-----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, A3vWNc03chx4GVMZdsfxtnLuU/4xiN6qPSHKQmp2UhHbfr0K3vCETdZ4+GFoMHUv OqeIfHMhkY4fK1RXgJAZgg== 0000950134-99-005714.txt : 19990628 0000950134-99-005714.hdr.sgml : 19990628 ACCESSION NUMBER: 0000950134-99-005714 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990625 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADVANCE PARADIGM INC CENTRAL INDEX KEY: 0001012956 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MISC HEALTH & ALLIED SERVICES, NEC [8090] IRS NUMBER: 752493381 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-21447 FILM NUMBER: 99652613 BUSINESS ADDRESS: STREET 1: 545 E JOHN CARPENTER FREEWAY STREET 2: STE 1570 CITY: IRVING STATE: TX ZIP: 75062 BUSINESS PHONE: 2148306199 MAIL ADDRESS: STREET 1: 545 E JOHN CARPENTER FREEWAY SUITE 1900 CITY: IRVING STATE: TX ZIP: 75062 10-K405 1 FORM 10-K405 FOR THE FISCAL YEAR ENDED 3/31/1999 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 31, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 0-21447 ADVANCE PARADIGM, INC. (Exact name of registrant as specified in its charter) DELAWARE 75-2493381 (State or other jurisdiction of (I.R.S. employer incorporation of organization) Identification No.) 545 E. JOHN CARPENTER FREEWAY, SUITE 1570, IRVING, TX 75062 (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (972)830-6199 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange Title of each class on which registered ------------------- --------------------- None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $0.01 PAR VALUE (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing sale price of the Common Stock on May 31, 1999 as reported on the Nasdaq National Market, was approximately $432,698,508. As of May 31, 1999, Registrant had outstanding 10,559,859 shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for Registrant's 1999 Annual Meeting of Stockholders are incorporated by reference in Part III. ================================================================================ 2 ITEM 1. BUSINESS OVERVIEW We are a leading independent provider of health benefit management services, providing pharmacy benefit management, disease management and clinical research programs. Our mission is to improve the quality of care delivered to health plan members while helping health plan sponsors reduce overall health benefit costs. We generate revenues from providing services to two primary customer groups: health plan sponsors and pharmaceutical manufacturers. We support a broad range of health plan sponsors, including managed care organizations, third-party health plan administrators, insurance companies, government agencies, employer groups and labor union-based trusts through our pharmacy benefit management and disease management services. We currently serve an estimated 27 million individuals enrolled in our customers' plans. We provide our clinical research services primarily to pharmaceutical manufacturers. We also work closely with pharmaceutical manufacturers in negotiating lower drug costs for our health plan sponsor customers. In the year ended March 31, 1999 ("fiscal year 1999"), we further enhanced our health benefit management services with our acquisitions. On December 1, 1998, we acquired Baumel-Eisner Neuromedical Institute, Inc., a privately-held clinical trials company based in South Florida. On March 31, 1999, we acquired Foundation Health Pharmaceutical Services, Inc., the parent company of Foundation Health Systems, Inc.'s pharmacy benefit management company, Integrated Pharmaceutical Services. INDUSTRY BACKGROUND Health care expenditures are expected to grow at a compound annual growth rate of approximately 7.1% from $1.1 trillion in 1998 to $2.1 trillion in 2007, according to the Health Care Financing Administration. Prescription drug costs are expected to be one of the fastest growing components of health care costs, and the Health Care Financing Administration has estimated that prescription drugs will account for approximately 8.0% of United States health care expenditures by 2007, up from 6.5% today. As a result, prescription drug sales in the United States are expected to increase at a compound annual growth rate of approximately 9.7%, from approximately $74.3 billion in 1998 to approximately $171.1 billion in 2007. We believe a number of factors will contribute to this trend, including: o increased expenditures on new drug development; o an increase in new drug introductions as a result of shorter approval cycles by the U.S. Food and Drug Administration; o relatively higher prices for new drugs; o an aging population; o effective direct-to-consumer advertising by pharmaceutical manufacturers; 1 3 o growing use of pharmaceuticals as first line of attack in disease treatment; and o increased availability of pharmacy benefits to health plan members. The concept of managed care originally developed in response to escalating health care costs. Health plan sponsors hoped that by exercising more control over health care delivery, they could control costs. Pharmacy benefit managers emerged to offer health plan sponsors a more efficient and less costly means of managing their members' drug use. In recent years, managed care has begun to evolve from a short-term, cost driven model to a long-term, medical outcomes-based model, where the overall cost and quality of patient care is considered by the health plan sponsor. Health benefit managers like us have emerged to assist health plan sponsors with the challenges of this new model of member care. OUR STRATEGY Our mission is to improve the quality of care delivered to health plan members while helping plan sponsors reduce overall health benefit costs. Our strategy is to develop and implement clinical programs that manage large patient populations more efficiently and effectively than is possible for an individual health plan. In order to implement our strategy, we plan to: o Increase our core pharmaceutical benefit management customer base. We believe that increased size will allow us to achieve economies of scale and pass lower costs on to our customers. We have successfully increased the number of individuals served by our programs from an estimated 5.2 million in 1995 to an estimated 27 million on April 1, 1999. We plan to continue to grow this customer base by marketing our comprehensive service offerings to a broader range of health plan sponsors. o Expand our disease management services. We have two strategies for growing these services. First, we have the opportunity to cross-sell existing disease management services to our pharmacy benefit management customers. Second, we plan to develop and market new disease management programs, using our clinical expertise and information management capabilities. o Develop additional clinical research capabilities. We believe we have a leading clinical trial operation in Alzheimer's studies. We also conduct studies for several other central nervous system disorders. We plan to expand our clinical research offerings by developing focused expertise in a select number of additional diseases. o Pursue strategic acquisitions and alliances. We plan to selectively pursue acquisitions and alliances that either: o increase the size of our core pharmacy benefit management business; o enhance our disease management programs; 2 4 o augment our clinical research capabilities; or o expand our Internet offerings. To date, we have successfully completed a number of acquisitions including Innovative Medical Research, Inc., Baumel-Eisner Neuromedical Institute, Inc. and Foundation Health Pharmaceutical Services. o Develop our Internet capabilities. While we currently offer a basic set of services on the Internet, we plan to dramatically broaden these offerings and expand access to our Internet site. Our future Internet initiatives may offer medical content to our health plan sponsor customers for use on their Internet sites, empower consumers by involving them more directly in their medical care and offer access to an on-line drugstore. HEALTH BENEFIT MANAGEMENT SERVICES PHARMACY BENEFIT MANAGEMENT. We offer a broad range of clinical, data and mail services to our customers through our pharmacy benefit management programs. Our pharmacy benefit management customer base included over 1,000 health plan sponsors at March 31, 1999. When the Foundation Health Pharmaceutical Services acquisition is fully implemented, we expect to serve an estimated 27 million individuals enrolled in our customers' health plans, and manage $5.0 billion in gross drug expenditures and over 150 million pharmacy claims annually. CLINICAL SERVICES. Our clinical services professionals work closely with health plan sponsors to design and administer pharmacy benefit plans that, through the use of formularies and other techniques, promote clinically appropriate drug usage while reducing drug costs. Formularies are lists of a health plan's preferred pharmaceutical products. The use of a formulary can reduce drug costs while preserving the same medical effect through substitution of brand-name drugs with a cost effective generic alternative -- known as generic substitution -- or substitution of a brand-name drug with another, lower cost brand-name drug in the same therapeutic class -- known as therapeutic substitution. We encourage formulary compliance by both patients and prescribing physicians. Our customers' plans include features such as tiered copayments, which require a health plan member to pay higher amounts for non-formulary drugs in order to influence them to choose the drugs in the formulary. We attempt to influence physician prescribing patterns by analyzing physicians' prescribing behavior relative to physician peer groups and notifying them when their practices differ from industry practice. We also provide our own educational materials to plan physicians, pharmacists and health plan sponsors. DATA SERVICES. Through our data services operations, we process the prescription claims for health plan sponsors. We have increased the number of claims processed from approximately 1.5 million claims in fiscal year 1995 to over 50 million claims in fiscal year 1999. We currently process approximately 5 million claims per month. 3 5 We administer a network of over 53,000 retail pharmacies that have agreed to provide prescription drugs to individual members of our customers' health plans at predetermined negotiated rates. Generally, we believe these rates are more favorable than typical retail prices. The retail pharmacies in the network are linked to us through our on-line claims processing system. Our on-line system provides pharmacists with the following information: o an analysis of whether the individual is eligible for benefits; o the prescription benefits the individual's health plan has selected; o the individual's co-payment obligation; o the amount the pharmacy can expect to receive as reimbursement for its services; and o an alert message to warn the pharmacist of possible interactions, including drug-drug, drug-food, drug-age, and drug-pregnancy interactions. MAIL SERVICES. Currently, our mail pharmacy operations dispense over 130,000 prescriptions per month, typically in the form of a three month supply of medications for chronic conditions. We believe that our mail pharmacy reduces costs to health plan sponsors by buying drugs at volume discounts and dispensing generic and therapeutic drug substitutes when appropriate. In addition, our control over the dispensing process allows us to improve patient compliance through methods such as calling members when they neglect to refill important prescriptions. Our mail pharmacy operations are located in approximately 38,000 square feet in a building we own in Richardson, Texas. Our mail service dispensing process is highly automated, featuring bar code and scanning technology to route and track orders, computerized dispensing of many medications and computer-generated mailing labels and invoices. To ensure accurate dispensing of prescriptions, our mail service system is equipped with automated quality control features, and each prescription is inspected by a registered pharmacist. While the vast majority of prescriptions are currently submitted by mail, we are expanding our Internet capabilities to take advantage of the growth we anticipate in this area. See "Internet strategy." DISEASE MANAGEMENT. Our disease management programs are designed to help health plan sponsors manage the cost and treatment of specific diseases. We believe our disease management programs help improve medical outcomes and lower the cost of health care delivery for our customers through our interaction with patients and physicians. These programs are designed to monitor the entire contracted population and intervene when individuals demonstrate symptoms of a disease or high risk indications. We currently provide disease programs for cardiovascular secondary risk reduction, asthma, diabetes, h. pylori, compliance and heart failure. We have completed and are marketing programs in depression, hypertension and gastrointestinal preservation, and we are developing new programs for HIV, migraine, polypharmacy and dementia. Our disease management programs 4 6 have five principal elements: o Data integration. We compile and analyze medical, pharmacy and other relevant data for a particular group of health plan members. o Case finding. We identify patients from this group who have the disease specified by the particular study and who we believe are at high risk for severe illness. o Treatment assessment. We compare treatment received by identified patients with nationally accepted treatment guidelines. o Targeted intervention. We intervene with identified patients by educating them about their disease and with physicians by providing information about treatment guidelines. o Outcomes analysis. We measure the results of the intervention by tracking the identified patients' medical outcomes and monitoring ongoing compliance with their treatment programs. We differentiate our disease management programs from those of our competitors with our outcomes assessment capabilities. We survey patients to assess quality of life, quality of care and overall satisfaction with the disease management program. We also assess the economic benefit of the program to our customers. As recognition of our surveying expertise, we are certified to administer HEDIS/CAHPS 2.OH member satisfaction surveys on behalf of health plan sponsors. These surveys use a set of standardized measures that compare the performance of health plans and allow consumers to draw comparisons across health plans. DECISION SUPPORT SYSTEMS. We use our decision support system to monitor, analyze and evaluate drug utilization for our health benefit management customers. One of our decision-support systems, ApotheQuery(R), allows us to identify cost-saving opportunities arising from the possible overuse or inappropriate use of drugs, the use of high cost drugs and the use of drugs not on the formulary. Our decision support systems have been developed using commercially available technology and are not protected by any patents. We also integrate our customers' pharmacy claims with applicable medical and laboratory claims and patient survey data, when available. This integrated health care database complements the capabilities of ApotheQuery(R) by including data relating to diagnosis and treatment of patients. This allows us and our customers to identify problem areas for the health plan sponsor and implement timely clinical solutions. The database further enhances our ability to complete medical outcomes studies and to develop disease management programs. 5 7 CLINICAL RESEARCH. The two principal components of our current clinical research capabilities are clinical trials and outcomes studies. We developed these capabilities through our acquisition of Innovative Medical Research, Inc. ("IMR") in February 1998 and Baumel-Eisner Neuromedical Institute, Inc. in December 1998. Our clinical research operations participated in 60 clinical trials and 21 surveys during fiscal year 1999. Through our clinical research operations, we assist pharmaceutical manufacturers in moving new drugs, or new uses for existing drugs, through the laborious clinical trials process and into the market quickly and efficiently. We provide an established vehicle for conducting studies that can document a drug's economic and clinical benefits in a real world environment. In addition, our surveying capabilities permit us to evaluate the effectiveness of disease management strategies. We provide key functions in the clinical trials process including: o recruiting patients and physicians to participate in trials; o administering the trials as designed by the pharmaceutical manufacturers; and o measuring the patients' results. We use a call center and medically appropriate surveys to identify patients eligible to participate in our clinical trials. This patient enrollment method is designed to reduce drug development time, which permits sponsors of clinical trials to introduce their products into the market faster and to maximize the economic return for such products. Our current clinical trial initiatives are in the following areas: Alzheimer's disease, analgesia and pain relief, migraine and tension headache, mild cognitive impairment, major depressive orders, Parkinson's disease and gastrointestinal motility. We also provide outcomes studies services to pharmaceutical manufacturers. These services include: o conducting studies to further the understanding of the characteristics of diseases; o conducting studies to develop simple to use tools, such as questionnaires and decision trees, for diagnosing diseases; o developing measurements for monitoring patient medical outcomes; o determining how to best influence the health status of individuals; o conducting surveys to evaluate physician knowledge and behavior in order to develop individualized educational materials for each physician; and o evaluating the direct and indirect costs of health care. 6 8 Our current outcomes studies initiatives are in the following areas: chronic pain, dementia, impaired memory, urinary incontinence, irritable bowel syndrome, asthma, vaccines, headache, osteoarthritis, gastrointestinal motility and diabetes. We believe we are a leader in clinical research and have received strong recognition in the clinical research arena. As of April 30, 1999, we employ 30 Medical Doctors, 2 Ph.D's., and 13 PharmDs. Many of our employees are on the staff of leading university-affiliated medical health centers. We believe we are leaders in Alzheimer's disease prevention and treatment research and are the largest enroller in Alzheimer's research. We were one of the lead investigators for the Excedrin Migraine(C) Program, and we recently conducted an asthma research program with the Robert Wood Johnson Foundation. INTERNET STRATEGY We are currently reviewing alternative approaches to enhance our existing Internet-based services for covered individuals. Our current services include: o ordering refills of pharmaceuticals; o checking the status of pharmacy orders; o locating network pharmacies; and o reviewing formulary information. We plan to develop our Internet capability beyond our current services for covered individuals to support our customers and to enhance our program offerings. Our future Internet initiatives may offer medical content to our health plan sponsor customers for use on their Internet sites, empower consumers by involving them more directly in their medical care and offer access to an on-line drugstore. Our future Internet offerings may include some or all of the following: o on-line drug store; o disease-specific chat rooms and information; o patient and member surveys; o personalized refill reminders; o monitoring of patient drug use; and o recruitment of patients and physicians for clinical trials. 7 9 SALES, MARKETING AND CUSTOMER SERVICE The sales process for health benefit management services usually lasts from six to nine months, yet may take over a year. We initiate our sales process with our large customers at the most senior levels of our company. A staff of seven sales representatives with a local presence in offices across the United States supports these senior level initiatives. We also have proposal development and marketing groups that work with our team to prepare the analysis that supports our person-to-person sales effort. With this team approach, we are able to work with customers at multiple levels within their organizations and they have multiple contacts within ours. Once we have signed up the customer for our services, we commit to provide them with the highest level of customer support. For example, our benefits design group works with the customers to design the pharmacy benefits that the customers will provide to individuals in their plans. Once the plans are established, each customer has a dedicated representative who acts as the primary contact for the customer to call if there are any questions, concerns or suggestions regarding their plans. This representative will also lead the effort within our company to respond to customer requests, such as analyzing potential formulary adjustments, performing data analysis and addressing member eligibility issues. Finally, we commit to our customers that the individuals enrolled in their plans will receive high quality customer service. To fulfill this promise, we manage our own advanced call center with employees available to answer incoming calls 24 hours a day, seven days a week. As of March 31, 1999, we employ approximately 142 customer service representatives in this call center. CUSTOMERS A significant portion of our revenues result from contracts with customers. These contracts typically provide for multi-year terms, with automatic 12-month renewals unless either party terminates the contract by giving written notice before the automatic renewal date. Some of our contracts are terminable by either party on as little as 30 to 180 days notice. In fiscal year 1999, our top five customers accounted for 52% of our revenues. One of our customers, the United Mine Workers of America, accounted for approximately 18% of our revenues, yet less than 8% of our total claims processed, in fiscal year 1999. No other customer accounted for over 10% of our revenues in this period. We expect that Foundation Health Systems will be our single largest customer in fiscal year 2000. Some of our major customers hold equity positions in our company in the form of common stock and warrants, which fosters the development of long-term strategic alliances. We believe this arrangement strengthens our ties to these customers. COMPETITION Many of our customers put their contracts out for competitive bidding prior to renewal. We compete with a number of larger, national companies, including Caremark International Inc., a subsidiary of MedPartners, Inc., Express Scripts, Inc., an affiliate of NYLIFE HealthCare Management, Inc., Merck-Medco Managed Care, LLC, a subsidiary of Merck & Co., Inc., a pharmaceutical manufacturer, and PCS Health Systems, Inc., a subsidiary of Rite-Aid 8 10 Corporation, a national pharmacy chain. These competitors are significantly larger than we are and possess greater financial, marketing and other resources than we do. These competitors may possess purchasing and other advantages over us that may allow them to price competing services more aggressively than we can because of their size or other aspects of their businesses. We believe that the primary competitive factors in the health benefit management industry include: o independence from pharmaceutical manufacturers, retail pharmacies and health plan sponsors; o the quality, scope and costs of programs offered; o the size and financial strength of the company; o the ability to reduce customer costs by negotiating favorable rebates and volume discounts from pharmaceutical manufacturers; o the ability to use clinical strategies to improve patient outcomes and reduce costs; and o the ability to provide flexible, clinically oriented services to customers. We believe that all of our larger competitors offer comprehensive pharmacy benefit management services and some form of disease management services. We consider our principal competitive advantages to be our strong clinical approach; our independence from pharmaceutical manufacturers, retail pharmacies and health plan sponsors; and our strong managed care customer base, which supports the development of health benefit management services. GOVERNMENT REGULATION Various aspects of our businesses are governed by federal and state laws and regulations and compliance is a significant operational requirement for our company. We believe that we are in substantial compliance with all existing legal requirements material to the operation of our business. Certain federal and state laws and regulations affect aspects of our pharmacy benefit management business. Among these are the following: FDA regulation. The U.S. Food and Drug Administration (the "FDA"), generally has authority to regulate drug promotional materials that are disseminated "by or on behalf" of a pharmaceutical manufacturer. In January 1998, the FDA issued a Draft Guidance for Industry regarding the regulation of activities of pharmacy benefit managers that are directly or indirectly controlled by pharmaceutical manufacturers. In that draft guidance, the FDA purported to have the authority to hold pharmaceutical manufacturers responsible for the promotional activities of pharmacy benefit management companies, depending upon the nature and extent of the relationship between the pharmaceutical manufacturer and the pharmacy benefit management 9 11 company. We and many other companies and associations commented to the FDA in writing regarding its authority to regulate the promotional activities of pharmacy benefit management companies that are not owned by pharmaceutical manufacturers. On July 1, 1998, the FDA responded to these comments by reconsidering the matter and announcing its attention to create a new draft guidance. To date, the FDA has not issued a new guidance. Although it appears that the FDA has changed its position regarding the ability to regulate the promotional activities of pharmacy benefit management companies that are not owned by pharmaceutical manufacturers, the FDA could still adopt the current draft guidance or an alternative guidance in which the FDA continues to assert the authority to regulate the promotional activities of such pharmacy benefit management companies. The conduct of clinical trials also is regulated by the FDA under the authority of the Federal Food, Drug and Cosmetic Act and related regulations. In general, the sponsor of the drug product which is being studied, or the manufacturer which will have the right to market the drug product if it is approved by the FDA, has the responsibility to comply with the laws and regulations that apply to the conduct of the clinical trials. However, in providing services related to the conduct of clinical trials, we may assume some or all of the sponsor's or clinical investigator's obligations related to the study of the drug. For example, in October 1998, the FDA announced that the agency would give Institutional Review Boards, independent bodies that oversee the conduct of clinical investigations, increased access to information pointing to violative or potentially violative conduct on the part of clinical investigators with whom they may be working. A clinical investigator is a physician conducting a clinical trial. On February 2, 1999, a regulation that requires clinical investigators to disclose certain financial information took effect. If required financial information, such as the financial interest of each investigator in the approval of the product, is not disclosed, or if any investigator fails to properly certify that he or she has no financial interest in the product under investigation, we could be subject to administrative, civil or criminal penalties. Because the interpretation and enforcement of laws and regulations relating to the conduct of clinical trials is uncertain, the FDA may consider our compliance efforts to be inadequate and initiate administrative enforcement actions against us. If we fail to successfully defend against an administrative enforcement action, it could result in an administrative order suspending, restricting or eliminating our ability to participate in the clinical trial process, which would materially limit our business operations. Moreover, some violations of the Federal Food, Drug and Cosmetic Act are punishable by civil and criminal penalties against both the violating company and responsible individuals. If warranted by the facts, we and our employees involved in the trials could face civil and criminal penalties which include fines and imprisonment. The FDA recently has expressed concern regarding the potential impact of the failure of companies in the pharmaceutical industry to remedy year 2000 computer problems. While the FDA appears most concerned with potential manufacturing problems, the FDA has recognized that year 2000 problems could cause errors in product distribution and in the gathering of data in clinical studies. For example, the FDA has stated that, in the worst case scenario, a year 2000 problem could cause the computers on which companies conducting clinical studies rely to generate flawed data. To date, the FDA has not required companies to make any formal submissions regarding efforts to remedy year 2000 problems. However, if a year 2000 problem 10 12 caused a drug product that we distributed to be adulterated, or caused our data gathered in connection with a clinical study to be flawed, our business could be adversely affected and we could be subject to administrative, civil or criminal liability. Regulation of identifiable patient information. Increased government regulation concerning the use of identifiable patient information may occur in the near future. Through our disease management programs, we assist our health plan sponsor customers in identifying individuals who will benefit most from the programs and measuring the patients' improvement after enrollment in the program. Government restrictions on the use of patient identifiable information may adversely affect our ability to conduct disease management programs and outcomes studies, as well as our business growth strategy based on these programs. Federal and state legislation has been proposed, and some state laws have been enacted, to restrict the use and disclosure of identifiable medical information. To our knowledge, no legislation has been enacted that would prohibit our ability to conduct our current disease management or clinical research programs. However, under the Health Insurance Portability and Accountability Act of 1996, Congress is required to establish standards to govern the privacy of individually identifiable health information by August 1999. If Congress fails to act by that date, the Health Insurance Portability and Accountability Act of 1996 requires that the Secretary of Health and Human Services issue regulations by February 2000. Consequently, it appears likely that federal legislation or regulations addressing the accessibility of individually identifiable health information will be in place in the near future. Anti-remuneration laws. Subject to certain exceptions, federal law prohibits the payment, offer, receipt or solicitation of any remuneration that is knowingly and willfully intended to induce the referral of Medicare, Medicaid or other federal health care program beneficiaries or the purchase, lease, ordering or recommendation of the purchase, lease or ordering of items or services reimbursable under federal health care programs. Several states also have similar laws which are not limited to services for which federal health care program payment may be made. Further, the Clinton administration has proposed that anti-remuneration laws also be applied to services for which Medicare or Medicaid payments are not made. Sanctions for violating these federal and state anti-remuneration laws may include imprisonment, criminal and civil fines, and exclusion from participation in federal health care programs. State anti-remuneration laws vary, and courts have not frequently interpreted such laws. However, the courts in several cases have ruled that contracts that violate anti-remuneration laws are voidable. The federal anti-remuneration statute has been interpreted broadly by courts; the Office of Inspector General, or OIG, within the Department of Health and Human Services; and administrative bodies. Because of the federal statute's broad scope, federal regulations establish some "safe harbors" from liability. Safe harbors exist for, among other things, certain properly reported discounts received from vendors, certain investment interests, certain properly disclosed payments made by vendors to group purchasing organizations and certain managed care risk-sharing arrangements. A practice that does not fall within a safe harbor is not necessarily unlawful, but may be subject to scrutiny and challenge. Courts have ruled that, in the absence of an applicable statutory exception or safe harbor, a violation of the statute may occur even if only one of the purposes of a payment arrangement is to induce patient referrals or purchases. Among the practices that have been identified by the OIG as potentially improper under the statute are 11 13 "product conversion programs" in which benefits are given by pharmaceutical manufacturers to pharmacists or physicians for changing a prescription, or recommending or requesting such a change, from one drug to another. These laws have been cited as a partial basis, along with the state consumer protection laws discussed below, for investigations and multi-state settlements relating to financial incentives provided by pharmaceutical manufacturers to retail pharmacists in connection with such programs. We believe that we are in substantial compliance with the legal requirements imposed by these laws and regulations, and we believe that there are material differences between the drug-switching programs that have been highlighted by the OIG and the programs we offer to our customers. However, in June 1998, the Philadelphia United States Attorney's office announced that it was investigating rebates and other payments made by pharmaceutical manufacturers to pharmacy benefit managers, including whether these payments may violate anti-remuneration laws. To date, no specific prosecutions have been made public. We could be subject to scrutiny or challenge under these laws and regulations, which could have a material adverse effect upon us. OIG study. The OIG Office of Evaluation and Inspections, which is not responsible for investigations of potential violations of anti-remuneration laws, but which seeks to improve the effectiveness and efficiency of the Department of Health and Human Services programs, issued a report on pharmacy benefit management arrangements on April 15, 1997. The report was based primarily on a nationwide survey of HMOs that use pharmacy benefit managers, and examined the benefits of, and concerns raised by, the HMOs' relationships with pharmacy benefit managers. The report identified two major concerns, the potential for bias resulting from alliances of pharmacy benefit managers and pharmaceutical manufacturers and the lack of oversight by HMOs regarding the performance of pharmacy benefit managers in delivering quality services to health plan members. The report makes two main recommendations. First, the Health Care Financing Administration and state Medicaid programs should include stronger oversight provisions in their risk contracts with HMOs by requiring HMOs to review the performance of the pharmacy benefit managers with which they contract. Second, the Health Care Financing Administration, the FDA and the Health Resources and Services Administration, working with outside organizations, should develop quality measures for pharmacy practices that can be used in managed care settings. In addition, legislation has been introduced in several states proposing to specifically regulate pharmacy benefit management companies. To date, no such legislation has passed. We intend to closely monitor these agency actions and legislative proposals and whether these actions and proposals would have any impact on our business. Managed care reform. Legislation is being debated on both the federal and state level, and has been enacted in some states, aimed at improving the quality of care provided to individuals enrolled in managed care plans. Some of these initiatives would, among other things, require that health plan members have greater access to drugs not included on a plan's formulary and give health plan members the right to sue their health plans for malpractice when they have been denied care. The scope of the managed care reform proposals under consideration by Congress and state legislatures and enacted by states to date vary greatly, and the extent to which future 12 14 legislation may be enacted is uncertain. However, these initiatives could greatly impact the managed care and pharmaceutical industries and, therefore, could have a material impact on our business. ERISA regulation. The Employee Retirement Income Security Act of 1974, or ERISA, regulates certain aspects of employee pension and health benefit plans, including self-funded corporate health plans with which we have agreements to provide pharmacy benefit management services. The U.S. Department of Labor, which is the agency that enforces ERISA, could assert that the fiduciary obligations imposed by the statute apply to certain aspects of our operations. Consumer protection laws. Most states have consumer protection laws that have been the basis for investigations and multi-state settlements relating to financial incentives provided by pharmaceutical manufacturers to retail pharmacies in connection with drug switching programs. In addition, under a settlement agreement entered into with 17 states on October 25, 1995, Merck-Medco Managed Care, the pharmacy benefit management subsidiary of pharmaceutical manufacturer Merck & Co., agreed to require pharmacists affiliated with Merck-Medco Managed Care mail service pharmacies to disclose to physicians and patients the financial relationships between Merck & Co., Merck-Medco Managed Care and the mail service pharmacy when such pharmacists contact physicians seeking to change a prescription from one drug to another. We believe that our contractual relationships with pharmaceutical manufacturers and retail pharmacies do not include the features that were viewed by enforcement authorities as problematic in these settlement agreements. However, we could be subject to scrutiny or challenge under one or more of these laws. Network access legislation. A majority of states have adopted some form of legislation affecting our ability to limit access to pharmacy provider networks or from removing network providers. Such legislation may require our customers and us to admit any retail pharmacy willing to meet the plan's price and other terms for network participation; this legislation is sometimes referred to as "any willing provider" legislation. We have not been materially affected by these statutes because we administer a large network of over 53,000 retail pharmacies and will admit any licensed pharmacy that meets our credentialing criteria, involving such matters as adequate insurance coverage, minimum hours of operation, and the absence of disciplinary actions by the relevant state agencies. Legislation imposing plan design restrictions. Some states have legislation that prohibits a health plan sponsor from implementing certain restrictive design features. For example, some states provide that members of the plan may not be required to use network providers, but must also be provided with benefits even if they choose to use non-network providers. This legislation is sometimes referred to as "freedom of choice" legislation. Other states mandate coverage of certain benefits or conditions. This legislation does not generally apply to us, but it may apply to some of our customers such as HMOs and insurers. If similar legislation were to become widespread and broad in scope, it could have the effect of limiting the economic benefits achievable through health benefit management services. 