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                                   FORM 10-Q

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

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         (Mark One)

                  [X]      QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
                                THE SECURITIES EXCHANGE ACT OF 1934

                  For the quarterly period ended March 31, 1997

                                                        OR

                  [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                                      SECURITIES EXCHANGE ACT OF 1934

         For the transition period from _______________ to _____________________
         Commission File No. 1-6639

                         MAGELLAN HEALTH SERVICES, INC.
             (Exact name of Registrant as specified in its charter)

                   Delaware                                    58-1076937
        (State or other jurisdiction of                      (I.R.S. Employer
        incorporation or organization)                       Identification No.)

                       3414 Peachtree Road, NE, Suite 1400
                             Atlanta, Georgia 30326
                    (Address of principal executive offices)
                                   (Zip Code)

                                 (404) 841-9200
              (Registrant's telephone number, including area code)

                   See Table of Additional Registrants below.

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                                 Not Applicable

              (Former name, former address and former fiscal year,
                          if changed since last report)

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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  whether  the  registrant  has filed all  documents  and
reports  required  to be filed by  Sections  12,  13 or 15(d) of the  Securities
Exchange Act of 1934 subsequent to the  distribution of securities  under a plan
confirmed by a court. Yes X No

The number of shares of the  Registrant's  Common Stock  outstanding as of April
30, 1997, was 28,807,931.

