements do not reflect any minority interest in the operations of the MSOs. In the event that profits remain in MSO entities in the future, minority interests will be reflected in the Company's consolidated financial statements. Intercompany accounts and transactions have been eliminated in consolidation. 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 disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-7 Revenue Recognition Operating revenues are generated form three principal sources: (a) Physician Practice Revenues: A physician group practice is a single legal entity comprised of multiple physicians. Through its majority or wholly-owned consolidated MSOs, the Company enters into management services agreements with physician group practices, whereby such physician practices outsource their non-medical and administrative functions to the MSO. Activity-based fees are generated by the MSO through the provision of these outsourced services as well as certain additional management, marketing and information services. Fees for such services are either fixed or based on the level of services provided, as negotiated in the Company's various agreements for the provision of services, and are recognized monthly or as these services are rendered, respectively, based on the terms of the related agreements. The Company's contracts with its physician group practices also include pre-determined incentives which are earned and recognized as revenue in the event that the Company is successful in reducing a physician group practice's administrative expenses. (b) Physician Network Revenues: A physician network is an aggregation of individual physicians and physician groups formed for the purpose of entering into contracts with third-party payors. A physician network enters into a contract with a third-party payor pursuant to which the physicians comprising the network agree to provide medical services to network enrollees in return for a fixed per enrollee fee. Such contracts are known as "capitated contracts". The physician network then enters into a management services agreement with the Company's majority-owned, consolidated MSO, pursuant to which the aggregate capitated payments are assigned to the MSO. From these capitated payments, the MSO pays a fixed percentage of the capitated premium to fund all administrative and management services required under the contract. After payment of such administrative and management expenses, the MSO pays the network physicians in return for the physicians' provision of medical services to medical enrollees. Such payments are based on a pre-determined fee schedule based on actuarial predictions of required medical utilization by the networks' enrollees. In the event that total capitated premiums exceed the sum of the costs of (i) administrative and management services provided and (ii) the physicians' provision of medical services to the network enrollees, such savings are shared between the MSO and the network physicians in differing pre-determined amounts. In the event that total capitated premiums are less than the sum of the abovementioned costs, such costs are accrued and are borne proportionally by the MSO. The Company has not earned, recognized or recorded any such capitated revenues through December 31, 1996. In the event that contracts between MSOs and physician practices and network are terminated, the terms of the related contracts do not require the Company, through the MSOs, to return any previously-earned revenues. (c) Information Systems and Services Revenue: The Company's current business strategy for providing integrated physician practice and network management services includes selling its information systems and services as a means of ultimately providing a full range of services. In order to generate operating funds and demonstrate the uses of its systems and development capabilities, the Company has licensed and may continue licensing certain components of its software to third parties. The Company recognizes revenue from the sale of its information systems and services (upon installation and acceptance), and from the licensing of its software to third parties (upon delivery). Certain of these third parties provide payment in advance for the development and installation of software, databases and systems. The Company accounts for these advance payments as deferred revenue when received, and recognizes revenue ratably over the period of time during which the software is delivered and services are performed. In December 1991, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 91-1, "Software Revenue Recognition". The Company's revenue recognition policy is in compliance with the provisions of the SOP. F-8 Cash and Cash Equivalents Cash and cash equivalents include cash and highly liquid investments with original maturities of three months or less when purchased. Concentration of Credit Risk Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade receivables from physician practice revenues, physician network revenues and information systems and services rendered. Investments in Marketable Securities The Company accounts for investments in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." In accordance with this pronouncement, the debt securities held by the Company and included in the accompanying consolidated balance sheets that may be sold in response to changes in interest rates, prepayments, and other factors have been classified as available-for-sale. Such securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity (on an after-tax basis). Gains and losses on the disposition of securities are recognized on the specific identification method in the period in which they occur. Property and Equipment Property and equipment, consisting primarily of electronic data processing equipment, are stated at cost and depreciated on a straight-line basis over the useful lives of the assets (3 to 5 years). Equipment held under capital leases is amortized utilizing the straight-line method over the lesser of the term of the lease or the estimated useful life of the asset. Intangible Assets Goodwill, which represents the excess of the purchase price over the fair value of the net assets acquired, covenants not-to-compete and management contracts are included in intangible assets and are presently being amortized over periods of 4 to 20 years on a straight-line basis. These amortization periods are evaluated by management on a continuing basis, and will be adjusted if the lives of the related intangible assets are impaired. Accounting for Long-Lived Assets During March 1995, the Financial Accounting Standards Board ("FASB") issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed Of." This statement establishes financial accounting and reporting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used, and for long-lived assets and certain identifiable intangibles to be disposed of. This statement is effective for financial statements for fiscal years beginning after December 15, 1995, and was adopted by the Company in 1996. The effect of the adoption was not material. F-9 Computer Software Costs The Company develops computer software which is marketed to third parties. The Company capitalizes such costs in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." Amortization of such costs is provided using the straight-line method over the estimated economic life of the products, which is generally five years. The Company has $100,569 and $1,130,143 of unamortized capitalized computer software costs included in other assets in the accompanying consolidated balance sheets as of December 31, 1995 and 1996, respectively. Such costs capitalized in 1996 were incurred primarily in the latter part of that year. Computer software amortization expense aggregated $0, $25,142 and $28,542, respectively, for the three years ended December 31, 1996. Research and Development Research and development costs are expensed as incurred by the Company. Research and development expense aggregated $1,582,332, $3,157,389 and $2,843,355, respectively, for the three years ended December 31, 1996. Income Taxes The Company accounts for income taxes under SFAS No. 109, "Accounting for Income Taxes," which requires recognition of deferred tax liabilities and assets for the estimated future tax effects of events that have been recognized in the financial statements or income tax returns. Under this method, deferred tax liabilities and assets are determined based on (1) differences between the financial accounting and income tax bases of assets and liabilities and (2) net operating loss carry-forwards, using enacted tax rates in effect for the years in which the differences and carry-forwards are expected to reverse and be utilized, respectively (Note 11). Net Loss Per Common Share Net loss per common share was computed by dividing net loss by the weighted average number of common shares and common share equivalents outstanding during the respective years, which includes, for all periods, (i) the effect of the conversion of Class A, B, C and D Convertible Preferred Stock to common stock, (ii) the retroactive effect of the reverse stock split, both described in Note 10, which occurred concurrent with the consummation of the Company's initial public offering and (iii) the impact of the issuance, in the year prior to the Company's initial public offering, of 504,477 warrants and options for all periods presented. Fully diluted net loss per common share has not been presented since the inclusion of the impact of stock options and warrants outstanding (Notes 3, 9 and 10) would be antidilutive. F-10 Stock-Based Compensation During October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation." This statement establishes financial accounting and reporting standards for stock-based employee compensation plans. SFAS No. 123 encourages entities to adopt a fair value based method of accounting for stock compensation costs under pre-existing accounting pronouncements. If the fair value based method of accounting is not adopted, SFAS No. 123 requires pro forma disclosures of net income (loss) and earnings (loss) per share in the notes to the consolidated financial statements. The accounting requirements of SFAS No. 123 are effective for transactions entered into in fiscal years that begin after December 15, 1995, though they may be adopted on issuance. The disclosure requirements of SFAS No. 123 are effective for financial statements for fiscal years beginning after December 15, 1995, or for an earlier fiscal year for which SFAS No. 123 is initially adopted for recognizing compensation cost. The Company has adopted this standard in 1996, and has elected to continue the accounting set forth in Accounting Principles Board No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and to provide the necessary pro-forma disclosures (Note 10). Recently Issued Accounting Standards Subsequent to December 31, 1996, the FASB issued SFAS No. 128, "Earnings Per Share." This statement establishes standards for computing and presenting earnings per share ("EPS"), replacing the presentation of currently required primary EPS with a presentation of Basic EPS. For entities with complex capital structures, the statement requires the dual presentation of both Basic EPS and Diluted EPS on the face of the statement of operations. Under this new standard, Basic EPS is computed based on weighted average shares outstanding and excludes any potential dilution. Diluted EPS reflects potential dilution from the exercise or conversion of securities into common stock or from other contracts to issue common stock and is similar to the currently-required fully diluted EPS. SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods, and earlier application is not permitted. When adopted, the Company will be required to restate its EPS data for all prior periods presented. The Company does not expect the impact of the adoption of this statement to be material to previously reported EPS amounts. Reclassifications Certain prior year amounts have been reclassified to conform to the current year's presentation. 