13 15 Licensure laws. Many states have licensure or registration laws governing certain types of ancillary health care organizations, including preferred provider organizations, third party administrators, and companies that provide utilization review services. The scope of these laws differs significantly from state to state, and the application of these laws to the activities of pharmacy benefit managers is often unclear. We have registered under these laws in those states in which we have concluded, after discussion with the appropriate state agency, that such registration is required. Legislation affecting drug prices. In the past, some states have adopted legislation providing that a pharmacy participating in the state's Medicaid program must give the state the best price that the pharmacy makes available to any third party plan. This legislation is sometimes referred to as "most favored nation" legislation. Such legislation, if enacted in any state, may adversely affect our ability to negotiate discounts in the future from network pharmacies. Other states have enacted "unitary pricing" legislation, which mandates that all wholesale purchasers of drugs within the state be given access to the same discounts and incentives. Additionally, Medicare reimbursement and coverage of prescription drugs may change significantly in the near future. Medicare presently covers only a limited number of outpatient prescription drugs, and reimbursement of covered drugs is generally based on a percentage of the drug's average wholesale price. Legislation has been proposed to reduce Medicare drug reimbursement amounts, although the prospects for enactment of such legislation are uncertain. At the same time, legislative initiatives are being considered to expand Medicare coverage of drugs, in some instances as part of a broad reform of the Medicare program. We cannot assess at this stage whether such legislation will be approved or how it would address drug costs. Enactment of legislation to reduce Medicare drug reimbursement or to expand Medicare drug coverage may have an adverse impact upon our business. Regulation of financial risk plans. Fee-for-service prescription drug plans are not generally subject to financial regulation by the states. However, if a pharmacy benefit manager offers to provide prescription drug coverage on a capitated basis or otherwise accepts material financial risk in providing the benefit, laws in various states may regulate the plan. These laws may require that the party at risk establish reserves or otherwise demonstrate financial responsibility. Laws that may apply in such cases include insurance laws, HMO laws or limited prepaid health service plan laws. Many of these state laws may be preempted in whole or in part by ERISA, which provides for comprehensive federal regulation of employee benefit plans. However, the scope of ERISA preemption is uncertain and is subject to conflicting court rulings. Other state laws may be invalid in whole or in part as an unconstitutional attempt by a state to regulate interstate commerce, but the outcome of challenges to these laws on this basis is uncertain. Accordingly, compliance with state laws and regulations is a significant operational requirement for us. Mail pharmacy regulation. Our mail pharmacy operations, located in Richardson, Texas, distribute drugs throughout the country. Some of the drugs that we distribute are classified as controlled substances, which are regulated by federal and state drug enforcement authorities. We are licensed by both United States and Texas authorities to do business as a pharmacy and distribute controlled substances. Many of the states into which we deliver pharmaceuticals and controlled substances also have laws and regulations that permit out-of-state mail service pharmacies to distribute pharmaceuticals and 14 16 controlled substances into the state so long as the pharmacy is registered with that state's board of pharmacy, or similar regulatory body. We have registered in every state, which, to our knowledge, requires such registration. In addition, various pharmacy associations and boards of pharmacy have promoted enactment of laws and regulations directed at restricting or prohibiting the operation of out-of-state mail service pharmacies by, among other things, requiring compliance with all laws of certain states into which the mail service pharmacy dispenses medications whether or not those laws conflict with the laws of the state in which the pharmacy is located. To the extent that such laws or regulations are found to be applicable to us, we would be required to comply with them. Other statutes and regulations also affect our mail pharmacy operations. The Health Care Financing Administration requires mail order pharmacies to provide toll-free numbers for patient counseling of Medicaid recipients residing out of state. However, we do not currently receive reimbursements from any Medicaid programs. Congressionally mandated goals to provide useful information on prescription drugs to consumers may involve participation by mail order pharmacies in assisting in the dissemination of such information. Federal statutes and regulations govern the labeling, packaging, advertising and adulteration of prescription drugs and the dispensing of controlled substances. The Federal Trade Commission requires mail order sellers of goods generally to engage in truthful advertising, to stock a reasonable supply of the product to be sold, to fill mail orders within thirty days, and to provide customers with refunds when appropriate. The United States Postal Service has statutory authority to restrict the transmission of drugs and medicines through the mail to a degree that could have an adverse effect on our mail service operations. The United States Postal Service historically has exercised this statutory authority only with respect to controlled substances. Alternative means of delivery are available to us. EMPLOYEES On May 31, 1999, we had 891 employees. None of our employees are represented by a labor union. In the opinion of management, our relationship with our employees is good. DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This Form 10-K includes "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included in this Form 10-K, including without limitation, statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" regarding our financial position, our business strategy and our management's plans and objectives for future operations, are forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. The cautionary statements made in this Form 10-K should be read as being applicable to all related forward-looking statements wherever they appear in this Form 10-K. Our actual results could differ materially from those discussed herein, and important factors that could cause actual results to differ materially from our expectations are disclosed under "Risk Factors", as well as 15 17 elsewhere in this Form 10-K. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this section. RISK FACTORS IF WE LOSE KEY HEALTH PLAN SPONSOR CUSTOMERS, OUR BUSINESS COULD BE ADVERSELY AFFECTED We depend on a limited number of large health plan sponsor customers for a significant portion of our consolidated revenues. Our business, profitability and growth prospects could be adversely affected if we were to lose one or more of our significant customers. We could lose customers if we fail to win a competitive bid at the time of contract renewal or if our customers are acquired by companies who are not our customers. Our contracts with our customers generally do not have terms of more than three years, and in some cases are terminable by either party on as little as 30 to 180 days notice. Five customers accounted for approximately 52% of our revenues in fiscal year 1999. During this period, United Mine Workers of America accounted for approximately 18% of our consolidated revenues, yet less than 8% of our total claims processed. In fiscal 2000, we expect that Foundation Health Services will become our largest customer. We cannot be sure that revenues from new customers will offset the revenues which may be lost from customers who terminate contracts because they are acquired by, or acquire, companies which are not our customers. Over the past several years, insurance companies, health maintenance organizations, or HMOs, and managed care companies have experienced significant consolidation. Our customers have been, and may continue to be, subject to consolidation pressures. We may lose some customers as a result of acquisitions, which could have a material adverse effect on our business, profitability and growth prospects. Many participants in the health care industry, including our customers, are under severe financial pressures due to rising claims and costs. If the financial condition of any of our significant customers deteriorates, which could occur for many reasons including adverse changes in governmental or private reimbursement programs, it could have an adverse effect on us. IF WE CANNOT RESPOND ADEQUATELY TO COMPETITION IN OUR INDUSTRY, OUR PROFITABILITY AND GROWTH PROSPECTS COULD BE REDUCED OR ELIMINATED The health benefit management industry is very competitive. If we don't compete effectively, our profitability and growth prospects could be reduced or eliminated. Our competitors include large, profitable and well-established companies which have substantially greater financial, marketing and other resources than we do. Some of our competitors in the pharmacy benefit management business, such as Merck-Medco Managed Care, LLC and PCS Health Systems, Inc., are owned by large, profitable and well-established pharmaceutical manufacturers or national drug store chains. Many of our customers put their contracts out for competitive bidding prior to renewal. Our competitors may possess purchasing and other advantages over us that may allow them to price competing services more aggressively than we can because of their size or 16 18 other aspects of their business. We also expect to experience competition from new sources in the future, such as Internet-based health care services companies. We cannot be sure that we will continue to remain competitive, nor can we be sure that we will be able to successfully market our health benefit management services to customers at our current levels of profitability. Over the last several years, the competitive pressures described above have caused health benefit management companies, including us, to reduce the prices charged to customers for basic pharmacy benefit management services and share a larger portion of the rebate revenues received from pharmaceutical manufacturers with our customers. Our gross margin may decline as we continue to attract larger customers, which typically have greater bargaining power than smaller customers and may require us to sell our services at decreased prices. IF WE FAIL TO TRANSITION THE OPERATIONS OF FOUNDATION HEALTH PHARMACEUTICAL SERVICES IN A TIMELY AND SUCCESSFUL MANNER, OUR BUSINESS, PROFITABILITY AND GROWTH PROSPECTS COULD BE ADVERSELY AFFECTED We acquired Foundation Health Pharmaceutical Services, a large pharmacy benefit management company, on March 31, 1999. If we fail to transition this new business in a timely and successful manner, our business, profitability and growth prospects could be adversely affected. This acquisition, along with the service agreement signed with Foundation Health Systems, Inc., approximately doubled the number of individuals enrolled in our programs. We have begun to implement a plan to address items such as: o retaining the non-affiliated customers of Foundation Health Pharmaceutical Services; o transitioning the Foundation Health Systems, Inc. affiliated health plan onto our system; and o coordinating customer service between our two organizations. We cannot be sure that we will successfully combine Foundation Health Pharmaceutical Services' operations with our own, or that the transaction will meet our financial expectations. The Foundation Health Pharmaceutical Services customers who were not part of health benefit plans affiliated with Foundation Health Systems have contracts which allow them to terminate their relationship with us with 60 to 90 days' notice. We believe that about half of the estimated 12 million new plan members we acquired fall under this type of contract. If a large number of customers terminate their relationship with us, we may not be able to achieve our customer retention goals. Because we placed a significant level of importance on Foundation Health Pharmaceutical Services' customer base when we decided to purchase the company, the loss of customers would adversely affect our future business plans. It is also possible that during our investigation of Foundation Health Pharmaceutical Services we failed to uncover or appropriately address material problems with Foundation Health Pharmaceutical Services' operations or financial condition, or failed to discover contingent liabilities. 17 19 IF WE ARE UNABLE TO OVERCOME THE PROBLEMS AND RISKS RELATED TO OUR ACQUISITION AND ALLIANCE STRATEGY, OUR BUSINESS, PROFITABILITY AND GROWTH PROSPECTS COULD SUFFER Part of our growth strategy includes acquisitions and/or alliances involving complementary services, technologies and businesses. If we are unable to overcome the potential problems and inherent risks related to acquisitions and alliances, our business, profitability and growth prospects could suffer. We completed three acquisitions in the past 15 months, and we continually review future acquisition opportunities. Our ability to continue to expand successfully through acquisitions and alliances depends on many factors, including our ability to identify acquisition/alliance prospects and negotiate and close transactions. If we complete future acquisitions or alliances: o we could fail to successfully integrate the operations, services and products of any acquired company; o we could fail to select the best alliance partners or fail to effectively plan and manage any alliance strategy; o our management's attention could be diverted from other business concerns; and o we could lose key employees of the acquired company or alliance business. Many companies compete for acquisition and alliance opportunities in the health benefit management industry. Some of our competitors are companies that have significantly greater financial and management resources than we do. This may reduce the likelihood that we will be successful in completing acquisitions and alliances necessary to the future success of our business. IF OUR BUSINESS CONTINUES TO GROW RAPIDLY AND WE ARE UNABLE TO MANAGE THIS GROWTH, OUR BUSINESS, PROFITABILITY AND GROWTH PROSPECTS COULD SUFFER If we are unable to manage future expansion successfully or are unable to hire and retain the personnel needed to manage our business successfully, then our business, profitability and growth prospects could be adversely affected. Our business has grown rapidly in the last five years, with total revenues increasing from approximately $91.3 million in fiscal year 1995 to $774.8 million in fiscal year 1999. If we continue to grow rapidly, we will need to hire additional senior and line management, increase our investment in employee recruitment and training, and expand our information processing and financial control systems. Our future operating results will depend in part on the ability of our officers and other key employees to continue to expand, train and effectively manage our employees as well as to improve our operations, customer support and financial control systems. Our future growth will also depend on our ability to access capital. 18 20 IF OUR QUARTERLY REVENUES AND OPERATING RESULTS FLUCTUATE SIGNIFICANTLY, THE PRICE OF OUR COMMON STOCK MAY BE VOLATILE Our revenues and operating results may in the future vary significantly from quarter to quarter. If our quarterly results fluctuate, it may cause our stock price to be volatile. We believe that a number of factors could cause these fluctuations, including: o the size and timing of our contract signings; o the expiration or termination of our contracts with significant customers; o changes in our revenues due to our entry into different types of customer contracts; o the number of covered individuals in our customers' health plans; o costs associated with additional Internet services; o the timing of our new service and program announcements; o market acceptance of our services and new programs; o changes in our pricing policies or in our competitors' pricing policies; o the introduction by competitors of new services which make ours obsolete or less valuable; o changes in our operating expenses and our investment in infrastructure; o personnel changes; and o conditions in the health care industry and the economy in general. It can take a year or more to sell our services to a new customer. Our long sales cycle adds to the unpredictability of our revenues, which could cause substantial volatility in the price of our common stock. Our sales cycle varies substantially from customer to customer because of a number of factors over which we have little or no control. These factors include: o our customers' financial objectives or constraints; o the timing of contract bids and renewals; o changes in our customers' budgetary or purchasing priorities; and o potential downturns in general economic conditions. Because of the factors listed above, we believe that our quarterly revenues, expenses and operating results may vary significantly in the future and that period-to-period comparisons of 19 21 our operating results are not necessarily meaningful. You should not rely on the results of one quarter as a indication of our future performance. It is also likely that in some future quarters, our operating results will fall below our expectations or the expectations of market analysts and investors. If we do not meet these expectations, the price of our common stock may decline significantly. IF THE PRICE OF OUR COMMON STOCK CONTINUES TO FLUCTUATE SIGNIFICANTLY, INVESTMENTS COULD BE ADVERSELY AFFECTED The closing price of our common stock has ranged from a low of $41.94 to a high of $64.25 in the past three months, and has fluctuated as much as $14.25 in five trading days. The quoted price of our common stock is subject to sudden and material increases and decreases, and decreases could adversely affect investments in our common stock. The quoted price of our common stock could fluctuate widely in response to: o our quarterly operating results; o changes in earnings estimates by securities analysts; o changes in our business; o changes in the market's perception of the Internet component of our business; o changes in the businesses, earnings estimates or market perceptions of our competitors; and o changes in general market or economic conditions. In addition, the stock market has experienced extreme price and volume fluctuations in recent years that have significantly affected the quoted prices of the securities of many companies. The changes often appear to occur without regard to specific operating performance. The quoted price of our common stock could increase or decrease based upon factors that have little or nothing to do with our company and these fluctuations could materially reduce our quoted stock price. IF OUR INTERNET STRATEGY IS NOT SUCCESSFUL, OUR BUSINESS, PROFITABILITY AND GROWTH PROSPECTS COULD BE ADVERSELY AFFECTED If our Internet strategy is not successful, our business, profitability and growth prospects could be adversely affected. We believe it is important for us to further develop our Internet presence, and we are currently reviewing alternative strategies to broaden our Internet-based services. Historically, we have experienced expense increases when introducing or expanding services. We anticipate that we will need to expend significant resources to develop our Internet services in the future, which may adversely impact our profitability. In addition, the structure of our Internet business is evolving and could involve joint ventures, acquisitions, strategic alliances or other collaborative arrangements. We cannot be certain that: o we will be successful in developing Internet services; 20 22 o we will select the best partners or will effectively plan and manage any alliance or acquisition; o the additional Internet services we develop will be profitable; or o anyone will demand Internet services in the future. IF WE LOSE RELATIONSHIPS WITH ONE OR MORE KEY PHARMACEUTICAL MANUFACTURERS, OUR BUSINESS, PROFITABILITY AND GROWTH PROSPECTS COULD BE ADVERSELY AFFECTED Approximately 15% of our consolidated revenues is attributable to our arrangements with pharmaceutical manufacturers. They provide us with formulary rebate payments based on drug use by health plan members, as well as fees for other services. Although we pass a majority of these rebates on to our health plan sponsor customers, we believe our business, profitability and growth prospects may suffer if: o we lose relationships with one or more key pharmaceutical manufacturers; o we fail to meet volume-related conditions; o legal restrictions are imposed on the ability of pharmaceutical manufacturers to offer formulary rebates; or o pharmaceutical manufacturers choose not to offer formulary rebates. Over the next few years, as patents expire covering many brand name drugs that currently have substantial market share, generic products will be introduced that may substantially reduce the market share of the brand name drugs. Historically, manufacturers of generic drugs have not offered formulary rebates on their drugs. If the use of newly-approved, brand name drugs added to our formulary does not offset the use of brand name drugs whose patents expire, our profitability could be reduced. IF WE LOSE PHARMACY NETWORK AFFILIATIONS, OUR BUSINESS COULD BE ADVERSELY AFFECTED Our contracts with retail pharmacies, which are non-exclusive, are generally terminable by either party on relatively short notice. If one or more of the top pharmacy chains elects to terminate its relationship with us, our members' access to retail pharmacies and our business could be significantly impaired. In addition, Rite-Aid Corporation recently acquired one of our major pharmacy benefit manager competitors, and other large retail pharmacy chains either own pharmacy benefit managers today or could attempt to acquire a pharmacy benefit manager in the future. Ownership of pharmacy benefit managers by retail pharmacy chains could have material adverse effects on our relationships with these pharmacy chains and on our business, profitability and growth prospects. 21 23 IF WE LOSE KEY EMPLOYEES ON WHOM WE DEPEND, IN PARTICULAR DAVID D. HALBERT, OUR BUSINESS COULD BE ADVERSELY AFFECTED We believe that our continued success will depend to a significant extent upon retaining the services of our senior management. Our business could be materially and adversely affected if we were to lose the services of Mr. David D. Halbert, who is our Chairman of the Board, Chief Executive Officer and President, or other persons in senior management. Any of our senior management could seek other employment at any time. If we cannot attract, motivate and retain key employees, our business, profitability and growth prospects could suffer. IF WE DO NOT ADEQUATELY ADDRESS YEAR 2000 ISSUES, OUR BUSINESS MAY BE ADVERSELY AFFECTED We have incurred internal and external personnel costs as well as other expenses related to our efforts to insure our internal computer systems and software products will function in the year 2000 and beyond. We cannot be sure that our efforts to address internal year 2000 issues will be entirely successful. In addition, we cannot be sure that the computer systems and software of other companies with which we do business will become year 2000 compliant before January 1, 2000. If we or any of these other companies fail to become year 2000 compliant, our systems and operations could be disrupted and our business, profitability and growth prospects could be harmed. We have not developed a likely worst case year 2000 scenario. However, we could experience a number of minor internal systems malfunctions and errors in early year 2000 that we did not detect during our renovation and testing process. In addition, some of our customers and vendors may not be year 2000 compliant. We have begun preparing contingency plans to handle these scenarios. We intend to complete our contingency plans by the third quarter of calendar year 1999. However, despite our compliance program, we may have overlooked or otherwise not remedied year 2000 issues which may have a material adverse effect on us. For additional information regarding year 2000 issues, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations." IF THERE ARE CHANGES IN FEDERAL OR STATE FINANCING AND REGULATION OF THE HEALTH CARE INDUSTRY, OUR CUSTOMERS MAY DELAY OR REDUCE THE PURCHASE OF OUR SERVICES During the past several years, the U.S. health care industry has been subject to an increase in governmental regulation, on both the federal and state level. We cannot predict what effect, if any, these proposals might have on our business, profitability and growth prospects. Congress is currently considering proposals to change Medicare drug coverage and reimbursement policies, and both Congress and the states are considering legislation to increase governmental regulation of managed care plans. These proposals may increase governmental involvement in health care and health benefit management services and otherwise change the way our customers do business. Health care organizations may react to these proposals and the uncertainty surrounding such proposals by cutting back or delaying the purchase of our health benefit management services. 22 24 IF LEGISLATIVE OR REGULATORY INITIATIVES RESTRICT OUR ABILITY TO USE PATIENT IDENTIFIABLE MEDICAL INFORMATION, OUR CLINICAL PROGRAMS AND OUR BUSINESS GROWTH STRATEGY BASED ON THESE SERVICES COULD BE ADVERSELY AFFECTED Through our disease management programs, we help our health plan sponsor customers identify individuals who will most benefit from the programs. Governmental restrictions on the use of patient identifiable information may hamper our ability to conduct disease management programs and medical outcomes studies and could adversely affect our business growth strategy based on these programs. Federal and state legislation has been proposed, and some state laws have been enacted, to restrict the use and disclosure of patient identifiable medical information. To our knowledge, no legislation has been enacted that would prohibit our ability to conduct our current disease management or clinical research programs. However, under the Health Insurance Portability and Accountability Act of 1996, Congress is required to establish standards to govern the privacy of individually identifiable health information by August 1999. If Congress fails to act by that date, the Health Insurance Portability and Accountability Act requires that the Secretary of Health and Human Services issue regulations by February 2000. Consequently, it appears likely that federal legislation or regulations addressing the accessibility of individually identifiable health information will be in place in the near future. Even if new legislation or regulations are not approved, individual health plan sponsor customers could prohibit us from including their patients' medical information in our various databases of medical data, or they could prohibit us from providing services to our customers that involve the compilation of such information. IF GOVERNMENT LAWS OR REGULATIONS RELATING TO THE FINANCIAL RELATIONSHIPS BETWEEN PHARMACY BENEFIT MANAGERS AND PHARMACEUTICAL MANUFACTURERS ARE INTERPRETED AND ENFORCED IN A MANNER ADVERSE TO OUR PHARMACY BENEFIT MANAGEMENT AND DISEASE MANAGEMENT PROGRAMS, WE MAY BE SUBJECT TO ENFORCEMENT ACTIONS AND OUR BUSINESS OPERATIONS COULD BE MATERIALLY LIMITED In January 1998, the U.S. Food and Drug Administration, or the FDA, issued a Draft Guidance for Industry regarding the regulation of activities of pharmacy benefit managers that are directly or indirectly controlled by pharmaceutical manufacturers. If the FDA adopts this guidance in this form, it could have a material adverse effect on our business, profitability and growth prospects. In that draft guidance, the FDA purported to have the authority to hold pharmaceutical manufacturers responsible for the promotional activities of pharmacy benefit management companies, depending upon the nature and extent of the relationship between the pharmaceutical manufacturer and the pharmacy benefit management company. We and many other companies and associations commented to the FDA in writing regarding its authority to regulate the promotional activities of pharmacy benefit management companies that are not owned by pharmaceutical manufacturers. On July 1, 1998 the FDA responded to these comments by reconsidering the matter and announcing its attention to create a new draft guidance. To date, the FDA has not issued a new guidance. Although it appears that the FDA has changed its position regarding the ability to regulate the promotional activities of pharmacy benefit management companies that are not owned by pharmaceutical manufacturers, the FDA could still adopt the current draft guidance or an alternative guidance in which the FDA continues to assert the authority to regulate the promotional activities of such pharmacy benefit management companies. 23 25 If our business arrangements are challenged under federal or state anti-remuneration laws, it could have a material adverse effect upon our business, profitability and growth prospects. Federal anti-remuneration laws generally prohibit the receipt or solicitation of payment in return for purchasing or ordering, or arranging for or recommending the purchasing or ordering of, items and services reimbursable by federal health care programs. To date, these laws have not been applied to prohibit the types of business arrangements we have with pharmaceutical manufacturers. However, courts and enforcement authorities that administer the anti-remuneration laws have historically interpreted these laws broadly. Moreover, at least one United States Attorney's office has announced that it is investigating whether rebates and other payments made by pharmaceutical manufacturers to pharmacy benefit managers may violate the anti-remuneration laws. In addition, anti-remuneration laws have been used as a partial basis for investigations and lawsuits against other pharmacy benefit managers relating to financial incentives provided by pharmaceutical manufacturers. IF GOVERNMENT LAWS OR REGULATIONS ARE INTERPRETED AND ENFORCED IN A MANNER ADVERSE TO OUR CLINICAL RESEARCH PROGRAMS, WE MAY BE SUBJECT TO ADMINISTRATIVE ENFORCEMENT ACTIONS, AS WELL AS CIVIL AND/OR CRIMINAL LIABILITY The conduct of clinical trials is regulated by the FDA under the authority of the Federal Food, Drug and Cosmetic Act and the related regulations. If government laws or regulations are interpreted and enforced in a manner adverse to our clinical research programs, we may be subject to administrative enforcement actions, as well as civil and/or criminal liability. In general, the sponsor of the drug product which is being studied, or the manufacturer which will have the right to market the drug product if it is approved by the FDA, has the responsibility to comply with the laws and regulations that apply to the conduct of the clinical trials. However, in providing services related to the conduct of clinical trials, we may assume some or all of the sponsor's or clinical investigator's obligations related to the study of the drug. For example, in October 1998, the FDA announced that the agency would give Institutional Review Boards, which are independent bodies that oversee the conduct of clinical investigations, increased access to information pointing to violative or potentially violative conduct on the part of clinical investigators with whom they may be working. A clinical investigator is a physician conducting a clinical trial. On February 2, 1999, a regulation that requires clinical investigators to disclose certain financial information took effect. If a clinical investigator fails to disclose required financial information, such as the financial interest of each investigator in the approval of the product, or fails to properly certify that he or she has no financial interest in the product under investigation, we could be subject to administrative, civil or criminal penalties. Because the interpretation and enforcement of these laws and regulations relating to the conduct of clinical trials is uncertain, the FDA may consider our compliance efforts to be inadequate and initiate administrative enforcement actions against us. If we fail to successfully defend against an administrative enforcement action, it could result in an administrative order suspending, restricting or eliminating our ability to participate in the clinical trial process, which would materially limit our business operations. Moreover, some violations of the Federal Food, Drug and Cosmetic Act are punishable by civil and criminal penalties against both the violating company and responsible individuals. If warranted by the facts, we and our employees involved 24 26 in the trials could face civil and criminal penalties which include fines and imprisonment. As a consequence of the severe penalties we and our employees potentially could face, we must devote significant operational and managerial resources to comply with these laws and regulations. Although we believe that we substantially comply with all existing statutes and regulations material to the operation of our business, regulatory authorities may disagree and initiate enforcement or other actions against us. In addition, we cannot predict the impact of future legislation and regulatory changes on our business or assure you that we will be able to obtain or maintain the regulatory approvals required to operate our business. IF WE BECOME SUBJECT TO LIABILITY CLAIMS WHICH ARE NOT COVERED BY OUR INSURANCE POLICIES, WE MAY BE LIABLE FOR DAMAGES AND OTHER EXPENSES WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, PROFITABILITY AND GROWTH PROSPECTS A successful product or professional liability claim in excess of our insurance coverage could have a material adverse effect on our business, profitability and growth prospects. While we intend to maintain professional and general liability insurance coverage at all times, we cannot assure you that we will be able to maintain insurance in the future, that insurance will be available on acceptable terms or that insurance will be adequate to cover any or all potential product or professional liability claims. Various aspects of our business, including the dispensing of pharmaceutical products; the performance of clinical trials, pharmacy benefit management services and disease management services; and the operation of our call center and Internet site, may subject us to litigation and liability for damages. For example, our clinical research services involve the risk of liability for personal injury or death from unforeseen adverse side effects or improper administration of a new drug. We could be materially and adversely affected if we were required to pay damages, incur defense costs or face negative publicity in connection with a claim that is outside the scope of our contractual indemnity or insurance coverage, or if the indemnity, although applicable, is not performed in accordance with its terms. Since 1993, retail pharmacies have filed over 100 separate lawsuits against pharmaceutical manufacturers, wholesalers and other pharmacy benefit managers. We are not a party to any of these proceedings. However, at this time we cannot assess whether we will be made a party to this type of lawsuit. Court decisions or terms of any settlements relating to these lawsuits could materially and adversely affect us in the future. These lawsuits challenge brand name drug pricing practices under various state and federal antitrust laws. These suits also allege in part that the pharmaceutical manufacturers offered, and some pharmacy benefit managers accepted, rebates and discounts on brand name prescription drugs that violate the federal Robinson-Patman Act and the federal Sherman Act. Some pharmaceutical manufacturers have settled certain of these actions. IF WE SOLD OR LIQUIDATED OUR COMPANY, THE VALUE OF OUR INTANGIBLE ASSETS MAY NOT BE REALIZED At March 31, 1999, $105.0 million, or 38% of our total assets, consisted of intangible assets, primarily goodwill. These intangible assets are being amortized over an average period of 29 25 27 years. If we were to face a sale or liquidation, we cannot be sure that the value of our intangible assets will be realized. In addition, if the value of our intangible assets were to decrease significantly, the resulting write-offs could have a material adverse effect on our business, profitability and growth prospects. ITEM 2. PROPERTIES
- --------------------------------------------------------------------------------------------------------------- SQUARE USE LOCATION FOOTAGE LEASE/OWN - --------------------------------------------------------------------------------------------------------------- Mail Service Pharmacy Richardson, Texas 38,400 Own - --------------------------------------------------------------------------------------------------------------- Corporate Office Irving, Texas 14,047 Lease expires 12/02 - --------------------------------------------------------------------------------------------------------------- Data Services Dallas, Texas 22,990 Lease expires 11/00 - --------------------------------------------------------------------------------------------------------------- Call Center Richardson, Texas 52,000 Lease expires 10/09 - --------------------------------------------------------------------------------------------------------------- Clinical Services Hunt Valley, Maryland 20,733 Lease expires 08/99 - --------------------------------------------------------------------------------------------------------------- Corporate Office and Clinic Towson, Maryland 16,322 Lease expires 06/03 - --------------------------------------------------------------------------------------------------------------- Sales Office Stamford, Connecticut 1,522 Lease expires 05/01 - --------------------------------------------------------------------------------------------------------------- Clinic Philadelphia, Pennsylvania 3,613 Lease expires 04/05 - --------------------------------------------------------------------------------------------------------------- Clinic Catonsville, Maryland 3,535 Lease expires 12/02 - --------------------------------------------------------------------------------------------------------------- Clinic Atlanta, Georgia 3,262 Lease expires 03/03 - --------------------------------------------------------------------------------------------------------------- Clinic Tamarac, Florida 3,367 Lease expires 06/02 - --------------------------------------------------------------------------------------------------------------- Clinic Miami Beach, Florida 12,000 Lease expires 03/04 - --------------------------------------------------------------------------------------------------------------- Clinic Boca Raton, Florida 3,129 Lease expires 05/03 - ---------------------------------------------------------------------------------------------------------------
ITEM 3. LEGAL PROCEEDINGS We are a party to routine legal and administrative proceedings arising in the ordinary course of our business. The proceedings currently pending are not, in our opinion, material either individually or in the aggregate. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of fiscal 1999. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS On October 8, 1996 the Company sold 2,397,067 shares of its common stock at $9.00 per share in an initial public offering. Prior to that time, there was no public market for the Company's common stock. 26 28 Our common stock has been traded on the Nasdaq National Market under the symbol ADVP since October 8, 1996. The following table sets forth the range of quarterly high and low sales prices per share of our common stock as quoted on the Nasdaq National Market.
HIGH LOW ---------- -------- FISCAL YEAR ENDED MARCH 31, 1997: Third Quarter (from October 8, 1996) $ 20 3/4 $ 7 3/4 Fourth Quarter................... 25 1/4 12 7/8 FISCAL YEAR ENDED MARCH 31, 1998: First Quarter.................... $ 18 7/8 $ 10 7/8 Second Quarter................... 24 1/4 18 Third Quarter.................... 33 1/4 18 7/8 Fourth Quarter................... 40 3/4 26 3/8 FISCAL YEAR ENDED MARCH 31, 1999: First Quarter.................... $ 43 1/2 $ 25 3/8 Second Quarter................... 37 17 Third Quarter.................... 35 1/4 21 1/4 Fourth Quarter................... 67 3/4 31 3/8
On March 31, 1999, there were approximately 4,000 beneficial owners of our common stock represented by 106 holders of record. We have never paid any cash dividends on our common stock and do not expect to pay cash dividends in the foreseeable future. In the past we have paid cash dividends on our preferred stock; however, we no longer have any preferred stock outstanding. We intend to retain future earnings to finance the ongoing operations and growth of our business. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following tables summarize certain selected consolidated financial data, which should be read in conjunction with the Company's Consolidated Financial Statements and the Notes related thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations", included elsewhere herein. The selected consolidated financial data of the Company as of and for each of the years in the five-year period ended March 31, 1999, have been derived from the Consolidated Financial Statements that have been audited by Arthur Andersen LLP, independent public accountants. 27 29
Year Ended March 31, ------------------------------------------------------------------ 1995 1996 1997 1998 1999 ---------- ---------- ---------- ---------- ---------- (In thousands, except per share data) STATEMENT OF OPERATIONS DATA: Revenues ........................ $ 91,306 $ 127,871 $ 256,450 $ 476,664 $ 774,822 Cost of operations: Cost of revenues .............. 85,532 120,334 245,466 455,847 743,084 Selling, general and administrative expenses ..... 4,963 6,158 7,309 10,083 13,949 ---------- ---------- ---------- ---------- ---------- Total cost of operations .... 90,495 126,492 252,775 465,930 757,033 ---------- ---------- ---------- ---------- ---------- Operating income ................ 811 1,379 3,675 10,734 17,789 Interest income ................. 91 366 1,560 2,814 2,685 Interest expense ................ (878) (732) (445) (67) -- Merger costs (2) ................ -- -- -- (689) -- Provision for income taxes ..... -- -- (1,564) (4,861) (7,780) ---------- ---------- ---------- ---------- ---------- Net income ...................... $ 24 $ 1,013 $ 3,226 $ 7,931 $ 12,694 ---------- ---------- ---------- ---------- ---------- Basic: Net income (loss) per share ... $ (.19) $ .05 $ .43 $ .88 $ 1.24 Weighted average shares outstanding ............... 4,007 4,007 6,265 8,756 10,252 Diluted: Net income (loss) per share ... $ (.19) $ .05 $ .35 $ .70 $ 1.09 Weighted average shares outstanding ................. 4,007 4,576 9,176 11,351 11,688
March 31, ------------------------------------------------------------------ 1995 1996 1997 1998 1999 ---------- ---------- ---------- ---------- ---------- (In thousands) BALANCE SHEET DATA: Working capital ................. $ (453) $ 269 $ 24,575 $ 28,362 $ 1,111 Total assets .................... 37,288 59,861 108,914 154,909 276,833 Long-term debt .................. 7,000 7,000 -- -- 50,000 Redeemable preferred stock ...... 11,076 11,896 -- -- -- Stockholders' equity (deficit) .. (1,747) (1,537) 42,577 50,564 69,061
Year Ended March 31, ------------------------------------------------------------------ 1995 1996 1997 1998 1999 ---------- ---------- ---------- ---------- ---------- (In thousands) SUPPLEMENTAL DATA: (1) Pharmacy network claims processed .................. 1,527 9,375 26,579 38,319 50,588 Mail pharmacy prescriptions filled ..................... 383 536 677 839 1,289 Estimated health plan members (at period end) .... 5,208 9,040 10,200 12,500 15,000
- ---------- (1) This data has not been audited. (2) Merger costs relate to the acquisition of IMR. 28 30 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We group the revenues from our health benefit management services into three categories: data, mail and clinical services. o Data services. In 1992, we established a retail pharmacy network, that currently consists of over 53,000 retail pharmacies nationwide, and began to provide on-line claims processing services. Under some of our customer contracts, we contract directly with the retail pharmacies in our national network. When we have an independent obligation to pay our own network of retail pharmacy providers for the drugs dispensed, meaning we are "at risk," we include payments from plan sponsors for the drug cost and the claims processing fees as revenues. We record payments we make to our retail pharmacy providers as cost of revenues. Under other contracts, we manage a network of pharmacies that are under direct contract with certain of our customers. For those plan sponsors that have established their own pharmacy network, we administer the plan sponsors' network pharmacy contracts. The plan sponsors have the independent obligation to fund payment to those pharmacies under contract and the plan sponsors are "at-risk" for the payment for drugs dispensed; we record only the claims processing fees as revenues. New customers that use our network, where we record both claims processing fees and costs of drugs as revenues, will generate higher revenues than new customers that use their own networks, where we only record claims processing fees as revenues. Thus, while a customer who uses our network may contribute the same gross profit in terms of dollars as a customer that uses its own network, gross profit as a percentage of revenue will be lower for customers using our network because of the higher level of revenue we recognize. o Mail services. We derive mail services revenues from the sale of pharmaceuticals to members of our customers' health plans. These revenues include the cost of the pharmaceuticals plus a dispensing fee. o Clinical services. We have historically derived our clinical revenues primarily from formulary rebates and volume discounts received from pharmaceutical manufacturers. Some of these revenues are based on estimates that are subject to final settlement with the manufacturer. In addition, we generate clinical revenues from our comprehensive disease management programs. We also include our newly acquired clinical trial and medical outcomes research businesses in our clinical services revenues. Our cost of revenues includes product costs and other direct costs associated with the dispensing of prescription drugs and the provision of claims processing and clinical services. 29 31 RESULTS OF OPERATIONS The following table sets forth certain consolidated financial data as a percentage of revenues.