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ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Behavioral Heath Systems Indiana 35-1990127 3414 Peachtree Rd., N.E. of Indiana, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Beltway Community Hospital, Texas 58-1324281 3414 Peachtree Rd., N.E. Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Blue Grass Physician Kentucky 66-1294402 3050 Rio Dosa Drive Management Group, Inc. Lexington, KY 40509 (606) 269-2325 C.A.C.O. Services, Inc. Ohio 58-1751511 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 CCM, Inc. Nevada 58-1662418 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 CMCI, Inc. Nevada 88-0224620 1061 East Flamingo Road Suite One Las Vegas, NV 89119 (702) 737-0282 CMFC, Inc. Nevada 88-0215629 1061 East Flamingo Road Suite One Las Vegas, NV 89119 (702) 737-0282 CMSF, Inc. Florida 58-1324269 3550 Colonial Boulevard Fort Myers, FL 33912 (813) 939-0403 CPS Associates, Inc. Virginia 58-1761039 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Alvarado Behavioral California 58-1394959 7050 Parkway Drive Health System, Inc. La Mesa, CA 91942-2352 (619) 465-4411 Charter Asheville North Carolina 58-2097827 60 Caledonia Road Behavioral Health System, Inc. Asheville, NC 28803 (704) 253-3681 i ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ The Charter Arbor Indy Delaware 58-2265776 3414 Peachtree Rd., N.E. Behavioral Health System, LLC Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Augusta Behavioral Georgia 58-1615676 3100 Perimeter Parkway Health System, Inc. P.O. Box 14939 Augusta, GA 30909 (404) 868-6625 Charter Bay Harbor Behavioral Florida 58-1640244 3414 Peachtree Rd., N.E. Health System, Inc. Suite 1400 Atlanta, Georgia 30326 (404) 841-9200 The Charter Beacon Behavioral Delaware 35-1994155 1720 Beacon Street Health System, LLC Fort Wayne, IN 46805 (219) 423-3651 Charter Behavioral Health System New Jersey 58-2097832 19 Prospect Street at Fair Oaks, Inc. Summit, NJ 07901 (908) 277-9102 Charter Behavioral Health System Maryland 52-1866212 3414 Peachtree Rd., N.E. at Hidden Brook, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System California 33-0606642 3414 Peachtree Rd., N.E. at Los Altos, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System Florida 65-0519663 1324 37th Avenue, East at Manatee Adolescent Treatment Bradenton, FL 34208 Services, Inc. (813) 746-1388 Charter Behavioral Health System Maryland 52-1866221 14901 Broschart Road at Potomac Ridge, Inc. Rockville, MD 20850 (301) 251-4500 Charter Behavioral Health Delaware 58-2213642 3414 Peachtree Rd., N.E. Systems, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System Georgia 58-1513304 240 Mitchell Bridge Road of Athens, Inc. Athens, GA 30606 (404) 546-7277 Charter Behavioral Health System Texas 58-1440665 8402 Cross Park Drive of Austin, Inc. Austin, TX 78754 (512) 837-1800 ii ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter Behavioral Health System Texas 76-0430571 3414 Peachtree Rd., N.E. of Baywood, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System Florida 58-1527678 4480 51st Street, West of Bradenton, Inc. Bradenton, FL 34210 (813) 746-1388 Charter Behavioral Health System Georgia 58-1408670 3500 Riverside Drive of Central Georgia, Inc. Macon, GA 31210 (912) 474-6200 Charter Behavorial Health System Virginia 54-1765921 1500 Westbrook Avenue of Central Virginia, Inc. Richmond, VA 23227 (804) 266-9671 Charter Behavioral Health System South Carolina 58-1761157 2777 Speissegger Drive of Charleston, Inc. Charleston, SC 29405-8299 (803) 747-5830 Charter Behavioral Health System Virginia 58-1616917 2101 Arlington Boulevard of Charlottesville, Inc. Charlottesville, VA 22903-1593 (804) 977-1120 Charter Behavioral Health System Illinois 58-1315760 3414 Peachtree Rd., N.E. of Chicago, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System California 58-1473063 3414 Peachtree Rd., N.E. of Chula Vista, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System Missouri 61-1009977 200 Portland Street of Columbia, Inc. Columbia, MO 65201 (314) 876-8000 Charter Behavioral Health System Texas 58-1513305 3126 Rodd Field Road of Corpus Christi, Inc. Corpus Christi, TX 78414 (512) 993-8893 Charter Behavioral Health System Texas 58-1513306 6800 Preston Road of Dallas, Inc. Plano, TX 75024 (214) 964-3939 Charter Behavioral Health System Maryland 52-1866214 3680 Warwick Road, Route 1 of Delmarva, Inc. East New Market, MD 21631 (410) 943-8108 The Charter Behavioral Health SystemDelaware 35-1994080 7200 East Indiana of Evansville, LLC Evansville, IN 47715 (812) 475-7200 iii ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter Behavioral Health System Texas 58-1643151 3414 Peachtree Rd., N.E. of Fort