3. ACQUISITION OF BUSINESSES: Acquisitions The transaction with Majean, Inc. described in Note 1 was accounted for as a purchase through the issuance of 543,564 shares of the Company's stock to the shareholders of Majean, Inc., who were not previously affiliated with the Company, for an aggregate purchase price of $1,368,471. Additionally, options to purchase 283,010 shares of common stock at $.0112 per share were issued as part of this transaction. These options are only exercisable, as contingent consideration, upon the achievement of certain capitalization levels related to regulatory requirements. The entire purchase price of this acquisition has been allocated to intangible assets in the accompanying consolidated balance sheets, as will any contingent consideration which arises due to the option described above, based on a twenty-year contract with an MSO, which was contributed to Majean, Inc. by its shareholders upon its formation immediately prior to the transaction. Accordingly, this intangible asset is being amortized over a period of twenty-years. F-11 Pursuant to an asset purchase agreement with Peltz Ventimiglia, Inc. ("Peltz") dated August 28, 1995, AHC acquired certain assets and assumed certain liabilities of Peltz for 75,996 shares of common stock for an aggregate purchase price of $191,327. Additionally, the former owners of Peltz received warrants to purchase 113,995 shares of the Company's common stock at $4.38 per share, which management believes to be in excess of the fair market value of such shares at the date of grant. These warrants are only exercisable, as contingent consideration, based on the achievement of targeted operating performance. Pursuant to a purchase agreement with U.S. Health Connections, Inc. ("Health Connections") dated September 1, 1995, the Company acquired, through its subsidiary AHM, all of the outstanding stock of Health Connections for $150,000 in cash, a note for $150,000 due in two installments within one year of the acquisition and 30,193 shares of common stock, for an aggregate purchase price of $376,014. Furthermore, the Health Connections purchase agreement calls for the issuance of an additional 56,611 common shares, as contingent consideration, based on the achievement of targeted operating performance by this entity. The Company will record the effect of the contingent consideration, if any, related to these acquisitions based upon the provisions of Emerging Issues Task Force Issue 95-8, "Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Company in a Purchase Business Combination", which sets forth the criteria for determining the allocation of contingent consideration as either additional purchase price or compensation expense. These criteria provide for the recognition of contingent consideration, as opposed to compensation expense, upon the exercisability, if any, of such options and warrants where relevant facts and circumstances, such as continued employment of the sellers, components of the selling shareholder group, reasons for contingent payments and other agreements and issues, indicate that such accounting is warranted. Management of the Company believes that the terms of the acquisitions described above meet the criteria for recognition of contingent consideration. These acquisitions described above were valued based on management's estimate of the fair value of common stock at the date of acquisition, which was determined by the Company's management by comparisons to (i) arms-length transactions with unrelated third-parties for the same or similar securities and (ii) an independent third-party appraisal. Costs in excess of net assets acquired were recorded as intangible assets as follows:
Peltz U.S. Health Majean, Inc. Ventimiglia, Inc. Connections, Inc. Accounts receivable $ - $ 41,555 $ 40,775 Management contracts 1,368,471 - - Goodwill - 173,551 355,239 Covenant not-to-compete - 10,000 10,000 Current liabilities - (33,779) (30,000) ---------------- ----------------- ------------------ Total purchase price $ 1,368,471 $ 191,327 $ 376,014 ============== =============== ==============
Pro Forma Results of Operations Summarized below are the unaudited pro forma results of operations of the Company as though these acquisitions had occurred at the beginning of 1994. This pro forma information does not give effect to any operations of Majean, Inc., which had no operations prior to the merger transaction with the Company. Adjustments have been made for pro forma income taxes and amortization of intangible assets related to these transactions. F-12 For the Years Ended December 31, -------------------------------- 1994 1995 Pro Forma: -------------- -------------- Revenues $ 1,228,409 $ 1,619,621 Net loss (2,467,198) (5,742,954) Net loss per share $ (1.18) $ (1.66) These pro forma results of operations are not necessarily indicative of the actual results of operations that would have occurred had the acquisitions been made at the beginning of 1994, or of results which may occur in the future. On April 1, 1996, the Company acquired certain assets and assumed certain liabilities of a network development company in exchange for 8,937 shares of the Company's common stock and $45,000, to be paid in two installments of $22,500 on the closing date and on the first anniversary thereof, for an aggregate purchase price of approximately $90,000, all of which is included in goodwill in the accompanying consolidated balance sheets. The pro forma effects of this transaction have not been presented, as the results are immaterial to the Company's consolidated financial statements taken as a whole. The stockholders agreements for these MSOs and those MSOs which were formed as described in Note 1, among other things, (i) restrict the transfer of MSO equity, (ii) provide the terms upon which the MSO can, at the Company's option, be merged with and into a wholly-owned subsidiary of the Company in a transaction in which the physician practice or network will receive stock of the Company in exchange for shares in the MSO and (iii) grant to the physician practice or network the right to put its equity share in the MSO to the Company within one year of the Company's satisfaction of certain specified targets if the Company has not called its right to acquire those interests within that period. The agreements provide that these call transactions will be paid in the Company's common stock, and put transactions will be paid in cash, and that either transaction, if effected, would be based on an agreed-upon amount at the time of the transaction. The Company will, in the event that these transactions take place, account for such transactions as purchases at the agreed-upon fair market value of the MSO interest being purchased. 4. RELATED PARTY TRANSACTIONS: Shared Services The Company previously shared office space and administrative services with Physicians' Online, Inc. ("POL"), a privately held healthcare information services company which is partly owned by several of the Company's shareholders, including certain officers and directors. During the three years ended December 31, 1996, POL also incurred expenses totaling $135,825, $180,631 and $94,605, respectively, on behalf of the Company for which the Company has reimbursed POL. The Company also repaid a loan from POL in the amount of $300,000 during the year ended December 31, 1995. In addition, during 1995, POL borrowed $500,000 from the Company. POL repaid this amount in full prior to December 31, 1995. Transactions with MSOs Revenues from MSOs, which are also related parties, are separately set forth in the accompanying consolidated financial statements. F-13 In December 1996, one of the MSOs purchased accounts receivable from a physician practice, under the terms of its management services agreement, for an aggregate amount of $4,501,352, which is included in accounts receivable in the accompanying consolidated balance sheet as of December 31, 1996. In accordance with the agreement, all purchased accounts receivable outstanding after ninety days from the purchase date are to be sold back to the physician practice at face value. In the event that the physician practice is unable to repurchase the receivables, the aggregate outstanding amount is converted to a loan which is collateralized by outstanding shares of the Company held by the shareholders of the physician practice. During 1996, a separate MSO made advances aggregating $600,000, in the ordinary course of business, to a physician practice with which the MSO has a long-term management services agreement. These advances were satisfied subsequent to December 31, 1996, as the physician practice simultaneously assigned certain accounts receivable to the MSO to satisfy the advances and sold additional accounts receivable to the MSO. This amount is included in advances to affiliates in the accompanying consolidated balance sheet. Transactions with Officers In accordance with the Company's Senior Executive Loan Policy, which is administered by the Compensation Committee of the Board of Directors, the Company has made loans to certain senior executives of the Company aggregating $430,000, which are included in other assets in the accompanying consolidated balance sheet as of December 31, 1996. These loans are due three years from the loan date with interest payable monthly at a rate of 6% per annum. There were such no loans outstanding at December 31, 1995. Management of the Company believes that these related party transactions were effected on terms which approximate fair market value. 5. INVESTMENTS IN MARKETABLE SECURITIES: The amortized cost, gross unrealized gains and losses and fair value of the available-for-sale securities as of December 31, 1996, are as follows:
Amortized Unrealized Unrealized Cost Gains Losses Fair Value ------------- ------------- ------------- ------------- Commercial paper $ 7,290,162 $ 99,809 $ - $ 7,389,971 ============= ============= ============= =============
All available-for-sale securities are due within one year. There were no sales of available-for-sale securities for the year ended December 31, 1996. The Company had no marketable securities prior to 1996. F-14 6. PROPERTY AND EQUIPMENT: Property and equipment is comprised of the following:
December 31, -------------------------------- 1995 1996 ---- ---- Computer equipment and software $ 1,152,077 $ 2,276,484 Equipment under capital leases 681,988 470,856 Furniture and fixtures 189,448 271,578 Leasehold improvements 60,236 43,061 -------------- --------------- 2,083,749 3,061,979 Less: Accumulated depreciation and amortization 544,851 1,008,930 -------------- --------------- Property and equipment, net $ 1,538,898 $ 2,053,049 ============== ==============
Depreciation and amortization aggregated $146,681, $396,618 and $781,980, respectively, for the three years ended December 31, 1996. 7. INTANGIBLE ASSETS: Intangible assets arising from acquisitions (Note 3) consist of the following:
December 31, ----------------------------------- 1995 1996 ---- ---- Management contracts $ 1,368,471 $ 1,368,471 Goodwill 528,790 618,790 Covenant not-to-compete 20,000 20,000 ----------------- --------------- 1,917,261 2,007,261 Less: Accumulated amortization 41,650 149,498 ----------------- --------------- Intangible assets, net $ 1,875,611 $ 1,857,763 =============== =============