YEAR ENDED MARCH 31, ---------------------------------------- 1997 1998 1999 ---------- ---------- ---------- STATEMENT OF OPERATIONS DATA: Revenues: Data services ........................ 55.2% 66.6% 67.2% Mail services ........................ 23.4 16.4 16.4 Clinical services .................... 21.4 17.0 16.4 ---------- ---------- ---------- Total revenues ............... 100.0 100.0 100.0 Cost of operations: Cost of revenues ..................... 95.7 95.6 95.9 Selling, general and administrative expenses ........................... 2.9 2.1 1.8 ---------- ---------- ---------- Total cost of operations ..... 98.6 97.7 97.7 ---------- ---------- ---------- Operating income ....................... 1.4 2.3 2.3 Interest income (expense), net ......... 0.5 0.6 0.3 Merger costs ........................... -- (0.2) -- Provision for income taxes ............. (0.6) (1.0) (1.0) ---------- ---------- ---------- Net income ............................. 1.3 % 1.7 % 1.6 % ========== ========== ==========
FISCAL YEAR 1999 COMPARED TO FISCAL YEAR 1998 REVENUES. Our revenues for fiscal year 1999 increased by $298.2 million, or 63%, compared to revenues for fiscal year 1998. The number of individuals we managed continued to increase in fiscal year 1999 as we obtained new customers and our current customers continued to increase their membership and utilization levels. New customer contracts resulted from increased marketing efforts and the expansion of our sales and marketing department. Contracts with new customers in fiscal year 1999 generally included all pharmacy benefit management products we offer, including claims processing, mail and clinical. Our revenues from claims processing increased $203.5 million, or 64%, compared to the prior year. The increase resulted from the addition of new individuals and an increase in use of our services by existing customers. The increase in new individuals resulted in an increase in pharmacy claims processed from 38.3 million in fiscal year 1998 to 50.6 million in fiscal year 1999, a 32% increase. Virtually all of the new fiscal year 1999 customer contracts use our pharmacy network, which has shifted a larger percentage of our total revenues to claims processing. Revenues from mail services increased $48.9 million, or 63%, compared to the prior year. The increase resulted primarily from the new individuals added during fiscal year 1999. The increase in new individuals resulted in an increase in mail prescriptions dispensed from 839,000 in fiscal year 1998 to 1.3 million in fiscal year 1999, a 54% increase. Revenues from clinical services increased $45.8 million, or 57%, compared to the prior year. The increase resulted primarily from the new individuals added and the additional claims processed during fiscal year 1999 compared to the prior year. 30 32 COST OF REVENUES. Our cost of revenues for fiscal year 1999 increased by $287.2 million, or 63%, compared to the prior fiscal year. This increase primarily resulted from the additional costs associated with our claims processing growth and the new customers that are using our retail pharmacy network. As a percentage of revenues, cost of revenues was 95.9% in fiscal year 1999 compared to 95.6% in fiscal year 1998. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Our selling, general and administrative expense for fiscal year 1999 increased by $3.9 million, or 38%, compared to fiscal year 1998. This increase was the result of our expansion of our sales and marketing activities, as well as increases in administrative and support staff levels and salaries and benefits in response to volume growth in all programs. In spite of the increase, selling, general and administrative expenses as a percentage of revenues decreased from 2.1% for in fiscal year 1998 to 1.8% in fiscal year 1999 as the result of greater economies of scale and due to the increase in revenues associated with our claims processing services. Additional revenues generated by customers using our network pharmacy providers typically do not result in an increase in selling, general and administrative expenses. INTEREST INCOME AND INTEREST EXPENSE. Our interest income, net of interest expense, was $2.7 million in both fiscal years 1999 and 1998. We incurred no interest expense in fiscal year 1999 since we had no outstanding indebtedness until March 31, 1999. We maintained higher cash balances during the first eight months of fiscal year 1999 compared to fiscal year 1998. In December 1998, we purchased Baumel-Eisner Neuromedical Institute for $25.0 million. Therefore, interest income declined in the fourth quarter of fiscal year 1999 compared to the first three quarters. We invest our excess cash in money market funds and high-grade commercial paper. INCOME TAXES. In fiscal years 1999 and 1998, our income tax expense approximated an effective tax rate of 38%. FISCAL YEAR 1998 COMPARED TO FISCAL YEAR 1997 REVENUES. Our revenues for fiscal year 1998 increased by $220.2 million, or 86%, compared to revenues for fiscal year 1997. The number of individuals we managed continued to increase in fiscal year 1998 as we obtained new customers and our current customers continued to increase their membership and utilization levels. New customer contracts resulted from increased marketing efforts and the expansion of our sales and marketing department. Contracts with new customers in fiscal year 1998 generally included all pharmacy benefit management products we offer, including claims processing, mail and clinical. Our revenues from claims processing increased $175.8 million, or 124%, compared to the prior year. The increase resulted from the addition of new individuals and an increase in use of our services by existing customers. The increase in new individuals resulted in an increase in pharmacy claims processed from 26.6 million in fiscal year 1997 to 38.3 million in fiscal year 1998, a 44% increase. Virtually all of the new fiscal year 1998 customer contracts use our pharmacy network which has shifted a larger percentage of our total revenues to claims processing. Revenues from mail services increased $18.4 million, or 31%, compared to the prior 31 33 year. The increase resulted primarily from the new individuals added during fiscal year 1998. The increase in new individuals resulted in an increase in mail prescriptions dispensed from 677,000 in fiscal year 1997 to 839,000 in fiscal year 1998, a 24% increase. Revenues from clinical services increased $26.1 million, or 48%, compared to the prior year. The increase resulted primarily from the new individuals added and the additional claims processed during fiscal year 1998 compared to the prior year. COST OF REVENUES. Our cost of revenues for fiscal year 1998 increased by $210.4 million, or 86%, compared to the prior fiscal year. This increase primarily resulted from the additional costs associated with our claims processing growth. As a percentage of revenues, cost of revenues was 95.6% in fiscal year 1998 compared to 95.7% in fiscal year 1997. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Our selling, general and administrative expenses for fiscal year 1998 increased by $2.8 million, or 38%, compared to fiscal year 1997. This increase was the result of our expansion of our sales and marketing capabilities, as well as increases in administrative and support staff functions in response to volume growth in all programs. In spite of the dollar increase, our selling, general and administrative expenses as a percentage of revenues decreased from 2.9% in fiscal year 1997 to 2.1% in fiscal year 1998 as the result of greater economies of scale and due to the increase in revenues associated with our claims processing services. Additional revenues generated by customers using our network pharmacy providers generally do not result in an increase in selling, general and administrative expenses. INTEREST INCOME AND INTEREST EXPENSE. Our interest income, net of interest expense, for fiscal year 1998 increased $1.6 million compared to fiscal year 1997. The increase resulted from cash management programs which used our short-term excess cash to generate interest income through investment in money market funds and high grade commercial paper. In addition, our cash balance throughout fiscal year 1998 included the $10.0 million proceeds from the June 1996 issuance of our Series B preferred stock and the $19.1 million net proceeds from our October 1996 initial public offering. A portion of the proceeds was used to retire debt and, as a result, interest expense decreased by $378,000. In fiscal year 1997, the proceeds from the offerings were available for only a portion of the year. MERGER COSTS. In February 1998, we completed a merger with Innovative Medical Research, Inc. and issued 876,078 shares and options to purchase 23,922 shares of our common stock in exchange for all the outstanding shares and options of Innovative Medical Research, Inc. The merger was accounted for as a pooling of interests and, accordingly, prior period consolidated financial statements were restated to include the combined results of operations, financial position and cash flows of Innovative Medical Research, Inc. as though it had always been a part our company. In connection with the merger, we recorded a charge to operating expenses of $689,000 -- $427,000 after taxes, or $.04 per common share on a dilutive basis -- for professional fees and other merger-related costs pertaining to the transaction. INCOME TAXES. We had income tax loss carryforwards available to partially offset income generated for fiscal year 1997 and, as a result, we recorded income tax expense of $1.6 million or 33% of income before income taxes. For fiscal 1998, we recorded tax expense of $4.9 million at 32 34 a rate of 38% of income before income taxes. The tax loss carryforwards were fully utilized prior to fiscal year 1998. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 1999, we had working capital of $1.1 million. While we have $149.0 million of accounts payable, the majority of these obligations are not due until cash is collected from our customers. Our net cash provided by operating activities was $15.4 million, $14.5 million and $29.0 million for the fiscal years ended 1997, 1998 and 1999, respectively. The significant increases in net cash provided by operating activities resulted primarily from the income we generated and due to the timing of receivables and payables resulting from our continued growth. Cash we used in investing activities was $3.1 million, $6.5 million and $97.3 million for the fiscal years ended 1997, 1998 and 1999, respectively. Such investing activities included purchases of property, plant and equipment associated with growth and expansion of our facilities, as well as cash paid for acquisitions. In December 1998, we used $24.7 million, net of cash acquired, for the acquisition of Baumel-Eisner Neuromedical Institute, Inc. In March 1999, we used $65.0 million, net of $5.0 million cash acquired, for the acquisition of Foundation Health Pharmaceutical Services. Historically, we have been able to fund our operations and continued growth through cash flow from operations. In fiscal years 1997, 1998 and 1999, our operating cash flow funded our capital expenditures and our short-term excess cash was invested in money market funds and high grade commercial paper. We anticipate that cash flow from operations, combined with our current cash balances and amounts available under our credit facility, will be sufficient to meet our internal operating requirements and expansion programs, including capital expenditures, for at least the next 18 months. However, if we successfully continue our expansion, acquisition and alliance plans, we may be required to seek additional debt or equity financing in order to achieve these plans. CREDIT FACILITY On March 31, 1999, we entered into a senior revolving credit facility with a group of lenders. The credit facility consists of a $75.0 million, three year revolving credit facility. On March 31, 1999, we borrowed $50.0 million under the credit facility to fund the acquisition of Foundation Health Pharmaceutical Services. Each of our subsidiaries has guaranteed the credit facility. The lenders received a first priority security interest in our subsidiaries' capital stock and negative pledges on accounts receivable and other assets. Interest on the credit facility accrues at a specified margin above the London Interbank Offered Rate, or LIBOR, or an alternate base rate. The alternate base rate is the bank's prime rate or the federal funds rate plus 0.5%. For LIBOR loans the applicable margin is 1.75% per annum as of April 1, 1999. The credit facility contains usual and customary affirmative and negative covenants, including limitations on liens, debts, dividends, capital expenditures, mergers, acquisitions and sale of assets. Covenants also include a specified minimum net worth, maximum leverage ratio and a 33 35 minimum interest coverage ratio. The credit facility contains customary events of default including: o nonpayment of principal, interest, fees or other amounts; o violation of covenants; o inaccuracy of representations and warranties; o default under other indebtedness; o bankruptcy and other insolvency events; o material judgements; o ERISA matters; and o change of control without the lender's prior written consent. RECENT ACCOUNTING PRONOUNCEMENTS We adopted Statement of Financial Accounting Standards ("SFAS") 130, "Reporting Comprehensive Income," effective April 1, 1998. SFAS 130 established standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as the total of net income and all other non-owner changes in equity. We do not have any non-owner changes in equity other than net income. Comprehensive income will be reported in our consolidated statement of stockholders' equity. We adopted SFAS 131, "Disclosure about Segments of an Enterprise and Related Information," effective April 1, 1998. This pronouncement changes the requirements under which public businesses must report segment information. The objective of the pronouncement is to provide information about a company's different types of business activities and different economic environments. SFAS 131 requires companies to select segments based on their internal reporting system. We provide integrated health benefit management services to our customers, and these services account for substantially all of our net revenues. Such services are typically negotiated under one contract with the customer. Therefore, our operations will continue to be reported in one segment. We adopted SFAS 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," as of April 1, 1998. This pronouncement revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans; however, it does require additional information on changes in the benefit obligations and fair values of plan assets in order to facilitate financial analysis. Currently, we do not have any pension or postretirement benefit plans; thus, the adoption of SFAS 132 has not had a material impact on our disclosures. 34 36 IMPACT OF INFLATION Changes in prices charged by manufacturers and wholesalers for pharmaceuticals we dispense affect our cost of revenues. Historically, we have been able to pass the effect of such price changes to our customers under the terms of our agreements. As a result, changes in pharmaceutical prices due to inflation have not adversely affected our company. YEAR 2000 READINESS DISCLOSURE Our operations require our computer systems and information technology to work effectively. In fiscal year 1998, we began addressing the year 2000 issue by forming a year 2000 project team. The year 2000 issue is the result of computer programs written using two digits rather than four digits to define "date" fields. Information systems have time-sensitive operations that, as a result of this date field limitation, could disrupt business activities in the normal business cycle. For example, some computers that are not year 2000 compliant may interpret the year 2000 as the year 1900. This treatment could result in significant miscalculations when processing critical date-sensitive information relating to dates after December 31, 1999. In the quarter ending June 30, 1998, we completed the "inventory" portion of our year 2000 project. We documented all internal hardware, software or equipment that was date-sensitive. In the quarter ending September 30, 1998, we completed the second stage of the year 2000 project, which involved assessing all of the items that had been "inventoried" to determine whether they were year 2000 compliant. This assessment stage also included surveying all external vendors and customers with whom we transact business to determine whether their systems were year 2000 compliant. In the quarter ending December 31, 1998, we completed the third stage of the year 2000 project, which involved the development of code to convert systems that are not year 2000 compliant to year 2000 compliant systems. We successfully completed the implementation phase on March 31, 1999 via upgrade or replacement of all non-compliant systems. While all core systems are currently considered to be compliant, further maintenance testing and certifications will continue throughout 1999. The potential impact of the year 2000 issue depends not only on the corrective measures we have undertaken, but also on the ways in which the year 2000 issue is addressed by third parties with whom we interact or upon whom we are dependent, including individual retail pharmacies, health plan sponsors and pharmaceutical manufacturers. We believe that our greatest risk with respect to year 2000 issues relates to failures by third parties to be year 2000 compliant. We have received responses from approximately 25% of the over 20,000 third parties we contacted. We cannot make any assurance that the software and systems of other companies with which we transact business will become year 2000 compliant in a timely manner. Any such failures could have a material adverse effect on our systems and operations. With respect to the systems we directly use, we believe our greatest exposure to the year 2000 issue involves our claims processing operations, which rely on computers to process prescription claims. We have installed a vendor upgrade and have substantially completed compliance testing on the upgrade. However, any failure of these systems to be year 2000 compliance may have a material adverse effect on us. 35 37 Our costs, as of March 31, 1999, related to our year 2000 project and related compliance efforts, total approximately $300,000. We have expensed these costs as incurred in fiscal 1999. We expect our total costs, both internal and external, associated with our year 2000 readiness process will range from $500,000 to $600,000. We anticipate funding these costs with cash generated from operations. We do not believe that these costs are or will be material to our results of operations or financial condition. Although we have substantially completed our compliance testing and remediation, we have not developed a likely worst case year 2000 scenario. We are, however, in the process of developing contingency plans for the risks of our failure, or the failure of third parties, to be year 2000 compliant. We intend to complete the contingency plans for the year 2000 issue during the third quarter of calendar year 1999. Due to the inability to predict all of the potential problems that may arise from the year 2000 issue, we cannot be sure that we will be able to anticipate all contingencies. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not engage in trading market risk sensitive instruments and do not purchase as investments, as hedges, or for purposes "other than trading" instruments that are likely to expose us to market risk, whether it be from interest rate, foreign currency exchange, commodity price or equity price risk. We have issued no debt instruments, entered into no forward or futures contracts, purchased no options and entered into no swaps. Our primary market risk exposure is that of interest rate risk. A change in LIBOR or the Prime Rate as set by NationsBank, N.A. , would affect the rate at which we could borrow funds under our credit facility. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is found on pages F-1 through F-20 hereof. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item will be incorporated by reference from our definitive proxy statement for our 1999 annual meeting of stockholders to be filed with the Securities and Exchange Commission not later than 120 days following our fiscal year pursuant to Regulation 14A (the "Proxy Statement"). 36 38 ITEM 11. EXECUTIVE COMPENSATION The information required by this item will be incorporated by reference from the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item will be incorporated by reference from the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item will be incorporated by reference from the Proxy Statement. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The response to this portion of Item 14 is submitted as a separate section of this report on page F-1. (b) Reports on Form 8-K. We filed reports on Form 8-K and Form 8-K/A dated March 31, 1999, relating to its acquisition of Foundation Health Pharmaceutical Services, Inc. (c) Exhibits Required by Item 601 of S-K: See index to exhibits on pages 37 - 40. Exhibits and Financial Statement Schedules Exhibit No. Exhibits 2.1(a) --- Stock Purchase Agreement, dated effective as of December 1, 1998, by and among Advance Paradigm, Inc. (the "Company"), Baumel-Eisner Neuromedical Institute, Inc., Barry Baumel, M.D. and Larry S. Eisner, M.D. 2.2(b) --- Purchase Agreement, dated as of February 26, 1999, among Foundation Health Systems, Inc., Foundation Health Corporation, Foundation Health Pharmaceutical Services, Inc., Integrated Pharmaceutical Services, Inc. and the Company. 3.1(c) --- Amended and Restated Certificate of Incorporation of the Company. 3.2(c) --- Certificate of Amendment to the Certificate of Incorporation of the Company. 37 39 3.3(c) --- Certificate of Correction to the Amendment to the Certificate of Incorporation of the Company. 3.4(c) --- Amended and Restated Bylaws of the Company. 3.5(c) --- Certificate of Incorporation of Advance Pharmacy Services, Inc. 3.6(c) --- Certificate of Amendment to the Certificate of Incorporation of Advance Pharmacy Services, Inc. 3.7(c) --- Certificate of Correction to the Certificate of Amendment to the Certificate of Incorporation of Advance Pharmacy Services, Inc. 3.8(c) --- Certificate of Amendment to the Certificate of Incorporation of Advance Pharmacy Services, Inc. 3.9(c) --- Bylaws of Advance Pharmacy Services, Inc. 4.1(d) --- Specimen Certificate for shares of Common Stock, $0.01 par value, of the Company. 4.2(e) --- Amended and Restated Incentive Stock Option Plan. 4.3(e) --- Incentive Stock Option Plan. 4.4(c) --- Warrant Agreement, dated as of September 12, 1996, by and between the Company and VHA, Inc. 4.5(c) --- Form of Agreement and Plan of Merger. 4.6(f) --- 1997 Nonstatutory Stock Option Plan. 4.7(b) --- Warrant Agreement, dated as of February 26, 1999, by and between the Company and Foundation Health Systems, Inc. 4.8(i) --- Warrant Agreement, dated as of February 25, 1999, by and between the Company and Arkansas BlueCross BlueShield 4.9(i) --- Warrant Agreement, dated as of June 12, 1998, by and between the Company and Wellmark, Inc. 10.1(c) --- Managed Pharmaceutical Agreement, dated November 1, 1993, by and between Advance Data and the Mega Life & Health Insurance Company. 10.2(c) --- Nondisclosure/Noncompetition Agreement, dated August 4, 1993, between the Company, Advance Data, Advance Mail and David D. Halbert. 38 40 10.3(c) --- Nondisclosure/Noncompetition Agreement, dated August 4, 1993, between the Company, Advance Mail, Advance Data and Jon S. Halbert. 10.4(c) --- Nondisclosure/Noncompetition Agreement, dated August 4, 1993, between the Company, Advance Mail, Advance Data and Danny Phillips. 10.5(d) --- Employment Agreement, effective as of December 1, 1996, by and between Advance Clinical (formerly ParadigM) and Joseph J. Filipek, Jr. and, for the limited purposes of Sections 3(d), 3(g) and 3(h) thereof, the Company. 10.6(d) --- Employment Agreement, effective as of November 14, 1996, by and between the Company and John H. Sattler. 10.7(d) --- Employment Agreement, effective as of June 17, 1996, by and between the Company and Ernest Buys. 10.8(c) --- Employment Agreement, effective as of February 15, 1996, by and between the Company and Alan T. Wright. 10.9(c) --- Form of Health Benefit Management Services Agreement. 10.10(c) --- Sublease, dated May 2, 1996, between Lincoln National Life Insurance Company and Advance Data. 10.11(c) --- Lease, dated March 6, 1994, by and between Hill Management Services, Inc. and Advance Clinical (formerly ParadigM). 10.12(c) --- Lease Agreement, dated as of February 24, 1989, as amended November 30, 1992, and December __, 1992, by and between TRST Las Colinas, Inc. and Advance Health Care. 10.13(c) --- Managed Pharmacy Benefit Services Agreement, dated September 1, 1995, between the Company and BCBS of Texas. 10.14(g) --- Agreement and Plan of Merger, dated February 9, 1998, by and among the Company, IMR, Inc. and Innovative Medical Research, Inc., Walter Stewart, Richard Lipton, The Lianna Lipton Trust, The Justin Lipton Trust, Stuart Bell, The Curren Bell Trust, The Kylie Bell Trust and The Ian Bell Trust. 10.15(h) --- Consulting Agreement, effective as of December 15, 1998, by and between the Company and David A. George. 10.16(b) --- Pharmacy Benefit Services Agreement, effective as of April 1, 1999, by and between the Company, Foundation Health Systems, Inc. and Integrated Pharmaceutical Services, Inc. 39 41 10.17(b) --- Credit Agreement, dated as of March 31, 1999, among the Company, the banks named in the Credit Agreement, NationsBanc Montgomery Securities LLC and NationsBank, N.A. 10.18(b) --- Guaranty, dated as of March 31, 1999, by each subsidiary of the Company, in favor of NationsBank, N.A. 10.19(i) --- Commercial Lease Agreement, commencing November 1, 1998, by and between Crin-Richardson I, L.P. and the Company. 11.1(i) --- Statement regarding computation of per share earnings. 21.1(i) --- Subsidiaries of the Company. 23.1(i) --- Consent of Arthur Andersen LLP. 27.1(i) --- Financial Data Schedule. - --------------- (a) Previously filed in connection with the Company's Current Report on Form 8-K, dated December 29, 1998, and incorporated herein by reference. (b) Previously filed in connection with the Company's Current Report on Form 8-K, dated April 12, 1999, and incorporated herein by reference. (c) Previously filed in connection with the Company's Registration Statement on Form S-1 filed October 8, 1996 (No. 333-06931), and incorporated herein by reference. (d) Previously filed in connection with the Company's Form 10-K for the year ended March 31, 1997, and incorporated herein by reference. (e) Previously filed in connection with the Company's Registration Statement on Form S-8 filed September 5, 1997 (No. 333-34999), and incorporated herein by reference. (f) Previously filed in connection with the Company's Form 10-Q for the three months ended June 30, 1997, and incorporated herein by reference. (g) Previously filed in connection with the Company's Current Report on Form 8-K, dated February 9, 1998, and incorporated herein by reference. (h) Previously filed in connection with the Company's Form 10-Q for the three months ended December 31, 1998, and incorporated herein by reference. (i) Filed herewith. 40 42 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on June 23, 1999 on its behalf by the undersigned, thereunto duly authorized. ADVANCE PARADIGM, INC. By: /s/ David D. Halbert --------------------------- David D. Halbert Chairman of the Board, President and Chief Executive Officer Each person whose signature appears below hereby authorizes David D. Halbert and Danny Phillips or either of them, as attorneys-in-fact to sign on his behalf, individually, and in each capacity stated below and to file amendments and/or supplements to the Annual Report on Form 10-K. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dated indicated.
Signature Title Date --------- ----- ---- /s/ David D. Halbert Chairman of the Board, President June 23, 1999 - -------------------------------------- and Chief Executive Officer David D. Halbert (Principal Executive Officer) /s/ Jon S. Halbert Executive Vice President, Chief June 23, 1999 - -------------------------------------- Operating Officer and Director Jon S. Halbert /s/ David A. George Executive Vice President, June 23, 1999 - -------------------------------------- and Director David A. George /s/ T. Danny Phillips Senior Vice President, Chief June 23, 1999 - -------------------------------------- Financial Officer, Secretary and T. Danny Phillips Treasurer (Principal Financial and Accounting Officer)
41 43 /s/ Rogers K. Coleman, M.D. Director June 23, 1999 - -------------------------------------- Rogers K. Coleman, M.D. /s/ Stephen L. Green Director June 23, 1999 - -------------------------------------- Stephen L. Green /s/ Jeffrey R. Jay, M.D. Director June 23, 1999 - -------------------------------------- Jeffrey R. Jay, M.D. /s/ Kenneth J. Linde Director June 23, 1999 - -------------------------------------- Kenneth J. Linde /s/ Michael D. Ware Director June 23, 1999 - -------------------------------------- Michael D. Ware
42 44 INDEX TO FINANCIAL STATEMENTS ADVANCE PARADIGM, INC. AND SUBSIDIARIES Report of Independent Public Accountants....................................................................F-2 Consolidated Balance Sheets--March 31, 1998 and 1999........................................................F-3 Consolidated Statements of Operations for the Years Ended March 31, 1997, 1998 and 1999............................................................................................F-4 Consolidated Statements of Stockholders' Equity for the Years Ended March 31, 1997, 1998 and 1999............................................................................F-5 Consolidated Statements of Cash Flows for the Years Ended March 31, 1997, 1998 and 1999............................................................................................F-6 Notes to Consolidated Financial Statements..................................................................F-7 Report of Independent Public Accountants on Financial Statement Schedule....................................S-1 Schedule II. Valuation and Qualifying Accounts and Reserves for the Years Ended March 31, 1997, 1998 and 1999................................................................S-2
F-1 45 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Advance Paradigm, Inc.: We have audited the accompanying consolidated balance sheets of Advance Paradigm, Inc. (a Delaware corporation) and subsidiaries as of March 31, 1998 and 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended March 31, 1999. 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 Advance Paradigm, Inc. and subsidiaries as of March 31, 1998 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 1999, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Dallas, Texas, May 17, 1999 F-2 46 ADVANCE PARADIGM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS
March 31, --------------------------- 1998 1999 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents ......................................... $ 58,342,000 $ 42,492,000 Accounts receivable, net of allowance for doubtful accounts of $247,000 and $371,000, respectively ............................. 68,335,000 107,582,000 Inventories ....................................................... 2,887,000 4,015,000 Prepaid expenses and other ........................................ 1,487,000 1,651,000 ------------ ------------ Total current assets ............................................ 131,051,000 155,740,000 PROPERTY AND EQUIPMENT, net of accumulated depreciation and amortization of $5,574,000 and $8,540,000, respectively ....... 10,494,000 15,155,000 INTANGIBLE ASSETS, net of accumulated amortization of $1,501,000 and $2,191,000, respectively ........................... 12,353,000 105,041,000 OTHER ASSETS ......................................................... 1,011,000 897,000 ------------ ------------ Total assets .................................................... $154,909,000 $276,833,000 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 97,495,000 $148,979,000 Accrued salaries and benefits 2,966,000 3,780,000 Other accrued expenses 2,228,000 1,870,000 ------------ ------------ Total current liabilities 102,689,000 154,629,000 NONCURRENT LIABILITIES: Long-term debt -- 50,000,000 Deferred income taxes 1,285,000 2,597,000 Other noncurrent liabilities 371,000 546,000 ------------ ------------ Total liabilities 104,345,000 207,772,000 ------------ ------------ COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value; 4,995,000 shares authorized, none issued and outstanding -- -- Series B convertible preferred stock, $.01 par value; 5,000 shares authorized, 4,444 and 0 shares issued and outstanding at March 31, 1998 and 1999, respectively -- -- Common stock, $.01 par value; 25,000,000 shares authorized, 8,904,472 and 10,528,449 shares issued and outstanding at March 31, 1998 and 1999, respectively 89,000 105,000 Additional paid-in capital 43,142,000 48,928,000 Accumulated earnings 7,333,000 20,028,000 ------------ ------------ Total stockholders' equity 50,564,000 69,061,000 ------------ ------------ Total liabilities and stockholders' equity $154,909,000 $276,833,000 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-3 47 ADVANCE PARADIGM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended March 31, -------------------------------------------------- 1997 1998 1999 -------------- -------------- -------------- REVENUES $ 256,450,000 $ 476,664,000 $ 774,822,000 -------------- -------------- -------------- COST OF OPERATIONS: Cost of revenues 245,466,000 455,847,000 743,084,000 Selling, general and administrative expenses 7,309,000 10,083,000 13,949,000 -------------- -------------- -------------- Total cost of operations 252,775,000 465,930,000 757,033,000 -------------- -------------- -------------- Operating income 3,675,000 10,734,000 17,789.000 INTEREST INCOME 1,560,000 2,814,000 2,685,000 INTEREST EXPENSE (445,000) (67,000) -- MERGER COSTS -- (689,000) -- -------------- -------------- -------------- INCOME BEFORE INCOME TAXES 4,790,000 12,792,000 20,474,000 PROVISION FOR INCOME TAXES 1,564,000 4,861,000 7,780,000 -------------- -------------- -------------- NET INCOME $ 3,226,000 $ 7,931,000 $ 12,694,000 ============== ============== ============== BASIC: NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 2,673,000 $ 7,731,000 $ 12,694,000 NET INCOME PER SHARE $ 0.43 $ 0.88 $ 1.24 WEIGHTED AVERAGE SHARES OUTSTANDING 6,264,521 8,755,754 10,252,145 DILUTED: NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 3,226,000 $ 7,931,000 $ 12,694,000 NET INCOME PER SHARE $ 0.35 $ 0.70 $ 1.09 WEIGHTED AVERAGE SHARES OUTSTANDING 9,176,127 11,350,919 11,688,101
The accompanying notes are an integral part of these consolidated financial statements. F-4 48 ADVANCE PARADIGM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED MARCH 31, 1997, 1998 AND 1999
Series B Preferred Common Stock Stock ------------------------- -------------------- Additional Accumulated Number of Number of Paid-In Earnings Shares Amount Shares Amount Capital (Deficit) Total ----------- -------- --------- -------- ------------ ------------ ------------ BALANCE, March 31, 1996 ........... 4,006,578 $ 40,000 -- $ -- $ 1,484,000 $ (3,061,000) $ (1,537,000) Comprehensive income: Net income ..................... -- -- -- -- -- 3,226,000 3,226,000 Issuance of Common Stock in connection with the exercise of employee stock options ................ 3,000 -- -- -- 12,000 -- 12,000 Issuance of Series B Preferred Stock .............. -- -- 4,444 -- 10,000,000 -- 10,000,000 Dividends and accretion on Series A Preferred Stock ..... -- -- -- -- -- (410,000) (410,000) Issuance of Common Stock in connection with an initial public offering .............. 2,397,067 24,000 -- -- 19,111,000 -- 19,135,000 Issuance of Common Stock in connection with the conversion of Series A Preferred Stock .............. 2,500,000 25,000 -- -- 12,279,000 -- 12,304,000 Reduction of Common Stock outstanding in connection with the merger with AHC ..... (229,750) (2,000) -- -- 2,000 -- -- Dividends on Series B Preferred Stock .............. -- -- -- -- -- (153,000) (153,000) ---------- -------- ------- ------ ------------ ------------ ------------ BALANCE, March 31, 1997 ........... 8,676,895 87,000 4,444 -- 42,888,000 (398,000) 42,577,000 Comprehensive income: Net income ..................... -- -- -- -- -- 7,931,000 7,931,000 Issuance of Common Stock in connection with the exercise of stock options and warrants ................. 227,577 2,000 -- -- 254,000 -- 256,000 Dividends on Series B Preferred Stock .............. -- -- -- -- -- (200,000) (200,000) ---------- -------- ------- ------ ------------ ------------ ------------ BALANCE, March 31,1998 ............ 8,904,472 89,000 4,444 -- 43,142,000 7,333,000 50,564,000 Comprehensive income: Net income ..................... -- -- -- -- -- 12,694,000 12,694,000 Issuance of Common Stock in connection with the conversion of Series B Preferred Stock ............. 1,111,111 11,000 (4,444) -- (11,000) -- -- Issuance of Common Stock in connection with the exercise of stock options and warrants ................. 512,866 5,000 -- -- 2,420,000 -- 2,425,000 Tax benefit relating to exercise of employee stock options and other .................... -- -- -- -- 877,000 1,000 878,000 Issuance of warrants ......... -- -- -- -- 2,500,000 -- 2,500,000 ---------- -------- ------- ------ ------------ ------------ ------------ BALANCE, March 31,1999 ............ 10,528,449 $105,000 -- $ -- $ 48,928,000 $ 20,028,000 $ 69,061,000 ========== ======== ======= ====== ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-5 49 ADVANCE PARADIGM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended March 31, ----------------------------------------------- 1997 1998 1999 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,226,000 $ 7,931,000 $ 12,694,000 Adjustments to reconcile net income to net cash provided by operating activities-- Depreciation and amortization 1,705,000 2,378,000 3,656,000 Provision for doubtful accounts 12,000 74,000 24,000 Deferred income taxes 844,000 441,000 1,312,000 Change in certain assets and liabilities-- Accounts receivable (12,612,000) (32,139,000) (38,391,000) Inventories (261,000) (1,028,000) (1,128,000) Prepaid expenses and other assets (256,000) (1,584,000) (922,000) Accounts payable, accrued expenses and other noncurrent liabilities 22,727,000 38,466,000 51,749,000 ------------- ------------- ------------- Net cash provided by operating activities 15,385,000 14,539,000 28,994,000 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (3,147,000) (6,525,000) (7,568,000) Purchase of subsidiaries, net of cash acquired -- -- (89,701,000) ------------- ------------- ------------- Net cash used in investing activities (3,147,000) (6,525,000) (97,269,000) ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from sale of preferred stock 10,000,000 -- -- Net proceeds from issuance of Common Stock 19,147,000 256,000 2,425,000 Proceeds from borrowings 1,000,000 708,000 50,000,000 Payments on long-term obligations (7,650,000) (1,608,000) -- Payment of preferred stock dividend (153,000) (200,000) -- ------------- ------------- ------------- Net cash provided by (used in) financing activities 22,344,000 (844,000) 52,425,000 ------------- ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 34,582,000 7,170,000 (15,850,000) CASH AND CASH EQUIVALENTS, beginning of year 16,590,000 51,172,000 58,342,000 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS, end of year $ 51,172,000 $ 58,342,000 $ 42,492,000 ============= ============= =============
SUPPLEMENTARY INFORMATION: Cash paid for interest totaled approximately $445,000, $67,000 and $0 in 1997, 1998 and 1999, respectively. The Company made income tax payments of $19,000, $5,100,000 and $5,900,000 in 1997, 1998 and 1999, respectively. The accompanying notes are an integral part of these consolidated financial statements. F-6 50 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. GENERAL: Advance Paradigm, Inc. (the "Company"), a Delaware corporation, is a leading independent provider of health benefit management services, providing integrated pharmacy benefit management, disease management and clinical research programs. The Company markets its services to managed care organizations, third-party health plan administrators, insurance companies, government agencies, employer groups and labor union-based trusts. In addition, the Company transacts business with pharmaceutical manufacturers as both suppliers and customers. During the year ended March 31, 1999, the Company purchased two companies for cash. Foundation Health Pharmaceutical Services, Inc. ("FHPS") was acquired on March 31, 1999 for $70 million. FHPS was the pharmacy benefit management business of Foundation Health Systems, Inc. On December 1, 1998, Baumel-Eisner Neuromedical Institute ("Baumel-Eisner") was acquired for $25 million. Baumel-Eisner was a privately held clinical trials company based in South Florida. (See Note 3) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Consolidation The accompanying consolidated financial statements include the accounts of API and its wholly owned subsidiaries. All significant 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. Cash and Cash Equivalents Cash and cash equivalents include overnight investments, money market accounts and high-grade commercial paper with original maturities of three months or less. F-7 51 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) Inventories Inventories consist of purchased pharmaceuticals stated at the lower of cost or market under the first-in, first-out method. Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed on the straight-line method over estimated useful lives ranging from three to twenty years. Amortization of leasehold improvements is computed over the lives of the assets or the lease terms, whichever is shorter. Major renewals and betterments are added to the property and equipment accounts while costs of repairs and maintenance are charged to operating expenses in the period incurred. The cost of assets retired, sold or otherwise disposed of and the applicable accumulated depreciation are removed from the accounts, and the resultant gain or loss, if any, is reflected in the statement of operations. Intangible Assets Intangible assets consist of goodwill, customer contracts acquired and non-compete agreements. Goodwill represents the excess of cost over the estimated fair value of tangible net assets acquired. Goodwill is amortized on a straight-line basis over periods from 25 to 40 years with a weighted average of 29 years. Customer contracts and non-compete agreements are amortized over 10 to 15 years. Amortization expense was $346,000 in each of the years ended March 31, 1997 and 1998 and $691,000 the year ended March 31, 1999 and is included in selling, general and administrative expenses. Impairment of Long-Lived Assets The Company evaluates whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets, including goodwill, may warrant revision or that the remaining balance of an asset may not be recoverable. The assessment of possible impairment is based on the ability to recover the carrying amount of the asset from expected future cash flows on an undiscounted basis. If the assessment indicates that the carrying amount of the asset exceeds the undiscounted cash flows, an impairment has occurred. The impairment is calculated as the total by which the carrying amount of the asset exceeds its fair value. The fair value of long-lived assets and goodwill is estimated based on quoted market prices, if available, or the expected total value of the cash flows, on a discounted basis. The Company recorded no impairment charges in fiscal 1997, 1998 or 1999. F-8 52 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) Fair Value of Financial Instruments The carrying values of cash, receivables, payables and accrued liabilities approximate the fair values of these instruments because of their short-term maturities. The Company's bank debt was borrowed on March 31, 1999 and, therefore, the estimated fair value and the carrying value is the same. Other Noncurrent Liabilities Other liabilities is comprised of deposits from certain customers in connection with pharmacy benefit contracts. Revenue Recognition Revenues from the dispensing of pharmaceuticals from the Company's mail service pharmacy are recognized when each prescription is shipped. Revenues from sales of prescription drugs by pharmacies in the Company's nationwide network and claims processing fees are recognized when the claims are adjudicated. At the point-of-sale, the pharmacy claims are adjudicated using the Company's on-line claims processing system. When the Company has an independent obligation to pay its network pharmacy providers, the Company includes payments from plan sponsors for these benefits as revenues and payments to its pharmacy providers as cost of revenues. If the Company is only administering plan sponsors' network pharmacy contracts, the Company records the claims processing service fees as revenues. Rebate revenues are recognized as they are earned in accordance with contractual agreements. Certain of these revenues are based on estimates which are subject to final settlement with the contract party. These estimates are reviewed and revised as settled. Revenues from certain disease management and health benefit management products are reimbursed at predetermined contractual rates based on the achievement of certain milestones. Cost of Revenues Cost of revenues includes product costs, pharmacy claims payments and other direct costs associated with the sale and dispensing of prescriptions. Certain of these expenses are recognized based on estimates which are subject to final settlement with the contract party. These estimates are reviewed and revised as settled. F-9 53 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) Net Income Per Share Net income per share is computed using the weighted average number of common and dilutive shares outstanding during the period. A reconciliation of the numerators and denominators of the basic and diluted per-share computations follows:
YEAR ENDED MARCH 31, -------------------------------------------------------------- 1997 1998 1999 ---------------- ---------------- ---------------- BASIC Numerator: Net income $ 3,226,000 $ 7,931,000 $ 12,694,000 Preferred stock dividends 553,000 200,000 --- ---------------- ---------------- ---------------- $ 2,673,000 $ 7,731,000 $ 12,694,000 ================ ================ ================ Denominator: Weighted average common stock outstanding 6,264,521 8,755,754 10,252,145 ================ ================ ================ Net income per share $ 0.43 $ 0.88 $ 1.24 ================ ================ ================ DILUTED Numerator: Net income $ 3,226,000 $ 7,931,000 $ 12,694,000 ================ ================ ================ Denominator: Weighted average common 6,264,521 8,755,754 10,252,145 stock outstanding Other Dilutive Securities: Series A preferred stock 1,250,000 --- --- Series B preferred stock 833,333 1,111,111 36,630 Options and warrants using the treasury stock method 828,273 1,484,054 1,399,326 ---------------- ---------------- ---------------- Weighted average shares outstanding 9,176,127 11,350,919 11,688,101 ================ ================ ================ Net income per share $ 0.35 $ 0.70 $ 1.09 ================ ================ ================
F-10 54 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) Reclassification Certain prior year amounts have been reclassified to conform with current year presentation. Recent Accounting Pronouncements The Company adopted Statement of Financial Accounting Standards ("SFAS") 130, "Reporting Comprehensive Income" effective April 1, 1998. SFAS 130 established standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as the total of net income and all other non-owner changes in equity. The Company does not have any non-owner changes in equity other than net income. Comprehensive income has been reported in the consolidated statement of stockholders' equity. The Company has adopted SFAS 131, "Disclosure about Segments of an Enterprise and Related Information," effective April 1, 1998. This pronouncement changes the requirements under which public businesses must report segment information. The objective of the pronouncement is to provide information about a company's different types of business activities and different economic environments. SFAS 131 requires companies to select segments based on their internal reporting system. The Company provides integrated health benefit management services to our customers, and these services account for substantially all of the Company's revenues. Such services are typically negotiated under one contract with the customer. Therefore, the Company's operations will continue to be reported in one segment. The Company adopted SFAS 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," as of April 1, 1998. This pronouncement revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans, however, it does require additional information on changes in the benefit obligations and fair values of plan assets in order to facilitate financial analysis. The Company does not have any pension or postretirement benefit plans, therefore the adoption of SFAS 132 did not have a material impact on the Company's disclosures. 3. ACQUISITIONS In December 1998, the Company acquired the outstanding stock of Baumel-Eisner for $25 million in cash. The acquisition has been accounted for using the purchase method of accounting. Baumel-Eisner's results have been included in the Company's consolidated statements of operations since December 1998. The purchase price was allocated to the net assets acquired, primarily goodwill, based on their estimated fair values. The excess of the purchase price over the fair value of the net assets acquired (goodwill) was approximately $24.2 million and is being amortized on a straight-line basis over 25 years. F-11 55 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. ACQUISITIONS: (CONTINUED) On March 31, 1999, the Company acquired the outstanding stock of FHPS for $70 million in cash and warrants to purchase 200,000 shares of its $0.01 par value common stock ("Common Stock"). The Company valued such warrants at fair market value based upon the Black Scholes valuation model. Such warrants are valued at $2.5 million. The acquisition has been accounted for using the purchase method of accounting. FHPS' results have not been included in the Company's results because the transaction occurred on the last day of the Company's fiscal year. The purchase price was allocated to Goodwill and other intangible assets. Goodwill was valued at approximately $68.3 and is being amortized on a straight-line basis over 30 years. The purchase price allocation used in the preparation of the accompanying financial statements is preliminary. The Company's management is assessing the net realizable value of certain contracts acquired and reviewing the assets acquired for other intangible assets. As a result, the purchase price allocation may be subsequently revised. The following unaudited pro forma information presents the results of operations of the Company as if the FHPS acquisition had taken place at the beginning of the periods presented (in thousands, except per share amounts):
1998 1999 ----------- ----------- Revenues $ 530,016 $ 855,810 Net income $ 4,286 $ 12,783 Net income per share: Basic $ 0.47 $ 1.25 Diluted $ 0.38 $ 1.09 Weighted average shares outstanding: Basic 8,755,754 10,252,145 Diluted 11,350,919 11,688,101
In February 1998, the Company completed a merger with IMR, a privately held clinical trial and survey research firm based in Towson, Maryland. The Company issued 876,078 shares and options to purchase 23,922 shares of its Common Stock in exchange for all the outstanding shares and options of IMR. The merger constituted a tax-free reorganization and has been accounted for as a pooling of interests under Accounting Principles Board Opinion No. 16 ("APB 16"). Accordingly, all prior period consolidated financial statements presented have been restated to include the combined results of operations, financial position and cash flows of IMR as though it had always been a part of the Company. F-12 56 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. ACQUISITIONS: (CONTINUED) The results of operations for the separate companies and the combined amounts presented in the consolidated financial statements follow.