Worth, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System Mississippi 58-1616919 3531 Lakeland Drive of Jackson, Inc. Jackson, MS 39208 (601) 939-9030 Charter Behavioral Health System Florida 58-1483015 3414 Peachtree Rd., N.E. of Jacksonville, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 The Charter Behavioral Health SystemDelaware 35-1994087 2700 River City Park Drive of Jefferson, LLC Jeffersonville, IN 47130 (812) 284-3400 Charter Behavioral Health System Kansas 58-1603154 8000 West 127th Street of Kansas City, Inc. Overland Park, KS 66213 (913) 897-4999 Charter Behavioral Health System Louisiana 72-0686492 302 Dulles Drive of Lafayette, Inc. Lafayette, LA 70506 (318) 233-9024 Charter Behavioral Health System Louisiana 62-1152811 3414 Peachtree Rd., N.E. of Lake Charles, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 The Charter Behavioral Health SystemDelaware 35-1994736 3414 Peachtree Rd., N.E. of Michigan City, LLC Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System Mississippi 58-2138622 8135 Goodman Rd. of Mississippi, Inc. Olive Branch, MS 38654 (901) 521-1400 Charter Behavioral Health System Alabama 58-1569921 3414 Peachtree Rd., N.E. of Mobile, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System New Hampshire 02-0470752 29 Northwest Boulevard of Nashua, Inc. Nashua, NH 03063 (603) 886-5000 Charter Behavioral Health System Nevada 58-1321317 7000 West Spring Mountain Rd. of Nevada, Inc. Las Vegas, NV 89117 (702) 876-4357 iv ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter Behavioral Health System New Mexico 58-1479480 5901 Zuni Road, SE of New Mexico, Inc. Albuquerque, NM 87108 (505) 265-8800 Charter Behavioral Health System North Carolina 56-1908581 3414 Peachtree Rd., N.E. of North Carolina, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System California 58-1857277 101 Cirby Hills Drive of Northern California, Inc. Roseville, CA 95678 (916) 969-4666 Charter Behavioral Health System Arkansas 58-1449455 4253 Crossover Road of Northwest Arkansas, Inc. Fayetteville, AR 72703 (501) 521-5731 The Charter Behavioral Health SystemDelaware 35-1994154 101 West 61st Avenue of Northwest Indiana, LLC State Road 51 Hobart, IN 46342 (219) 947-4464 Charter Behavioral Health System Kentucky 61-1006115 435 Berger Road of Paducah, Inc. Paducah, KY 42002-7609 (502) 444-0444 Charter Behavioral Health Georgia 66-0523678 Caso Bldg., Suite 1504 of Puerto Rico, Inc. 1225 Ponce de Leon Avenue Santurce, PR 00907 Charter Behavioral Health System California 58-1747020 455 Silicon Valley Boulevard of San Jose, Inc. San Jose, CA 95138 (408) 224-2020 Charter Behavioral Health System Georgia 58-1750583 1150 Cornell Avenue of Savannah, Inc. Savannah, GA 31406 (912) 354-3911 Charter Behavioral Health System Arkansas 71-0752815 3414 Peachtree Rd., N.E. of Texarkana, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System California 95-2685883 2055 Kellogg Drive of the Inland Empire, Inc. Corona, CA 91719 (714) 735-2910 Charter Behavioral Health System Ohio 58-1731068 1725 Timberline Road of Toledo, Inc. Maumee, Ohio 43537 (419) 891-9333 Charter Behavioral Health System Arizona 86-0757462 3414 Peachtree Rd., N.E. of Tucson, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 v ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter Behavioral Health System California 33-0606644 3414 Peachtree Rd., N.E. of Visalia, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health System Minnesota 41-1775626 109 North Shore Drive of Waverly, Inc. Waverly, MN 55390 (612) 658-4811 Charter Behavioral Health System North Carolina 56-1050502 3637 Old Vineyard Road of Winston-Salem, Inc. Winston-Salem, NC 27104 (919) 768-7710 Charter Behavioral Health System California 33-0606646 3414 Peachtree Rd., N.E. of Yorba Linda, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Behavioral Health Georgia 58-1900736 811 Juniper St., N.E. Systems of Atlanta, Inc. Atlanta, GA 30308 (404) 881-5800 Charter Talbott Behavioral Georgia 58-0979827 3414 Peachtree Rd., N.E. Health System, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter By-The-Sea Georgia 58-1351301 2927 Demere Road Behavioral Health System, Inc. St. Simons Island, GA 31522 (912) 638-1999 Charter Canyon Behavioral Health Utah 58-1557925 3414 Peachtree Rd., N.E. System, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Canyon Springs California 33-0606640 69696 Ramon Road Behavioral Health System, Inc. Cathedral City, CA 92234 (619) 321-2000 Charter Centennial Peaks Colorado 58-1761037 2255 South 88th Street Behavioral Health System, Inc. Louisville, CO 80027 (303) 673-9990 Charter Community Hospital, California 58-1398708 21530 South Pioneer Boulevard Inc. Hawaiian Gardens, CA 90716 (310) 860-0401 Charter Contract Services, Inc. Georgia 