Amortization aggregated $41,650 and $107,848, respectively, for the years ended December 31, 1995 and 1996. There were no intangible assets prior to 1995. 8. ACCRUED EXPENSES: Accrued expenses consist of the following as of December 31, 1996: Reimbursable physician practice expense $ 326,225 Public stock offering expenses 244,656 Other 341,883 --------------- Total accrued expenses $ 912,764 ============= The Company had no individual accrued expenses in excess of 5% of current liabilities as of December 31, 1995. F-15 9. BRIDGE FINANCING: Bridge Financing On February 28, 1996, the Company entered into an agreement to issue three 8% promissory notes to an investor for an aggregate amount of $3,000,000. The Company issued one promissory note and received $1,500,000 upon the closing, issued a second promissory note and received $750,000 at the second closing date, April 26, 1996, and issued a third promissory note and received the remaining $750,000 on the third closing date, June 28, 1996. Each note was due on the earlier of the initial public offering of the Company's securities or one year from the respective closing dates. Interest was due quarterly on each of the notes. In addition, the investor received warrants to purchase 16,757 shares of common stock of the Company at $16.78 per share which expire on June 28, 2001. The exercise price of $16.78 per share is, in the opinion of management, greater than the fair market value of such shares at the date the warrants were issued. The investor also received 8,937 contingent warrants to purchase the Company's stock at $8.39 per share. These contingent warrants were to be exercisable during the period from January 1, 1997 through June 28, 2001 if payment had not been made on the notes by the agreed-upon payment dates described above or if an initial public offering was not consummated prior to January 1, 1997; however, when payments on the notes were made by the specified dates, these contingent warrants were canceled. The Company also entered into an agreement with the owners of the Company's Series D Convertible Preferred Stock and related warrants (Note 10) for additional bridge financing in the amount of approximately $2,000,000. This financing was unsecured, bore interest at 9% and expired on the earlier of the consummation of an initial public offering or July 31,1997. On June 19, 1996, the Company issued three promissory notes in the aggregate principal amount of $1 million and on August 13, 1996, the Company issued three additional promissory notes in the aggregate principal amount of $1 million under this agreement. The Company used a portion of the proceeds of the initial public offering to repay this bridge financing. The supplementary net loss per share for the year ended December 31, 1996, which follows, gives supplementary effect to the issuance of 384,615 shares of common stock for the entire period during which the related bridge financing was outstanding, which is the number of shares issued in the initial public offering, the proceeds of which were used to repay the bridge financing, as well as to the effect of the reduction of related interest expense, net of tax, in the period during which that debt was outstanding. These shares are presumed outstanding for supplementary purposes only, and were neither issued nor outstanding for any purpose during the year ended December 31, 1996. For the year ended December 31, 1996 Supplementary net loss per share $ (.24) ============= Supplementary weighted average common shares outstanding 5,931,241 ============= F-16 10. SHAREHOLDERS' EQUITY: Common Stock (a) In November 1994, the Company sold 75,960 common shares pursuant to a private placement agreement dated August 22, 1994 for an aggregate of $639,655. Of these shares sold, all of which were paid for in 1994, 25,319 were issued prior to December 31, 1994 and 50,641 were issued in January 1995. In accordance with this agreement, the holders of these shares have the right, on two occasions, to participate on a "piggy-back" basis in a registration by the Company under the Securities Act of 1933, as amended, subject to certain restrictions, for a period ending on October 31, 1999, and commencing twelve months from the closing of an initial public offering of the securities of the Company. (b) In 1995, the Company sold 79,780 common shares pursuant to a private placement agreement dated April 21, 1995 for an aggregate of $625,059. In accordance with this agreement, the holders of these shares have the right, on two occasions, to participate on a "piggy-back" basis in a registration by the Company under the Securities Act of 1933, as amended, subject to certain restrictions, for a period ending on September 30, 2000, and commencing twelve months from the closing of an initial public offering of the securities of the Company. (c) In October 1996, the Company completed an initial public offering of its securities. The offering included the sale of 2,300,000 shares of common stock (on a basis which reflected the reverse split described below) at $13 per share plus an underwriters' overallotment of 345,000 shares. Total net proceeds from this offering were $30,483,168. Preferred Stock Prior to the initial public offering, the Company had 2,000,000 shares of authorized Preferred Stock with a par value of $.01 per share, of which 971,800 shares had been designated Series A Convertible Preferred Stock. On August 31, 1993, the Company sold 971,800 shares of Series A Convertible Preferred Stock for $97,180. In March 1994, the Company authorized and sold 282,900 shares of Series B Convertible Preferred Stock for $2,000,103 pursuant to a Private Placement Agreement. In January 1995, the Company authorized and sold 200,000 shares of Series C Convertible Preferred Stock for $1,500,000 pursuant to a Private Placement Agreement. In August 1995, the Company authorized and sold 666,360 shares of Series D Convertible Preferred Stock for $4,997,700 pursuant to a Private Placement Agreement. All of the above shares are not redeemable. Each individual share of Series A, B, C and D Convertible Preferred Stock was convertible into 1.5 common shares at the holder's option, subject to adjustment for antidilution. The holders of Series A, B, C and D Convertible Preferred Stock are entitled to receive dividends as and if declared by the Board of Directors. In the event of liquidation, dissolution or winding up of the Company, the holders of Series A, B, C and D Convertible Preferred Stock are entitled to receive all accrued dividends, if applicable, plus the liquidation price per share of $.07, $4.71, $5.00 and $5.00, respectively. Subject to certain provisions, registration rights, as defined in the agreement, may be exercised after the earlier of (1) August 23, 1999 or (2) the effective date of the first registration statement for a public offering of securities of the Company. Holders of Series B, C and D Convertible Preferred Stock have voting rights. Furthermore, holders of Series D Convertible Preferred Stock have the right to purchase 446,858 shares of Class D Convertible Preferred Stock at $8.39 per share. F-17 Stock Splits and Conversion of Preferred Stock In January 1995, the Company authorized a 100 for 1 stock split on its Series A and B Preferred Stock and a 100 for 1 stock split on the common stock sold in 1993. In April 1996, the Company authorized a 1.5 for 1 stock split on its common stock in the form of a stock dividend. Pursuant to the terms of the Series A, B, C and D Convertible Preferred Stock, these securities were converted, on a 1.5 to 1 share basis, to common stock immediately prior to the effective date of the initial public offering. In connection with the initial public offering, the Company effected a recapitalization whereby the presently outstanding common stock (including converted Series A, B, C and D Convertible Preferred Stock) was converted to shares of common stock on a .59581 to 1 share basis. All information in the accompanying consolidated financial statements and footnotes has been retroactively restated to give effect to these transactions. Stock Options During 1994, the Company issued options to employees to purchase 970,860 shares of common stock at prices ranging from $.0112 to $2.52 per share. During 1995, the Company adopted the 1995 Stock Option Plan (the "1995 Plan") for the purpose of granting incentive stock options to employees, officers or directors of, or consultants or advisors to, the Company, provided that incentive stock options may only granted to individuals who are employees of the Company. Options granted under the 1995 Plan typically vest annually over a three-year period and expire ten years from the date of grant. The Company reserved 1,500,000 shares of common stock for issuance under the 1995 Plan. The Company also adopted the Advanced Health Corporation Employee Stock Purchase Plan (the "Employee Plan") during 1996 in order to allow the employees of the Company to acquire a proprietary interest in the Company through the purchase of the Company's common stock. Under the Employee Plan, eligible employees will be granted options to purchase shares of common stock through regular payroll deductions. The total number of shares of common stock that are authorized for issuance under the Employee Plan is 1,200,000. No shares have been issued under the Employee Plan. The Company accounts for these plans under APB Opinion No. 25, under which no compensation cost has been recognized. Had compensation cost for these plans been determined consistent with SFAS No. 123, the Company's net loss and net loss per share would have been changed to the following pro forma amounts:
1995 1996 Net loss: As Reported $ (5,706,607) $ (1,465,188) Pro Forma (5,898,054) (1,850,482) Net loss per share: As Reported $ (1.47) $ (0.26) Pro Forma (1.51) (0.33)
Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. F-18 A summary of the status of the 1995 Plan at December 31, 1995 and 1996, and changes during the years then ended, is presented in the table and narrative below:
1995 1996 Wtd Avg Wtd Avg Shares Ex Price Shares Ex Price ---------------- --------------------- --------------- ------------------- Outstanding at beg. of year 841,264 $ 0.27 888,916 $ 0.17 Grant 980,968 2.73 154,733 6.77 Exercised (885,279) 0.01 (21,734) 3.71 Forfeited (48,037) 2.52 (217,471) 4.17 ------------- --------------- Outstanding at end of year 888,916 0.17 804,444 1.31 ============= =============== Exercisable at end of year 22,479 n/a 306,511 n/a ============= =============== Weighted average fair value of options granted $ 1.43 n/a $ 3.54 n/a
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1995 and 1996, respectively: risk-free interest rates of 6.2%; expected dividend yields of 0%; expected lives of 3 years; expected stock price volatility of 74%. Stock Warrants In October 1995, the Company issued warrants to a financial advisor to purchase 17,874 shares of common stock at $3.52 per share. In the opinion of management, the exercise price of $3.52 per share represents the fair value of such shares at the date the warrants were issued. Accordingly, management has determined that the intrinsic value of these warrants is not material to the Company's consolidated financial statements. F-19 11. INCOME TAXES: Income tax benefit consists of the following:
Year Ended December 31, -------------- ------------------ -------------- 1994 1995 1996 ---- ---- ---- Federal: Current $ - $ - $ - Deferred - - 757,014 State and Local: Current - - - Deferred - - 219,778 -------- --------- ------------ Total income tax benefit $ - $ - $ 976,792 ======== ========= ============
A reconciliation of difference between the statutory U.S. Federal Income Tax Rate and the Company's effective tax rate for the years ended December 31, 1994, 1995 and 1996 follows: 1994 1995 1996 --- --- --- U.S. Federal statutory income tax rate 34% 34% 34% State income taxes, net of federal tax tax benefit 6% 6% 6% Net operating loss without tax benefit (40%) (40%) -- ------ ----- ----- -- -- 40% ====== ===== ===== The tax effects of temporary differences, that give rise to a significant portion of the deferred income tax asset, net, are as follows:
December 31, ----------------------------------- 1995 1996 ---- ---- Current deferred income tax assets: Net operating loss carryforward $ - $ 976,792 --------------- -------------- Current deferred tax asset - 976,792 --------------- -------------- Noncurrent deferred income tax asset, net: Net operating loss carryforwards 2,564,800 3,510,540 Amortization 522,969 380,346 Deferred revenue 240,000 160,000 Allowance for doubtful accounts - 84,000 Other 178,771 (10,924) --------------- -------------- 3,506,540 4,123,962 --------------- -------------- Less: Valuation allowance (3,506,540) (4,123,962) --------------- -------------- Total deferred income taxes, net $ - $ 976,792 =============== ==============