Year Ended March 31, ----------------------------- 1997 1998 ------------- ------------- Revenues: API $ 251,562,000 $ 468,287,000 IMR 4,888,000 8,377,000 ------------- ------------- Combined $ 256,450,000 $ 476,664,000 ------------- ------------- Net income: API $ 3,138,000 $ 7,165,000 IMR 88,000 766,000 ------------- ------------- Combined $ 3,226,000 $ 7,931,000 ============= =============
In connection with the merger, the Company recorded in the fourth quarter of fiscal 1998 a charge to operating expenses of $689,000 ($427,000 after taxes, or $.04 per common share on a dilutive basis) for professional fees and other merger-related costs pertaining to the transaction. 4. PROPERTY AND EQUIPMENT: Property and equipment consisted of the following:
March 31, -------------------------------- 1998 1999 --------------- --------------- Machinery and equipment................................................... $ 3,521,000 $ 4,208,000 Computer equipment and software........................................... 8,591,000 12,840,000 Furniture and equipment................................................... 1,381,000 2,324,000 Leasehold improvements.................................................... 1,017,000 2,765,000 Land and buildings........................................................ 1,558,000 1,558,000 --------------- --------------- 16,068,000 23,695,000 Less--Accumulated depreciation and amortization........................... (5,574,000) (8,540,000) --------------- --------------- $ 10,494,000 $ 15,155,000 =============== ===============
F-13 57 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. DEBT: On March 31, 1999, the Company entered into a senior credit facility with a group of lenders. The credit facility consists of a $75 million, 3-year revolving credit facility. On March 31, 1999, the Company borrowed $50 million under the credit facility to fund the acquisition of FHPS. Outstanding borrowings will mature on March 31, 2002. Each of the Company's subsidiaries has guaranteed the credit facility. The lenders received a first priority security interest in the subsidiaries' capital stock and negative pledges on accounts receivable and other assets. Interest on the credit facility accrues at a specified margin above the London Interbank Offered Rate, or LIBOR, or an alternate base rate. The alternate base rate is the bank's prime rate or the federal funds rate plus 0.5%. For LIBOR loans the applicable margin is 1.75% per annum as of April 1, 1999. The credit facility contains usual and customary affirmative and negative covenants, including limitations on liens, debts, dividends, capital expenditures, mergers, acquisitions and sale of assets. Covenants also include a specified minimum net worth, maximum leverage ratio and a minimum interest coverage ratio. 6. LEASES: The Company leases office and dispensing facility space, equipment, and automobiles under various operating leases. The Company was obligated to make future minimum payments under noncancelable operating lease agreements as of March 31, 1999, as follows:
Years Ending March 31, ------------- 2000................................................... $ 4,061,000 2001................................................... 3,585,000 2002................................................... 2,735,000 2003................................................... 1,419,000 2004................................................... 962,000 ----------- Total minimum lease payments...................... $12,762,000 ===========
Total rent expense incurred in the years ended March 31, 1997, 1998 and 1999 was approximately $2,313,000, $3,096,000 and $ 4,018,000, respectively. 7. COMMITMENTS AND CONTINGENCIES: The Company has entered into long-term employment and non-compete agreements with certain management employees. These employment agreements provide for certain minimum payments should the agreements be terminated. F-14 58 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The pharmacy industry is governed by extensive federal and state laws and regulations. The regulatory requirements with which the Company must comply in conducting its business vary from state to state. Management believes the Company is in substantial compliance with, or is in the process of complying with, all existing laws and regulations material to the operation of its business. In management's opinion, any events of noncompliance would not have a material adverse effect on the results of operations or financial condition of the Company. 8. CONCENTRATION OF BUSINESS: A significant portion of the Company's revenues result from contracts with customers. These contracts normally have terms from one to five years with renewal options. One customer of the Company accounted for approximately 21% and 18% of the Company's revenues for the years ended March 31, 1998 and 1999, respectively. Another customer accounted for approximately 15% of the Company's revenues for the year ended March 31, 1998, but revenues from this customer did not exceed 10% of the Company's revenues for the year ended March 31, 1999. No other customer accounted for over 10% of the Company's revenues in fiscal years 1998 or 1999. Effective April 1, 1999, the Company entered into a Pharmacy Benefit Services Agreement with Foundation Health Systems, Inc. ("FHS"). Under the terms of the Service Agreement the Company will provide pharmacy services to FHS' affiliated health plans. In fiscal 2000, we expect that FHS will become the Company's largest customer. 9. STOCK TRANSACTIONS: Series B Preferred Stock On June 25, 1996, the Company issued a total of 4,444 shares of $.01 par value, Series B convertible preferred stock ("Series B Preferred Stock") to a customer at a price of $2,250 per share. Shares of the Series B Preferred Stock could be converted by the holder into 250 fully-paid and non-assessable shares of Common Stock. On April 13, 1998, the holders of the Series B Preferred Stock converted all of the shares into 1,111,111 shares of Common Stock. Common Stock On October 7, 1996, the Company amended and restated its Certificate of Incorporation to, among other things, increase the number of authorized shares of its $.01 par value common stock ("Common Stock") to 25,000,000 and the number of shares of its preferred stock to 5,000,000, of which 5,000 shares are designated as Series B Preferred Stock. On October 8, 1996, the Company effected a 250-for-one stock split of the Company's Common Stock. Accordingly, all share and per share amounts have been adjusted to reflect the stock split as though it had occurred at the beginning of the initial period presented. F-15 59 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. STOCK TRANSACTIONS: (CONTINUED) On October 8, 1996, the Company completed the offering ("Offering") of its Common Stock. The Company sold 2,397,067 shares of its Common Stock at a price of $9.00 per share, prior to underwriting discount and other offering expenses. In connection with the Offering, the Company's redeemable Series A cumulative convertible preferred stock ("Series A Preferred Stock") automatically converted into 2,500,000 shares of Common Stock. In connection with the IMR merger, the Company issued 876,078 shares of its Common Stock in exchange for all the outstanding shares of IMR. Under the provisions of APB 16, the shares are reflected as outstanding as though IMR had always been a part of the Company. Warrants to Purchase Common Stock The Company has issued warrants to four of our key health plan sponsor customers representing the right to purchase up to a total of 357,180 shares of our Common Stock at prices per share ranging from $8.10 to $35.50. The right to exercise each warrant vests in equal installments on the first five anniversaries of the date of grant so long as the customer's service agreement remains in effect. In addition, during the year ended March 31, 1997, the Company agreed to issue warrants to purchase 281,250 shares of its Common Stock to one customer contingent upon future expansion of member lives. As of March 31, 1999, none of these warrants have been earned or issued. Prior to November of 1997, the Company accounted for these warrant agreements under the provisions of SFAS 123 and the related Emerging Issues Task Force ("EITF") 96-3. These pronouncements require that all stock issued to non-employees be accounted for based on the fair value of the consideration received or the fair value of equity instruments issued. In addition, they require that the fair value be measured on the date the parties come to a "mutual understanding of the terms of the arrangement and agree to a binding contract" (i.e. the grant date). If the number of equity instruments is contingent upon the outcome of future events, the number of instruments that should be accounted for when determining the fair value of the transaction should be based on the best available estimate of the number of instruments expected to be issued. In management's opinion, the fair value of the warrants at the date of the agreements was not material. Subsequent to November 20, 1997, the Company follows the guidance of EITF 96-18, under which the measurement date is the earlier of the performance commitment date or completed performance date. The Company chose not to retroactively apply EITF 96-18 to the eligible warrants, but chose to apply this EITF prospectively to new arrangements and any modifications of existing arrangements. F-16 60 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. STOCK TRANSACTIONS: (CONTINUED) The Company has reserved shares of Common Stock at March 31, 1999, for the following: Exercise of stock options.................................................. 2,430,432 Exercise of warrants....................................................... 638,430 ------------- 3,068,862 =============
10. STOCK OPTION PLAN: At March 31, 1999, the Company has three stock-based compensation plans: Incentive Stock Option Plan, Amended and Restated Incentive Stock Option Plan and the 1997 Nonstatutory Stock Option Plan (the "Plans"). The Plans provide for the granting of qualified stock options and incentive options to officers, directors, advisors and employees of the Company. The options must be granted with exercise prices which equal or exceed the market value of the Common Stock at the date of grant. As of March 31, 1999, the number of shares of Common Stock issuable under the Plans may not exceed 2,837,750 shares. The Plans are administered by a compensation committee appointed by the Board of Directors of the Company. The stock options generally vest over 5-year periods. In the event of the sale or merger with an outside corporation gaining 50% or greater ownership, options granted to certain employees become 100% vested. The options are exercisable for a period not to exceed 10 years from the date of grant. As of March 31, 1999, 907,600 options were vested at exercise prices of $.65 to $35.63 per share. SFAS 123 establishes a fair value-based method of accounting for stock-based compensation. The Company has elected to adopt SFAS 123 through disclosure with respect to employee stock-based compensation. The following table summarizes the Company's stock option activity.
1997 1998 1999 ------------------------------------------------------------------------------------------------ Wtd. Avg. Wtd. Avg. Wtd. Avg. Shares Ex. Price Shares Ex. Price Shares Ex. Price -------------- ---------- -------------- ------------ -------------- ---------- Outstanding at beginning of year 1,040,250 $ 4.26 1,457,750 $ 6.02 2,023,745 $ 10.54 Granted 445,000 10.34 614,375 21.25 525,500 31.42 Transferred from IMR -- -- 23,922 1.18 -- -- Exercised (3,000) 3.20 (43,052) 5.26 (355,766) 6.79 Canceled (24,500) 10.75 (29,250) 9.78 (90,896) 29.02 -------------- ---------- -------------- ------------ -------------- ---------- Outstanding at end of year 1,457,750 6.02 2,023,745 10.54 2,102,583 15.86 ============== ========== ============== ============ ============== ========== Exercisable at end of year 632,850 2.95 879,382 4.40 907,600 6.68 Price range $.65 to $19.75 $.65 to $33.13 $.65 to $41.38 Weighted average fair value of options granted $ 3.31 $ 7.94 $ 14.64
F-17 61 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. STOCK OPTION PLAN: (CONTINUED) The following table reflects the weighted average exercise price and weighted average contractual life of various exercise price ranges of the 2,102,583 options outstanding as of March 31, 1999.
Options Outstanding Options Exercisable -------------------------------------- ----------------------------- Weighted Wtd. Avg. Weighted Avg. Exercise Contractual Avg. Exercise Exercise Price Range Shares Price Life (yrs.) Shares Price - ------------------------------------------------------------------------------------------------------- $ .65 to $ 2.71 204,674 $ .98 2.5 196,700 $ .98 $ 3.20 to $ 4.80 424,850 $ 3.24 4.8 424,850 $ 3.24 $ 9.00 to $ 12.50 689,200 $ 11.26 7.4 225,667 $ 11.67 $ 16.63 to $ 23.75 54,670 $ 19.72 8.5 9,003 $ 19.33 $ 24.50 to $ 31.62 484,000 $ 29.80 9.1 6,000 $ 29.13 $ 33.13 to $ 41.38 245,189 $ 34.67 9.0 45,380 $ 33.34
The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted average ranges of assumptions for the years ended March 31, 1997, 1998 and 1999, respectively: risk-free interest rates of 4.8% to 6.5%; expected lives of three to five years; expected volatility of 30% to 50%. The Company continues to account for stock based compensation under APB 25, "Accounting for Stock Issued to Employees", as allowed by SFAS 123. Had compensation cost for these plans been determined consistent with SFAS 123, the Company's net income and net income per share would have been reduced to the following pro forma amounts:
1997 1998 1999 ---- ---- ---- Net income: As reported $3,226,000 $7,931,000 $12,694,000 Pro forma $3,065,000 $7,382,000 $11,121,000 Basic net income per share: As reported $ 0.43 $ 0.88 $ 1.24 Pro forma $ 0.40 $ 0.82 $ 1.08 Diluted net income per share: As reported $ 0.35 $ 0.70 $ 1.09 Pro forma $ 0.33 $ 0.65 $ 0.95
Because SFAS 123 method of accounting has not been applied to options granted prior to April 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. F-18 62 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. RELATED PARTY TRANSACTIONS: In fiscal 1998, the Company entered into an agreement with Advance Capital Markets ("ACM") pursuant to which ACM agreed to act as financial advisor for the Company. In exchange for these professional services, the Company paid ACM a fee of $150,000 in 1998 in connection with the IMR transaction and $85,000 in connection with the Baumel-Eisner transaction. The fees paid are equivalent to or less than similar fees incurred in arm's-length transactions. The Managing Director of ACM is also a Director of the Company. 12. RETIREMENT PLAN BENEFITS: The Company sponsors a retirement plan for all eligible employees, as defined in the plan document. The plan is qualified under Section 401(k) of the Internal Revenue Code. The Company is required to contribute at least 50% of the first 6% of salary deferral contributed by each participant. The Company's contributions to the plan amounted to approximately $129,000, $177,000 and $268,000 for the years ended March 31, 1997, 1998 and 1999, respectively. 13. INCOME TAXES: The provision for income taxes for the years ended March 31, 1997, 1998 and 1999 differed from the amounts computed by applying the U.S. federal tax rate of 34 percent to pretax earnings as a result of the following:
1997 1998 1999 --------------- ---------------- --------------- Tax at U.S. federal $ 1,629,000 $ 4,349,000 $ 6,961,000 income tax rate State taxes --- 457,000 666,000 Benefit of operating (89,000) --- loss carryforwards Other, net 24,000 55,000 153,000 --------------- ---------------- --------------- Provision for income taxes $ 1,564,000 $ 4,861,000 $7,780,000 =============== ================ ===============
Of the $7,780,000 provision for income taxes in 1999, $1,312,000 represents deferred income taxes and $6,468,000 represents the current portion. F-19 63 ADVANCE PARADIGM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Deferred income taxes reflect the tax consequences on future years of temporary differences between the tax bases of assets and liabilities and their financial reporting bases and the potential benefits of certain tax carryforwards. The significant deferred tax assets and liabilities and the changes in those assets and liabilities are as follows:
March 31, March 31, 1998 Changes 1999 ------------ ------------ ------------ Gross deferred tax assets: Accruals .......................... $ 57,000 $ 96,000 $ 153,000 Other ............................. 50,000 76,000 126,000 ------------ ------------ ------------ 107,000 172,000 279,000 ------------ ------------ ------------ Gross deferred tax liabilities: Amortization of goodwill .......... (850,000) (197,000) (1,047,000) Depreciation ...................... (542,000) (158,000) (700,000) Conversion from cash basis of acquired entities .... -- (1,129,000) (1,129,000) ------------ ------------ ------------ (1,392,000) (1,484,000) (2,876,000) ------------ ------------ ------------ Net deferred tax liability ........ $ (1,285,000) $ (1,312,000) $ (2,597,000) ============ ============ ============
F-20 64 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE We have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Advance Paradigm, Inc. and subsidiaries included in this Form 10-K and have issued our report thereon dated May 17, 1999. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Dallas, Texas May 17, 1999 S-1 65 ADVANCE PARADIGM, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Balance at Additions Balance at Beginning Charged to (1) End of of Year Expenses Deductions Year ----------- ------------ ------------ ------------- Year ended March 31, 1997: Allowance for doubtful accounts receivable $ 180,000 $ 12,000 $ -- $ 192,000 Year ended March 31, 1998: Allowance for doubtful accounts receivable $ 192,000 $ 74,000 $ 19,000 $ 247,000 Year ended March 31, 1999: Allowance for doubtful accounts receivable $ 247,000 $ 124,000(2) $ -- $ 371,000
- ------------------------------------ (1) Uncollectible accounts written off, net of recoveries (2) Includes $100,000 reflected in the acquisition of Baumel-Eisner S-2 66 INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION - ------- ----------- 2.1(a) --- Stock Purchase Agreement, dated effective as of December 1, 1998, by and among Advance Paradigm, Inc. (the "Company"), Baumel-Eisner Neuromedical Institute, Inc., Barry Baumel, M.D. and Larry S. Eisner, M.D. 2.2(b) --- Purchase Agreement, dated as of February 26, 1999, among Foundation Health Systems, Inc., Foundation Health Corporation, Foundation Health Pharmaceutical Services, Inc., Integrated Pharmaceutical Services, Inc. and the Company. 3.1(c) --- Amended and Restated Certificate of Incorporation of the Company. 3.2(c) --- Certificate of Amendment to the Certificate of Incorporation of the Company. 3.3(c) --- Certificate of Correction to the Amendment to the Certificate of Incorporation of the Company. 3.4(c) --- Amended and Restated Bylaws of the Company. 3.5(c) --- Certificate of Incorporation of Advance Pharmacy Services, Inc. 3.6(c) --- Certificate of Amendment to the Certificate of Incorporation of Advance Pharmacy Services, Inc. 3.7(c) --- Certificate of Correction to the Certificate of Amendment to the Certificate of Incorporation of Advance Pharmacy Services, Inc. 3.8(c) --- Certificate of Amendment to the Certificate of Incorporation of Advance Pharmacy Services, Inc. 3.9(c) --- Bylaws of Advance Pharmacy Services, Inc. 4.1(d) --- Specimen Certificate for shares of Common Stock, $0.01 par value, of the Company. 4.2(e) --- Amended and Restated Incentive Stock Option Plan. 4.3(e) --- Incentive Stock Option Plan. 4.4(c) --- Warrant Agreement, dated as of September 12, 1996, by and between the Company and VHA, Inc. 4.5(c) --- Form of Agreement and Plan of Merger. 4.6(f) --- 1997 Nonstatutory Stock Option Plan. 4.7(b) --- Warrant Agreement, dated as of February 26, 1999, by and between the Company and Foundation Health Systems, Inc. 4.8(i) --- Warrant Agreement, dated as of February 25, 1999, by and between the Company and Arkansas BlueCross BlueShield 4.9(i) --- Warrant Agreement, dated as of June 12, 1998, by and between the Company and Wellmark, Inc. 10.1(c) --- Managed Pharmaceutical Agreement, dated November 1, 1993, by and between Advance Data and the Mega Life & Health Insurance Company. 10.2(c) --- Nondisclosure/Noncompetition Agreement, dated August 4, 1993, between the Company, Advance Data, Advance Mail and David D. Halbert.
67 10.3(c) --- Nondisclosure/Noncompetition Agreement, dated August 4, 1993, between the Company, Advance Mail, Advance Data and Jon S. Halbert. 10.4(c) --- Nondisclosure/Noncompetition Agreement, dated August 4, 1993, between the Company, Advance Mail, Advance Data and Danny Phillips. 10.5(d) --- Employment Agreement, effective as of December 1, 1996, by and between Advance Clinical (formerly ParadigM) and Joseph J. Filipek, Jr. and, for the limited purposes of Sections 3(d), 3(g) and 3(h) thereof, the Company. 10.6(d) --- Employment Agreement, effective as of November 14, 1996, by and between the Company and John H. Sattler. 10.7(d) --- Employment Agreement, effective as of June 17, 1996, by and between the Company and Ernest Buys. 10.8(c) --- Employment Agreement, effective as of February 15, 1996, by and between the Company and Alan T. Wright. 10.9(c) --- Form of Health Benefit Management Services Agreement. 10.10(c) --- Sublease, dated May 2, 1996, between Lincoln National Life Insurance Company and Advance Data. 10.11(c) --- Lease, dated March 6, 1994, by and between Hill Management Services, Inc. and Advance Clinical (formerly ParadigM). 10.12(c) --- Lease Agreement, dated as of February 24, 1989, as amended November 30, 1992, and December __, 1992, by and between TRST Las Colinas, Inc. and Advance Health Care. 10.13(c) --- Managed Pharmacy Benefit Services Agreement, dated September 1, 1995, between the Company and BCBS of Texas. 10.14(g) --- Agreement and Plan of Merger, dated February 9, 1998, by and among the Company, IMR, Inc. and Innovative Medical Research, Inc., Walter Stewart, Richard Lipton, The Lianna Lipton Trust, The Justin Lipton Trust, Stuart Bell, The Curren Bell Trust, The Kylie Bell Trust and The Ian Bell Trust. 10.15(h) --- Consulting Agreement, effective as of December 15, 1998, by and between the Company and David A. George. 10.16(b) --- Pharmacy Benefit Services Agreement, effective as of April 1, 1999, by and between the Company, Foundation Health Systems, Inc. and Integrated Pharmaceutical Services, Inc.
68 10.17(b) --- Credit Agreement, dated as of March 31, 1999, among the Company, the banks named in the Credit Agreement, NationsBanc Montgomery Securities LLC and NationsBank, N.A. 10.18(b) --- Guaranty, dated as of March 31, 1999, by each subsidiary of the Company, in favor of NationsBank, N.A. 10.19(i) --- Commercial Lease Agreement, commencing November 1, 1998, by and between Crin-Richardson I, L.P. and the Company. 11.1(i) --- Statement regarding computation of per share earnings. 21.1(i) --- Subsidiaries of the Company. 23.1(i) --- Consent of Arthur Andersen LLP. 27.1(i) --- Financial Data Schedule.