58-2100699 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 vi ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter Cove Forge Behavioral Pennsylvania 25-1730464 New Beginnings Road Health System, Inc. Williamsburg, PA 16693 (814) 832-2121 Charter Fairmount Behavioral Pennsylvania 58-1616921 561 Fairthorne Avenue Health System, Inc. Philadelphia, PA 19128 (215) 487-4000 Charter Fenwick Hall South Carolina 57-0995766 3414 Peachtree Rd., N.E. Behavioral Health System, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Financial Offices, Inc. Georgia 58-1527680 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Forest Behavioral Louisiana 58-1508454 9320 Linwood Avenue Health System, Inc. Shreveport, LA 71106 (318) 688-3930 Charter Franchise Services,LLC Delaware 58-2292977 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Grapevine Behavioral Texas 58-1818492 2300 William D. Tate Ave. Health System, Inc. Grapevine, TX 76051 (817) 481-1900 Charter Greensboro Behavioral North Carolina 58-1335184 700 Walter Reed Drive Health System, Inc. Greensboro, NC 27403 (919) 852-4821 Charter Health Management Texas 58-2025056 6800 Park Ten Blvd. of Texas, Inc. Suite 275-W San Antonio, TX 78213 (210) 699-8585 Charter Hospital of Ohio 58-1598899 3414 Peachtree Rd., N.E. Columbus, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Hospital of Denver, Colorado 58-1662413 3414 Peachtree Rd., N.E. Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Hospital of Ft. Collins, Colorado 58-1768534 3414 Peachtree Rd., N.E. Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 vii ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter Hospital of Laredo, Inc. Texas 58-1491620 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Hospital of Miami, Inc. Florida 61-1061599 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Hospital of Mobile, Inc. Alabama 58-1318870 5800 Southland Drive Mobile, AL 36693 (334) 661-3001 Charter Hospital of Santa New Mexico 58-1584861 3414 Peachtree Rd., N.E. Teresa, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Hospital of St. Louis, Inc. Missouri 58-1583760 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Hospital of Torrance, Inc. California 58-1402481 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Indiana BHS Indiana 58-2247985 3414 Peachtree Rd., N.E. Holding, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 The Charter Indianapolis Behavioral Delaware 35-1994923 5602 Caito Drive Health System, LLC Indianapolis, IN 46226 (317) 545-2111 The Charter Lafayette Behavioral Delaware 35-1994151 3700 Rome Drive Health System, LLC Lafayette, IN 47905 (317) 448-6999 Charter Lakehurst New Jersey 22-3286879 3414 Peachtree Rd., N.E. Behavioral Health System, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Lakeside Behavioral Tennessee 62-0892645 2911 Brunswick Road Health System, Inc. Memphis, TN 38134 (901) 377-4700 Charter Laurel Heights Georgia 58-1558212 3414 Peachtree Rd., N.E. Behavioral Health System, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 viii ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter Linden Oaks Illinois 36-3943776 852 West Street Behavioral Health System, Inc. Naperville, IL 60540 (708) 305-5500 Charter Little Rock Behavioral Arkansas 58-1747019 1601 Murphy Drive Health System, Inc. Maumelle, AR 72113 (501) 851-8700 Charter Louisiana Behavioral Louisiana 72-1319231 1514 Doctor's Drive Health System, Inc. Suite 102 Bossier City, LA 71111 (318) 747-4362 Charter Louisville Behavioral Kentucky 58-1517503 1405 Browns Lane Health System, Inc. Louisville, KY 40207 (502) 896-0495 Charter Meadows Behavioral Maryland 52-1866216 3414 Peachtree Rd., N.E. Health System, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Medical - California, Inc. Georgia 58-1357345 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Medical - Clayton Georgia 58-1579404 3414 Peachtree Rd., N.E. County, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Medical - Cleveland, Inc. Texas 58-1448733 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Medical - Long California 58-1366604 3414 Peachtree Rd., N.E. Beach, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Medical - New York, Inc. New York 58-1761153 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Medical (Cayman Cayman Islands, BWI 58-1841857 Caledonian Bank & Trust Islands) Ltd. Swiss Bank Building Caledonian House Georgetown-Grand Cayman Cayman Islands (809) 949-0050 ix ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter Medical Executive Georgia 58-1538092 3414 Peachtree Rd., N.E. Corporation Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Medical Information Georgia 58-1530236 3414 Peachtree Rd., N.E. Services, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Medical