F-20 As of December 31, 1996, the Company had net operating loss carryforwards ("NOLs") available to offset future book and taxable income of approximately $10.2 million and $8.7 million, respectively, which expire in varying amounts through 2011. Certain of these carryforwards are limited as to their utilization due to cumulative changes in ownership of the Company through 1996 (Note 10). Future changes in ownership, as defined by Section 382 of the Internal Revenue Code, as amended could limit the amount of net operating loss carryforwards in any one year. In 1996, management of the Company determined that it has become more likely than not that the current year deferred income tax assets will be realized and has, accordingly, recorded the current year deferred income tax asset of $976,792, which is included in the income tax benefit in the accompanying consolidated statement of operations for 1996. The determination that the net deferred income tax asset of $976,792, which includes the deferred income tax benefit for the current year, is realizable is based on the Company's profitability in the latter part of 1996. 12. CAPITAL LEASE OBLIGATIONS INCOME TAX: The Company is the lessee of certain equipment under capital leases expiring through 2001. The assets and liabilities are recorded at the lower of the present value of minimum lease payments or the fair market value of the asset. The interest rates on the capital leases vary from 2.63% to 17.00%. Future minimum payments under these lease agreements are as follows: Year ending December 31, 1997 $ 145,048 1998 77,818 1999 8,458 2000 10,648 2001 3,550 ------------- Total minimum lease payments 245,522 Less: Amount representing interest 33,306 ------------- Present value of net minimum lease payments 212,216 Less: Current portion 131,441 ------------- $ 80,775 ============= 13. COMMITMENTS: The Company leases certain office space for its operations. Leases for this space expire through 2002 and call for annual rent, with immaterial escalations through the end of the leases. The Company has also entered into several operating leases for office equipment. Future minimum payments for operating leases at December 31, 1996 are as follows: Year ending December 31, 1997 $ 631,012 1998 719,016 1999 784,040 2000 813,764 2001 and thereafter 792,289 Rent expense was $69,774, $125,881 and $629,847, respectively, for the three years ended December 31, 1996. 14. SUBSEQUENT EVENT: Subsequent to December 31, 1996, the Company loaned $2,000,000 to Madison at the prime rate plus 2%, not to exceed 10%, with interest payable monthly and the outstanding principal payable in twelve monthly installments beginning in January 1998. In conjunction with this loan, the Company has guaranteed a letter of credit of Madison, in the amount $1,727,000, by depositing and restricting cash in the same amount with the same financial institution providing that letter of credit. These obligations are secured by the 49% ownership interest in Uptown held by Madison. F-21 EXHIBIT INDEX Exhibit No. Description of Exhibit Page - ----------- ---------------------- ---- **2.1 Agreement and Plan of Merger dated as of August 2, 1995, among Med-E-Systems Corporation, MES Acquisition Corp. and the Registrant **2.2 Agreement and Plan of Merger dated as of August 7, 1995, between the Registrant and Majean, Inc. **2.3 Asset Purchase Agreement dated as of August 28, 1995, among Advanced Clinical Networks Corporation, Peltz Ventimiglia, Inc., Richard Ventimiglia and Steven Peltz **2.4 Agreement and Plan of Merger dated as of September 1, 1995, among U.S. Health Connections, Inc., the Registrant and Advanced Clinical Networks Corporation **3.1 Restated Certificate of Incorporation of the Registrant **3.2 By-laws of the Registrant +**10.1 Development and Marketing Agreement dated as of August 1, 1995, between Med-E- Systems Corporation and Integrated Disease Management, Inc +**10.2 Software License Agreement dated as of September 27, 1995, between Med-E- Systems Corporation and Medco Containment Services Inc +**10.3 System Implementation Agreement dated September 14, 1995, between IDX Systems Corporation and the Registrant **10.4 Investors' Rights Agreement dated as of August 31, 1993, among Med-E-Mail Corporation, Financial Strategic Portfolios, Inc. -- Health Sciences Portfolio and The Global Health Sciences Fund **10.5 Amended and Restated Investors' Rights Agreement dated as of March 16, 1994, among Med-E-Mail Corporation, Financial Strategic Portfolios, Inc. -- Health Sciences Portfolio and The Global Health Sciences Fund **10.6 Amended and Restated Investors' Rights Agreement dated as of January 27, 1995, among Med-E-Systems Corporation, Invesco Strategic Portfolios, Inc. -- Health Sciences Portfolio and The Global Health Sciences Fund **10.7 Investors' Rights Agreement dated as of August 23, 1995, among the Registrant, 21st Century Communications Partners, L.P., 21st Century Communications T-E Partners, L.P. and 21st Century Communications Foreign Partners, L.P **10.8 Registrant Rights Agreement dated February 28, 1996, among the Registrant, Park Avenue Capital, L.P. and Access Industries, LLC +**10.9 Management Services Agreement dated as of December 11, 1995, between Madison Medical -- The Private Practice Group of New York, L.L.P. and Uptown Physician Management, Inc. **10.10 Stockholders' Agreement dated as of December 11, 1995, among Uptown Physician Management, Inc. and certain stockholders +**10.11 Management Services Agreement dated as of August 7, 1995, among Advanced Heart Institute of New York, P.C., Valavanur A. Subramanian, M.D., Jeffrey Moses M.D. and Majean Sub 2, Inc. +**10.12 Management Services Agreement dated as of July 1, 1996, between Specialist Physicians Management, Inc. and Cardiology First of New Jersey, P.A. Exhibit No. Description of Exhibit Page - ----------- ---------------------- ---- **10.13 Stockholders' Agreement dated as of July 1, 1996 among Specialist Physicians Management, Inc., Specialist Physicians MSO, L.L.C. and Advanced Health Management Corporation. +**10.14 Management Services Agreement dated as of July 1, 1996 between Diamond Physician Management, Inc. and Long Island Interventional Cardiology. **10.15 Stockholders' Agreement dated as of July 1, 1996 among Diamond Physician Management, Inc., Long Island Interventional Cardiology and Advanced Health Management Corporation. +**10.16 Administrative Services Base Agreement dated as of June 30, 1994, between U.S. Health Connections, Inc. and The Emory Clinic, Inc. **10.17 Tarrytown, New York Office Lease Agreement dated November 30, 1995, between Tarrytown Corporate Center IV, L.P. and the Registrant. **10.18 Tarrytown, New York Office Sublease Agreement dated October 31, 1995, between American Software, USA, Inc. and the Registrant *10.19 First Amendment to Lease Agreement between Reckson Operating Partnership, LP, as Owner, and the Registrant, as Tenant **10.20 Chicago Office Lease Agreement dated December 8, 1995, between Adams Family, L.L.C. and the Registrant **10.21 Form of Director Indemnification Agreement **10.22 Employment Agreement between the Registrant and Jonathan Edelson, M.D. **10.23 Employment Agreement between the Registrant and Steven Hochberg **10.24 Employment Agreement between the Registrant and Alan B. Masarek **10.25 Amended and Restated Advanced Health Corporation 1995 Stock Option Plan **10.26 Employee Stock Purchase Plan *11.1 Supplemental Net Loss Per Common Share Computation **21 List of Subsidiaries *23.2 Consent of Arthur Andersen LLP *27 Financial Data Schedule - -------- * Filed herewith. ** Filed as an exhibit to the Registrant's Registration Statement on Form S-1, as amended (Registration No. 333-06283), and incorporated herein by reference. + Portions of such exhibit have been deleted therefrom pursuant to Rule 406 promulgated under the Securities Act of 1933, as amended, and confidential treatment has been granted therefor. EX-10.19 2 EXHIBIT 10.19 FIRST AMENDMENT TO LEASE AGREEMENT BETWEEN RECKSON OPERATING PARTNERSHIP, LP, AS OWNER, AND ADVANCED HEALTH CORPORATION, AS TENANT, Premises: 555 White Plains Road Tarrytown, New York 10591 Prepared By: The Law Office of STEVEN C. HIRSCH, ESQ. 595 Stewart Avenue Suite 800 Garden City, New York 11530 (516) 227-1117 THIS FIRST AMENDMENT TO LEASE, made as of the 20th day of September, 1996, between RECKSON OPERATING PARTNERSHIP, LP, having an office at 660 White Plains Road, Tarrytown, New York 10591, hereinafter called the "Owner" and ADVANCED HEALTH CORPORATION, having an office at 660 White Plains Road, Tarrytown, New York 10591 hereinafter referred to as the "Tenant." W I T N E S S E T H: WHEREAS, Owner, is the fee simple owner of the building commonly known as and located at 560 White Plains Road, Tarrytown, New York 10591 (the "560 Building"); WHEREAS, Owner's predecessor-in-interest entered into that certain lease dated January 14, 1992, with Integrated Systems Solutions Corporation ("ISSC"), as Tenant (the "Prime Lease") for the Second, Third, and Fourth floors of the 560 Building for a term which exprires on March 31, 1997, which Prime Lease was thereafter assigned to and assumed by International Business Machines Corporation ("IBM") pursuant to a certain Assignment, Assumption and Release Agreement dated January 1, 1994; WHEREAS, IBM entered into that certain sublease dated June 2, 1994, with American Software, USA, Inc. ("American") as subleasee, for a portion of the Second (2nd) Floor of the 560 Building consisting of Six Thousand, Five Hundred and Nine (6,509) rentable square feet more particularly described therein (the "American Premises") for a period commencing on July 1, 1994 and ending on March 30, 1997 (the "American Sublease"); WHEREAS, American entered into that certain sublease dated October 31, 1995 with Tenant for the American Premises for a period commencing on November 1, 1995 and ending on March 29, 1997 (the "American/Advanced Sublease"); WHEREAS, IBM entered into that certain sublease dated January 14, 1994, with Industri-Matematik North American Operations, Inc. ("IMI"), for a portion of the Second (2nd) Floor of the 560 Building consisting of Five Thousand, Five Hundred and Seventy-One (5,571) rentable square feet (the "IMI Premises") for a period commencing on April 1, 1994 and ending on March 30, 1997 (the "IMI Sublease"); WHEREAS, IMI entered into that certain sublease dated July 1, 1996 with Tenant for the IMI Premises for a period ending on March 30, 1997 (the "IMI/Advanced Sublease"); WHEREAS, IBM entered into that certain sublease dated August 1, 1993, with Physicians OnLine, Inc., ("POL") as sublessee, for a portion of the Second (2nd) Floor of the 560 Building consisting of Four Thousand, Eight Hundred (4,800) rentable square feet more particularly described therein (the "POL Premises") for a period commencing on August 8, 1993 and ending on March 30, 1997 (the "POL Sublease"); WHEREAS, Tenant, presently occupies the POL Premises pursuant to a written sublease with POL; WHEREAS, Tenant, by reason of the American/Advanced Sublease, IMI/Advanced Sublease and the POL Sublease, presently occupies Sixteen Thousand, Eight Hundred and Eighty (16,880) rentable Page 1 of 14 square feet in the 560 Building (the "560 Premises") until March 30, 1997; WHEREAS, Owner's predecessor-in-interest entered into that certain Lease dated November 30, 1995 with Tenant for the entire Second (2nd) Floor of the 560 Building consisting of Twenty-Six Thousand, Three Hundred and Two (26,302) rentable square feet for the period commencing on April 1, 1997 and ending March 31, 2002 (the "Lease"); WHEREAS, Owner, is also the fee simple owner of the building commonly known as and located at 555 White Plains Road, Tarrytown, New York 10591 (the "555 Building"); WHEREAS Tenant is desirous of relocating its business to the 555 Building and Owner has agreed to lease to Tenant a portion of the Fifth (5th) Floor of the 555 Building consisting of Twenty-Six Thousand, Three Hundred and Two (26,302) rentable square feet (the "555 Premises") within which to operate its business on substantially the same terms and conditions as contained in the Lease; NOW, THEREFORE, for and in consideration of the foregoing and for other good and valuable consideration and of the mutual agreements hereinafter set forth, Owner and Tenant stipulate, covenant and agree as follows: ARTICLE-1 LEASE AMENDMENTS SECTION 1.01. Effective as of the Commencement Date (as hereinafter defined), the Lease, is hereby modified as follows: A. The term "Demised Premises" is hereby amended as follows: "Demised Premises" shall mean that portion of the Fifth (5th) Floor in the building commonly known as and located at 555 White Plains Road, Tarrytown, New York 10591 (the "Building") comprising approximately Twenty-Six Thousand, Three Hundred and Two (26,302) rentable square feet as delineated on the floor plan(s) attached to this First Amendment of Lease as Exhibit "A-1". B. The third paragraph in Section 2 entitled "Taxes" on page 4 of the Lease is hereby deleted and a new third paragraph is hereby substituted in its place as follows: "Tenant agrees to pay Owner, throughout the term of this Lease, as additional rental, a sum equal to 21.72% percent ("Tenant's Proportionate Share") of the amount by which the Impositions levied against the Property in each fiscal tax year (or, in the event this Lease shall expire on other than December 31, the applicable portion thereof) exceeds the Base Impositions." C. Section 5 entitled "Commencement Date, Rent Commencement Date; Rent" of the Lease is hereby deleted and a new Section 5 is hereby substituted in its place as follows: "The Lease shall commence on the Commencement Date (as hereinafter defined) and shall end on the last day of the Sixty-Fifth (65th) month from the Commencement Date (the "Expiration Date"). Page 2 of 14 (a) Tenant shall pay to Owner, or to such other person as Owner may from time to time designate, at Owner's address specified above, fixed rent, over and above