- --------------- (a) Previously filed in connection with the Company's Current Report on Form 8-K, dated December 29, 1998, and incorporated herein by reference. (b) Previously filed in connection with the Company's Current Report on Form 8-K, dated April 12, 1999, and incorporated herein by reference. (c) Previously filed in connection with the Company's Registration Statement on Form S-1 filed October 8, 1996 (No. 333-06931), and incorporated herein by reference. (d) Previously filed in connection with the Company's Form 10-K for the year ended March 31, 1997, and incorporated herein by reference. (e) Previously filed in connection with the Company's Registration Statement on Form S-8 filed September 5, 1997 (No. 333-34999), and incorporated herein by reference. (f) Previously filed in connection with the Company's Form 10-Q for the three months ended June 30, 1997, and incorporated herein by reference. (g) Previously filed in connection with the Company's Current Report on Form 8-K, dated February 9, 1998, and incorporated herein by reference. (h) Previously filed in connection with the Company's Form 10-Q for the three months ended December 31, 1998, and incorporated herein by reference. (i) Filed herewith. EX-4.8 2 WARRANT AGREEMENT DATED FEBRUARY 25, 1999 1 EXHIBIT 4.8 ADVANCE PARADIGM, INC. WARRANT AGREEMENT This Warrant Agreement (this "Agreement") dated as of February 25, 1999 is entered into by and between Advance Paradigm, Inc., a Delaware corporation (the "Company") and Arkansas Blue Cross Blue Shield, a mutual insurance company ("Client"). TERMS OF AGREEMENT NOW THEREFORE, in consideration of the premises and the mutual covenants herein contained, the Company and Client hereby agree as follows: Section 1. SERVICES AGREEMENT. Reference is made to that certain First Amendment dated as of the date hereof (the "First Amendment") to the Managed Pharmacy Benefit Services Agreement dated as of the date hereof entered into by and between the Company and Client (as amended, the "Services Agreement"). Capitalized terms not otherwise defined herein shall have the meanings given to them in the Services Agreement. Section 2. GRANT OF THE RIGHT TO PURCHASE COMMON STOCK. The Company hereby grants to Client the right, and Client shall be entitled, subject to the terms and conditions hereinafter set forth, to purchase from the Company 16,430 shares of its common stock, par value $0.01 per share (the "Common Stock")(which number is referred to herein as the "Total Exercise Number") at a per share exercise price equal to $35.125 (the "Exercise Price"). The right to purchase such shares shall be evidenced by five (5) warrant certificates each in the form of Exhibit A hereto (collectively, the "Warrant Certificates" and each a "Warrant Certificate"). Subject to Section 3 hereof, each Warrant Certificate shall be delivered to the Client following the Vesting Date (as defined below) thereof. The Total Exercise Number and Exercise Price of such shares are subject to adjustment as provided in Section 4 hereof. Section 3. EXERCISE OF WARRANT CERTIFICATES. The purchase rights granted hereunder will be exercisable as to twenty percent (20%) of the Total Exercise Number as of the first anniversary of the effective date of the First Amendment, and the right to exercise with respect to an additional twenty percent (20%) of the Total Exercise Number will accrue on each of the next four anniversaries of the effective date of the First Amendment (each a "Vesting Date") and will be cumulative; provided, however, that if on any vesting date the number of lives for which the Company is providing integrated pharmacy benefit management services under the Services Agreement is less 260,000, then the scheduled vesting for such date will be forfeited. The Warrant Certificates may be exercised only so long as the Company is the exclusive vendor of integrated pharmacy benefit management services for Client. Except as otherwise provided for 2 herein, the term of the Warrant Certificates and the right to purchase Common Stock as described therein shall commence on the Vesting Date of such Warrant Certificate and will end on the earlier of April 1, 2005 or three months following the termination date of the Services Agreement (the "Exercise Period"). Shares of Common Stock purchased upon exercise of each Warrant Certificate shall at the time of purchase be paid for in full. To the extent that the right to purchase shares has accrued hereunder, the Warrant Certificates may be exercised by written notice to the Company in the form attached to the Warrant Certificates, which specifies an exercise date (the "Date of Exercise"), accompanied by full payment for the shares by wire transfer or certified or official bank check or the equivalent thereof acceptable to Company. Upon the initial exercise of a Warrant Certificate, Client and the Company shall execute and enter into the Stockholders Agreement attached hereto as Exhibit B (the "Stockholders Agreement"). At the time of delivery, the Company shall, without stock transfer tax to the holder of the Warrant Certificate ("Holder"), deliver to the Holder (or to such other person as the Holder directs) at the principal office of the Company, or such other place as shall be mutually agreed upon, a certificate or certificates for such shares, provided, however, that the time of delivery may be postponed by the Company for such period as may be required for it with reasonable diligence to comply with any requirements of law. The Company at the time of exercise will require in addition that the registered owner of the shares deliver an executed copy of the Stockholder Agreement, an investment representation in form acceptable to the Company, and the Company will place a legend on the certificate for such Common Stock restricting the transfer of same. At no time shall the Company have any obligation or duty to register under the Securities Act of 1933 (the "1933 Act") the Common Stock issuable upon exercise of a Warrant Certificate. Section 4. ADJUSTMENTS TO EXERCISE PRICE AND NUMBER OF SHARES. The Exercise Price and number of shares of Common Stock purchasable pursuant to the exercise of the Warrant Certificates shall be subject to adjustment from time to time as follows: (a) Adjustment for Combinations or Consolidations of Common Stock. In the event the Company, at any time or from time to time after the date hereof, effects a subdivision or capital reorganization of its outstanding Common Stock for a greater or lesser number of shares, then and in each such event the Total Exercise Number and the Exercise Price shall be adjusted proportionately such that Client is entitled to purchase the same percentage of all shares of the Company's outstanding capital stock then issued and issuable for the same aggregate consideration as such Holder was entitled to purchase immediately prior to such event. (b) Adjustment for Certain Dividends and Distributions. In the event the Company at any time or from time to time after the date hereof shall pay a dividend payable in Common Stock of the Company, or otherwise make a distribution of Common Stock to its stockholders, then the Exercise Price shall be adjusted, from and after the record date of such dividend or the date of such distribution, to that price determined by multiplying the Exercise Price by a fraction, (i) the numerator of which shall be the total number of shares of capital stock issued and outstanding or deemed to be issued and outstanding immediately prior to the time of such issuance or the close of business on such record date; and 2 3 (ii) the denominator of which shall be the number of shares of capital stock issued and outstanding or deemed to be issued and outstanding immediately prior to the time of such issuance or the close of business on such record date plus the number of shares of capital stock to be issued; provided, however, that if such record date shall have been fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Exercise Price shall be recomputed accordingly as of the close of business on such record date and thereafter the Exercise Price shall be adjusted pursuant to this Section 4(b) as of the time of actual payment of such dividend or distribution. Client shall thereafter be entitled to purchase, at the Exercise Price resulting from such adjustment, the number of shares of Common Stock (calculated to the nearest whole share) obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of shares of Common Stock issuable upon the exercise hereof immediately prior to such adjustment and dividing the product thereof by the Exercise Price resulting from such adjustment. (c) Number of Shares. Upon any adjustment of the Exercise Price pursuant to Section 4(b) hereof, Client shall thereafter (until another such adjustment) be entitled to purchase, at the new Exercise Price, the number of shares, calculated to the nearest full share, obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of shares purchasable pursuant hereto immediately prior to such adjustment and dividing the product thereof by the new Exercise Price resulting from such adjustment. Section 5. RESERVATION AND AUTHORIZATION OF COMMON STOCK. The Company shall at all times reserve and keep available, free from preemptive rights, out of its authorized but unissued Common Stock, solely for the purposes of effecting the exercise of all outstanding Warrant Certificates, the full number of shares of Common Stock issuable upon the exercise of all outstanding Warrant Certificates. For the purpose of this Section 5, the full number of shares of Common Stock issuable upon the exercise of all outstanding Warrant Certificates shall be computed as if at the time of computation of such number of shares of Common Stock all outstanding Warrant Certificates were held by a single holder. The Company shall from time to time, in accordance with applicable law, increase the authorized amount of its Common Stock if at any time the authorized amount of its Common Stock remaining unissued shall not be sufficient to permit the exercise of all Warrant Certificates at the time outstanding. Section 6. TRANSFERABILITY. (a) The Warrant Certificates are not transferable by Client except to the Company or affiliates of Client. Any permitted transfer of a Warrant Certificate shall be recorded on the books of the Company upon receipt by the Company of a notice of transfer in the form attached hereto as Exhibit B, at its principal offices and the payment to the Company of all transfer taxes and other governmental charges imposed on such transfer. The shares of Common Stock purchased by Client are not transferable except as provided in the Stockholders Agreement. 3 4 (b) Unless and until otherwise permitted by this Section and the Stockholders Agreement, each certificate representing Common Stock initially issued upon the exercise of each Warrant Certificate (a "Stock Certificate"), and each certificate for Common Stock issued to any subsequent transferee of any such certificate, shall be stamped or otherwise imprinted with a legend in substantially the following form: "THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY BE REOFFERED AND SOLD ONLY IF SO REGISTERED OR IF AN EXEMPTION FROM SUCH REGISTRATION IS AVAILABLE. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE ALSO SUBJECT TO ADDITIONAL RESTRICTIONS ON TRANSFER, CERTAIN REPURCHASE OPTIONS AND CERTAIN OTHER AGREEMENTS SET FORTH IN A STOCKHOLDERS AGREEMENT BETWEEN THE COMPANY AND ARKANSAS BLUE CROSS BLUE SHIELD, A MUTUAL INSURANCE COMPANY, DATED AS OF ______________, A COPY OF WHICH MAY BE OBTAINED BY THE HOLDER HEREOF AT THE COMPANY'S PRINCIPAL PLACE OF BUSINESS WITHOUT CHARGE." Prior to any permitted transfer of a Warrant Certificate or any Stock Certificate, the holder thereof shall furnish, at the expense of such holder, to the Company an opinion of counsel, reasonably satisfactory in form and substance to the Company, to the effect that such transfer is exempt from registration under the Securities Act. Upon any exercise of any Warrant Certificate for shares of Common Stock to be registered in the name of a person other than Client, Client shall furnish, at the expense of Client, to the Company an opinion of the General Counsel of Client, reasonably satisfactory in form and substance to the Company, to the effect that the issuance of the shares of Common Stock to such other person upon exercise of the Warrant is exempt from registration under the Securities Act. Section 7. FRACTIONAL SHARES. The Company shall not be required to issue a fractional share of stock upon any exercise of a Warrant Certificate. As to any final fraction of a share that Client would otherwise be entitled to purchase upon exercise of a Warrant Certificate, the Company shall, if it does not issue a fractional share, pay a cash adjustment in respect of such final fraction in an amount equal to the same fraction of the Exercise Price per share of Common Stock. Section 8. EXCHANGE AND REPLACEMENT OF WARRANT CERTIFICATES. In the event of loss, theft or destruction of a Warrant Certificate, the Company will make and deliver a new Warrant Certificate of like tenor, in lieu of such Warrant Certificate, upon receipt by the Company of evidence reasonably satisfactory to it of such loss, theft, or destruction and indemnity or security reasonably satisfactory to it, and reimbursement to the Company of all reasonable expense incidental thereto. In the case of mutilation of a Warrant Certificate and upon surrender and cancellation of such Warrant Certificate, the Company will make and deliver a new Warrant Certificate of like tenor, in lieu of such Warrant Certificate. 4 5 Section 9. RIGHTS PRIOR TO EXERCISE OF WARRANT CERTIFICATES. Prior to the exercise of a Warrant Certificate, Client shall not be entitled to any rights of a stockholder of the Company with respect to the Common Stock for which such Warrant Certificate may then be exercisable, including without limitation the right to vote, to receive dividends or other distributions or to exercise any preemptive rights and shall not be entitled to receive any notice of any proceedings of the Company except as provided herein. Section 10. AUTHORIZATION AND ISSUANCE. The Company represents and warrants to Client that it has the corporate power and authority to issue the Warrant Certificates; this Warrant Agreement has been duly authorized, executed and delivered and the Warrant Certificates, when delivered, will be duly and validly issued, fully paid and nonassessable; the issuance of the Warrant Certificates, and the shares of Common Stock issuable upon their exercise, are not prohibited or restricted by the Certificate of Incorporation or Bylaws of the Company or any material agreement to which the Company is a party; except for those agreements for which the Company has received the requisite consents or waivers; and the shares of Common Stock issuable upon exercise of the Warrant Certificates, when issued upon exercise of the Warrant Certificates pursuant to the terms hereof, will be duly and validly issued, fully paid and nonassessable. Section 11. REPRESENTATIONS AND COVENANTS OF CLIENT. This Warrant Agreement has been entered into by the Company in reliance upon the following representations and covenants of Client: (a) Investment Purpose. The right to acquire the Common Stock issuable upon exercise of Client's rights contained herein will be acquired for investment and not with a view to the sale or distribution of any part thereof, and Client has no present intention of selling or engaging in any public distribution of the same except pursuant to a registration or exemption. (b) Private Issue. Client understands (i) that the Common Stock issuable upon exercise of the Warrant Certificates is not registered under the 1933 Act or qualified under applicable state securities laws on the ground that the issuance contemplated by this Warrant Agreement will be exempt from the registration and qualifications requirements thereof, and (ii) that the Company's reliance on such exemption is predicated on the representations set forth in this Section 11. (c) Financial Risk. Client has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of its investment, and has the ability to bear the economic risks of its investment. (d) Risk of No Registration. Client understands that if the Company does not register with the Securities and Exchange Commission pursuant to Section 11 of the 1933 Act, or file reports pursuant to Section 15(d) of the Securities Exchange Act of 1934 (the "1934 Act"), or if a registration statement covering the securities under the 1933 Act is not in effect when it desires to sell the Common Stock issuable upon exercise of the right to purchase, it may be required to hold such securities for an indefinite period. Client also understands that any sale of its rights to 5 6 purchase Common Stock which might be made by it in reliance upon Rule 144 under the 1933 Act may be made only in accordance with the terms and conditions of that Rule. (e) Stockholders Agreement. Prior to the exercise of any Warrant Certificate, Client agrees to, and to cause any permitted transferee to, enter into, execute and perform the Stockholders Agreement. Section 12. GENERAL. (a) Expenses. Each party shall bear and pay all costs and expenses incurred by them respecting the transactions contemplated herein and all investigations and proceedings in connection therewith, including, without limitation, fees, commissions or expenses of their respective counsel, accountants and financial advisors. (b) Notice. Any notice required to be given pursuant to the terms and provisions of this Agreement shall be in writing and shall be sent by certified mail, return receipt requested, or by overnight delivery service, or facsimile transmission confirmed by telephone and followed by overnight delivery to the parties at the addresses below or such other address as shall be specified by the parties by like notice to the Company at: Advance Paradigm, Inc. Attn: General Counsel 545 E. John Carpenter Freeway, Suite 1570 Irving, Texas 75062 Fax No.: 972/830-6196 and to Client at: Arkansas Blue Cross and Blue Shield, a mutual insurance company Attn: General Counsel 601 S. Gaines St. Little Rock, AR 72203 Fax No: 501/378-3366 Notice so given shall, in the case of notice so given by mail, be deemed to be given and received on the fourth calendar day after posting, in the case of notice so given by express delivery service, on the date of actual delivery and, in the case of notice so given by facsimile transmission or personal delivery, on the date of actual transmission or personal delivery, as the case may be. (c) Binding Nature and Assignment. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their successors and assigns. Neither party may assign this Agreement without the prior written consent of the other; provided, however, that either party may transfer or assign its rights and obligations under this Agreement, to any affiliate, and 6 7 provided further that no such assignment shall have the effect of releasing such party from any of its obligations under this Agreement. (d) Headings and Interpretation. The headings of the various sections of this Agreement are inserted for convenience only and do not, expressly or by implication, limit, define or extend the specific terms of the section so designated. (e) Governing Law. The validity, enforceability, and interpretation of this Agreement shall be determined and governed by the internal laws of the State of Texas (and not the law of conflicts). (f) Entire Agreement. This Agreement contains all the terms and conditions agreed upon by the parties, and supersedes all prior understandings, writings, proposals, representations, or communications, oral or written, of the parties hereto. (g) Authority. Company and Client warrant that each has full power and authority to enter into and perform this Agreement, and the person signing this Agreement on behalf of each party certifies that such person has been properly authorized and empowered to enter into this Agreement on behalf of such party. (h) Non-Waiver. The failure of either party to insist, in any one or more instances, upon performance of any of the terms, covenants or conditions of this Agreement shall not be construed as a waiver or a relinquishment of any right or claim granted or arising hereunder or of the future performance of any such term, covenant, or condition, and such failure shall in no way affect the validity of this Agreement or the rights and obligations of the parties hereunder. (i) Survival. Should any part, term or condition of this Agreement be declared illegal or unenforceable or in conflict with any other laws, the remaining provisions shall be valid and not affected thereby. (j) Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original and all of which taken together shall constitute one and the same instrument. (k) Further Assurances. From time to time upon request and without further consideration, the parties hereto shall, and shall cause their subsidiaries and affiliates, to execute, deliver or acknowledge such documents and do such further acts as the other party hereto may reasonably require to effectuate its obligations contemplated by this Agreement. 7 8 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed and delivered by their proper and duly authorized officers on the date first above written. By executing the Agreement, the undersigned individuals hereby warrant and represent that they have read this Agreement in its entirety and agree to all its terms. ADVANCE PARADIGM, INC. By: /s/ DAVID D. HALBERT ------------------------------------- David D. Halbert Chairman of the Board and Chief Executive Officer ARKANSAS BLUE CROSS AND BLUE SHIELD, A MUTUAL INSURANCE COMPANY By: /s/ RANDY L. SPICER ------------------------------------- Name: Randy L. Spicer Title: Vice President of Marketing, Underwriting And Product Development 8 9 EXHIBITS Exhibit A Warrant Certificate Exhibit B Stockholders Agreement
9 10 EXHIBIT A THIS WARRANT AND THE UNDERLYING SHARES HEREOF HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY NOT BE SOLD OR TRANSFERRED UNLESS THERE IS AN EFFECTIVE REGISTRATION STATEMENT UNDER SUCH ACT COVERING SUCH SECURITIES OR THE COMPANY RECEIVES AN OPINION OF COUNSEL (WHICH MAY BE COUNSEL FOR THE COMPANY) STATING THAT SUCH SALE OR TRANSFER IS EXEMPT FROM THE REGISTRATION AND PROSPECTUS DELIVERY REQUIREMENTS OF SUCH ACT. WARRANT NO. 1 For Purchase of Shares of Common Stock of ADVANCE PARADIGM, INC. APRIL 1, 2000 THIS CERTIFIES THAT Arkansas Blue Cross Blue Shield, a mutual insurance company ("Client"), or registered transferees or assigns, is entitled, subject to the terms and conditions set forth in this Warrant, to purchase from Advance Paradigm, Inc., a Delaware corporation (the "Company"), 3,286 (the "Exercise Number") fully paid and nonassessable shares of Common Stock, $0.01 par value per share, of the Company (the "Common Stock"), at any time during the Exercise Period upon payment in full of the Exercise Price. The Total Exercise Number and Exercise Price shall be subject to adjustment as set forth in the Warrant Agreement referred to below. This Warrant is issued pursuant to a Warrant Agreement between Client and the Company dated as of February 25, 1999 (the "Warrant Agreement"), and is subject to all the terms thereof, including the limitations on transferability set forth therein. Capitalized terms used herein as defined terms but not otherwise defined shall have the meaning assigned to such term in the Warrant Agreement. This Warrant may be exercised, by the holder hereof, for all shares of Common Stock covered hereby, by the presentation and surrender of this Warrant together with the duly executed Election to Purchase in the form attached as hereto, at the principal office of the Company (or at such other address as the Company may designate by notice in writing to the holder hereof at the address of such holder appearing on the books of the Company), and upon payment to the Company of the Exercise Price and execution of the Stockholders Agreement as set forth in the Warrant Agreement. IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed and delivered by its duly authorized officer as an instrument under seal as of the date of first above written. ADVANCE PARADIGM, INC. By: ------------------------------------- David D. Halbert Chairman of the Board and Chief Executive Officer 10 11 ELECTION TO PURCHASE TO: ADVANCE PARADIGM, INC. (the "Company") The undersigned, owner of the accompanying Warrant hereby irrevocably exercises the option to purchase ____ shares of Common Stock in accordance with the terms of such Warrant, directs that the shares issuable and deliverable upon such purchase (together with any check for a fractional interest) be issued in the name of and delivered to the undersigned, and makes payment in full therefor at the Exercise Price provided or referenced in such Warrant. COMPLETE FOR REGISTRATION OF SHARES OF COMMON STOCK ON THE STOCK TRANSFER RECORDS MAINTAINED BY THE COMPANY: - -------------------------------------------------------------------------------- Name of Warrant Holder - -------------------------------------------------------------------------------- Address - -------------------------------------------------------------------------------- Federal ID Tax Number or Social Security Number - -------------------------------------------------------------------------------- Date of Exercise (must be at least fifteen days after the date of this Notice) ----------------------------------------- Signature ----------------------------------------- Title ----------------------------------------- Date 11 12 EXHIBIT B STOCKHOLDER AGREEMENT This Stockholder Agreement dated as of ___________, by and among Arkansas Blue Cross Blue Shield, a mutual insurance company (the "STOCKHOLDER"), and Advance Paradigm, Inc., a Delaware corporation (the "COMPANY"). PRELIMINARY STATEMENTS Pursuant to the terms and conditions of the Warrant Agreement, dated as of February 25, 1999, by and between the Company and Stockholder, the Company agreed to issue a warrant to acquire shares of the Company's common stock, par value $.01 per share (the "COMMON STOCK"). Pursuant to the terms of the Warrant Agreement, the Stockholder agreed to execute and enter into this Agreement prior to the issuance of any shares of Common Stock thereunder. NOW THEREFORE, in consideration of the premises and the mutual agreements contained herein and for other good, valuable and binding consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound, hereby agree as follows: STATEMENT OF AGREEMENT 1. Restricted Stock. The terms and conditions of this Agreement shall apply to all shares of Common Stock issued to Stockholder pursuant to the Warrant Agreement and any shares of Common Stock otherwise acquired by Stockholder (collectively the "STOCK"). 2. Restrictions on Transfers. 2.1 Transfers to Affiliate. (a) Transfers to Affiliates. Stockholder shall be entitled to transfer the Stock held by it to entities that directly or indirectly control, are controlled by, or are under common control with Stockholder (each, an "AFFILIATE"), provided that any such Affiliates first deliver to the Company their written acknowledgment of, and agreement to be bound by, the terms and provisions contained in this Agreement; and the Stockholder delivers to the Company an opinion of counsel, reasonably acceptable in form and substance to the Company and its counsel, that registration under the Securities Act is not required in connection with such transfer. The foregoing notwithstanding, Stockholder shall not, without the prior written consent of the Company which consent will not be unreasonably withheld, transfer any shares of Stock to any Affiliate, nor any officer, director, employee or holder of debt or equity in any Affiliate that is primarily engaged in the business of pharmacy benefit management services, pharmacy network management, pharmacy claims adjudication, mail service pharmacy, pharmacy clinical services, 12 13 and/or pharmacy outcomes management, or the manufacture of drugs, biotech products or biologicals. (b) Affiliates' Proxy. In the event that Stockholder transfers less than all of its Stock pursuant to Section 2.1(a), Stockholder shall exercise all of the rights inuring under this Agreement with respect to such transferred Stock and the transferees shall grant Stockholder proxies to exercise such rights. In the event that Stockholder transfers all of its Stock pursuant to Section 2.1(a), one such transferee reasonably acceptable to the Company shall be designated by Stockholder to exercise all rights inuring under this Agreement with respect to such Stock and the other transferees shall grant such designated transferee proxies to exercise such rights. 2.2 Restrictions on Third Party Transfers of the Stock. (a) General. During the first two years following the date the Stock is issued the ("ISSUANCE DATE"), Stockholder agrees that it will not sell, pledge or otherwise transfer any interest in any shares of the Stock in a private sale without the prior written consent of the Company. At any time after the second anniversary of the Issuance Date, the Stockholder may sell, pledge or otherwise transfer shares of the Stock to any third party. ("THIRD PARTY TRANSFER"); provided that such transfer is in accordance with this Section 2.2, and provided further that the transferring Stockholder delivers to the Company an opinion of counsel, reasonably acceptable in form and substance to the Company and its counsel, that registration under the Securities Act is not required in connection with such transfer. The foregoing notwithstanding, Stockholder agrees that it shall not transfer any shares of Stock to any person or entity, nor any officer, director, employee or holder of debt or equity in any entity that is engaged in the business, or has an affiliate engaged in the business of pharmacy benefit management services, pharmacy network management, pharmacy claims adjudication, mail service pharmacy, pharmacy clinical services, and/or pharmacy outcomes management, or the manufacture of drugs, biotech products or biologicals. (b) Sale Notice. At least 30 days prior to making any Third Party Transfer under Section 2.2(a), the transferring Stockholder will deliver a written notice (the "SALE NOTICE") to the Company. The Sale Notice will disclose in reasonable detail the identity of the prospective transferee(s) and the terms and conditions of the proposed transfer. Stockholder agrees not to consummate any such transfer until 30 days after the Sale Notice has been delivered to the Company. (c) First Refusal Rights. The Company may elect to purchase some or all of the Stock to be transferred upon the same terms and conditions as those set forth in the Sale Notice by delivering a written notice of such election to Stockholder within 30 days after the receipt of the Sale Notice by the Company. If the Company elects to purchase any shares of Stock, the Company shall consummate such purchase within 45 days of delivery of notice of intent to purchase. If the Company has not elected to purchase all of the Stock specified in the Sale Notice, Stockholder may transfer the Stock specified in the Sale Notice at a price and on terms no more favorable to the transferee(s) thereof than specified in the Sale Notice during the 60-day period immediately following notice of the Company's election not to purchase such shares. Any 13 14 shares of Stock not transferred within such 60-day period will be subject to the provisions of this Section 2.2(c) upon subsequent transfer. (d) Non-Cash Consideration. In the event the consideration for the Stock as disclosed in the Sale Notice is other than cash, a promissory note or a combination thereof, the price for the Stock shall be the value of that consideration as agreed to by the transferring Stockholder and the Company, or, if no agreement can be reached as to the valuation of such consideration, the fair market value of such consideration as determined by two appraisers (one appointed by the Stockholder and one appointed by the Company). In the event the two appraisers are unable to agree on a fair market value within 20 days after they are appointed, the fair market value of the consideration shall be the average of the appraised values of the two appraisers; provided, however, that if the appraised values of the two appraisers differ by more than five percent (5%) of the higher of the two appraised values, the two respective appointed appraisers shall select a third appraiser who shall independently, within 20 days after this appointment, make a determination of the value of the consideration and the average of the appraised values of the three appraisers shall be the purchase price and shall be binding on the parties hereto. The transferring Stockholder and the Company shall each bear the cost of their respective appraisers and shall share the cost equally of the third appraiser, if any. Notwithstanding anything herein to the contrary, if an appraisal is used to determine the value of the consideration pursuant to this Section 2.2(d), the time periods provided for in Sections 2.2(b) and 2.2(c) shall be tolled from the time of the initial appointment of the two appraisers until a final appraised value is determined pursuant to this Section 2.2(d). (e) Public Sale. Notwithstanding the foregoing, at any time after the first anniversary of the Issuance Date, the Stockholder may sell, pledge or otherwise transfer shares of the Stock to the public in a market transaction without complying with the restrictions set forth in Section 2.2(b), (c) and (d); provided that the transferring Stockholder delivers to the Company an opinion of counsel, reasonably acceptable in form and substance to the Company and its counsel, that registration under the Securities Act is not required in connection with such transfer. 2.3 Legend. The certificates representing the Stock will bear the following legend: "THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY BE REOFFERED AND SOLD ONLY IF SO REGISTERED OR IF AN EXEMPTION FROM SUCH REGISTRATION IS AVAILABLE. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE ALSO SUBJECT TO ADDITIONAL RESTRICTIONS ON TRANSFER, CERTAIN REPURCHASE OPTIONS AND CERTAIN OTHER AGREEMENTS SET FORTH IN A STOCKHOLDER AGREEMENT BETWEEN THE COMPANY AND ARKANSAS BLUE CROSS BLUE SHIELD, A MUTUAL INSURANCE COMPANY, DATED AS OF ______________, A COPY OF WHICH MAY BE OBTAINED BY THE HOLDER HEREOF AT THE 14 15 COMPANY'S PRINCIPAL PLACE OF BUSINESS WITHOUT CHARGE." Any legend endorsed on a certificate pursuant to Section 2.3 hereof and the stop transfer instructions and record notations with respect thereto shall be removed and the Company shall issue a certificate without such legend to the holder thereof at such time as the securities evidenced thereby cease to be restricted securities 2.4 Extraordinary Transaction. In the event of a merger of the Company with a third party where the Company is not the surviving entity, sale of a majority of the capital stock of the Company, or the sale of all or substantially all of its assets ("EXTRAORDINARY TRANSACTION"), the Stock shall be entitled to receive the same benefits as the holders of the Common Stock will receive in the Extraordinary Transaction. The Stockholder agrees to consent to and execute all required documents in connection with the Extraordinary Transaction. 2.5 Limitation on Stock Holdings. The Stockholder agrees that in no event, shall it, either independently or together with its Affiliates, own Common Stock or rights to acquire Common Stock, that represent, or if converted to Common Stock would represent, more than ten percent (10%) of the Company's issued and outstanding Common Stock, without the Company's prior written consent. 3. Notices. All notices and other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered personally, mailed by certified mail (return receipt requested) or sent by express delivery service, or facsimile transmission (confirmed by telephone conversation and followed by overnight delivery) to the parties at the following addresses or at such other addresses as shall be specified by the parties by like notice: if to the Company: Advance Paradigm, Inc. Attn: General Counsel 545 E. John Carpenter Freeway Suite 1570 Irving, TX 75062 Fax No.: (972) 830-6196 if to Stockholder: Arkansas Blue Cross Blue Shield, a mutual insurance company Attn: General Counsel ---------------------- ---------------------- Fax No.: -------------- 15 16 Notice so given shall, in the case of notice so given by mail, be deemed to be given and received on the fourth calendar day after posting, in the case of notice so given by express delivery service, on the date of actual delivery and, in the case of notice so given by facsimile transmission or personal delivery, on the date of actual transmission or personal delivery, as the case may be. 4. Severability. If any provision of this Agreement shall be held to be illegal, invalid or unenforceable under any applicable law, then such contravention or invalidity shall not invalidate the entire Agreement. Such provision shall be deemed to be modified to the extent necessary to render it legal, valid and enforceable, and if no such modification shall render it legal, valid and enforceable, then this Agreement shall be construed as if not containing the provision held to be invalid, and the rights and obligations of the parties shall be construed and enforced accordingly. 5. Complete Agreement. This Agreement and those documents expressly referred to herein and of even date herewith, embody the complete agreement and understanding among the parties and supersede and preempt any prior understandings, agreements or representations by or among the parties, written or oral, which may have related to the subject matter hereof in any way. 6. Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, with the same effect as if all parties had signed the same document. All such counterparts shall be deemed an original, shall be construed together and shall constitute one and the same instrument. 7. Successors and Assigns. This Agreement is intended to bind and inure to the benefit of and be enforceable by and against the Stockholder and the Company, and their respective heirs, successors and assigns. Stockholder hereby agrees not to transfer or assign, directly or indirectly, any of the Stock unless such transferee or assignee agrees in writing (i) to be bound by the provisions of this Agreement and (ii) not to make subsequent assignments or transfers other than in accordance with this Agreement. Notwithstanding the foregoing, any holder of the Stock (other than a holder who purchases the stock through a market sale) shall be bound by the provisions of this Agreement even if such holder is not a party hereto or otherwise agreed in writing to be bound by the provisions hereof. 8. CHOICE OF LAW. THE INTERNAL LAW OF THE STATE OF TEXAS (AND NOT THE LAW OF CONFLICTS) WILL GOVERN THE CONSTRUCTION, VALIDITY AND INTERPRETATION OF THIS AGREEMENT. 16 17 9. Remedies. Each of the parties to this Agreement will be entitled to enforce its rights under this Agreement specifically, to recover damages by reason of any breach of any provision of this Agreement and to exercise all other rights existing in its favor. The parties hereto agree and acknowledge that money damages may not be an adequate remedy for any breach of the provisions of this Agreement and that any party may in its sole discretion apply to any court of law or equity of competent jurisdiction for specific performance and/or injunctive relief in order to enforce or prevent any violations of the provisions of this Agreement. In the event a party hereto brings an action under this agreement, the prevailing party in such dispute shall be entitled to recover from the losing party all fees, costs and expenses of enforcing any right of such prevailing party under or with respect to this Agreement, including without limitation such reasonable fees and expenses of attorneys and accountants, which shall include, without limitation, all fees, costs and expenses of appeals. 10. Amendments and Waivers. Any provision of this Agreement may be amended or waived only with the prior written consent of each of the parties hereto. 11. Confidentiality. Each of the parties hereto agrees to hold in the strictest confidence the existence of this Agreement and the terms and conditions hereof. Specifically, but without limiting the generality of the foregoing, each of the parties hereto agrees not to disclose the existence of this Agreement or any of its terms to any third party without the prior written consent of every other party hereto (unless such disclosure is required by law). [Signature page follows] 17 18 IN WITNESS WHEREOF, the parties have executed this Agreement on the day and year first above written. ADVANCE PARADIGM, INC. By: ------------------------------------- Name: ----------------------------------- Title: ---------------------------------- ARKANSAS BLUE CROSS BLUE SHIELD, A MUTUAL INSURANCE COMPANY By: ------------------------------------- Name: ----------------------------------- Title: ---------------------------------- 18 EX-4.9 3 WARRANT AGREEMENT DATED JUNE 12, 1998 1 Exhibit 4.9 ADVANCE PARADIGM, INC. WARRANT AGREEMENT This Warrant Agreement (this "Agreement") dated as of June 12, 1998 is entered into by and between Advance Paradigm, Inc., a Delaware corporation (the "Company") and Wellmark Inc., an Iowa mutual insurance company ("Client"). TERMS OF AGREEMENT NOW THEREFORE, in consideration of the premises and the mutual covenants herein contained, the Company and Client hereby agree as follows: Section 1. PHARMACEUTICAL SERVICE AGREEMENT. Reference is made to that certain Managed Pharmacy Benefit Services Agreement dated January 1, 1998 entered into by and between the Company and Client (the "Services Agreement"). Capitalized terms not otherwise defined herein shall have the meanings given to them in the Services Agreement. Section 2. GRANT OF THE RIGHT TO PURCHASE COMMON STOCK. The Company hereby grants to Client the right, and Client shall be entitled, subject to the terms and conditions hereinafter set forth, to purchase from the Company Fifty-Six Thousand Two Hundred Fifty (56,250) shares of its common stock, par value $0.01 per share (the "Common Stock") set forth below (which number is referred to herein as the "Initial Exercise Number") at a per share exercise price equal to the $32 5/8 per share (the "Exercise Price"). The right to purchase such shares shall be evidenced by five (5) warrant certificates in the form of Exhibit A hereto with each warrant certificate representing the right to purchase 20% of the Initial Exercise Number. The Initial Exercise Number and Exercise Price of such shares are subject to adjustment as provided in Section 4 hereof. Section 3. EXERCISE OF WARRANT. The purchase rights represented by the warrant certificate shall vest in consecutive years, with the right to exercise the first warrant certificate vesting on January 1, 1999 and the right to exercise each of the other warrant certificates vesting on each January 1 thereafter (each a "vesting date") and will be cumulative; provided, however, that if on any vesting date the number of lives for which the Company is providing pharmacy benefit management services under the Services Agreement is less than one million lives, then the scheduled vesting of the warrant certificate for such date will be forfeited. Any such forfeiture shall not affect any previously vested rights or the prospective vesting of rights hereunder. Each warrant certificate may be exercised only so long as the Company is the exclusive vendor of pharmacy benefit management services for Client. Except as otherwise provided for herein, the term of this Warrant Agreement and the right to purchase Common Stock as described herein shall commence on January 1, 1999 and will end on December 31, 2003 (the "Exercise Period"). No warrant certificate shall be exercisable after the expiration of the Exercise Period. Shares of Common Stock purchased upon exercise of each warrant certificate shall at the time of purchase be paid for in full. To the extent that the right to purchase shares under any warrant certificate has vested hereunder, such warrant certificate may be 2 exercised by written notice to the Company in the form attached to such warrant certificate, which specifies an exercise date (the "Date of Exercise"), accompanied by full payment for the shares by wire transfer or certified or official bank check or the equivalent thereof acceptable to Company. Upon the exercise of the initial warrant certificate, Client and the Company shall execute and enter into the Stockholders Agreement attached hereto as Exhibit B (the "Stockholders Agreement"). At the time of delivery, the Company shall, without stock transfer tax to the warrant certificate holder, deliver to such holder (or to such other person) at the principal office of the Company, or such other place as shall be mutually agreed upon, a certificate or certificates for such shares, provided, however, that the time of delivery may be postponed by the Company for such period as may be required for it with reasonable diligence to comply with any requirements of law. The Company at the time of exercise will require in addition that the registered owner of the Common Stock deliver an executed copy of the Stockholder Agreement, an investment representation in form acceptable to the Company, and the Company will place a legend on the certificate for such Common Stock restricting the transfer of same. At no time shall the Company have any obligation or duty to register under the Securities Act of 1933 (the "1933 Act") the Common Stock issuable upon exercise of warrant. Section 4. ADJUSTMENTS TO EXERCISE PRICE AND NUMBER OF SHARES. The Exercise Price and number of shares of Common Stock purchasable pursuant to the exercise of each warrant certificate shall be subject to adjustment from time to time as follows: (a) Adjustment for Combinations or Consolidations of Common Stock. In the event the Company, at any time or from time to time after the date hereof, effects a subdivision or capital reorganization of its outstanding Common Stock for a greater or lesser number of shares, then and in each such event the Initial Exercise Number and the Exercise Price shall be adjusted proportionately such that Client is entitled to purchase the same percentage of all shares of the Company's outstanding capital stock then issued and issuable for the same aggregate consideration as such warrant certificate holder was entitled to purchase immediately prior to such event. (b) Adjustment for Certain Dividends and Distributions. In the event the Company at any time or from time to time after the date hereof shall pay a dividend payable in Common Stock of the Company, or otherwise make a distribution of Common Stock to its stockholders, then the Exercise Price shall be adjusted, from and after the record date of such dividend or the date of such distribution, to that price determined by multiplying the Exercise Price by a fraction, (i) the numerator of which shall be the total number of shares of capital stock issued and outstanding or deemed to be issued and outstanding immediately prior to the time of such issuance or the close of business on such record date; and (ii) the denominator of which shall be the number of shares of capital stock issued and outstanding or deemed to be issued and outstanding immediately prior to the time of such issuance or the close of business on such record date plus the number of shares of capital stock to be issued; 2 3 provided, however, that if such record date shall have been fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Exercise Price shall be recomputed accordingly as of the close of business on such record date or date of distribution and thereafter the Exercise Price shall be adjusted pursuant to this Section 4(b) as of the time of actual payment of such dividend or distribution. Client shall thereafter be entitled to purchase, at the Exercise Price resulting from such adjustment, the number of shares of Common Stock (calculated to the nearest whole share) obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of shares of Common Stock issuable upon the exercise hereof immediately prior to such adjustment and dividing the product thereof by the Exercise Price resulting from such adjustment. (c) Number of Shares. Upon any adjustment of the Exercise Price in accordance with Section 4(b), Client shall thereafter (until another such adjustment) be entitled to purchase, at the new Exercise Price, the number of shares, calculated to the nearest full share, obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of shares purchasable pursuant hereto immediately prior to such adjustment and dividing the product thereof by the new Exercise Price resulting from such adjustment. Section 5. RESERVATION AND AUTHORIZATION OF COMMON STOCK. The Company shall at all times reserve and keep available, free from preemptive rights, out of its authorized but unissued Common Stock, solely for the purposes of effecting the exercise of all outstanding warrant certificates, the full number of shares of Common Stock issuable upon the exercise of all outstanding warrant certificates. For the purpose of this Section 5, the full number of shares of Common Stock issuable upon the exercise of all outstanding warrant certificates shall be computed as if at the time of computation of such number of shares of Common Stock all outstanding warrant certificates were held by a single holder. The Company shall from time to time, in accordance with applicable law, increase the authorized amount of its Common Stock if at any time the authorized amount of its Common Stock remaining unissued shall not be sufficient to permit the exercise of all warrant certificates at the time outstanding. Section 6. TRANSFERABILITY. (a) The warrant certificates are not transferable by Client except to the Company or affiliates of Client. Any permitted transfer of a warrant certificate shall be recorded on the books of the Company upon receipt by the Company of a notice of transfer in the form attached hereto as Exhibit B, at its principal offices and the payment to the Company of all transfer taxes and other governmental charges imposed on such transfer. The shares of Common Stock purchased by Client are not transferable except as provided in the Stockholders Agreement. (b) Unless and until otherwise permitted by this Section and the Stockholders Agreement, each certificate representing Common Stock initially issued upon the exercise of each warrant certificate (a "Stock Certificate"), and each certificate for Common Stock issued to any subsequent transferee of any such certificate, shall be stamped or otherwise imprinted with a legend in substantially the following form: 3 4 "THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY BE REOFFERED AND SOLD ONLY IF SO REGISTERED OR IF AN EXEMPTION FROM SUCH REGISTRATION IS AVAILABLE. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE ALSO SUBJECT TO ADDITIONAL RESTRICTIONS ON TRANSFER, CERTAIN REPURCHASE OPTIONS AND CERTAIN OTHER AGREEMENTS SET FORTH IN A STOCKHOLDER AGREEMENT BETWEEN THE COMPANY AND CLIENT, DATED AS OF [DATE], A COPY OF WHICH MAY BE OBTAINED BY THE HOLDER HEREOF AT THE COMPANY'S PRINCIPAL PLACE OF BUSINESS WITHOUT CHARGE." Prior to any permitted transfer of a warrant certificate or any Stock Certificate, the holder thereof shall furnish, at the expense of such holder, to the Company an opinion of counsel, reasonably satisfactory in form and substance to the Company, to the effect that such transfer is exempt from registration under the Securities Act. Upon any exercise of any warrant certificate for shares of Common Stock to be registered in the name of a person other than Client, Client shall furnish, at the expense of Client, to the Company an opinion of counsel (which may be the General Counsel of Client), reasonably satisfactory in form and substance to the Company, to the effect that the issuance of the shares of Common Stock to such other person upon exercise of the warrant certificate is exempt from registration under the Securities Act. Section 7. FRACTIONAL SHARES. The Company shall not be required to issue a fractional share of stock upon any exercise of a warrant certificate. As to any final fraction of a share that Client would otherwise be entitled to purchase upon exercise of a warrant certificate, the Company shall, if it does not issue a fractional share, pay a cash adjustment in respect of such final fraction in an amount equal to the same fraction of the Exercise Price per share of Common Stock. Section 8. EXCHANGE AND REPLACEMENT OF WARRANT. In the event of loss, theft or destruction of a warrant certificate, the Company will make and deliver a new warrant certificate of like tenor, in lieu of such warrant certificate, upon receipt by the Company of evidence reasonably satisfactory to it of such loss, theft, or destruction and indemnity or security reasonably satisfactory to it, and reimbursement to the Company of all reasonable expense incidental thereto. In the case of mutilation of a warrant certificate and upon surrender and cancellation of such warrant certificate, the Company will make and deliver a new warrant certificate of like tenor, in lieu of such warrant certificate. Section 9. RIGHTS PRIOR TO EXERCISE OF WARRANT. Prior to the initial exercise of a warrant certificate, Client shall not be entitled to any rights of a stockholder of the Company with respect to the Common Stock for which such warrant certificate may then be exercisable, including without limitation the right to vote, to receive dividends or other distributions or to exercise any preemptive rights and shall not be entitled to receive any notice of any proceedings of the Company except as provided herein. Section 10. AUTHORIZATION AND ISSUANCE. The Company represents and warrants to Client that it has the corporate power and authority to issue the warrant certificates; the 4 5 warrant certificates have been duly authorized, executed and delivered and are duly and validly issued, fully paid and nonassessable; the issuance of the warrant certificates, and the shares of Common Stock issuable upon their exercise, are not prohibited or restricted by the Certificate of Incorporation or Bylaws of the Company or any material agreement to which the Company is a party; except for those agreements for which the Company has received the requisite consents or waivers; and the shares of Common Stock issuable upon exercise of the warrant certificates, when issued upon exercise of the warrant certificates pursuant to the terms hereof, will be duly and validly issued, fully paid and nonassessable. The Company will not, by amendment to its Articles of Incorporation or Bylaws or through reorganization, merger, sale of assets or otherwise, avoid or seek to avoid its performance hereunder. Section 11. REPRESENTATIONS AND COVENANTS OF CLIENT. This Warrant Agreement has been entered into by the Company in reliance upon the following representations and covenants of Client: (a) Investment Purpose. The right to acquire the Common Stock issuable upon exercise of Client's rights contained herein will be acquired for investment and not with a view to the sale or distribution of any part thereof, and Client has no present intention of selling or engaging in any public distribution of the same except pursuant to a registration or exemption. (b) Private Issue. Client understands (i) that the Common Stock issuable upon exercise of the warrant certificates is not registered under the 1933 Act or qualified under applicable state securities laws on the ground that the issuance contemplated by this Warrant Agreement will be exempt from the registration and qualifications requirements thereof, and (ii) that the Company's reliance on such exemption is predicated on the representations set forth in this Section 11. (c) Financial Risk. Client has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of its investment, and has the ability to bear the economic risks of its investment. (d) Risk of No Registration. Client understands that if the Company does not register with the Securities and Exchange Commission pursuant to Section 11 of the 1933 Act, or file reports pursuant to Section 15(d) of the Securities Exchange Act of 1934 (the "1934 Act"), or if a registration statement covering the securities under the 1933 Act is not in effect when it desires to sell the Common Stock issuable upon exercise of the right to purchase, it may be required to hold such securities for an indefinite period. Client also understands that any sale of its rights to purchase Common Stock which might be made by it in reliance upon Rule 144 under the 1933 Act may be made only in accordance with the terms and conditions of that Rule. (e) Stockholders Agreement. Prior to the exercise of any warrant certificate, Client agrees to, and to cause any permitted transferee to, enter into, execute and perform the Stockholders Agreement. Section 12. GENERAL. (a) Expenses. Each party shall bear and pay all costs and expenses incurred by them respecting the transactions contemplated herein and all investigations and proceedings in 5 6 connection therewith, including, without limitation, fees, commissions or expenses of their respective counsel, accountants and financial advisors. (b) Notice. Any notice required to be given pursuant to the terms and provisions of this Agreement shall be in writing and shall be sent by certified mail, return receipt requested, or by overnight delivery service, or facsimile transmission confirmed by telephone and followed by overnight delivery to the parties at the addresses below or such other address as shall be specified by the parties by like notice to the Company at: Advance Paradigm, Inc. Attn: General Counsel 545 E. John Carpenter Freeway, Suite 1570 Irving, Texas 75062 Fax No.: 972/830-6196 and to Client at: Wellmark, Inc. Attn. Linda Sufficool 636 Grand Avenue Des Moines, Iowa 50309 Fax No.: 515/245-6000 Notice so given shall, in the case of notice so given by mail, be deemed to be given and received on the fourth calendar day after posting, in the case of notice so given by express delivery service, on the date of actual delivery and, in the case of notice so given by facsimile transmission or personal delivery, on the date of actual transmission or personal delivery, as the case may be. (c) Binding Nature and Assignment. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their successors and assigns. Neither party may assign this Agreement without the prior written consent of the other; provided, however, that either party may transfer or assign its rights and obligations under this Agreement, to any affiliate, and provided further that no such assignment shall have the effect of releasing such party from any of its obligations under this Agreement. (d) Headings and Interpretation. The headings of the various sections of this Agreement are inserted for convenience only and do not, expressly or by implication, limit, define or extend the specific terms of the section so designated. (e) Governing Law. The validity, enforceability, and interpretation of this Agreement shall be determined and governed by the internal laws of the State of Texas (and not the law of conflicts). 6 7 (f) Entire Agreement. This Agreement and those documents expressly referred to herein contain all the terms and conditions agreed upon by the parties, and supersedes all prior understandings, writings, proposals, representations, or communications, oral or written, of the parties hereto. (g) Authority. Company and Client warrant that each has full power and authority to enter into and perform this Agreement, and the person signing this Agreement on behalf of each party certifies that such person has been properly authorized and empowered to enter into this Agreement on behalf of such party. (h) Non-Waiver. The failure of either party to insist, in any one or more instances, upon performance of any of the terms, covenants or conditions of this Agreement shall not be construed as a waiver or a relinquishment of any right or claim granted or arising hereunder or of the future performance of any such term, covenant, or condition, and such failure shall in no way affect the validity of this Agreement or the rights and obligations of the parties hereunder. (i) Survival. Should any part, term or condition of this Agreement be declared illegal or unenforceable or in conflict with any other laws, the remaining provisions shall be valid and not affected thereby. (j) Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original and all of which taken together shall constitute one and the same instrument. (k) Further Assurances. From time to time upon request and without further consideration, the parties hereto shall, and shall cause their subsidiaries and affiliates, to execute, deliver or acknowledge such documents and do such further acts as the other party hereto may reasonably require to effectuate its obligations contemplated by this Agreement. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed and delivered by their proper and duly authorized officers on the date first above written. By executing the Agreement, the undersigned individuals hereby warrant and represent that they have read this Agreement in its entirety and agree to all its terms. ADVANCE PARADIGM, INC. By: David D. Halbert Chairman of the Board and Chief Executive Officer WELLMARK, INC. By: ---------------------------------------------- Name: -------------------------------------------- Title: ------------------------------------------- 7 8 EXHIBITS Exhibit A Warrant Certificate Exhibit B Stockholders Agreement
8 9 EXHIBIT A THIS WARRANT CERTIFICATE AND THE UNDERLYING SHARES HEREOF HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY NOT BE SOLD OR TRANSFERRED UNLESS THERE IS AN EFFECTIVE REGISTRATION STATEMENT UNDER SUCH ACT COVERING SUCH SECURITIES OR THE COMPANY RECEIVES AN OPINION OF COUNSEL (WHICH MAY BE COUNSEL FOR THE COMPANY) STATING THAT SUCH SALE OR TRANSFER IS EXEMPT FROM THE REGISTRATION AND PROSPECTUS DELIVERY REQUIREMENTS OF SUCH ACT. For Purchase of Shares of Common Stock of ADVANCE PARADIGM, INC. June 12, 1998 THIS CERTIFIES THAT Wellmark, Inc. ("Client"), or registered transferees or assigns, is entitled, subject to the terms and conditions set forth in this warrant certificate, to purchase from Advance Paradigm, Inc., a Delaware corporation (the "Company"), 11,250 (the "Exercise Number") fully paid and nonassessable shares of Common Stock, $0.01 par value per share, of the Company (the "Common Stock"), at any time during the Exercise Period upon payment in full of the Exercise Price. The Initial Exercise Number and Exercise Price shall be subject to adjustment as set forth in the Warrant Agreement referred to below. This warrant certificate is issued pursuant to a Warrant Agreement between Client and the Company dated as of June 12, 1998 (the "Warrant Agreement"), and is subject to all the terms thereof, including the limitations on transferability set forth therein. Capitalized terms used herein as defined terms but not otherwise defined shall have the meaning assigned to such term in the Warrant Agreement. This warrant certificate may be exercised, by the holder hereof, for all shares of Common Stock covered hereby, by the presentation and surrender of this warrant certificate together with the duly executed Election to Purchase in the form attached as hereto, at the principal office of the Company (or at such other address as the Company may designate by notice in writing to the holder hereof at the address of such holder appearing on the books of the Company), and upon payment to the Company of the Exercise Price and execution of the Stockholders Agreement as set forth in the Warrant Agreement. IN WITNESS WHEREOF, the Company has caused this warrant certificate to be duly executed and delivered by its duly authorized officer as an instrument under seal as of the date of first above written. ADVANCE PARADIGM, INC. By: ----------------------------------- David D. Halbert Chairman of the Board and Chief Executive Officer 10 ELECTION TO PURCHASE TO: ADVANCE PARADIGM, INC. (the "Company") The undersigned, owner of the accompanying warrant certificate hereby irrevocably exercises the option to purchase ____ shares of Common Stock in accordance with the terms of such warrant certificate, directs that the shares issuable and deliverable upon such purchase (together with any check for a fractional interest) be issued in the name of and delivered to the undersigned, and makes payment in full therefor at the Exercise Price provided or referenced in such warrant certificate. COMPLETE FOR REGISTRATION OF SHARES OF COMMON STOCK ON THE STOCK TRANSFER RECORDS MAINTAINED BY THE COMPANY: - -------------------------------------------------------------------------------- Name of Warrant Certificate Holder - -------------------------------------------------------------------------------- Address - -------------------------------------------------------------------------------- Federal ID Tax Number or Social Security Number - -------------------------------------------------------------------------------- Date of Exercise (must be at least fifteen days after the date of this Notice) Wellmark, Inc. ----------------------------------------------- Signature ----------------------------------------------- Title ----------------------------------------------- Date 10 11 EXHIBIT B STOCKHOLDER AGREEMENT This Stockholder Agreement dated as of ___________, by and among Wellmark, Inc. an Iowa mutual insurance company (the "STOCKHOLDER"), and Advance Paradigm, Inc., a Delaware corporation (the "COMPANY"). PRELIMINARY STATEMENTS Pursuant to the terms and conditions of the Warrant Agreement, dated as of June 12, 1998, by and between the Company and Stockholder, the Company agreed to issue five (5) warrant certificates to acquire shares of the Company's common stock, par value $.01 per share (the "COMMON STOCK"). Pursuant to the terms of the Warrant Agreement, the Stockholder agreed to execute and enter into this Agreement prior to the issuance of any shares of Common Stock thereunder. NOW THEREFORE, in consideration of the premises and the mutual agreements contained herein and for other good, valuable and binding consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound, hereby agree as follows: STATEMENT OF AGREEMENT 1. Restricted Stock. The terms and conditions of this Agreement shall apply to all shares of Common Stock issued to Stockholder pursuant to the Warrant Agreement (the "STOCK"). 2. Restrictions on Transfers. 2.1 Transfers to Affiliate. (a) Transfers to Affiliates. Stockholder shall be entitled to transfer the Stock held by it to entities that directly or indirectly control, are controlled by, or are under common control with Stockholder (each, an "AFFILIATE"), provided that any such Affiliates first deliver to the Company their written acknowledgment of, and agreement to be bound by, the terms and provisions contained in this Agreement; and the Stockholder delivers to the Company an opinion of counsel, reasonably acceptable in form and substance to the Company and its counsel, that registration under the Securities Act is not required in connection with such transfer. The foregoing notwithstanding, Stockholder shall not, without the prior written consent of the Company which consent will not be unreasonably withheld, transfer any shares of Stock to any Affiliate, nor any officer, director, employee or holder of debt or equity in any Affiliate that is primarily engaged in the business of pharmacy benefit management services, pharmacy network management, pharmacy claims adjudication, mail service pharmacy, pharmacy clinical services and/or the manufacture of drugs, biotech products or biologicals. 11 12 (b) Affiliates' Proxy. In the event that Stockholder transfers less than all of its Stock pursuant to Section 2.1(a), Stockholder shall exercise all of the rights inuring under this Agreement with respect to such transferred Stock and the transferees shall grant Stockholder proxies to exercise such rights. In the event that Stockholder transfers all of its Stock pursuant to Section 2.1(a), one such transferee reasonably acceptable to the Company shall be designated by Stockholder to exercise all rights inuring under this Agreement with respect to such Stock and the other transferees shall grant such designated transferee proxies to exercise such rights. 2.2 Restrictions on Third Party Transfers of the Stock. (a) General. During the first two years following the date the Stock is issued the ("ISSUANCE DATE"), Stockholder agrees that it will not sell, pledge or otherwise transfer any interest in any shares of the Stock to any party that is not an Affiliate, without the prior written consent of the Company. At any time after the second anniversary of the Issuance Date, the Stockholder may sell, pledge or otherwise transfer shares of the Stock to third parties ("THIRD PARTY TRANSFER"); provided that such transfer is in accordance with this Section 2.2, and provided further that the transferring Stockholder delivers to the Company an opinion of counsel, reasonably acceptable in form and substance to the Company and its counsel, that registration under the Securities Act is not required in connection with such transfer. The foregoing notwithstanding, Stockholder agrees that it shall not transfer any shares of Stock to any person or entity, nor any officer or director in any entity that is primarily engaged in the business, or has an affiliate engaged in the business of pharmacy benefit management services, pharmacy network management, pharmacy claims adjudication, mail service pharmacy, pharmacy clinical services, and/or pharmacy outcomes management, or the manufacture of drugs, biotech products or biologicals without the prior written consent of the Company. (b) Sale Notice. At least 30 days prior to making any Third Party Transfer under Section 2.2(a), the transferring Stockholder will deliver a written notice (the "SALE NOTICE") to the Company. The Sale Notice will disclose in reasonable detail the identity of the prospective transferee(s) and the terms and conditions of the proposed transfer. Stockholder agrees not to consummate any such transfer until 30 days after the Sale Notice has been delivered to the Company. (c) First Refusal Rights. The Company may elect to purchase all of the Stock to be transferred upon the same terms and conditions as those set forth in the Sale Notice by delivering a written notice of such election to Stockholder within 15 days after the receipt of the Sale Notice by the Company. If the Company elects to purchase such shares of Stock, the Company shall consummate such purchase within 15 days of delivery of notice of election to purchase. If the Company has not elected to purchase all of the Stock specified in the Sale Notice, Stockholder may transfer the Stock specified in the Sale Notice at a price and on terms no more favorable to the transferee(s) thereof than specified in the Sale Notice during the 60-day period immediately following notice of the Company's election not to purchase such shares. Any shares of Stock not transferred within such 60-day period will be subject to the provisions of this Section 2.2(c) upon subsequent transfer. 12 13 (d) Non-Cash Consideration. In the event the consideration for the Stock as disclosed in the Sale Notice is other than cash, a promissory note or a combination thereof, the price for the Stock shall be the value of that consideration as agreed to by the transferring Stockholder and the Company, or, if no agreement can be reached as to the valuation of such consideration, the fair market value of such consideration as determined by two appraisers (one appointed by the Stockholder and one appointed by the Company). In the event the two appraisers are unable to agree on a fair market value within 10 days after they are appointed, the fair market value of the consideration shall be the average of the appraised values of the two appraisers; provided, however, that if the appraised values of the two appraisers differ by more than five percent (5%) of the higher of the two appraised values, the two respective appointed appraisers shall select a third appraiser who shall independently, within 10 days after this appointment, make a determination of the value of the consideration and the average of the appraised values of the three appraisers shall be the purchase price and shall be binding on the parties hereto. The transferring Stockholder and the Company shall each bear the cost of their respective appraisers and shall share the cost equally of the third appraiser, if any. Notwithstanding anything herein to the contrary, if an appraisal is used to determine the value of the consideration pursuant to this Section 2.2(d), the time periods provided for in Sections 2.2(b) and 2.2(c) shall be tolled from the time of the initial appointment of the two appraisers until a final appraised value is determined pursuant to this Section 2.2(d). (e) Public Sale. Notwithstanding the foregoing, at any time after the first anniversary of the Issuance Date, the Stockholder may sell, pledge or otherwise transfer shares of the Stock to the public in a market transaction without complying with the restrictions set forth in Section 2.2(b), (c) and (d). 2.3 Legend. The certificates representing the Stock will bear the following legend: "THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY BE REOFFERED AND SOLD ONLY IF SO REGISTERED OR IF AN EXEMPTION FROM SUCH REGISTRATION IS AVAILABLE. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE ALSO SUBJECT TO ADDITIONAL RESTRICTIONS ON TRANSFER, CERTAIN REPURCHASE OPTIONS AND CERTAIN OTHER AGREEMENTS SET FORTH IN A STOCKHOLDER AGREEMENT BETWEEN THE COMPANY AND WELLMARK, INC., DATED AS OF [DATE], A COPY OF WHICH MAY BE OBTAINED BY THE HOLDER HEREOF AT THE COMPANY'S PRINCIPAL PLACE OF BUSINESS WITHOUT CHARGE." Any legend endorsed on a certificate pursuant to Section 2.3 hereof and the stop transfer instructions and record notations with respect thereto shall be removed and the Company shall issue a certificate without such legend to the holder thereof at such time as the securities evidenced thereby cease to be restricted securities 13 14 2.4 Extraordinary Transaction. In the event of a merger of the Company with a third party where the Company is not the surviving entity, sale of a majority of the capital stock of the Company, or the sale of all or substantially all of its assets ("EXTRAORDINARY TRANSACTION"), the Stock shall be entitled to receive the same benefits as the holders of the Common Stock will receive in the Extraordinary Transaction. The Stockholder agrees to consent to and execute all required documents in connection with the Extraordinary Transaction. 2.5 Limitation on Stock Holdings. The Stockholder agrees that in no event, shall it, either independently or together with its Affiliates, own Common Stock or rights to acquire Common Stock, that represent, or if converted to Common Stock would represent, more than ten percent (10%) of the Company's issued and outstanding Common Stock, without the Company's prior written consent. 3. Notices. All notices and other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered personally, mailed by certified mail (return receipt requested) or sent by express delivery service, or facsimile transmission (confirmed by telephone conversation and followed by overnight delivery) to the parties at the following addresses or at such other addresses as shall be specified by the parties by like notice: if to the Company: Advance Paradigm, Inc. Attn: General Counsel 545 E. John Carpenter Freeway Suite 1570 Irving, Texas 75062 Fax No.: (972) 830-6196 if to Stockholder: Wellmark, Inc. Attn: Linda Sufficool 636 Grand Avenue Des Moines, Iowa 50309 Fax No.: (515) 245-6000 Notice so given shall, in the case of notice so given by certified mail, be deemed to be given and received on the date of actual delivery, in the case of notice so given by express delivery service, on the date of actual delivery and, in the case of notice so given by facsimile transmission or personal delivery, on the date of actual transmission or personal delivery, as the case may be. 14 15 4. Severability. If any provision of this Agreement shall be held to be illegal, invalid or unenforceable under any applicable law, then such contravention or invalidity shall not invalidate the entire Agreement. Such provision shall be deemed to be modified to the extent necessary to render it legal, valid and enforceable, and if no such modification shall render it legal, valid and enforceable, then this Agreement shall be construed as if not containing the provision held to be invalid, and the rights and obligations of the parties shall be construed and enforced accordingly. 5. Complete Agreement. This Agreement and those documents expressly referred to herein and of even date herewith, embody the complete agreement and understanding among the parties and supersede and preempt any prior understandings, agreements or representations by or among the parties, written or oral, which may have related to the subject matter hereof in any way. 6. Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, with the same effect as if all parties had signed the same document. All such counterparts shall be deemed an original, shall be construed together and shall constitute one and the same instrument. 7. Successors and Assigns. This Agreement is intended to bind and inure to the benefit of and be enforceable by and against the Stockholder and the Company, and their respective heirs, successors and assigns. Stockholder hereby agrees not to transfer or assign, directly or indirectly, any of the Stock (other than through a market sale) unless such transferee or assignee agrees in writing (i) to be bound by the provisions of this Agreement and (ii) not to make subsequent assignments or transfers other than in accordance with this Agreement. Notwithstanding the foregoing, any holder of the Stock (other than a holder who purchases the Stock through a market sale) shall be bound by the provisions of this Agreement even if such holder is not a party hereto or otherwise agreed in writing to be bound by the provisions hereof. 8. CHOICE OF LAW. THE INTERNAL LAW OF THE STATE OF TEXAS (AND NOT THE LAW OF CONFLICTS) WILL GOVERN THE CONSTRUCTION, VALIDITY AND INTERPRETATION OF THIS AGREEMENT. 9. Remedies. Each of the parties to this Agreement will be entitled to enforce its rights under this Agreement specifically, to recover damages by reason of any breach of any provision of this Agreement and to exercise all other rights existing in its favor. The parties hereto agree and 15 16 acknowledge that money damages may not be an adequate remedy for any breach of the provisions of this Agreement and that any party may in its sole discretion apply to any court of law or equity of competent jurisdiction for specific performance and/or injunctive relief in order to enforce or prevent any violations of the provisions of this Agreement. In the event a party hereto brings an action under this agreement, the prevailing party in such dispute shall be entitled to recover from the losing party all fees, costs and expenses of enforcing any right of such prevailing party under or with respect to this Agreement, including without limitation such reasonable fees and expenses of attorneys and accountants, which shall include, without limitation, all fees, costs and expenses of appeals. 16 17 10. Amendments and Waivers. Any provision of this Agreement may be amended or waived only with the prior written consent of each of the parties hereto. IN WITNESS WHEREOF, the parties have executed this Agreement on the day and year first above written. ADVANCE PARADIGM, INC. By: ---------------------------- Name: -------------------------- Title: ------------------------- WELLMARK, INC. By: ---------------------------- Name: -------------------------- Title: ------------------------- 17 EX-10.19 4 COMMERCIAL LEASE AGREEMENT-NOVEMBER 1, 1998 1 EXHIBIT 10.19 COMMERCIAL LEASE AGREEMENT CRIN - RICHARDSON I, L.P. (LANDLORD) AND ADVANCE PARADIGM, INC. (TENANT) ---------------------------------------- Address: 1300 East Campbell Road Richardson, TX 75081 ---------------------------------------- 2 TABLE OF CONTENTS
Page No. -------- 1. PREMISES, TERM, AND EXISTING IMPROVEMENTS................................................................1 2. BASE RENT AND ADDITIONAL RENT............................................................................1 3. TAXES....................................................................................................3 4. LANDLORD'S MAINTENANCE...................................................................................3 5. TENANT'S MAINTENANCE AND REPAIR OBLIGATIONS..............................................................4 7. WINDOW TREATMENTS........................................................................................5 8. UTILITIES................................................................................................5 9. INSURANCE................................................................................................6 10. CASUALTY DAMAGE..........................................................................................6 11. LIABILITY, INDEMNIFICATION...............................................................................6 12. USE......................................................................................................7 13. INSPECTION...............................................................................................7 14. ASSIGNMENT AND SUBLETTING................................................................................7 15. CONDEMNATION.............................................................................................9 16. SURRENDER OF PREMISES; HOLDING OVER......................................................................9 17. QUIET ENJOYMENT.........................................................................................10 18. EVENTS OF DEFAULT.......................................................................................10 19. REMEDIES................................................................................................10 20. LANDLORD'S DEFAULT......................................................................................12 21. MORTGAGES...............................................................................................12 22. ENCUMBRANCES............................................................................................12 23. MISCELLANEOUS...........................................................................................12 24. NOTICES.................................................................................................14 25. HAZARDOUS WASTE.........................................................................................14 26. LANDLORD'S LIEN.........................................................................................15 27. NO OFFER................................................................................................15 28. NO WARRANTIES...........................................................................................15 29. EXHIBITS................................................................................................15 30. SPECIAL PROVISIONS......................................................................................16
i 3 LIST OF DEFINED TERMS
Page No. AAA.................................................................7 Abatement Period....................................................1 Additional Rent.....................................................1 Additional Space..................................................E-1 Affiliate...........................................................9 Base Rent...........................................................1 Building............................................................1 Building Structure..................................................3 Claimant ...........................................................9 Commencement Date...................................................1 Construction Allowance..............................................4 Environmental Law..................................................11 Event of Default....................................................7 Existing Improvements...............................................1 Extension Notice..................................................C-1 Generator..........................................................12 Hazardous Substances...............................................11 HVAC System.........................................................3 including..........................................................10 Initial Improvements...............................................4 Land................................................................1 Landlord............................................................1 Landlord's Mortgagee................................................9 Landlord's Proposal...............................................D-1 Law.................................................................9 Laws................................................................9 Lease...............................................................1 Lease Month.........................................................2 Legal Requirements.................................................12 Loss................................................................5 Mortgage............................................................9 MSDS...............................................................11 Need................................................................3 New Parking Area Construction Costs..............................D-1 New Parking Area.................................................D-1 Offer Notice......................................................E-1 Operating Expenses..................................................1 Parking Area Construction Financing...............................D-1 Permitted Activities...............................................11 Permitted Materials................................................11 Permitted Transfer..................................................6 Permitted Transferee................................................6 Possession Date.....................................................1 Premises............................................................1 Primary Lease.......................................................9 Rent................................................................2 Repair Allowance..................................................F-1 Repair Period.......................................................5 Sign...............................................................12 Sign Requirements..................................................12
ii 4 Taking..............................................................7 Tangible Net Worth..................................................6 Taxes...............................................................2 Tenant..............................................................1 Tenant Party.......................................................10 Term................................................................1 Third Party Offer.................................................E-1 Total Construction Costs............................................4 Transfer............................................................6 Vacation Date.......................................................5 Work..............................................................B-1 Working Drawings..................................................B-1
iii 5 LEASE AGREEMENT This Lease Agreement (this "LEASE") is entered into by CRIN-RICHARDSON I, L.P., a Delaware limited partnership ("LANDLORD"), and ADVANCE PARADIGM, INC., a Delaware corporation ("TENANT"). 1. PREMISES, TERM, AND EXISTING IMPROVEMENTS (a) Landlord leases to Tenant, and Tenant leases from Landlord, the real property described on Exhibit A (the "PREMISES"), which includes the approximately 52,000 rentable square foot building (the "BUILDING") located on the real property described on Exhibit A1 (the "LAND"), subject to the terms and conditions in this Lease. The calculation of rentable square feet contained within the Premises shall be subject to measurement and verification by Landlord's and Tenant's architects according to BOMA Standards, and in the event of a variation, Landlord and Tenant agree to amend this Lease accordingly. (b) The Lease term shall be 132 months, beginning on the Commencement Date (defined below) (the "TERM", which defined term shall include all renewals and extensions of the Term); however, if the Commencement Date is not the first day of a calender month, then the Term shall end on the last day of the 132-month period that begins with the first day of the first full calendar month of the Term. The "POSSESSION DATE" shall mean the date that the current tenant of the Building has vacated the Premises. Landlord shall provide Tenant immediate written notice of the Possession Date and amount of prepaid Rent due in accordance with this section and Section 2(d). The "COMMENCEMENT DATE" shall be the earlier to occur of (i) the date on which Tenant occupies more than 3,500 square feet on of the Premises and begins conducting business therein, or (ii) 90 days after the Possession Date; provided, however, that if the Possession Date has not occurred by August 15, 1998, then Landlord shall abate Base Rent and additional Rent under Section 2 (b) from the date Tenant would otherwise be obligated to commence paying Rent hereunder, for a period (the "ABATEMENT PERIOD") equal to one day for each day after August 15, 1998 that possession of the Premises is not so tendered to Tenant; provided further, however, that if the Possession Date has not occurred by September 30, 1998, either Landlord or Tenant may terminate this Lease by delivering written notice thereof to the other. If either party terminates this Lease pursuant to this Section 1.(b), Landlord shall reimburse Tenant for Tenant's out-of-pocket expenses relating to this Lease. (c) Tenant may during the Term, at its sole risk and expense, use any existing fixtures, improvements or equipment in the Premises (the "EXISTING IMPROVEMENTS"). Unless expressly stated otherwise in this section, Landlord makes no representation or warranties regarding the Existing Improvements, including without limitation that the Existing Improvements comply with any Laws (defined below). Landlord shall not be required to perform any repairs other than those outlined on Exhibit F attached hereto or maintenance of the Existing Improvements. By occupying the Premises, Tenant shall have accepted the Premises in their "As-Is" condition, subject to Exhibit F. Landlord warrants that on the Possession Date Landlord will own all Existing Improvements constituting non-trade fixtures then in the Premises. 2. BASE RENT AND ADDITIONAL RENT (a) Tenant shall pay to Landlord "BASE RENT", in advance, without demand, deduction or set off, unless otherwise specified herein, equal to the following amounts for the following months of the term:
=========================================================== Lease Month Monthly Base Rent - ----------------------------------------------------------- 1 through 12 $36,250.00 - ----------------------------------------------------------- 13 through 72 $60,812.50 - ----------------------------------------------------------- 73 through 132 $66,879.16 ===========================================================