the other and additional payments to be made by Tenant as herein provided, as follows: (i) during and in respect of the period from the Commencement Date to the end of the Fourth (4th) month from the Commencement Date (both dates inclusive) the sum of Eighty-Two Thousand, Nine Hundred and Ninety-Two and 00/100 ($82,992.00) Dollars payable in equal monthly installments of Twenty Thousand, Seven Hundred and Forty Eight and 00/100 ($20,748.00) Dollars; (ii) during and in respect of the Fifth (5th) month from the Commencement Date the Sum of Twenty-One Thousand, Four Hundred and Fifty-Two and 00/100 ($21,452.00) Dollars payable in one monthly installment; (iii) during and in respect of the period from the Sixth (6th) month from the Commencement Date to the end of the Seventeenth (17th) month from the Commencement Date (both dates inclusive) the sum of Four Hundred and One Thousand, One Hundred and Six and 00/100 ($401,106) Dollars payable in equal monthly installments of Thirty-Three Thousand, Four Hundred and Twenty-Five and 00/100 ($33,425.00) Dollars; (iv) during and in respect of the period from the Eighteenth (18th) month from the Commencement Date to the end of the Twenty-Ninth (29th) month from the Commencement Date (both dates inclusive) the sum of Four Hundred and Eighty Thousand, and Twelve and 00/100 ($480,012.00) Dollars payable in equal monthly installments of Forty Thousand and One and 00/100 ($40,001.00) Dollars; (v) during and in respect of the period from the Thirtieth (30th) month from the Commencement Date to the end of the Forty-First (41st) month from the Commencement Date (both dates inclusive) the sum of Five Hundred and Forty-Five Thousand, Seven Hundred and Seventy-Two and 00/100 ($545,772.00) Dollars payable in equal monthly installments of Forty-Five Thousand, Four Hundred and Eighty-One and 00/100 ($45,481.00) Dollars; (vi) during and in respect of the period from the Forty-Second (42nd) month from the Commencement Date to the end of the Fifty-Third (53rd) month from the Commencement Date (both dates inclusive) the sum of Six Hundred and Twenty-Four Thousand, Six Hundred and Seventy-Two and 00/100 ($624,672.00) Dollars payable in equal monthly installments of Fifty-Two Thousand and Fifty-Six and 00/100 ($52,056.00) Dollars; and (vii) during and in respect of the period from the Fifty Fourth (54th) month from the Commencement Date to the Expiration Date (both dates inclusive) the sum of Six Hundred and Thirty-Seven Thousand, Eight Hundred and Twenty-Four and 00/100 ($637,824.00) Dollars payable in equal monthly installments of Fifty-Three Thousand, One Hundred and Fifty-Two and 00/100 ($53,152.00) Dollars. Page 3 of 14 (b) Notwithstanding the foregoing, Owner represents that on or before December 1, 1996, there will be a food service/cafeteria located and operating in the 555 Building. In the event that the food service/cafeteria is not operating by December 1, 1996, then in such event, Owner represents that it will provide an interim food service in the 555 Building until the food service/cafeteria is operating in the 555 Building. Lessor further represents that the landscaping around the 555 Building will be substantially complete on or before March 1, 1997. (c) (i) If Owner is unable to give possession of the 555 Premises on the date of the commencement of the term, because of the holding-over or retention of possession of any tenant, undertenant or occupants or if the 555 Premises are being constructed or built-out by Owner in accordance with the provisions of this First Amendment to Lease, because such construction or build-out has not been sufficiently completed to make the 555 Premises ready for occupancy or because of the fact that a certificate of occupancy has not been procured or for any other reason, Owner shall not be subject to any liability for failure to give possession on said date and the validity of the Lease shall not be impaired under such circumstances, nor shall the same be construed in any wise to extend the duration of Term, but the term hereof shall not be deemed to have commenced (provided Tenant is not responsible for Owner's inability to obtain or deliver possession) until after Owner shall have given Tenant at least Twenty (20) days prior written notice that the 555 Premises are substantially ready for Tenant's occupancy and the term of this Lease shall commence on a date which shall be the earlier of: (a) the date that the 555 Premises are substantially complete and a certificate of occupancy or temporary certificate or occupancy shall have been issued (but not necessarily actually received by Owner) respecting the 555 Premises, or (b) the day Tenant shall occupy or take possession of any portion of the 555 Premises (the "Commencement Date"). (ii) If permission is given to Tenant to enter into the possession of the 555 Premises or to occupy premises other than the 555 Premises prior to the date specified as the commencement of this Lease, Tenant covenants and agrees that such occupancy shall be deemed to be under all the terms, covenants, conditions and provisions of this Lease, except as to the covenant to pay fixed rent. (d) The provisions of Section 5(b) of this Rider to Lease are intended to constitute "an express provision to the contrary" within the meaning of Section 223-a of the New York Real Property Law." D. Section 19 entitled "Owner's Allowance for Work, Owner's Work" of the Lease is hereby deleted and a new Section 19 is hereby substituted in its place as follows: "A. Owner and Tenant agree that Tenant will take the 555 Premises on the Commencement Date of the term in "AS IS" condition. Notwithstanding the foregoing, prior to the commencement of the initial term of this Lease, Owner shall retain Reckson Construction Group, Inc., at its sole cost and expense, to act as general contractor with respect to the design and build-out of the 555 Premises (the "Work") and, in such capacity, shall perform the Work in accordance with the plans and specifications annexed hereto as EXHIBIT "B" (the "Plans"), which Plans Owner and Tenant have both approved. B. Owner shall use diligence to complete the Work so as to have the 555 Premises Page 4 of 14 ready for occupancy on or before November 1, 1996. However, Owner's agreement to complete this Work shall not require it to incur overtime costs and expenses and shall be subject to any delays due to acts of God, governmental restrictions or guidelines, strikes, labor disturbances, shortages of materials and supplies and for any other causes or events whatsoever beyond Owner's reasonable control. Owner has not made, and makes, no representations as to the date when the 555 Premises will be ready for Tenant's occupancy, and notwithstanding any date specified elsewhere in this First Amendment to Lease as the commencement date it is understood that the same is merely an estimate. C. Tenant shall submit to Owner, on or before the thirtieth (30th) day following notice of substantial completion of the Work, a punch list setting forth such details provided for in the Plans as remain to be completed and, except as noted therein, Tenant shall be deemed to have accepted the Work as of the date of substantial completion, except for those items which are considered to be seasonal in nature. Owner agrees to complete all punch list items within Thirty (30) days, subject however to Unavoidable Delays and items which are considered to be seasonal in nature. D. Owner shall act as general contractor, or retain a general contractor, with respect to the build-out of the 555 Premises and, in such capacity, shall perform the Work at its sole cost and expense. Owner and Tenant have agreed upon the Plans for all Work to be completed which shall encompass the scope and time-frame with respect to such Work and which shall indicate the estimated Cost thereof (the "Cost Estimate"). Any material increase in the scope of Work to be performed by Owner beyond that contained in the Plans ("Extra Work") shall be approved as follows: (i) a written request for any such Extra Work (including any and all change orders) defining the scope of such Extra Work plus any possible time delay and containing an "Extra Work Cost Estimate" shall be prepared by Owner for review and acceptance by Tenant; and (ii) upon execution by Tenant of such written request of Owner, Owner shall pursue completion of the Extra Work stipulated therein at Tenant's sole cost and Expense. Tenant shall pay to Owner the cost of the Extra Work upon the commencement of such Extra Work. As used in this section, the term "material" shall mean any increase in the scope of the Work, which cost, in the aggregate, in excess of the Three Thousand and 00/100 ($3,000.00) Dollars, inclusive of the installation of telephone, data, and computer lines and cabling in that portion of the 555 Premises in excess of Sixteen Thousand, Eight Hundred and Eighty (16,880) rentable square feet. E. To the extent (i) Owner (which term as used herein may be deemed to mean Owner and/or Owner's affiliated or non-affiliated general contractor) may be or is required to or actually does perform Extra Work as provided for herein above, and/or (ii) Owner performs other build-out or similar work or alterations to the 555 Premises of any kind or any other demolition, renovation or construction on Tenant's behalf during the term of this Lease, pursuant to Section 4 of this Lease and otherwise, the "Cost", as such term is used in connection herewith, shall mean that Owner will perform all such services on a "cost plus" basis, whereby Cost shall include, but not be limited to, the cost of sub-contractors, material, equipment rental, transportation and delivery items, permits, fees, taxes, insurance's, debris removal, demolition, safety protection, labor, purchasing, expediting and material handling, and shall also include a contingency, based on the complexity of the work to be performed, of up to five percent (5%) of the total of all such items otherwise included within such definition. In addition, Cost shall include Owner's fee for acting as general contractor which shall be equal to Fifteen percent (15%) of the total Cost otherwise Page 5 of 14 determined; provided however, that with respect to decorating only, such fee shall be applicable to labor and service items such as decorator fees and costs of installation and other labor but shall not be applicable to the cost of furniture, and similar items otherwise included therein. F. In addition to the Work provided for on EXHIBIT B attached hereto, Owner agrees, at its sole cost and expense, to: (i) relocate Tenant, including, but not limited to all its existing furniture, files and equipment, from the 560 Premises to the 555 Premises; (ii) dismantling and set-up of all Tenant's existing work cubes located at the 560 Premises to the 555 Premises; (iii) to remove from the 560 Premises and install in the 555 Premises all of tenant's existing telephone, data and computer lines and cabling; (iv) prepare and install all of Tenant's signs, including internal building directory, floor directional and entrance door signs; and (v) reimburse Tenant for the cost of printing new stationary, business cards, announcements and the postage for such announcements to reflect its relocation to the 555 Premises." E. Section 28 entitled "Additional Premises," Section 29 entitled "Tenant's Right to Give Back Space," and Exhibit "C" of the Lease are all hereby deleted in there entirety and shall be of no further force and effect. F. Subparagraph (f) of Section 30 entitled "Miscellaneous" of the Lease is hereby deleted and a new subparagraph (f) is hereby substituted in its place as follows: "(f) Tenant's Proportionate Share for the 555 Premises is Twenty-One and Seventy-Two Hundreths (21.72%) Percent, which is the ratio that the Twenty-Six Thousand, Three Hundred and Two (26,302) square feet of rentable area comprising the 555 Premises bears to the One Hundred and Twenty-One Thousand, (121,000) square feet of rentable area in the Building." Section 1.02. Effective as of the Commencement Date, Owner agrees that Tenant shall have no obligation to repay the Thirteen Thousand, Five Hundred and Seventy and 00/100 ($13,570.00) Dollars of the Interim Allowance used by Tenant in connection with American Premises. In consideration of the foregoing, Tenant hereby waives, as of the date hereof, its right to draw down the Sixteen Thousand, Four Hundred and Thirty and 00/100 ($16,430.00) Dollars remaining on the Interim Allowance in connection with the IMI Premises as provided in the IMI/Advanced Sublease. Section 1.03. In the event that Owner