1 6 (b) Tenant shall pay, as Additional Rent, all costs incurred in owning, managing, operating and maintaining the Premises and the facilities and services provided for the use of Tenant (collectively, "OPERATING EXPENSES"), including the following items: (1) Taxes (defined below) and the cost of any tax consultant employed to assist Landlord in determining the fair tax valuation of the Premises; (2) the cost of insurance; (3) the cost of management fees and expenses; (4) the cost of dues actually incurred by Landlord, assessments, and other charges applicable to the Premises payable to any property or community owner association under restrictive covenants or deed restrictions to which the Premises are subject; and (5) alterations, additions, and improvements made by Landlord to comply with Law (defined below). Additional Rent under this Section 2.(b) shall be payable by Tenant to Landlord in monthly installments equal to 1/12 of Landlord's estimate of the annual Operating Expenses. The initial monthly payments are based upon Landlord's estimate of the Operating Expenses for the year in question, and shall be increased or decreased annually to reflect the projected actual Operating Expenses for that year. Within 90 days after each calendar year or as soon thereafter as is reasonably practicable, Landlord shall deliver to Tenant a statement setting forth the actual Operating Expenses for such year. If Tenant's total payments in respect of Operating Expenses for any year are less than the Operating Expenses for that year, Tenant shall pay the difference to Landlord within ten business days after receipt of Landlord's written request therefor; if such payments are more than such Operating Expenses, Landlord shall retain such excess and credit it against Tenant's future annual payments. Operating Expenses shall not include the following: (A) any costs for interest, amortization, or other payments on loans to Landlord; (B) federal income taxes imposed on or measured by the income of Landlord from the operation of the Building; (C) rents under ground leases; (D) costs incurred in selling, syndicating, financing, mortgaging, or hypothecating any of Landlord's interests in the Premises; and (E) overhead and profit increment paid to Affiliates of Landlord or its partners for services (including insurance) on or to the Building, to the extent that the costs of such services exceed competitive costs for such services rendered by persons or entities of similar skill, competence and experience, other than an Affiliate of Landlord or its partners. There shall be no duplication of costs for reimbursements in calculating Operating Expenses. The amounts of the initial monthly installments of Base Rent and Operating Expenses (and the portion thereof attributable to Taxes) are as follows: Base Rent (Section 2.(a)).............................. $36,250.00 Operating Expenses, excluding Taxes (Section 2.(b)).... $ 1,511.88 Taxes (Sections 2.(b) and 3.(a))....................... $ 5,416.67 Total initial monthly payment.......................... $43,178.55 =========
(c) All payments and reimbursements required to be made by Tenant under this Lease shall constitute "RENT" (herein so called) and shall be payable without demand, deduction or set off, unless otherwise specified. (d) As used herein, the term "LEASE MONTH" shall mean each calendar month during the Term. If the Commencement Date does not occur on the first day of a calendar month, the Rent for the period from the Commencement Date through the last day of such calendar month shall be included in the second full Lease Month, and Tenant shall pay as monthly Rent an amount for such partial month equal to $43,178.55 multiplied by a fraction whose numerator is the number of days in the Term which falls within such month and whose denominator is the number of days in such month. The Rent for the first full Lease Month shall be prepaid within three (3) business days of receipt of Landlord's written notice of the Possession Date; thereafter, monthly installments of Rent and additional rent shall be due on the first day of each calendar month following the Commencement Date. Any abatement amount accrued under Section 1.(b) not deducted from the first full Lease Month Rent shall be deducted by Tenant from the second full Lease Month Rent. (e) All payments required of Tenant hereunder shall bear interest from the date due until paid at the maximum lawful rate. Alternatively, after Landlord has twice delivered to Tenant written notice of its failure to pay Rent when due, then Landlord may, without delivering to Tenant notice of such delinquency, charge Tenant a fee equal to 5% of any future delinquency payment during the 12-month period following such delinquency to reimburse 2 7 Landlord for its cost and inconvenience as a consequence of Tenant's delinquency. In no event, however, shall the charges permitted under this Section 2.(e) or elsewhere in this Lease, to the extent they are considered to be interest under applicable law, exceed the maximum lawful rate of interest. 3. TAXES. (a) Landlord shall pay all taxes, assessments and governmental charges whether federal, state, county, or municipal and whether they are imposed by taxing or management districts or authorities presently existing or hereafter created (collectively, "TAXES") that accrue against the Premises. If, during the Term, there is levied, assessed or imposed on Landlord a capital levy or other tax directly on the Rent or a franchise tax, assessment, levy or charge measured by or based, in whole or in part, upon Rent, then all such taxes, assessments, levies or charges, or the part thereof so measured or based, shall be included within the term "Taxes". "Taxes" shall not include any corporate income tax levied on Landlord. (b) Tenant shall (1) before delinquency pay all taxes levied or assessed against any personal property, fixtures or alterations placed in the Premises and (2) upon the request of Landlord, deliver to Landlord receipts from the applicable taxing authority or other evidence acceptable to Landlord to verify that such taxes have been paid. If any such taxes are levied or assessed against Landlord or Landlord's property and (A) Landlord pays them or (B) the assessed value of Landlord's property is increased thereby and Landlord pays the increased taxes, then Tenant shall pay to Landlord such taxes within 10 business days after receipt of Landlord's written request therefor; however, Landlord shall not pay such amounts if Tenant notifies Landlord that it will contest the validity or amount of such taxes and thereafter diligently proceeds with such contest in accordance with applicable Law and the non-payment thereof does not pose a threat of loss or seizure of the Building or interest of Landlord therein. If Tenant notifies Landlord that it will contest the validity or amount of taxes, Landlord shall cooperate with Tenant, at Tenant's request, in such contest. Tenant hereby agrees to reimburse Landlord for any reasonable costs incurred in contesting the taxes. 4. LANDLORD'S MAINTENANCE. (a) This Lease is intended to be a net lease; accordingly, Landlord's maintenance obligations are limited to the repair and replacement of the Building's roof as provided in Section 4.(b) and maintenance of the foundation and structural members of the exterior walls; however, subject to Section 4.(b) Landlord shall not be responsible (1) for any such work until Tenant delivers to Landlord written notice of the need therefor and Landlord agrees such work is necessary or (2) for alterations to the Building's Structure required by Law because of Tenant's use of the Premises (which alterations shall be performed by Tenant). The Building's Structure does not include skylights, windows, glass or plate glass, doors, special store fronts or office entries, all of which shall be maintained by Tenant. Subject to Section 11.(a), Landlord's liability for any defects, repairs, replacement or maintenance for which Landlord is responsible hereunder shall be limited to the cost of performing such work. (b) Landlord shall repair and maintain the Building's roof throughout the term of this Lease. Landlord shall complete replacement of the roof during the first half of the fourth year of the term of this Lease or earlier if, despite repeated repair, leaks or instability in the roof pose a risk to the safety and security of Tenant's employees and business invitees and/or personal property or repeated repairs unduly interfere with Tenant's business operations ("NEED"); provided, however, that in the event a reputable third party engineer who is mutually agreed upon by both Landlord and Tenant certifies the Need for roof replacement prior to the commencement of the first half of the fourth year of the term of this Lease, then Landlord shall commence replacement of the roof within thirty (30) days of receipt of such third party engineer's report. Landlord's approval of the third party engineer shall not be unreasonably withheld, delayed, or conditioned, and Landlord shall reimburse Tenant for its costs incurred in connection with the third party engineer. To the extent possible, Landlord shall repair and replace the roof with minimal interference with Tenant's business operations. (c) If (1) Tenant fails to commence any of Tenant's maintenance, repair and replacement obligations or any other items that are Tenant's obligation pursuant to Section 5 within fifteen business days after receipt of written notice by Landlord of the occurrence of damage or the need for repair and thereafter diligently to pursue the 3 8 completion thereof or (2) notwithstanding such diligence, Tenant fails to complete such repairs or replacements within 60 days of receipt of notice, then Landlord shall make the same at Tenant's cost. If any such damage is considered an emergency, in Landlord's sole determination then Landlord may elect to repair such damage at Tenant's expense, rather than having Tenant repair such damage. The cost of all replacement or repair work performed by Landlord under this Section 4.(c) shall be paid by Tenant to Landlord within 10 business days after Tenant receives Landlord's invoice. 5. TENANT'S MAINTENANCE AND REPAIR OBLIGATIONS. (a) Tenant shall maintain all parts of the Premises (except for maintenance work which Landlord is expressly responsible for under Section 5.(d)) in good condition and promptly make all necessary repairs and replacements to the Premises. Tenant shall repair and pay for any damage caused by a Tenant Party (defined below) or caused by Tenant's default hereunder. (b) Tenant shall maintain the parking areas, sidewalks, driveways, alleys and grounds located on the Land in a clean and sanitary condition, consistent with the operation of a first-class office/warehouse building, including, without limitation, prompt maintenance, repairs and replacements of (1) the exterior of the Building (including painting), (2) landscaping, (3) sprinkler systems and sewage lines, four (4) parking areas and any other items normally associated with the foregoing. Tenant may request Landlord to perform any or all Tenant's repair, replacement, and maintenance obligations and if Landlord does so, then Tenant shall reimburse Landlord for the cost thereof within ten (10) business days after Tenant receives an invoice therefor. (c) Tenant shall maintain the hot water equipment and the heating, air condition, and ventilation equipment and system (the "HVAC SYSTEM") in good repair and condition and in accordance with all Laws and with such equipment manufacturers' suggested operation/maintenance service program to the extent Landlord provides Tenant with notice thereof. Such obligation shall include repair and replacement of all equipment necessary to maintain such equipment and system in good working order. Within 30 days after the Commencement Date, Tenant shall enter into regularly scheduled preventive maintenance/service contracts for such equipment, in a form and substance and with a contractor reasonably acceptable to Landlord, and deliver copies thereof to Landlord. At least 14 days before the end of the Term, Tenant shall deliver to Landlord a certificate from an engineer mutually acceptable to Landlord and Tenant certifying that the hot water equipment and the HVAC System are then in good repair and working order. (d) Tenant shall be responsible for all pest control in the Premises. If requested by Landlord (such request must be in writing and be accompanied by the recommendation of an independent pest control expert), Tenant shall enter into a regularly scheduled termite control contract with a contractor reasonably acceptable to Landlord. At Landlord's election and with advance written notice to Tenant, Landlord may perform the work required under this Section 5.(d), at Tenant's expense. 6. ALTERATIONS. (a) Tenant shall not make any alterations, additions or improvements to the Premises which affect the Building's Structure (defined below) without the prior written consent of Landlord. Landlord shall not be required to notify Tenant of whether it consents to any such alteration, addition or improvements until it (1) has received plans and specifications thereof which are sufficiently detailed to allow construction of the work depicted thereon to be performed in a good and workmanlike manner and (2) has had a reasonable opportunity, not to exceed 10 business days, to review them. If the alteration, addition or improvement will affect the Building's roof, foundation and structural elements (the roof, foundation, and structural elements herein collectively called the "BUILDING STRUCTURE"), HVAC System, or mechanical, electrical, or plumbing systems, then the plans and specifications therefor must be prepared by a licensed engineer reasonably acceptable to Landlord. Landlord's approval of any plans and specifications shall not be a representation that the plans or the work depicted thereon will comply with Law or be adequate for any purpose, but shall merely be Landlord's consent to performance of the work. Upon completion of any alteration, addition, or improvement, Tenant shall deliver to Landlord accurate, reproducible as-built plans therefor. Unless Landlord specifies in writing otherwise, all alterations, additions, improvements, and fixtures shall be Landlord's property when installed in the Premises, except for furniture and equipment of Tenant which is not affixed to the Premises so as to become a fixture (i.e., unattached items and items which are temporarily attached by bolts and screws, but not items which are built-in or incorporated into the Building or the electrical, plumbing, or mechanical systems therein). In addition, Tenant may erect shelves, bins, and trade fixtures provided that such items (A) do not alter 4 9 the basic character of the Premises; (B) do not overload or damage the Premises; and (C) may be removed without damage to the Premises (normal wear and tear excepted). All work performed by a Tenant Party in the Premises (including that relating to the installations, repair, replacement, or removal of any item) shall be performed in accordance with all Laws and with Landlord's specifications and requirements, in a good and workmanlike manner, and so as not to damage or alter the Building's Structure or the Premises, provided, however, that Tenant may make non-structural alterations, additions or improvements to the Premises at an estimated cost of up to $25,000 without Landlord's prior written consent, specifications and requirements. (b) INITIAL TENANT IMPROVEMENTS. Tenant shall construct the initial tenant improvements following the Possession Date and during the first 18 months of the Term (those improvements completed during such period are herein called the "INITIAL IMPROVEMENTS") in accordance with Exhibit B, at Tenant's expense, except as provided below. (1) Tenant shall bear the entire cost of performing the Work (defined below) relating to the Initial Improvements (including, without limitation, design of the Initial Improvements and preparation of the Working Drawings, costs of construction labor and materials, electrical usage during construction, additional janitorial services, general tenant signage, related taxes and insurance costs relating thereto, all of which are herein collectively called the ("TOTAL CONSTRUCTION COSTS") in excess of the Construction Allowance. Upon the approval of the Working Drawings for the Initial Improvements and selection of a contractor, Tenant shall promptly execute a mutually agreeable work order agreement prepared by Landlord which identifies such drawings, itemizes the Total Construction Costs and sets forth the Construction Allowance. (2) Provided no Event of Default exists, Landlord shall provide to Tenant a construction allowance for the Initial Improvements the "CONSTRUCTION ALLOWANCE") equal to the lesser of (A) the Total Construction Costs incurred for the Initial Improvements or (B) $624,000, of which a minimum of $520,000 of the Construction Allowance must be utilized to improve the Premises. The Construction Allowance shall be disbursed in monthly advances based on the cost of work incurred. Tenant shall submit to Landlord (but not more frequently than once per month) Construction Allowance requests accompanied by all invoices from contractors, subcontractors, and suppliers evidencing the cost of performing the Work for which the request is being submitted, together with lien waivers from such parties. Provided that no Event of Default exists, Landlord shall make advances of the Construction Allowance within 30 days after its receipt of the advance request accompanied by the appropriate documentation; however, the final draw of the amount of the applicable allowance utilized to improve the Premises, which shall be 10% of the amount of such allowance allocated to improvement, shall not be disbursed until Landlord has received final lien waivers from all persons performing work or supplying materials for the Initial Improvements and certificate of occupancy from the appropriate governmental authority, if applicable to the Work for the Initial Improvements or, if applicable, evidence of governmental inspection and approval of the Work for the Initial Improvements. Any amount of the Construction Allowance above the minimum which must be utilized to improve the Premises shall be credited against Tenant's Rent during the first year of the Term. 7. WINDOW TREATMENTS. Tenant shall not place, install or attach any decorations, advertising media, blinds, draperies, window treatments, bars, or security installations to the Premises or the Building which are visible from the outside of the Building without Landlord's prior written approval which approval may be withheld in Landlord's sole discretion, provided that Landlord shall not unreasonably delay notifying Tenant of its decision. Tenant shall not (a) make any changes to the exterior of the Premises or the Building, (b) install any exterior lights, decorations, balloons, flags, pennants, banners or paintings, or (c) erect or install any signs, windows or door lettering, decals, window or storefront stickers, placards, decorations or advertising media of any type that is visible from the exterior of the Premises without Landlord's prior written consent. 8. UTILITIES. Tenant shall obtain and pay for all water, gas, electricity, heat, telephone, sewer, sprinkler charges and other utilities and services used at the Premises, together with any taxes, penalties, surcharges, maintenance charges, and the like pertaining to the Tenant's use of the Premises. Landlord shall not be liable for any interruption or failure of utility service to the Premises. If Tenant fails to pay any such amounts when due, Landlord 5 10 may, after notifying Tenant in writing of the amounts due, and giving Tenant 10 business days to pay such amount, to do so, in which case, Tenant shall reimburse Landlord for all amounts paid by Landlord within 10 business days after Tenant receives Landlord's invoice therefor. Landlord agrees it will not pay any amounts due in the event Tenant, in good faith, is disputing any charges from such providers. 9. INSURANCE. Tenant shall maintain (a) workers' compensation insurance (with a waiver of subrogation endorsement reasonably acceptable to Landlord) and commercial general liability insurance (with contractual liability endorsement), including personal injury and property damage in the amount of $1,000,000 per occurrence combined single limit for personal injuries and death of persons and property damage occurring in or about the Premises, plus umbrella coverage of at least $3,000,000 per occurrence, (b) fire and extended coverage insurance covering (1) the replacement cost of all alterations, additions, partitions and improvements installed in the Premises, (2) the replacement cost of all of Tenant's personal property in the Premises, and (3) loss of profits in the event of an insured peril damaging the Premises, and (c) such other insurance as Landlord may reasonably require. Such policies, other than worker's compensation, shall (A) name Landlord, Landlord's Mortgagee, Landlord's agents, and their respective Affiliates (defined below), as additional insureds (and as loss payees on the fire and extended coverage insurance), (B) be issued by an insurance company rated "A-X" or better as established by Best's Rating Guide or (C) provided that Landlord shall receive 30 days' prior written notice of cancellation, (D) be delivered to Landlord by Tenant before the Commencement Date and at least 15 days before each renewal thereof, and (E) provide primary coverage to Landlord when any policy issued to Landlord is similar or duplicate in coverage, in which case Landlord's policy shall be excess over Tenant's policies. 10. CASUALTY DAMAGE. (a) Tenant immediately shall give written notice to Landlord of any damage to the Premises. If the Premises are totally destroyed by an insured peril or so damaged by an insured peril that, in Landlord's estimation , rebuilding or repairs cannot be substantially completed within 210 days after the date of Landlord's actual knowledge of such damage, then Landlord shall immediately notify Tenant in writing of its intent not to rebuild. Landlord or (if a Tenant Party did not intentionally cause such damage) Tenant may terminate this Lease by delivering to the other written notice thereof within 30 days after Tenant's receipt of Landlord's notice of intent not to rebuild, in which case, the Rent shall be abated during the unexpired portion of this Lease, effective upon the date such damage occurred. Time is of the essence with respect to the delivery of such notices. (b) Subject to Section 10.(c), if this Lease is not terminated under Section 10.(a), then Landlord shall restore the Premises to substantially its previous condition, except that Landlord shall not be required to rebuild, repair or replace any part of the partitions, fixtures, additions and other improvements or personal property required to be covered by Tenant's insurance under Section 9. If the Premises are untenantable, in whole or in part, during the period beginning on the date such damage occurred and ending on the date of substantial completion of Landlord's repair or restoration work (the "REPAIR PERIOD"), then the Rent for such period shall be reduced to such extent as may be fair and reasonable under the circumstances and the Term shall be extended by the number of days in the Repair Period. (c) If the Premises are destroyed or substantially damaged by any peril not covered by the insurance maintained by Landlord or any Landlord's Mortgagee (defined below) requires that insurance proceeds be applied to the indebtedness secured by its Mortgage (defined below) or to the Primary Lease (defined below) obligations, Landlord may terminate this Lease by delivering written notice of termination to Tenant within 15 days after such destruction or damage or such requirement is made known by any such Landlord's Mortgagee, as applicable, whereupon all rights and obligations hereunder shall cease and terminate, except for any liabilities of, Landlord and Tenant which accrued before this Lease is terminated. 11. LIABILITY, INDEMNIFICATION, WAIVER OF SUBROGATION AND NEGLIGENCE CLAIMS. (a) Subject to Section 11.(b) Tenant shall defend, indemnify, and hold harmless Landlord and its agents from and against all claims, demands, liabilities, causes of action, suits, judgments, and expenses (including 6 11 attorneys' fees) for any injury to or death of any person or persons or the damage to or theft, destruction, loss, or loss of use of any property or inconvenience (A "LOSS") (other than a Loss arising from the ordinary or gross negligence or willful misconduct of Landlord or its agents or employees), arising from any occurrence on the Premises. Subject to Section 11.(b), Landlord shall indemnify, defend, and hold harmless Tenant, its successors, assigns, agents, employees, contractors, partners, directors, officers, subsidiaries and affiliates from and against all fines, suits, losses, costs, liabilities, claims, demands, actions and judgments of every kind and character arising out of the ordinary or gross negligence or willful misconduct of Landlord or any of its duly authorized agents or employees. These indemnity provisions shall survive termination or expiration of this Lease. (b) Landlord and Tenant each waives any claim it might have against the other for any damage to or theft, destruction, loss, or loss of use of any property, to the extent the same is insured against under any insurance policy maintained by it that covers the Premises, Landlord's or Tenant's fixtures, personal property, leasehold improvements, or business, or is required to be insured against by the waiving party under the terms hereof, REGARDLESS OF WHETHER THE NEGLIGENCE OR FAULT OF THE OTHER PARTY CAUSED SUCH LOSS; HOWEVER, LANDLORD'S WAIVER SHALL NOT APPLY TO ANY DEDUCTIBLE AMOUNTS MAINTAINED BY LANDLORD UNDER ITS INSURANCE. Each party shall cause its insurance carrier to endorse all applicable policies waiving the carrier's rights of recovery under subrogation or otherwise against the other party. The deductible amount shall not exceed $25,000 without Tenant's prior written consent. 12. USE. Tenant shall continuously occupy and use the Premises only for general office use and shall comply with all laws, orders, rules, and regulations relating to the use, condition, and occupancy of the Premises. The Premises shall not be used for any use which is disreputable or creates extraordinary fire hazards or results in an increased rate of insurance on the Building or its contents or the storage of any hazardous materials or substances. If, because of Tenant's acts, the rate of insurance on the Building or its contents increases, failing Tenant's cure of such condition within 10 business days of receipt of Landlord's written notice of such condition, then Tenant shall pay to Landlord the amount of such increase within 10 business days after receipt of a written notice thereof, and acceptance of such payment shall not constitute a waiver of any of Landlord's other rights. Tenant shall conduct its business and control its agents, employees, and invitees in such a manner as not to create any nuisance or interfere with other tenants or Landlord in its management of the Building. 13. INSPECTION. Upon reasonable advance written notice, which, excluding emergencies (in which case no notice is required), shall be one business day, Landlord and Landlord's agents and representatives may enter the Premises during business hours to inspect the Premises; to make such repairs as may be required or permitted under this Lease; to perform any unperformed obligations of Tenant hereunder; and to show the Premises to prospective purchasers, mortgagees, ground lessors, and (during the last 12 months of the Term) tenants. During the last 12 months of the Term, Landlord may erect a sign on the Premises indicating that the Premises are available. Tenant shall notify Landlord in writing of its intention to vacate the Premises at least 60 days before Tenant will vacate the Premises; such notice shall specify the date on which Tenant intends to vacate the Premises (the "VACATION DATE"). At least 30 days before the Vacation Date, Tenant shall arrange to meet with Landlord for a joint inspection of the Premises. After such inspection, Landlord shall prepare a list of items that, subject to Paragraph 16, Tenant must perform before the Vacation Date. If Tenant intentionally or in bad faith fails to arrange for such inspection, then Landlord may conduct such inspection and Landlord's determination of the work Tenant is required to perform before the Vacation Date shall be conclusive. If Tenant fails to perform such work before the Vacation Date, then Landlord may perform such work at Tenant's cost. Tenant shall pay all reasonable costs incurred by Landlord in performing such work within 10 business days after receipt of Landlord's written request therefor. 14. ASSIGNMENT AND SUBLETTING. (a) Tenant shall not, without prior written consent of Landlord, (1) assign, transfer, or encumber this Lease or any estate or interest herein, whether directly or by operation of law, (2) permit any other entity to become Tenant hereunder by merger, consolidation, or other reorganization, except as provided in Section 14.(c), (3) if Tenant is an entity other than a corporation whose stock is publicly traded, permit the transfer of the ownership interest in Tenant, (4) sublet any portion of the Premises, (5) grant any licence, concession, or other right of occupancy of any portion of the Premises, or (6) permit the use of the Premises by any parties other than Tenant (any of the events listed in Sections 14.(a)(1) through 14.(a)(6) being a "Transfer"). Provided that (A) the proposed assignment or sublease is for the entire Premises, Landlord shall not unreasonably withhold, delay or condition its consent to any assignment or subletting of the Premises to a party which may reasonably be expected to 7 12 fulfill the obligations of Tenant hereunder, and (B) will use the Premises for the purposes herein stated. Without limiting the foregoing, Landlord may withhold its consent to any such assignment or subletting of the Premises to (i) any governmental agency, (ii) any party which will use Hazardous Substances in the Premises, or (iii) any party to whom Landlord's Mortgagee objects. If Tenant requests Landlord's consent to a Transfer, then Tenant shall provide Landlord with a written description of all relevant terms and conditions of the proposed Transfer, copies of the proposed documentation, and the following information about the proposed transferee: name and address, reasonably satisfactory information about its business and business history; its proposed use of the Premises; banking, financial, and other credit information; and general references sufficient to enable Landlord to determine the proposed transferee's creditworthiness and character. Tenant shall reimburse Landlord for its reasonable attorney's fees and other expenses incurred in connection with considering any request for its consent to a Transfer. Landlord shall, within 10 business days of receipt of such information from Tenant, approve such Transfer or notify Tenant in writing of Landlord's reason for not approving such proposed Transfer. Landlord will use commercially reasonable efforts to obtain the consent of Landlords' Mortgagee to any proposed assignee or subtenant of which Landlord approves. If Landlord fails to so notify Tenant within such period, then the proposed Transfer shall be deemed approved. If Landlord consents to a proposed Transfer, then the proposed transferee shall deliver to Landlord a written agreement whereby it expressly assumes the Tenant's obligations hereunder (however, any transferee of less than all of the space in the Premises shall be liable only for obligations under this Lease, that are properly allocable to the space subject to the Transfer, and only to the extent of the Rent it has agreed to pay Tenant therefor). No transfer shall release Tenant from performing the obligations of the "Tenant" under this Lease, but rather Tenant and its transferee shall be jointly and severally liable therefor. Landlord's consent to any Transfer shall not waive Landlord's rights as to any subsequent Transfers. If an Event of Default occurs while the Premises or any part thereof are subject to a Transfer, then Landlord, in addition to its other remedies, may collect directly from such transferee all rents becoming due to Tenant and apply such rents against Tenant's Rent obligations. Tenant authorizes its transferees to make payments of Rent directly to Landlord upon receipt of notice from Landlord to do so. (b) Tenant hereby assigns, transfers and conveys all consideration (less reasonable costs and expenses actually incurred by Tenant directly relating to such Transfer) received by Tenant under any Transfer, which are in excess of the rents payable by Tenant under this Lease, and Tenant shall hold such amounts in trust for Landlord and pay them to Landlord within 10 business days after receipt. (c) Notwithstanding the foregoing, Tenant may Transfer all or part of its interest in this Lease or all or part of the Premises to the following types of entities (a "PERMITTED TRANSFEREE") without the written consent of Landlord (a "PERMITTED TRANSFER"). (1) a subsidiary or an Affiliate of Tenant; (2) any corporation in which or with which Tenant, or its corporation successors or assigns, is merged or consolidated, in accordance with applicable statutory provisions governing merger and consolidation of corporations, so long as (A) Tenant's obligations hereunder are assumed by the corporation surviving such merger or created by such consolidation; and (B) the Tangible Net Worth of surviving or created corporation is not less than the Tangible Net Worth of Tenant as of the date hereof; or (3) any corporation acquiring all or substantially all of Tenant's assets, if such corporation's Tangible Net Worth after such acquisition is not less than the Tangible Net Worth of Tenant as of the date hereof. Tenant shall promptly notify Landlord of any such Permitted Transfer. As a condition precedent to any Permitted Transfer, the proposed Permitted Transferee must deliver to Landlord a written agreement whereby it expressly assumes the Tenant's obligations hereunder. As used herein, "TANGIBLE NET WORTH" shall mean the excess of total assets over total liabilities (in each case, determined in accordance with GAAP) excluding from the determination of total assets all assets which would be classified as intangible assets under GAAP, including, without limitation, goodwill, licenses, patents, trademarks, trade names, copyrights, and franchises. Any subsequent Transfer by a Permitted Transferee shall be subject to the provisions of this Section 14. Notwithstanding any assignment or subletting, Tenant shall at all times 8 13 remain fully responsible and liable for the payment of Rent and for compliance with all of Tenant's other obligations under this Lease (regardless of whether Landlord's approval has been obtained for any such assignments or sublettings). (d) With respect to any written request by Tenant to Landlord for Landlord's consent to a Transfer (other than a Permitted Transfer), if such Transfer is for more than fifty percent (50%) of the Premises or for more than five years, Landlord may, within 10 business days after submission of such request, cancel this Lease (or, as to a subletting or assignment, cancel as to the portion of the Premises proposed to be sublet or assigned) as of the date of the proposed Transfer was to be effective. If, pursuant to the exercise of this right, Landlord cancels this Lease as to any portion of the Premises, then this Lease shall cease for such portion of the Premises and Tenant shall pay to Landlord all Rent accrued through the cancellation date relating to the portion of the Premises covered by the proposed Transfer. Thereafter, Landlord may lease such portion of the Premises to the prospective transferee (or to any other person) without liability to Tenant. (e) If Tenant believes Landlord has unreasonably withheld its consent, then, as Tenant's exclusive remedy therefor, Tenant may notify Landlord in writing of such dispute, whereupon the following shall occur. Within 10 business days of Landlord's receipt of such notice, Landlord and Tenant shall jointly appoint a person to resolve such dispute, who shall have at least 3-years' experience in commercial real estate matters. If Landlord and Tenant are unable to agree on such person within such ten-day period, then either party may ask the Dallas office of the American Arbitration Association ("AAA") to select such person. The AAA's selection of the arbitrator shall be binding on Landlord and Tenant. The parties shall bear equally any appointment fee charged by AAA. The arbitration shall be conducted in accordance with the expedited version of the AAA Commercial Arbitration Rules and shall take place in Dallas, Texas. The determination of the arbitrator shall be final and binding on Landlord and Tenant. The non-prevailing party shall pay the fees of the arbitrator. Each party shall bear its own expenses. 15. CONDEMNATION. If 50% or more of the Land or Premises is taken for any public or quasi-public use by right of eminent domain or private purchase in lieu thereof (a "TAKING"), and the Taking prevents or materially interferes with the use of the remainder of the Premises for the purpose for which they were leased to Tenant, either party may terminate this Lease by delivering to the other written notice thereof within 30 days after the Taking, in which case Rent shall be abated during the unexpired portion of the Term, effective on the date of such Taking. If (a) less than 50% of the Land or Premises are subject to a Taking or (b) 50% or more of the Land or Premises are subject to a Taking, but the Taking does not prevent or materially interfere with the use of the remainder of the Premises for the purpose for which they were leased to Tenant, then neither party may terminate this Lease, but the Rent payable during the unexpired portion of the Term shall be reduced to such extent as may be fair and reasonable under the circumstances. If any Taking occurs, then Landlord shall receive the entire award or other compensation for the Land, the Building, and other improvements taken, and Tenant may separately pursue a contemporaneous claim against the condemner for the value of Tenant's personal property which Tenant is entitled to remove under this Lease, moving costs, loss of business, and other claims it may have. 16. SURRENDER OF PREMISES; HOLDING OVER. (a) No act by Landlord shall be an acceptance of a surrender of the Premises, and no agreement to accept a surrender of the Premises shall be valid unless it is in writing and signed by Landlord. At the end of the Term or the termination of Tenant's right to possess the Premises, Tenant shall (1) deliver to Landlord the Premises with all improvements located thereon in good repair and condition, reasonable wear and tear (subject however to Tenant's maintenance obligations) excepted, and with the HVAC System and hot water equipment, light and light fixtures (including ballasts), and overhead doors and related equipment in good working order, (2) deliver to Landlord all keys to the Premises, and (3) remove all signage placed on the Premises by or at Tenant's request. All fixtures, alterations, additions, and improvements shall be Landlord's property and shall remain on the Premises except as provided in the next two sentences. Tenant may remove all unattached trade fixtures, furniture, and personal property placed in the Premises by Tenant (but Tenant shall not remove any such item which was paid for, in whole or in part, by Landlord). Additionally, Tenant shall remove such alterations, additions, improvements, fixtures, equipment, wiring, furniture, and other property not previously approved by Landlord, as Landlord may request, provided such request is made within one month after the end of the Term; however, Tenant shall not be required to remove any addition or improvements to the Premises unless Landlord has specifically required in writing at the time of approval in accordance with Section 9 14 6 or Exhibit B that the improvement or addition in question must be removed. All items not so removed shall, at the option of Landlord, be deemed abandoned by Tenant and may be appropriated, sold, stored, destroyed, or otherwise disposed of by Landlord without notice to Tenant and without any obligation to account for such items and Tenant shall pay for the costs incurred by Landlord in connection therewith. All work required of Tenant under this Section 16 shall be coordinated with Landlord and be done in a good and workmanlike manner, in accordance with all Laws, and so as not to damage the Building. Tenant shall, at its expense, repair all damage caused by any work performed by Tenant under this Section 16.(a). (b) If Tenant fails to vacate the Premises at the end of the Term, then Tenant shall be a Tenant at will and Tenant shall pay, in addition to the other Rent due hereunder, a daily base rental equal to 150% of the daily Base Rent payable during the last month of the Term, even if Landlord consents to such holdover, unless Landlord agrees otherwise in writing. Additionally, Tenant shall defend, indemnify, and hold harmless Landlord from any damage, liability and expense (including attorneys' fees and expenses) incurred because of such holding over. No payments of money by Tenant to Landlord after the Term shall reinstate, continue or extend the Term, and no extension of the Term shall be valid unless it is in writing and signed by Landlord and Tenant. 17. QUIET ENJOYMENT. Provided Tenant has substantially performed its obligations under this Lease, Tenant shall peaceably and quietly hold and enjoy the Premises for the Term, without hindrance from Landlord or any party claiming by, through, or under Landlord, but not otherwise. 18. EVENTS OF DEFAULT. Each of the following events shall constitute an "EVENT OF DEFAULT" under this Lease: (a) Tenant's failure to pay Rent within ten (10) business days after Landlord has delivered written notice to Tenant that the same is due; however, an Event of Default shall occur hereunder without any obligation of Landlord to give any notice if Landlord has given Tenant written notice under this Section 18.(a) more than twice during the twelve (12) month interval preceding such failure by Tenant; (b) The filing of a petition by or against Tenant or any guarantor of Tenant's obligations hereunder (1) in any bankruptcy or other insolvency proceeding; (2) seeking in any relief under any debtor relief Law; (3) for the appointment of a liquidator, receiver, trustee, custodian, or similar official for all or substantially all of Tenant's property or for Tenant's interest in this Lease; or (4) for reorganization or modification of Tenant's capital structure (however, if any such petition is filed against Tenant, then the filing of such petition shall not constitute an Event of Default, unless it is not dismissed within 45 days after the filing thereof). (c) Tenant fails to discharge any lien placed upon the Premises in violation of Section 22 within ten (10) days after Tenant receives written notice that any such lien or encumbrance is filed against the Premises. (d) Tenant fails to comply with any term, provision or covenant of this Lease (other than those listed in this Section 18), and such failure continues for 30 days after written notice thereof to Tenant. 19. REMEDIES. (a) Upon any Event of Default, Landlord may, in addition to all other rights and remedies afforded Landlord hereunder or by Law, take any of the following actions: (1) Terminate this Lease by giving Tenant written notice thereof, in which event, Tenant shall pay to Landlord the sum of (A) all Rent accrued hereunder through the date of termination, (B) all amounts due under Section 19.(b), and (C) an amount equal to (i) the total Rent that Tenant would have been required to pay for the remainder of the Term discounted to present value at a per annum rate equal to the rate of interest set forth for 26-week U.S. governmental bills sold at a discount from face value in units of $10,000 to $1,000,000 as published on the date this Lease is terminated by The Wall Street Journal, Southwest Edition, in its listing of "Money Rates" under the heading "Treasury Bills" (or, if no such rate is published, the 10 15 "Discount Rate" as published on such date under the "Money Rate" listing), minus (ii) the then present fair rental value of the Premises for such period, similarly discounted; or (2) Terminate Tenant's right to possess the Premises without terminating this Lease by giving written notice thereof to Tenant, in which event Tenant shall pay to Landlord (A) all Rent and other amounts accrued hereunder to the date of termination of possession, (B) all amounts due from time to time under Section 19.(b), and (C) all Rent and other sums required hereunder to be paid by Tenant during the remainder of the Term, diminished by any net sums thereafter received by Landlord through reletting the Premises during such period. Landlord shall use reasonable efforts to relet the Premises on such terms and conditions as Landlord, in its sole discretion, may determine (including a term different than the Term, rental concessions, alterations to, and improvement of, the Premises); Landlord shall use commercially reasonable efforts to relet the Premises. Landlord shall not be liable for, nor shall Tenant's obligations hereunder be diminished because of, Landlord's failure to relet the Premises or to collect Rent due for a reletting. Tenant shall not be entitled to the excess of any consideration obtained by reletting over the Rent due hereunder. Reentry by Landlord in the Premises shall not affect Tenant's obligations hereunder for the unexpired Term; rather, Landlord may, from time to time, bring action against Tenant to collect amounts due by Tenant, without the necessity of Landlord's waiting until the Term ends. Unless Landlord delivers written notice to Tenant expressly stating that it has elected to terminate this Lease, all actions taken by Landlord to exclude or dispossess Tenant of the Premises shall be deemed to be taken under this Section 19.(a)(2). If Landlord elects to proceed under this Section 19.(a)(2), it may at any time elect to terminate this Lease under Section 19.(a)(1). Additionally, Landlord may perform Tenant's unperformed obligations hereunder and, without notice, Landlord may alter locks or other security devices at the Premises to deprive Tenant of access thereto, and Landlord shall not be required to provide a new key or right of access to Tenant; provided, however, that Landlord shall provide Tenant written notice and a reasonable opportunity to remove all of its temporary and/or unattached trade fixtures, furniture, and personal property placed on the Premises by Tenant (but Tenant shall not remove any such item which was paid for, in whole or in part, by Landlord) in accordance with Section 16.(a). (b) Tenant shall pay to Landlord all costs incurred by Landlord (including court costs and reasonable attorneys' fees and expenses) in (1) obtaining possession of the Premises, (2) removing and storing Tenant's or any other occupant's property, (3) repairing, restoring, altering, remodeling, or otherwise putting the Premises into condition acceptable to a new tenant, (4) if Tenant is dispossessed of the Premises and this Lease is not terminated, reletting all or any part of the Premises (including brokerage commissions, cost of tenant finish work, and other costs incidental to such reletting), (5) performing Tenant's obligations which Tenant failed to perform, and (6) enforcing, or advising Landlord of, its rights, remedies, and recourses. Landlord's acceptance of Rent following an Event of Default shall not waive Landlord's rights regarding such Event of Default. Landlord's receipt of Rent with knowledge of any default by Tenant hereunder shall not be a waiver of such default, and no waiver by Landlord of any provision of this Lease shall be deemed to have been made unless set forth in writing and signed by Landlord. No waiver by Landlord of any violation or breach of any of the terms contained herein shall waive Landlord's rights regarding any future violation of such term or violation of any other term. If Landlord repossesses the Premises pursuant to the authority herein granted, then Landlord shall have the right to (A) keep in place or (B) remove and store, at Tenant's expense, all of the furniture, fixtures, equipment and other property in the Premises, including that which is owned by or leased to Tenant at all times before any repossession thereof by any lessor thereof or third party having a lien thereon. Landlord may relinquish possession of all or any portion of such furniture, fixtures, equipment and other property to any person (a "CLAIMANT") who presents to Landlord a copy of any instrument represented by Claimant to have been executed by Tenant (or any predecessor of Tenant) granting Claimant the right under various circumstances to take possession of such furniture, fixtures, equipment or other property, without the necessity on the part of Landlord to inquire into the authenticity or legality of the instrument, but with reasonable advance written notice to Tenant. Landlord may, at its option and without prejudice to or waiver of any rights it may have, (i) escort Tenant to the Premises to retrieve any personal belongings of Tenant and/or its employees or (ii) obtain a list from Tenant of the personal property of Tenant and/or its employees and make such property available to Tenant and/or Tenant's employees; however, Tenant first shall pay in cash all costs and estimated expenses to be incurred, if any, in connection with the removal of such property and making it available. The rights of Landlord herein stated are in addition to any 11 16 and all other rights that Landlord has or may hereafter have at law or in equity, unless otherwise expressly waived in this Lease. 20. LANDLORD'S DEFAULT. If Landlord fails to perform any of its obligations hereunder within 30 days after written notice from Tenant specifying such failure, Tenant's exclusive remedy shall be an action for damages. Unless Landlord fails to so cure such default after such notice, Tenant shall not have any remedy or cause of action by reason thereof. Liability of Landlord to Tenant for any default by Landlord, shall be limited to actual, direct, but not consequential, damages therefor and shall be recoverable only from the interest of Landlord in the Building and the Land, and neither Landlord nor Landlord's owners shall have any personal liability therefor. 21. MORTGAGES. (a) Upon receipt of a non-disturbance, attornment and subordination agreement, this Lease shall be subordinate to any deed of trust, mortgage or other security instrument (a "MORTGAGE"), and any ground lease, master lease, or primary lease (a "PRIMARY LEASE") that now or hereafter covers any portion of the Premises (the mortgagee under any Mortgage or the lessor under any Primary Lease is referred to herein as "LANDLORD'S MORTGAGEE"), and to increases, renewals, modifications, consolidations, replacements, and extensions thereof. However, any Landlord's Mortgagee may elect to subordinate its Mortgage or Primary Lease (as the case may be) to this Lease by delivering written notice thereof to Tenant. Landlord shall use reasonable efforts to obtain a non-disturbance, attornment and subordination agreement from the current Landlord's Mortgagee, substantially in the form of Exhibit G attached hereto, within 10 business days from the date hereof. (b) Tenant shall attorn to any party succeeding to Landlord's interest in the Premises, whether by purchase, foreclosure, deed in lieu of foreclosure, power of sale, termination of lease, or otherwise, upon such party's request, and Tenant's receipt of documentation confirming such party's interest in the Premises and shall execute such agreements confirming such attornment as such party may reasonably request. Tenant's obligation to attorn to any future Landlord's Mortgagee under this Section 21 shall be conditioned upon such future Landlord's Mortgagee's execution and delivery of a non-disturbance, attornment and subordination agreement substantially in the form of the non-disturbance, attornment and subordination agreement executed in connection with the execution of this Lease attached hereto as Exhibit G. Tenant shall execute and deliver any such non-disturbance, attornment and subordination agreement within ten (10) days after Landlord's request therefor. 22. ENCUMBRANCES. Tenant has no authority, express or implied, to create or place any lien or encumbrance of any kind or nature whatsoever upon, or in any manner to bind Landlord's property or the interest of Landlord or Tenant in the Premises or to deduct from the Rent for any claim in favor of any person dealing with Tenant, including those who may furnish materials or perform labor for any construction or repairs. Tenant shall pay or cause to be paid all sums due for any labor performed or materials furnished in connection with any work performed on the Premises by or at the request of Tenant. Tenant shall give Landlord immediate written notice of the placing of any lien or encumbrance against the Premises. 23. MISCELLANEOUS. (a) Words of any gender used in this Lease shall include any other gender, and words in the singular shall include the plural, unless the context otherwise requires. The captions inserted in this Lease are for convenience only and in no way affect the interpretation of this Lease. The following terms shall have the following meanings: "LAWS" means all federal, state, and local laws, rules, and regulations; all court orders, governmental directives, and governmental orders; and all restrictive covenants affecting the Property (of which Landlord has notified Tenant in writing), "LAW" means any of the foregoing; "AFFILIATE" means any person or entity which, directly or indirectly, controls, is controlled by, or is under common control with the party in question; "TENANT PARTY" shall include Tenant, any assignees claiming by, through, or under Tenant, any subtenants claiming by, through, or under Tenant, and any of their respective agents, contractors, employees, and invitees; and "INCLUDING" means "including, without limitation." 12 17 (b) Landlord may transfer and assign, in whole or in part, its rights and obligations in the Premises, in which case Landlord shall have no further liability hereunder for all obligations expressly assumed in writing by transferee or assignee. Each party represents and warrants that it has full power and authority to enter into this Lease. (c) Whenever a period of time is herein prescribed for action to be taken by either party, such party shall not be liable or responsible for, and there shall be excluded from the computation for any such period of time, any delays due to strikes, riots, acts of God, shortages of labor or materials, war, governmental Laws, regulations, or restrictions, or any other causes of any kind whatsoever which are beyond the reasonable control of such party. (d) Tenant shall, from time to time, within 10 business days after receipt of written request of Landlord, or as soon thereafter as is practicable in the event such document is unavailable due in whole or in part to the action or inaction of a non-related third party, deliver to Landlord, or Landlord's designee, a certificate of occupancy for the Premises, financial statements for itself and any guarantor of its obligations hereunder, evidence reasonably satisfactory to Landlord that Tenant has performed its obligations under this Lease, and an estoppel certificate stating that this Lease is in full effect, the date to which Rent has been paid, the unexpired Term and such other factual matters pertaining to this Lease as may be requested by Landlord. Consolidated quarterly financial statements shall satisfy the requirement of this Section 23.(d). Tenant's obligation to furnish the above-described items in a timely fashion is a material inducement for Landlord's execution of this Lease. If Tenant fails to execute any such estoppel certificate within such 10 business-day period, Landlord may do so as attorney-in-fact for Tenant. (e) This Lease, together with its Exhibits, constitutes the entire agreement of the Landlord and Tenant with respect to the subject matter of this Lease, and contains all of the covenants and agreements of Landlord and Tenant with respect thereto. Landlord and Tenant each acknowledge that no representations, inducements, promises or agreements, oral or written, have been made by Landlord or Tenant, or anyone acting on behalf of Landlord or Tenant, which are not contained herein, and any prior agreements, promises, negotiations, or representations not expressly set forth in this Lease are of no effect. This Lease may not be altered, changed or amended except by an instrument in writing signed by both parties hereto. (f) All obligations of the parties hereunder not fully performed by the end of the Term shall survive, including, without limitation, all payment obligations with respect to Taxes and insurance and all obligations concerning the condition and repair of the Premises. Subject to Section 16, upon the end of the Term and before Tenant vacates the Premises, Tenant shall pay to Landlord any amount reasonably estimated by Landlord as necessary to put the Premises in good condition and repair, reasonable wear and tear excluded. Tenant shall also, prior to vacating the Premises, pay to Landlord the amount, as estimated by Landlord, of Tenant's obligation hereunder for Operating Expenses for that portion of the year in which the Term ends. All such amounts shall be used and held by Landlord for payment of such obligations of Tenant hereunder, with Tenant being liable for any additional costs therefor upon demand by Landlord or with any excess to be returned to Tenant after all such obligations have been determined and satisfied as the case may be. (g) If any provision of this Lease is illegal, invalid or unenforceable, then the remainder of this Lease shall not be affected thereby, and in lieu of each such provision, there shall be added, as a part of this Lease, a provision as similar in terms to such illegal, invalid or unenforceable clause or provision as may be possible and be legal, valid and enforceable. (h) All references in this Lease to "the date hereof" or similar references shall be deemed to refer to the last date, in point of time, on which all parties hereto have executed this Lease. (i) Landlord and Tenant each warrant to the other that it has not dealt with any broker or agent in connection with this Lease other than The Staubach Company. Landlord shall pay any amounts due to The Staubach Company as a real estate brokerage commission as agreed upon by a separate document. Tenant and Landlord shall each indemnify the other against all costs, attorneys' fees, and other liabilities for commissions or other compensation claimed by any broker or agent claiming the same by, through, or under the indemnifying party. 13 18 (j) Subject to Section 24.(c) requiring duplicate notice to Tenant, if and when included within the term "Tenant," as used in this instrument, there is more than one person, firm or corporation, all shall jointly arrange among themselves for their joint execution of a notice specifying an individual at a specific address within the continental United States for the receipt of notices and payments to Tenant. All parties included within the terms "Landlord" and "Tenant," respectively, shall be bound by notices given in accordance with the provisions of Section 24 to the same effect as if each had received such notice. (k) The terms and conditions of this Lease are confidential and Tenant shall not disclose the terms of this Lease to any third party except as may be required by Law as necessary or to enforce its rights hereunder or in the course of discussions or negotiations preceding a potential corporate transaction. (l) Subject to Section 2.(b) of this Lease, Tenant shall pay interest on all past-due Rent from the date due until paid at the maximum lawful rate. In no event, however, shall the charges permitted under this Section 23.(l) or elsewhere in this Lease, to the extent they are considered to be interest under applicable Law, exceed the maximum lawful rate of interest. 24. NOTICES. Each provision of this instrument or of any applicable Laws and other requirements with reference to the sending, mailing or delivering of notice or the making of any payment hereunder shall be deemed to be complied with when and if the following steps are taken: (a) All Rent shall be payable to Landlord at the address for Landlord set forth below or at such other address as Landlord may specify from time to time by written notice delivered in accordance herewith. Tenant's obligation to pay Rent shall not be deemed satisfied until such Rent has been actually received by Landlord. (b) All payments required to be made by Landlord to Tenant hereunder shall be payable to Tenant at the address set forth below, or at such other address within the continental United States as Tenant may specify from time to time by written notice delivered in accordance herewith. (c) Unless otherwise provided herein, any written notice or document required or permitted to be delivered hereunder shall be deemed to be delivered upon the earlier to occur of (1) actual of delivery (in the case of a hand-delivered or overnight mail or courier notice), (2) five days following deposit in the United States Mail, postage prepaid, Certified Mail, or (3) receipt by facsimile transmission confirmed by telephone conversation (recorded message is insufficient), in each case, addressed to the parties hereto at the respective addresses set out below, or at such other address as they have theretofore specified by written notice delivered in accordance herewith; provided, however, that a duplicate notice shall be delivered for Tenant to: Sr. Vice President and General Counsel, 545 E. John Carpenter Freeway, Suite 1570, Irving, Texas 75062, Phone: 972/830-6199, Fax: 972/830-6196. If Landlord has attempted to deliver notice to Tenant at Tenant's address reflected on Landlord's books but such notice was returned or acceptance thereof was refused, then Landlord may post such notice in or on the Premises, which notice shall be deemed delivered to Tenant upon the posting thereof. 25. HAZARDOUS WASTE. The term "HAZARDOUS SUBSTANCES," as used in this Lease shall mean pollutants, contaminants, toxic or hazardous wastes, or any other substances, the removal of which is required or the use of which is restricted, prohibited or penalized by any "ENVIRONMENTAL LAW," which term shall mean any Law relating to health, pollution or protection of the environment. Tenant shall not be responsible for the cleanup of any Hazardous Substances that existed on the Property prior to the date hereof. Tenant hereby agrees that (a) no activity will be conducted on the Premises that will produce any Hazardous Substances, except for such activities that are part of the ordinary course of Tenant's business activities (the "PERMITTED ACTIVITIES") provided such Permitted Activities are conducted in accordance with all Environmental Laws and have been approved in advance in writing by Landlord; (b) the Premises will not be used in any manner for the storage of any Hazardous Substances except for any temporary storage of such materials that are used in the ordinary course of Tenant's business (the "PERMITTED MATERIALS") provided such Permitted Materials are properly stored in a manner and location satisfying all Environmental Laws and approved in advance in writing by Landlord; (c) no portion of the Premises will be used as a landfill or a dump; (d) Tenant will not install any underground tanks of any type; (e) Tenant will not allow any surface or subsurface conditions to exist or come into existence that constitute, or with the passage of time may constitute a public or private nuisance; and (f) 14 19 Tenant will not permit any Hazardous Substances to be brought onto the Premises, except for the Permitted Materials, and if so brought or found located thereon, the same shall be immediately removed by Tenant, with proper disposal, and all required cleanup procedures shall be diligently undertaken pursuant to all Environmental Laws. If at any time during or after the Term, the Premises are found to be so contaminated or subject to such conditions, Tenant shall defend, indemnify and hold Landlord harmless from all claims, demands, actions, liabilities, costs, expenses, damages and obligations of any nature arising from or as a result of the use of the Premises by Tenant. Tenant will maintain on the Premises a list of all materials stored at the Premises for which a material safety data sheet (an "MSDS") was issued by the producers or manufacturers thereof, together with copies of the MSDS's for such materials and shall deliver such lists and MSDS copies to Landlord upon Landlord's request therefor. Tenant shall remove all Permitted Materials from the Premises in a manner acceptable to Landlord before Tenant's right to possess the Premises ends. Unless expressly identified on an addendum to this Lease, as of the date hereof there are no "Permitted Activities" or "Permitted Materials" for purposes of the foregoing provision and none shall exist unless and until approved in writing by the Landlord. Provided Landlord has delivered to Tenant at least ten (10) business days prior written notice thereof (except in an emergency, in which case no prior notice will be required), Landlord may enter the Premises and conduct environmental inspections and tests therein as it may require from time to time, provided that Landlord shall use reasonable efforts to minimize the interference with Tenant's business. Such inspections and tests shall be conducted at Landlord's expense, unless they reveal the presence of Hazardous Substances (other than Permitted Materials) or that Tenant has not complied with the requirements set forth in this Section 25, in which case Tenant shall reimburse Landlord for the cost thereof within ten business days after receipt of Landlord's written request therefor. 26. LANDLORD'S LIEN. Landlord hereby waives any and all lien or other security interest, statutory or otherwise, it may have in all goods inventory, equipment, fixtures, furniture, improvements, chattel paper, accounts, and general intangibles, and other personal property of Tenant now or hereafter situated on or relating to Tenant's use of the Premises, other than any liens Landlord may obtain to secure a judgment obtained against Tenant. 27. NO OFFER. The submission of this Lease to Tenant shall not be construed as an offer to enter into this Lease. Tenant shall have no rights under this Lease or in or to the Premises, unless and until Landlord has executed a copy of this Lease and delivered it to Tenant. 28. NO WARRANTIES. EXCEPT AS EXPRESSLY PROVIDED OTHERWISE IN THIS AGREEMENT, TENANT ACKNOWLEDGES THAT (1) IT HAS INSPECTED AND ACCEPTS THE PREMISES IN AN "AS IS, WHERE IS" CONDITION, (2) THE BUILDINGS AND IMPROVEMENTS COMPRISING THE SAME ARE SUITABLE FOR THE PURPOSE FOR WHICH THE PREMISES ARE LEASED AND LANDLORD HAS MADE NO WARRANTY, REPRESENTATION, COVENANT, OR AGREEMENT WITH RESPECT TO THE MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF THE PREMISES, (3) SUBJECT TO SECTION 1 (C), THE PREMISES ARE IN GOOD AND SATISFACTORY CONDITION, (4) NO REPRESENTATIONS AS TO THE REPAIR OF THE PREMISES, NOR PROMISES TO ALTER, REMODEL OR IMPROVE THE PREMISES HAVE BEEN MADE BY LANDLORD (UNLESS AND EXCEPT AS MAY BE SET FORTH IN EXHIBIT B ATTACHED TO THIS LEASE, IF ONE SHALL BE ATTACHED, OR AS IS OTHERWISE EXPRESSLY SET FORTH IN THIS LEASE), AND (5) THERE ARE NO REPRESENTATIONS OR WARRANTIES, EXPRESSED, IMPLIED OR STATUTORY, THAT EXTEND BEYOND THE DESCRIPTION OF THE PREMISES. 29. EXHIBITS. The following exhibits hereto are incorporated herein by this reference: Exhibit A Outline of Premises Exhibit A1 Legal Description of Land Exhibit B Tenant Work Exhibit C Extension Options Exhibit D Parking Exhibit D -1 New Parking Area Exhibit E Tenant Preferential Right to Lease Exhibit F Repair Allowance Exhibit F - 1 List of Repair Items Exhibit G Non-disturbance, subordination and attornment agreement
15 20 30. SPECIAL PROVISIONS (a) ROOF. Tenant shall have the right of access to and upon the roof of the Building for Tenant uses approved by Landlord, which approval shall not be unreasonably withheld, delayed or conditioned. Any installations or improvements made in or upon the roof of the Building shall be made only in accordance with plans and specifications which have been previously approved by Landlord and shall be removed by Tenant prior to the end of the Term (and Tenant shall repair all damage caused thereby if requested by Landlord). All improvements shall be constructed, maintained and used by Tenant, at its risk and expense in accordance with all Laws; Landlord's approvals of the plans and specifications therefor shall not be a representation by Landlord that such improvements comply with any Law. (b) SIGNAGE. Subject to Landlord's prior approval (which shall not be unreasonably withheld, delayed or conditioned) of the location, design, size, color, material composition, and plans and specifications therefor, Tenant may, at its sole risk and expense, construct a monument and/or Building sign (the "SIGN") on the grounds or the Building. If Landlord grants its approval, Tenant shall erect the Sign in accordance with the approved plans and specifications, in a good and workmanlike manner, in accordance with all Laws, regulations, restrictions (governmental or otherwise), and architectural guidelines in effect for the area in which the Building is located and has received all requisite approvals thereunder (the "SIGN REQUIREMENTS"), and in a manner so as not to unreasonably interfere with the use of the Building grounds or the Building while such construction is taking place; thereafter, Tenant shall maintain the Sign in a good, clean, and safe condition in accordance with the Sign Requirements. After Tenant's right to possess the Premises has been terminated, Landlord may require that Tenant remove the Sign by delivering to Tenant written notice thereof within 30 days after the end of the Term. If Landlord so requests (but only with a Building sign), Tenant shall remove the Sign, repair all damage caused thereby, and return that portion of the Building on which the Sign was located to their condition before the installation of the Sign within 30 days after after receipt of Landlord's written request therefor. If Tenant fails to timely do so, Landlord may, without compensation to Tenant, at Tenant's expense, remove the Sign, perform the related restoration and repair work and dispose of the Sign in any manner Landlord deems appropriate. Tenant shall defend, indemnify, and hold harmless Landlord from all losses, claims, costs and liabilities arising in connection with or relating to the construction, installation, maintenance and use during the Term of the Lease, or removal of the Sign, INCLUDING THOSE ARISING FROM LANDLORD'S NEGLIGENCE. The rights granted to Tenant under this Section 30.(b) may not be assigned to any party, except as to a Permitted Transferee. (c) GENERATOR. Tenant may install, operate, and maintain generators reasonably necessary for Tenant's business operations in the Premises for emergency back-up purposes (the "GENERATOR", which defined term shall also refer to all related equipment) at a location on the Building grounds acceptable to Landlord, provided that the installation, maintenance, use, and operation thereof complies with all Laws and architectural guidelines in effect for the area in which the Building is located as they may be amended from time to time (the "LEGAL REQUIREMENTS"), and Tenant receives all approvals, consents, and permits required under the Legal Requirements before the installation, maintenance, use, and operation thereof. Before beginning the installation of the Generator, Tenant shall deliver to Landlord final plans and specifications therefor prepared by an engineer reasonably approved by Landlord and setting forth in detail the design, location, size, and method of installation (including, without limitation, separation walls and ventilation system) for Landlord's review and approval, together with evidence reasonably satisfactory to Landlord that all Legal Requirements have been satisfied. Landlord's approval of any such plans and specifications shall not constitute a representation or warranty by Landlord that such plans and specifications comply with the Legal Requirements; such compliance shall be the sole responsibility of Tenant. The Generator shall be installed and screened in a manner acceptable to Landlord, and no underground storage tanks may be installed or used in connection therewith. Additionally, the generator model, size and weight shall be subject in all respects to Landlord's prior written approval, not to be unreasonably withheld, delayed or conditioned. Upon approval of the plans and specifications therefor and the size and location thereof, Tenant may install the Generator provided that such work is performed in a good and workmanlike manner, in accordance with all Legal Requirements and the plans and specifications therefor and in a manner so as not to damage the Building; thereafter, Tenant shall use, maintain, and operate the Generator in a good, clean, and safe condition and in accordance with all Legal Requirements. Tenant shall repair all damage caused by the installation, use, maintenance, operation, or removal of the Generator and, upon its removal, restore the portion of the Building or grounds where it was located to its condition immediately before the installation thereof. If Tenant fails 16 21 to do so within 30 days after receipt Landlord's written request, Landlord may perform such work and Tenant shall pay to Landlord all reasonable costs incurred in connection therewith within 30 days after receipt of Landlord's written request therefor or Landlord may deem the Generator abandoned by Tenant and, at Landlord's sole risk and expense, use such Generator without compensation to Tenant. Tenant shall properly fuel and immediately remove from the area surrounding the Generator any spills or other leaks of fluid from the Generator. Additionally, Tenant shall ensure that the Generator is properly exhausted at all times so no odors emanate therefrom. The Generator shall be installed, used, maintained, operated, and removed at Tenant's risk and expense and Tenant shall maintain insurance in respect thereof reasonably satisfactory to Landlord, listing Landlord as an additional insured. IT IS THE INTENTION OF THE PARTIES THAT TENANT BEAR ALL RISKS RELATING TO THE INSTALLATION, REMOVAL AND TENANT'S USE, MAINTENANCE, AND OPERATION DURING THE TERM, AND REMOVAL OF THE GENERATOR; THEREFORE, TENANT SHALL DEFEND, INDEMNIFY, AND HOLD HARMLESS LANDLORD, ITS AGENTS, AND THEIR RESPECTIVE AFFILIATES FROM ALL LOSSES, CLAIMS, COSTS, AND LIABILITIES ARISING IN CONNECTION WITH OR RELATING TO THE INSTALLATION, REMOVAL AND TENANT'S USE, MAINTENANCE, AND OPERATION DURING THE TERM OF THE GENERATOR, INCLUDING, WITHOUT LIMITATION, THAT ARISING FROM LANDLORD'S NEGLIGENCE (OTHER THAN ITS SOLE OR GROSS NEGLIGENCE OR WILLFUL MISCONDUCT). Executed by Tenant on July 14, 1998. TENANT: ADVANCE PARADIGM, INC., a Delaware corporation By: --------------------------------------------------------- Jon S. Halbert, Executive Vice President, Chief Operating Officer Address: 545 E. John Carpenter Frwy., Suite 1570 Irving, Texas 75062 Telephone: 972-830-6057 Fax: 972-830-6196 By: --------------------------------------------------------- Name: David D. Halbert Title: President & Chief Executive Officer Address: 545 E. John Carpenter Frwy., Suite Irving, Texas 75062 Telephone: 972-830-6199 Fax: 972-830-6197 Executed by Landlord on July 14, 1998. LANDLORD: CRIN-RICHARDSON I, L.P., a ______ limited partnership By: CRIN-Campbell I, L.L.C., as general partner By: InvestCrow I, L.L.C., its Managing Member By: --------------------------------------------------------- Name: P. Jonathan Draces Title: Chairman of the Executive Committee Address: 1300 Campbell Road Associates Ltd. C/o Trammel Crow P.O. Box 971122, Dallas, TX 75397 Telephone: (972) 715-1666 Fax: (972) 991-7461 A-1 22 EXHIBIT A Outline of Premises [Description of Premises and Land] A-2 23 EXHIBIT B TENANT WORK 1. Except as provided in Section 1.(c) of the Lease, Tenant hereby accepts the Premises in their "AS-IS" condition, and Landlord shall have no obligation to perform any work therein (including, without limitation, demolition of any improvements existing therein or construction of any tenant finish-work or other improvements therein), and, except as provided in Section 6.(b) of the Lease shall not be obligated to reimburse Tenant or provide an allowance for any costs related to the demolition or construction of improvements therein. Before Tenant may occupy the Premises to conduct its business therein, Tenant shall, at its expense, obtain and deliver to Landlord a certificate of occupancy or equivalent form from the appropriate governmental authority for the Premises. 2. Before commencing any Work, Tenant shall provide to Landlord for its approval final working drawings or partial drawings sufficient to begin Work, prepared by an architect that has been approved by Landlord (which approval shall not unreasonably be withheld, delayed, or conditioned), of all improvements that Tenant proposes to install in the Premises; such working drawings shall include the partition layout, ceiling plan, electrical outlets and switches, telephone outlets, drawings for any modifications to the mechanical and plumbing systems of the Building, and detailed plans and specifications for the construction of the improvements called for under this Exhibit in accordance with all Laws. Further, if any of Tenant's proposed construction work will affect the Building's Structure, the Building's HVAC, electrical, mechanical, or plumbing systems, then the working drawings pertaining thereto shall be prepared by a licensed engineer selected by Tenant and reasonably acceptable to Landlord, whom Tenant shall at its cost engage for such purpose. Landlord's approval of such working drawings shall not be unreasonably withheld, delayed, or conditioned and shall be given in writing within 5 days of receipt by Landlord or such drawings shall be deemed approved by Landlord. The Working Drawings shall (a) comply with all Laws, (b) be sufficiently detailed to allow construction of the improvements in a good and workmanlike manner, and (c) the improvements depicted thereon conform to the rules and regulations promulgated from time to time by the Landlord for the construction of tenant improvements (a copy of which has been delivered to Tenant). As used herein, "WORKING DRAWINGS shall mean the final working drawings approved by Landlord, as amended from time to time by any approved changes thereto, and "WORK" shall mean all improvements to be constructed in accordance with and as indicated on the Working Drawings. Approval by Landlord of the Working Drawings shall not be a representation or warranty of Landlord that such drawings are adequate for any use, purpose, or condition, or that such drawings comply with any applicable law or code, but shall merely be the consent of Landlord to the performance of the Work. Landlord shall, at Tenant's request, sign the Working Drawings to evidence its review and approval thereof. All changes in the Work must receive the prior written approval of Landlord, and in the event of any such approved change Tenant shall, upon completion of the Work, furnish Landlord with an accurate, reproducible "as-built" plan (e.g., sepia) of the improvements as constructed, which plan shall be incorporated into this Lease by this reference for all purposes. 3. All Work shall be performed only by contractors and subcontractors approved in writing by Landlord, which approval shall not be unreasonably withheld, delayed, or conditioned. Tenant shall have the right to competitive bid all the work to reputable contractors. Landlord or an affiliate shall perform construction management services in connection with the Work. Tenant shall pay such entity a construction management fee of $5,000. All contractors and subcontractors shall be required to procure and maintain insurance against such risks, in such amounts, and with such companies as Landlord may reasonably require and Certificates of such insurance, with paid receipts thereof, must be received by Landlord before the Work is commenced. The Work shall be performed in a good and workmanlike manner that is free of defects and is in strict conformance with the Working Drawings. At Landlord's request, Tenant shall deliver suitable evidence of timely and complete payment of all contractors performing any part of the Work, together with lien waivers relating to such work. 4. Landlord or its affiliate shall have the right to supervise all Work and coordinate the relationship between the Work, the Building, and the Building's systems. B-1 24 5. To the extent not inconsistent with this Exhibit, Section 6 of this Lease shall govern the performance of all Work and the Landlord's and Tenant's respective rights and obligations regarding the improvements installed pursuant thereto. 6. After Landlord tenders possession of the Premises to Tenant, Tenant may enter the Premises to perform the Work, provided that (a) Landlord is given prior written notice of any such entry, (b) such entry shall be coordinated with Landlord, and (c) Tenant shall deliver to Landlord evidence that the insurance required under this Lease has been obtained. Any such entry shall be on the terms of this Lease, but no Rent shall accrue in respect of Base Rent or Operating Expenses during the period before the Commencement Date that Tenant so enters the Premises. B-2 25 EXHIBIT C EXTENSION OPTIONS Provided no Event of Default exists and Tenant is occupying the entire Premises at the time election, Tenant may renew this Lease for two additional periods of five years each on the same terms provided in the Lease (except as set forth below). If Tenant wishes to renew the Lease, Tenant shall deliver to Landlord written notice thereof (an "EXTENSION NOTICE") no later than 9 months before the expiration of the Term. Landlord shall then have a period of thirty days after receipt of the Extension Notice to provide Tenant with the Fair Market Rental Rate (defined below) for the extended Term. Tenant shall notify Landlord in writing whether Tenant elects to extend the Term at the Fair Market Rental Rate within 60 days after receipt of Landlord's notice. As used herein, the term Fair Market Rental Rate shall mean the rate (including tenant improvements, inducements and allowances) then being charged to new tenants in comparable buildings (within a one mile radius of the Building), at the commencement of such extended Term, for space of comparable quality, size, and utility. If Tenant elects to extend the Term, on or before the Commencement Date of extended Term in question, Landlord and Tenant shall execute an amendment to this Lease extending the Term on the same terms provided in this Lease, except as follows: (1) The Basic Rental payable for each month during each such extended Term shall be the Fair Market Rental Rate for the extended Term; (2) Tenant shall have no further options for additional parking; (3) Tenant shall have no further renewal options or expansion options (except as otherwise provided herein) unless expressly granted by Landlord in writing; and (4) Landlord shall lease to Tenant the Premises in their then-current condition, and Landlord shall provide to Tenant all allowances and other tenant inducements available in the market for comparable office buildings within a 1-mile radius of the Building. Tenant's right under this Exhibit shall terminate if (A) this Lease of Tenant's right to possession of the Premises is terminated, (B) Tenant assigns any of its interest in this Lease or sublets any portion of the Premises, except to a Permitted Transferee , or (C) Tenant fails to timely exercise its option under this Exhibit, time being of the essence with respect to Tenant's exercise thereof. Tenant may not assign its right under this Exhibit to any assignee or subtenant other than to a Permitted Transferee of the entire Premises. X-1 26 EXHIBIT D PARKING Landlord shall provide Tenant 295 parking spaces as of the Lease Commencement Date. Landlord shall construct additional surface parking pursuant to the plan attached hereto on the portion of the Land depicted on Exhibit D-1 (the "NEW PARKING AREA"). Within 30 days from the date hereof, Landlord shall submit a proposal to Tenant for Landlord's construction of the New Parking Area ("LANDLORD'S PROPOSAL") which proposal shall be subject to compliance with all Laws and Landlord's agreement as to the size, location, design, color and material composition therefor, the date by which the New Parking Area would be complete, and estimates of all hard and soft costs incurred in connection with the design and construction of the New Parking Area (the "NEW PARKING AREA CONSTRUCTION COSTS"). However, in no event shall the New Parking Area Construction Costs exceed $150,000 unless Landlord, in its sole discretion, determines otherwise. Within 15 days from delivery of Landlord's Proposal, Landlord and Tenant shall execute an agreement confirming whether Tenant accepts Landlord's Proposal. If Tenant accepts Landlord's Proposal, Tenant shall increase the annual per-rentable-square-foot Base Rent for the remainder of the Term after the completion of the New Parking Area by an amount equal to the amortization of the New Parking Area Construction Costs over the remaining Term at an interest rate of ten percent (10%). If Tenant rejects Landlord's Proposal, Tenant may at Tenant's sole cost and expense and with Landlord's consent, construct the New Parking Area and Landlord shall have no further obligation to construct the New Parking Area. Any such work to be performed by Tenant to construct the New Parking Area which Landlord consents to shall be performed in accordance with the terms of Exhibit B to the extent applicable and in a good and workmanlike manner free of any liens. Landlord's obligation to construct the New Parking Area shall be subject to (a) all applicable Laws, (b) Landlord obtaining financing acceptable to the Landlord in its sole discretion in all respects for the construction of the New Parking Area (the "PARKING AREA CONSTRUCTION FINANCING") and (c) the occurrence of no Event of Default. Landlord shall use reasonably diligent efforts to obtain such financing. Accordingly, if any Law would prohibit the Construction of the New Parking Area, or if Landlord cannot obtain Parking Area Construction Financing on commercially reasonable terms acceptable to Landlord in its sole discretion, or an Event of Default has occurred, Landlord shall have no obligation to construct the New Parking Area. D-1 27 EXHIBIT E TENANT'S PREFERENTIAL RIGHT TO LEASE 1. Provided no Event of Default exists, Landlord shall first offer to lease to Tenant or a Permitted Transferee any new space constructed on the Land which adds leasable square footage to the Building (the "ADDITIONAL SPACE") before leasing such space to any third party. Such offer shall be in writing and specify the lease terms for the Additional Space, including the Rent to be paid for the Additional Space, the term therefor, and the date on which the Additional Space shall be included in the Premises (the "OFFER NOTICE"). Tenant or a Permitted Transferee shall notify Landlord in writing whether Tenant or a Permitted Transferee elects to lease all of the Additional Space on the terms set forth in the Offer Notice, within 10 business days after receipt by Tenant or a Permitted Transferee of the Offer Notice. If Tenant or a Permitted Transferee timely elects to lease all the Additional Space, then Landlord and Tenant or a Permitted Transferee shall execute an amendment to this Lease, effective as of the date the Additional Space is to be included in the Premises, on the terms set forth in the Offer Notice and, to the extent not inconsistent with the Offer Notice terms, the terms of this Lease; however, Tenant or a Permitted Transferee shall accept all the Additional Space in an "AS-IS" condition and Landlord shall not provide to Tenant or a Permitted Transferee any allowances (e.g., moving allowance, construction allowance, and the like) or other tenant inducements except as specifically provided in the Offer Notice. Notwithstanding the foregoing, if prior to Landlord's delivery to Tenant or Permitted Transferee of the Offer Notice, Landlord has received an offer to lease all or part of the Additional Space from a third party (a "THIRD PARTY OFFER"), Tenant or Permitted Transferee must exercise its rights hereunder. If Tenant or Permitted Transferee fails or is unable to timely exercise its right hereunder, then such right shall lapse, time being of the essence with respect to the exercise thereof, and Landlord may lease all or a portion of the Additional Space to the same third party on the terms and conditions of the Third Party Offer provided such third party shall pay its proportionate share of any common area and Operating Expenses. If Landlord does not lease the Additional Space to such third party, then the preferential right to lease given by this Exhibit shall remain in full force and effect for Tenant and Permitted Transferees. In no event shall Landlord be required to construct Additional Space. 2. Tenant's rights under this Exhibit shall terminate if this Lease or Tenant's right to possession of the Premises is terminated. E-1 28 EXHIBIT F-1 F-1-1 29 EXHIBIT F REPAIR ALLOWANCE Landlord shall within 180 days of the Commencement Date cause certain repairs described on Exhibit F-1 attached hereto, to be made to the Building. In no event shall Landlord pay more than $50,000 (the "REPAIR ALLOWANCE") to repair such items. In the event the Repair Allowance is not adequate to repair the entire list of repairs, Landlord shall notify Tenant, promptly following the Possession Date, of the cost estimate of each item and Tenant shall thereafter notify Landlord in writing of the priority of the items to be repaired; except for items 18 through 23 on Exhibit F-1 which Landlord shall commence to repair immediately after the Possession Date. F-1 EX-11.1 5 STATEMENT REGARDING COMPUTATION-PER SHARE EARNINGS 1 EXHIBIT 11.1 STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS Net Income Per Share Net income per share is computed using the weighted average number of common and dilutive shares outstanding during the period. A reconciliation of the numerators and denominators of the basic and diluted per-share computations follows:
YEAR ENDED MARCH 31, -------------------------------------------------------------- 1997 1998 1999 ---------------- ---------------- ---------------- BASIC Numerator: Net income $ 3,226,000 $ 7,931,000 $ 12,694,000 Preferred stock dividends 553,000 200,000 --- ---------------- ---------------- ---------------- $ 2,673,000 $ 7,731,000 $ 12,694,000 ================ ================ ================ Denominator: Weighted average common stock outstanding 6,264,521 8,755,754 10,252,145 ================ ================ ================ Net income per share $ 0.43 $ 0.88 $ 1.24 ================ ================ ================ DILUTED Numerator: Net income $ 3,226,000 $ 7,931,000 $ 12,694,000 ================ ================ ================ Denominator: Weighted average common 6,264,521 8,755,754 10,252,145 stock outstanding Other Dilutive Securities: Series A preferred stock 1,250,000 --- --- Series B preferred stock 833,333 1,111,111 36,630 Options and warrants using the treasury stock method 828,273 1,484,054 1,399,326 ---------------- ---------------- ---------------- Weighted average shares outstanding 9,176,127 11,350,919 11,688,101 ================ ================ ================ Net income per share $ 0.35 $ 0.70 $ 1.09 ================ ================ ================
EX-21.1 6 SUBSIDIARIES OF THE COMPANY 1 EXHIBIT 21.1 SUBSIDIARIES OF THE COMPANY Advance Paradigm Mail Services, Inc. Advance Paradigm Data Services, Inc. Advance Paradigm Clinical Services, Inc. Innovative Medical Research, Inc. Baumel-Eisner Neuromedical Institute Foundation Health Pharmaceutical Services, Inc. EX-23.1 7 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23.1 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 Form S-8 Registration Statement File No. 333-75351, Form S-8 Registration Statement File No. 333-34999, and Form S-3 Registration Statement File No. 333-55837. ARTHUR ANDERSEN LLP Dallas, Texas, June 16, 1999 EX-27.1 8 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ADVANCE PARADIGM, INC. FORM 10-K FOR THE YEAR ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR MAR-31-1999 APR-01-1998 MAR-31-1999 42,492 0 107,953 371 4,015 155,740 23,695 8,540 276,833 154,629 0 0 0 105 68,956 276,833 774,822 774,822 743,084 743,084 13,949 0 (2,685) 20,474 7,780 12,694 0 0 0 12,694 1.24 1.09
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