is unable to deliver the 555 Premises, on or before March 1, 1997, subject however to Unavoidable Delays, then in such event, Owner agrees that it will be obligated to perform the Work (as that term is defined in Section 19 of the Lease) in the 560 Premises in accordance with and pursuant to the provisions of the Section 19 of the Lease. Notwithstanding, the foregoing, Tenant agrees to vacate and surrender the 560 Premises in accordance with the provisions hereof and to occupy the 555 Premises upon substantial completion of same. Owner's obligation to perform the Work in the 560 Premises shall in no way be construed as a release of Owner's obligation to perform the Work (as that term is defined in this First Amendment to Lease) in the 555 Premises, except as otherwise specifically provided for in Section 1.04. Of this First Amendment to Lease. Section 1.04. Tenant acknowledges that Owner has entered into a lease with Ciba-Geigy ("Ciba") to occupy the 560 Premises as of the Commencement Date hereof. Notwithstanding the foregoing, Tenant further acknowledges that Ciba has the right to cancel its lease with Owner for the 560 Premises in the event that Owner can not deliver possession thereof by December 31, 1996. In the event Page 6 of 14 that Ciba exercises its right to cancel its lease with Owner for the 560 premises prior to substantial completion of the 555 Premises, then in such event, Owner shall have the right, upon five (5) days written notice to Tenant, to cancel this First Amendment to Lease, provided that Owner shall have notified Tenant of same within ten (10) days after Owner's receipt of the notice of cancellation from Ciba. In the event that Owner shall exercise its right to cancel this First Amendment to Lease, then in such event this First Amendment to Lease shall become null and void and of no further force and effect upon the expiration of said five (5) day period and the Lease will continue in full force and effect, without amendment, on its then executory terms with respect to the 560 Premises. ARTICLE -2 GUARANTEED ADDITIONAL TSS SPACE, RIGHT OF FIRST OFFER SECTION 2.01.A. Lessee acknowledges that the Eight Thousand, Eight Hundred and Twenty-Eight (8,828) rentable square feet on the Fifth (5th) floor of the 555 Building immediately adjacent to the 555 Premises (the "Guaranteed Additional TSS Space") will be occupied by Technology Service Solutions ("TSS") for period of two (2) years pursuant to a written lease with Owner (the "TSS Lease"). Lessee further acknowledges that from and after the first (1st) anniversary of the commencement of the TSS Lease, TSS has the right, on sixty (60) days notice to Owner, to cancel the TSS Lease and surrender the Guaranteed Additional TSS Space prior to the expiration of the two (2) year term (the "TSS Cancellation Notice"). Owner, agrees that within thirty (30) days after receipt of TSS Cancellation Notice, or six (6) months prior to the expiration of the TSS Lease, in the event TSS does not exercise its right to early termination, it shall give Tenant notice of (the "Guaranteed Additional TSS Space Notice"), and a one time right to, at Tenant's option, expand the 555 Premises herein to include all of the Guaranteed Additional TSS Space with occupancy to commence on the Guaranteed Additional TSS Space Commencement Date (as hereinafter defined) and to end on the Expiration Date originally provided for herein (the "Guaranteed Additional TSS Space Term"). B. Tenant shall, within Thirty (30) days after receipt of Guaranteed Additional TSS Space Notice, notify Owner of its intention to lease the Guaranteed Additional TSS Space (time being of the essence with respect thereto). Tenant's failure to notify Owner within the Thirty (30) day period shall be deemed a waiver of the right to hire the Guaranteed Additional TSS Space. In the event that Tenant shall elect to hire the Guaranteed Additional TSS Space, same shall be deemed added to and a part of the 555 Premises, with the same force and effect as if originally so demised under the Lease as of the Guaranteed Additional TSS Space Commencement Date. C. As used herein the "Guaranteed Additional TSS Space Commencement Date" shall be the date which is the sooner of: (1) six (6) months from the date that TSS vacates and surrenders the Guaranteed Additional TSS Space, or (2) the date on which the Guaranteed Additional TSS Work Space (as hereinafter defined) is substantially complete. D. Tenant shall have the right to inspect the Guaranteed Additional TSS Space prior to exercising its rights herein, Tenant agrees to accept the Guaranteed Additional TSS Space in its "AS IS" state and condition on the Guaranteed Additional TSS Space Commencement Date, except that Owner shall provide Tenant with a Guaranteed Additional TSS Space Alteration Allowance (as hereinafter defined) and perform the work and build-out of the Guaranteed Additional TSS Space (the "Guaranteed Additional TSS Space Work"). As used herein the Guaranteed Additional TSS Space Alteration Allowance shall be determined by multiplying the product of (i) Eight Thousand, Eight Hundred and Twenty-Eight (8,828) and the amount, on a square footage basis, of the cost to perform the Work in the 555 Premises (inclusive of all Page 7 of 14 architectural, and engineering fees) plus One and 50/100 ($1.50) Dollars per square foot by (ii) a fraction, the numerator of which is the number of months remaining on the Term originally provided for herein and the denominator of which is the total number of months of Term originally provided for herein. E. Any notice of election to exercise the right to expand the 555 Premises to include the Guaranteed Additional TSS Space as herein provided must be in writing and sent to Owner as provided for in the Lease. Neither the right granted to Tenant in this section to expand the 555 Premises to include the Guaranteed Additional TSS Space, nor the exercise of such right by Tenant, shall prevent Owner from exercising any option or right granted or reserved to Owner in this Lease to terminate this Lease, and the effective exercise of any such right of termination by Owner shall terminate any such expansion of Tenant to the Guaranteed Additional TSS Space, whether or not Tenant shall have exercised any such right to expand the 555 Premises to include the Guaranteed Additional TSS Space. Any such option or right on the part of Owner to terminate this Lease pursuant to the provisions hereof shall apply to the Guaranteed Additional TSS Space. F. All of the terms, covenants and conditions of this Lease applicable to the 555 Premises as originally constituted shall be applicable to the 555 Premises including the Guaranteed Additional TSS Space, except that: (1) the annual fixed rent provided for in Section 5 of the Rider to Lease shall be increased by the product of (i) ninety-five (95%) percent of the fair market value of the Guaranteed Additional TSS Space as determined in accordance with this Article 2 and (ii) the rentable square footage of the Guaranteed Additional TSS Space; and (2) Tenant's Proportionate share shall be increased by the amount of the Guaranteed Additional TSS Space. G. If Tenant shall effectively exercise its right to hire the Guaranteed Additional TSS Space, Owner and Tenant, upon demand of either, shall execute and deliver to each other duplicate originals of an instrument, duly acknowledged, setting forth (i) that the 555 Premises have been expanded to include the Guaranteed Additional TSS Space, (ii) the amount of such Guaranteed Additional TSS Space, (iii) the annual fixed rent payable during the Term and (iv) that such Guaranteed Additional TSS Space is upon and subject to all of the terms, covenants, conditions and limitations contained herein. H. The right of Tenant to hire the Guaranteed Additional TSS Space as provided for herein is conditioned in all respects upon Tenant's not being in default in the observance or performance of any material term, covenant, condition or agreement of Tenant's part to be observed or performed under this Lease both at the time the notice of exercise is given and immediately prior to Guaranteed Additional Space TSS Commencement Date. Any termination, cancellation or surrender of this Lease shall terminate Tenant's right to hire the Guaranteed Additional TSS Space. SECTION 2.02.A. In the event that Tenant shall fail to exercise its right to the Guaranteed Additional TSS Space, Owner, agrees that thereafter, and prior to offering for lease the balance of the Eight Thousand, Eight Hundred and Twenty-Eight (8,828) rentable square feet on the Fifth (5th) floor of the 555 Building (the "Optional Additional Space"), it shall give Tenant notice of and the right to , at its option, expand the 555 Premises to include the Optional Additional Space with occupancy to commence on the Optional Additional Space Commencement Date (as hereinafter defined) and to end on the Expiration Date originally provided for herein (the "Optional Additional Space Term"). B. Tenant shall, within Thirty (30) days after receipt of the notice from Owner that the Optional Additional Space will become available for hire, notify Owner of its intention to lease the Optional Page 8 of 14 Additional Space (time being of the essence with respect thereto). Tenant's failure to notify Owner within the Thirty (30) day period shall be deemed a waiver of the right to hire the Optional Additional Space. In the event that Tenant shall elect to hire the Optional Additional Space, same shall be deemed added to and a part of the 555 Premises, with the same force and effect as if originally so demised under the Lease as of the Optional Additional Space Commencement Date. C. Tenant shall have the right to inspect the Additional Space prior to exercising its rights herein. Tenant agrees to accept the Optional Additional Space in its "AS IS" state and condition on the Option Additional Space Commencement Date, except that Owner shall provide Tenant with an Optional Additional Space Alteration Allowance equal to the allowance that Owner is giving to renewing, non-equity tenants for comparable space in the Building on the date of the commencement of the Optional Additional Space Term with a term equal to the Optional Additional Space Term and otherwise containing the same quality of construction and appearance to that of the 555 Premises, as determined by agreement between Owner and Tenant. D. As used herein the "Optional Additional Space Commencement Date" shall be sooner of: (i) the date specified in Owner's notice; (ii) or the date on which Tenant occupies all or part of the Optional Additional Space. SECTION 2.03. Any notice of election to exercise the right to expand the 555 Premises as hereinbefore provided must be in writing and sent to Owner as provided in the Lease. In addition, if prior to the exercise of the right to expand the 555 Premises, Tenants herein named shall have assigned this Lease, no notice by the then Tenant of election to exercise an option to expand shall be valid unless joined in or consented to in writing by Tenant herein named (which consent, in order for the exercise of such right to be effective, shall be delivered to Owner at or prior to the time of the exercise of the right as to which consent of Tenant herein named had been given). Neither the right granted to Tenant in this Article to expand the 555 Premises, nor the exercise of such right by Tenant, shall prevent Owner from exercising any option or right granted or reserved to Owner in this Lease to terminate this Lease, and the effective exercise of any such right of termination by Owner shall terminate any such right of Tenant to the Optional Additional Space, whether or not Tenant shall have exercised any such right to expand the 555 Premises to the include the Optional Additional Space. Any such option or right on the part of Owner to terminate this Lease pursuant to the provisions hereof shall apply to the Optional Additional Space. SECTION 2.04.A All of the terms, covenants and conditions of this Lease applicable to the 555 Premises as originally constituted shall be applicable to the 555 Premises including the Additional Space, except that the annual Fixed Rent provided for in Article 5 of the Rider to Lease shall be increased by the product of the fair market rent as determined in Section 2.05. hereof and the gross square footage of the Optional Additional Space, and Tenant agrees to pay such amount from and after the Optional Additional Space Commencement Date. B. During and in respect of the Term hereof, Tenant's Proportionate Share shall be increased by the gross square footage of all Additional Space that Tenant occupies in the Building. SECTION 2.05.A. During the Optional Additional Space Term, Tenant shall pay to Owner annual Fixed Rent, at the same times and in the same manner as in the Term originally provided for, at the annual rate equal to ninety-five (95%) percent of the annual fair rental value of the Optional Additional Space (without deduction for the cash value of free rent and leasehold improvements), which renewing, Page 9 of 14 non-equity tenants are then receiving in connection with a lease for comparable space in a building of the same age, quality, size, location, services, amenities, quality of construction and appearance to that of the Building on the date of the commencement of the Optional Additional Space Term with a term equal to the Optional Additional Space Term and otherwise containing the same provisions as this Lease contains, as determined by agreement between Owner and Tenant. If, prior to the commencement of the Optional Additional Space Term, Owner and Tenant are unable to agree on the amount of the annual Fixed Rent during the Optional Additional Space Term, then in such event, the determination of such annual fair rental value shall be made by arbitration pursuant to the provisions of Section 2.05.B. hereof. If the Optional Additional Space Term, shall commence prior to determination of the amount of annual Fixed Rent payable during the Optional Additional Space Term, either by agreement or by decision of the arbitrators, Tenant, in the meantime, shall pay the monthly installments of Fixed Rent at the annual rate payable under this Lease for the year ending on the Optional Additional Space Commencement Date. If monthly installments of the amount agreed upon by Owner and Tenant, or found by the arbitrators, shall be greater than such amount, then Tenant, forthwith after such agreement or arbitrators' decision, shall pay to Owner, for the period from the Optional Additional Space Commencement Date to the last day of the calendar month in which the agreement or the arbitrators' decision takes effect, the difference between the monthly installments actually paid and the monthly installments which should have been paid in accordance with such agreement or arbitrator's decision; and, thereafter, Tenant shall pay the monthly installments at the new rate. In no event shall the annual Fixed Rent during the Optional Additional Space Term be less than the annual Fixed Rent payable immediately prior to the Optional Additional Space Term. B.(1) In the event that Owner and Tenant are unable to agree on the amount of the annual Fixed Rent during the Optional Additional Space Term, then either Owner or Tenant (hereinafter referred to as the "Initiating Party") may give the other party (hereinafter called the "Responding Party") a notice designating the name and address of the arbitrator designated by the Initiating Party to act on its behalf in the arbitration process hereinafter described (the "Review Notice"). (2) If the Initiating Party gives a Review Notice, then within twenty (20) days after giving such Review Notice, the Responding Party shall give notice to Initiating Party specifying in such notice the name and address of the arbitrator designated by the Responding Party to act on its behalf. In the event the Responding Party shall fail to give such notice within such twenty (20) day period, then the appointment of such arbitrator shall be made in the same manner as hereinafter provided for the appointment of a third arbitrator in a case where two arbitrators are appointed hereunder and the parties are unable to agree to such appointment. The two arbitrators so chosen shall meet within thirty (30) days after the second arbitrator is appointed and shall exchange sealed envelopes each containing such arbitrators written determination of the fair market rent of the Optional Additional Space based on the criteria set forth in Section 2.05.A. The fair market rent specified by Owner's arbitrator shall be called the "Owner's Submitted Value" and the fair market rent specified by Tenant's arbitrator shall be called the "Tenant's Submitted Value". Copies of such written determinations shall promptly be sent to both Owner and Tenant. Any failure of either such arbitrator to meet and exchange such determinations shall be acceptance of the other party's arbitrator's determination as to fair market rent, if, and only if, such failure persists for five (5) days after notice to whom such arbitrator is acting, and, provided that such five (5) day period shall be extended by reason of any Unavoidable Delay. If the higher determination of the fair market rent for the Additional Space is not more than one hundred and five (105%) percent of the lower determination of the fair market rent, then the fair market rent for such space shall be deemed to be the average of the two determinations. If however, the higher determination is more than one hundred and Page 10 of 14 five (105%) percent of the lower determination, then within ten (10) days of the date the arbitrators submitted their respective fair market rent determinations, the two arbitrators shall appoint a third arbitrator. In the event of their being unable to agree upon such appointment within ten (10) days after the exchange of the sealed envelopes, the third arbitrator shall be selected by the parties themselves if they can agree thereon within a further period of ten (10) days. If the parties do not so agree, then either party, on behalf of both and on notice to the other, may request such an appointment by the American Arbitration Association (or any successor organization) in accordance with its rules then prevailing or if the American Arbitration Association (or any successor organization) shall fail to appoint said third arbitrator within fifteen (15) days after such request is made, then either party may apply for such appointment, on notice to the other, to the President of the Westchester County Bar Association (who may consult with the Chairman of the Real Property Law Committee of the Westchester County Bar Association). Within ten (10) days after the appointment of such third arbitrator, the Owner's arbitrator shall submit Owner's Submitted Value to such third arbitrator and the Tenant's arbitrator shall submit Tenant's Submitted Value to such third arbitrator. Such third arbitrator shall within thirty (30) days after the end of such fifteen (15) day period, make his own determination of the fair market rent of the Additional Space using the criteria set forth in Section 2.04.A, hereof, and send copies of his determination promptly to both Owner and Tenant specifying whether Owner's Submitted Value or Tenant's Submitted Value was closer to the determination by such third arbitrator of the fair market rent of the Optional Additional Space. Whichever of Owner's Submitted Value or Tenant's Submitted Value shall be closer to the determination by such third arbitrator shall conclusively be deemed to be the fair market rent of the Optional Additional Space. (3) In no event shall the arbitrator enlarge upon, or alter or amend, this Lease or Owner's or Tenant's rights as provided in this Lease, it being understood that the sole issue for determination by the arbitrators shall be the single issue of fact of the annual fair rental value of the Optional Additional Space as provided in paragraph A of this Section 2.05 (4) Except as otherwise provided in the following sentence, the fees and expenses of an arbitration proceeding shall by borne by the parties equally. The fees of respective counsel engaged by the parties the fees and expenses of expert witnesses and other witnesses called and the cost of transcripts shall be borne by the parties engaging such counsel or calling such witness or ordering such transcripts. SECTION 2.06. If Tenant shall effectively exercise its rights to hire the Optional Additional Space, Owner and Tenant, upon demand of either, shall execute and deliver to each other duplicate originals of an instrument, duly acknowledged, setting forth (i) that the 555 Premises have been expanded to include the Optional Additional Space (ii) the amount of such Optional Additional Space,(iii) the annual Fixed Rent payable during the Term, (iv) that such Optional Additional Space is upon and subject to all of the terms, covenants, conditions and limitations contained herein, and (v) Tenant's Proportionate Share as increased by the Optional Additional Space. SECTION 2.07. The right of Tenant to hire the Optional Additional Space as provided herein is conditioned in all respects upon there being no event of default in the observance or performance of any material term, covenant, condition or agreement on Tenant's part to be observed or performed under this Lease both at the time the notice of exercise is given and immediately prior to Optional Additional Space Commencement Date. Any termination, cancellation or surrender of this Lease shall terminate Tenant's right to hire the Optional Additional Space. Page 11 of 14 ARTICLE -3 RENEWAL TERM SECTION 3.01. A. Tenant shall have the right, at its option, to extend this lease for one (1) five (5) year term ("Renewal Term") commencing on the Expiration Date originally provided for herein and to end at noon on the fifth anniversary of such Expiration Date originally provided for herein, by giving Owner notice of such election at anytime but not less than nine (9) months prior to the Expiration Date originally provided for herein (time being of the essence with respect thereto), and upon the giving of such notice this Lease thereupon shall be automatically extended for each such Renewal Term with the same force and effect as if such Renewal Term had been originally included in the Term, without the execution of any further instrument. B. Any notice of election to exercise the option to extend as hereinbefore provided must be in writing and set to Owner as provided for in the Lease. In addition, if prior to the exercise of the option to extend Tenant herein named shall have assigned this Lease, no notice by the then Tenant of election to exercise an option to extend shall be valid unless joined in or consented to in writing by Tenant herein named (which consent, in order for the exercise of such option to be effective, shall be delivered to Owner at or prior to the time of the exercise of the option as to which consent of Tenant herein named had been given). Neither the option granted to Tenant in this Section to extend the Term, nor the exercise of such option by Tenant, shall prevent Owner from exercising any option or right granted or reserved to Owner in this Lease to terminate this Lease, and the effective exercise of any such right of termination by Owner shall terminate any such renewal or extension and any right of Tenant to any such renewal or extension, whether or not Tenant shall have exercised any such option to extend the Term. Any such option or right on the part of Owner to terminate this Lease pursuant to the provisions of this Lease shall continue during the Renewal Term. C. All of the terms, covenants and conditions of this Lease shall continue in full force and effect during the Renewal Term except that (i) the fixed rent for the Renewal Term shall be equal to ninety-five (95%) percent of the fair market value of the 555 Premises (including the Guaranteed Additional TSS Space or the Optional Additional Space, as the case may be) determined in accordance with the provisions of Section 2.05 hereof (all other rent and charges payable by Tenant remaining unaffected), and (b) there shall be no further privilege of extension of this Lease beyond the Renewal Term. SECTION 3.02. The right of Tenant to extend the term of this Lease as provided herein is conditioned in all respects upon there being no material event of default in the observance or performance of any material term, covenant, condition or agreement on Tenant's part to be observed or performed under this Lease both at the time the notice of exercise is given and immediately prior to the Renewal Term. Any termination, cancellation or surrender of this Lease shall terminate Tenant's right to extend the term of this Lease. ARTICLE-4 SURRENDER OF POSSESSORY RIGHTS IN THE 560 BUILDING SECTION 4.01 Commencing five (5) business days after the Commencement Date, Tenant agrees to and hereby surrenders all of its right, title and interest in and to the IMI Premises, American Premises, POL Premises and the balance of the Second (2nd) Floor of the 560 Building (hereinafter collectively referred to as the "560 Premises") and agrees that Owner shall have the right to and physical possession of the 560 Premises, from and after said date. Page 12 of 14 SECTION 4.02. Within five (5) business days after the Commencement Date, Tenant shall peaceably and quietly leave, surrender and deliver the IMI Premises, American Premises and POL Premises to Owner, together with (a) all alterations, changes, additions and improvements, which may have been made upon therein, and (b) except for Tenant's personal property, all fixtures and articles of personal property of any kind or nature which Tenant, or its predecessors-in-interest, may have installed or affixed on, in, or to the IMI Premises, American Premises and POL Premises for use in connection with the operation and maintenance of Tenant's business therein (whether or not said property be deemed to be fixtures), all of the foregoing to be surrendered broom clean and in good, substantial and sufficient repair, order and condition, reasonable use, wear and tear, and damage by fire or other casualty excepted. SECTION 4.03. In the event that Tenant retains possession of the IMI Premises, American Premises or POL Premises, or any part thereof, after five (5) business days from the Commencement Date, for any reason whatsoever, without the prior written approval of Owner, Tenant shall: (i) pay to Owner use and occupancy charges, at two times the then fixed rent for IMI Premises, American Premises, and/or POL Premises, as contained the IMI/Advanced Sublease, American/Advanced Sublease or the POL Sublease, respectively, as the case may be, for the time that Tenant remains in possession of thereof, (ii) pay to Owner all damages, consequential as well as direct (including fees of counsel incurred in connection therewith) sustained by reason of Tenant's retention of possession of same; and (iii) be in default under the Lease and Owner shall be entitled to all rights and remedies provided therein. ARTICLE-5. NO OTHER CHANGES SECTION 5.01. Except as otherwise specifically provided for in this First Amendment to Lease, all other terms, covenants and conditions of the Lease, as amended, and all exhibits and schedules thereto shall remain in full force and effect, are hereby ratified, confirmed and incorporated herein by reference as though set forth fully herein at length. IN WITNESS WHEREOF, duly authorized representatives of the parties hereto have executed this First Amendment to Lease as of the day and year first above written. ADVANCED HEALTH CORPORATION, Tenant By: /s/ Jeffrey M. Sauerhoff --------------------------------------- Name: Jeffrey M. Sauerhoff Title: Vice President RECKSON OPERATING PARTNERSHIP, L.P., Owner By: Reckson Realty Associates Corp., Its General Partner By: /s/ Jon L. Halpern --------------------------------------- Name: Jon L. Halpern Title: Executive Vice President Page 13 of 14 STATE OF NEW YORK ) ) SS.: COUNTY OF WESTCHESTER ) On the day of September, 1996, before me personally came______________________ , to me known, who being by me duly sworn, did depose and say that he maintains an office at 660 White Plains Road, Tarrytown, New York 10591; that he is the of Reckson Realty Associates Corp., the General Partner of RECKSON OPERATING PARTNERSHIP, L.P., the limited partnership described in and which executed the foregoing instrument; That he signed his name thereto on behalf of the limited partnership described therein by order of its board of directors of its corporate general partner. ------------------------------ Notary Public STATE OF NEW YORK ) ) SS.: COUNTY OF WESTCHESTER ) On the day of September, 1996, before me personally came____________________________ , to me known, who being by me duly sworn, did depose and say that he maintains an office at 560 White Plains Road, Tarrytown, New York 10591; that he is the of ADVANCED HEALTH CORPORATION, the corporation described in and which executed the foregoing instrument; That he signed his name thereto on behalf of the Corporation described therein by order of its board of directors. ------------------------------ Notary Public Page 14 of 14 WORK SCHEDULE OF LANDLORD'S RESPONSIBILITY FOR ADVANCED HEALTH 555 WHITE PLAINS ROAD TARRYTOWN, NEW YORK I. PARTITIONS: Landlord shall furnish and install ceiling-high partitions constructed from metal studs with 5/8" sheetrock on both sides and 4" tile base, as per attached plan. The corridor and between Tenant partitions shall be sound attenuating construction, extending to under side of floor above. II. CLOSETS: Landlord shall furnish closets as per attached plan. Closets will contain one (1) wood hat shelf and one (1) metal coat rod. III. DOORS: Landlord shall furnish and install necessary doors as per attached plan. IV. HARDWARE: Landlord shall furnish and install necessary building standard hardware such as latch sets, hinges, door stops and bucks where required. Landlord shall supply and install a combination lock on one of the entrance doors to the demised premises. Landlord shall relocate coat hooks in existing offices to the 555 premises. V. CEILINGS: Existing 2'0" X 4'0" textured acoustical tile ceiling to remain. Landlord shall replace any damaged or stained ceiling tile in such a matter as to maintain the appearance of the ceiling. VI. ELECTRICAL: A. Lighting Landlord shall supply and install in perimeter and interior working areas, recessed parabolic building standard 2' X 4" fluorescent light fixtures (except where conditions necessitate a surface mounted fixtures). Initial bulbs supplied by Landlord; all subsequent replacements by Tenant. B. Outlets Supply and install duplex wall convenience outlets as per attached plan. C. Telephone Landlord shall, at Landlord's expense, provide all telephone wiring and relocate Tenant's telephone switch. D. Computer Wiring Landlord shall at Landlord's expense, provide wire the premises to accommodate Tenant's computer system. With reference to the telephone and computer wiring, Landlord's obligation shall be limited to approximately 16,800 sq. ft. of installation and not the entire 26,302 sq. ft. which Tenant is leasing as of April 1, 1997. E. Circuits and Service The building will contain sufficient electrical facilities to provide for all normal installations. The design capacity is based on a combined lighting and receptacle load of four (4) watts per square foot of office area at 208/120 volts. Three-phase 208 volt electrical service will be provided by the owner in the electrical service panel on each floor. VII. VENETIAN BLINDS: Landlord shall supply and install ceiling-high venetian blinds on all exterior windows. These blinds shall be maintained by Tenant. VIII. CARPETING: Landlord shall supply and install throughout the demised premises Landlord's building standard carpeting, colors to be selected from samples submitted by Landlord. Landlord shall provide and install upgraded carpeting in the areas indicated on attached plan. IX. WALL FINISHES PAINTING: Landlord shall paint the entire premises (excluding the acoustical ceiling) in a good workman-like manner with primer and two (2) coats of paint in colors to be selected by Tenant from building color chart consisting of fifteen (15) colors. Tenant will be permitted five (5) of the standard colors per floor and one (1) color per room. WALL COVERING Landlord shall provide and install wall covering in areas indicated on attached plan. X. HEATING AND AIR CONDITIONING: 1. This work shall comprise essentially the design and installation of duct system on each floor together with a reasonable amount of air diffusers and associated fixtures, all supplied from a central system designed to conform to the standards per performance of the best new office buildings in Suburban New York. Normal operating hours shall be 8:30 a.m. to 6:00 p.m., Monday through Friday. The type and design ceiling diffusers and return grilles shall be building standard, locations to be approved by Tenant's architects. Landlord shall give quiet enjoyment to Tenant regarding noise or vibration from any of the building's installation of mechanical equipment or systems. The system shall be capable of delivering 100% outside fresh air and shall never deliver less than 25% outside fresh air, but at no time will there will be less than 0.35 C.F.M. of fresh air per square foot, during periods specified and is based upon the normal design of air conditioning, where four (4) watts of light and power/square foot is available for Tenant's use and an average occupancy of one (1) person per 100 square feet. The system shall capable of maintaining and shall be operated by the Landlord so as to maintain inside conditions of not more than 78 degrees Fahrenheit and 50% relative humidity when outside conditions are not more than 95 degrees Fahrenheit dry bulb and 75 degrees Fahrenheit wet bulb except that as the outside temperature conditions shall be maintained approximately as follows:
OUTSIDE CONDITIONS MAXIMUM INSIDE CONDITIONS ---------------------- ------------------------------ 66 - 72 db 72 (PLUS OR MINUS) 2db, 25 - 50 (plus or minus) 5RH 72 - 80 db 74 (plus or minus) 2db, 35 - 50 (plus or minus) 5RH 85 - 90 db 76 (plus or minus) 2db, 35 - 50 (plus or minus) 5RH 91 - 95 db 78 (plus or minus) 2db, 35 - 50 (plus or minus) 5RH
* With normal humidity tolerance The performance requirements noted above shall be maintained all year round, either by the use of varying amounts of outside air or by mechanical refrigeration. A. The above noted performance requirements shall be based upon the following conditions of internal heat and moisture gain. 1. One person per 100 square feet. 2. Four watts per square foot for Tenant light and power use. B. The system shall also be capable of maintaining a minimum temperature throughout the demised premises of 69 F when the outside temperature is 0 F. System shall be automatically controlled, free of noticeable noise, vibration, or drafts and require minimum cost expenditure in fuel. XI. PLUMBING: The Landlord shall provide and install two (2) wet columns, designed to carry a cold water line, a hot water line, a sewer line and a vent line. These wet columns shall be located in the corners of the building approximately halfway between the exterior wall and the core. Wet connections and extensions of said system shall be performed by the Landlord at the Tenant's expense. XII. PARKING: The Landlord shall provide Tenant with 75 parking spaces on a non-reserved, non-exclusive basis and 13 reserved parking spaces in the under-building parking area. EX-11.1 3 EXHIBIT 11.1 ADVANCED HEALTH CORPORATION AND SUBSIDIARIES SUPPLEMENTAL NET LOSS PER COMMON SHARE COMPUTATION
For the year ended December 31, 1996 (unaudited) ------------------- Calculation of Supplemental Shares Outstanding: Debt repaid by offering proceeds $ 5,000,000 Proceeds per share 13 .00 ---------------- Additional shares assumed outstanding 384,615 ---------------- Additional weighted average common shares assumed outstanding 296,343 Weighted average common shares outstanding 5,634,898 ---------------- Supplemental weighted average common shares outstanding 5,931,241 ================ Supplemental Net Loss Per Share: Net loss $ (1,465,188) Pro forma impact of use of proceeds on interest expense, net of tax 55,464 ---------------- Supplemental net loss (1,409,724) Supplemental weighted average common shares outstanding 5,931,241 ---------------- Supplemental net loss per common share $ (0.24) ================
EX-23.2 4 EXHIBIT 23.2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Registration Statement, Files No. 333-16919 and 333-16921. ARTHUR ANDERSEN LLP New York, New York March 30, 1997 March 31, 1997 VIA EDGAR Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 ADVANCED HEALTH CORPORATION FILE NUMBER 0-21209 Dear Sirs: On behalf of the above-named registrant (the "Registrant"), transmitted herewith for filing pursuant to the Securities Exchange Act of 1934 is a Form 10-K, Annual Report, including exhibits thereto. Pursuant to the instructions to the Form 10-K, we supplementally inform you, on behalf of the Registrant, that the financial statements included in the Form 10-K do not reflect any change from the preceding year in accounting principles or practices, or in the method of applying any such principles or practices. Sincerely, /s/ Alan B. Masarek ---------------------------------------- Alan B. Masarek Attachments EX-27 5 FDS --
5 1 US DOLLAR YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1 12,086 7,390 8,637 210 0 29,918 2,053 1,009 35,400 3,235 0 0 0 72 31,812 35,400 19,136 19,136 9,707 11,826 0 0 165 (2,442) 977 0 0 0 0 (1,465) (.26) 0
-----END PRIVACY-ENHANCED MESSAGE-----