International, Cayman Islands, BWI N/A Caledonian Bank & Trust Inc. Swiss Bank Building Caledonian House Georgetown-Grand Cayman Cayman Islands (809) 949-0050 Charter Medical International, Nevada 58-1605110 3414 Peachtree Rd., N.E. S.A., Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Managed Care Sales and Georgia 58-1195352 3414 Peachtree Rd., N.E. Services, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Medical of East Arizona 58-1643158 2190 N. Grace Boulevard Valley, Inc. Chandler, AZ 85224 (602) 899-8989 Charter Medical of England United Kingdom N/A 111 Kings Road Limited Box 323 London SW3 4PB London, England 44-71-351-1272 Charter Medical of Florida, Inc. Florida 58-2100703 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Medical of North Arizona 58-1643154 6015 W. Peoria Avenue Phoenix, Inc. Glendale, AZ 85302 (602) 878-7878 Charter Medical of Puerto Commonwealth of 58-1208667 Caso Building, Suite 1504 Rico, Inc. Puerto Rico 1225 Ponce De Leon Avenue Santurce, P.R. 00907 (809) 723-8666 Charter Milwaukee Behavioral Wisconsin 58-1790135 11101 West Lincoln Avenue Health System, Inc. West Allis, WI 53227 (414) 327-3000 x ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter Mission Viejo Behavioral California 58-1761156 23228 Madero Health System, Inc. Mission Viejo, CA 92691 (714) 830-4800 Charter MOB of Virginia 58-1761158 1023 Millmont Avenue Charlottesville, Inc. Charlottesville, VA 22901 (804) 977-1120 Charter North Behavioral Alaska 58-1474550 2530 DeBarr Road Health System, Inc. Anchorage, AK 99508-2996 (907) 258-7575 Charter Northbrooke Wisconsin 39-1784461 46000 W. Schroeder Drive Behavioral Health System, Inc. Brown Deer, WI 53223 (414) 355-2273 Charter North Counseling Alaska 58-2067832 2530 DeBarr Road Center, Inc. Anchorage, AK 99508-2996 (907) 258-7575 Charter Northridge Behavioral North Carolina 58-1463919 400 Newton Road Health System, Inc. Raleigh, NC 27615 (919) 847-0008 Charter Oak Behavioral California 58-1334120 1161 East Covina Boulevard Health System, Inc. Covina, CA 91724 (818) 966-1632 Charter of Alabama, Inc. Alabama 63-0649546 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, Georgia 30326 (404) 841-9200 Charter Palms Behavioral Texas 58-1416537 1421 E. Jackson Avenue Health System, Inc. McAllen, TX 78502 (512) 631-5421 Charter Peachford Behavioral Georgia 58-1086165 2151 Peachford Road Health System, Inc. Atlanta, GA 30338 (404) 455-3200 Charter Pines Behavioral North Carolina 58-1462214 3621 Randolph Road Health System, Inc. Charlotte, NC 28211 (704) 365-5368 Charter Plains Behavioral Texas 58-1462211 801 N. Quaker Avenue Health System, Inc. Lubbock, TX 79408 (806) 744-5505 Charter-Provo School, Inc. Utah 58-1647690 4501 North University Ave. Provo, UT 84604 (801) 227-2000 xi ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter Real Behavioral Texas 58-1485897 8550 Huebner Road Health System, Inc. San Antonio, TX 78240 (512) 699-8585 Charter Ridge Behavioral Kentucky 58-1393063 3050 Rio Dosa Drive Health System, Inc. Lexington, KY 40509 (606) 269-2325 Charter Rivers Behavioral South Carolina 58-1408623 2900 Sunset Boulevard Health System, Inc. West Columbia, SC 29169 (803) 796-9911 Charter Rockford Behavioral Delaware 51-0374617 100 Rockford Drive Health System, Inc. Newark, DE 19713 (302) 996-5480 Charter San Diego Behavioral California 58-1669160 11878 Avenue of Industry Health System, Inc. San Diego, CA 92128 (619) 487-3200 Charter Sioux Falls Behavioral South Dakota 58-1674278 2812 South Louise Avenue Health System, Inc. Sioux Falls, SD 57106 (605) 361-8111 The Charter South Bend Behavioral Delaware 35-1994307 6704 N. Gumwood Drive Health System, LLC Granger, IN 46530 (219) 272-9799 Charter Springs Behavioral Florida 58-1517461 3130 S.W. 27th Avenue Health System, Inc. Ocala, FL 32674 (904) 237-7293 Charter Springwood Virginia 58-2097829 Route 4, Box 50 Behavioral Health System, Inc. Leesburg, VA 22075 (703) 777-0800 Charter Suburban Hospital Texas 75-1161721 3414 Peachtree Rd., N.E. of Mesquite, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 The Charter Terre Haute Behavioral Delaware 35-1994308 1400 Crossing Boulevard Health System, LLC Terre Haute, IN 47802 (812) 299-4196 Charter Thousand Oaks Behavioral California 58-1731069 3414 Peachtree Rd., N.E. Health System, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Westbrook Behavioral Virginia 54-0858777 1500 Westbrook Avenue Health System, Inc. Richmond, VA 23227 (804) 266-9671 xii ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Charter White Oak Behavioral Maryland 52-1866223 3414 Peachtree Rd., N.E. Health System, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Charter Wichita Behavioral Kansas 58-1634296 8901 East Orme Health System, Inc. Wichita, KS 67207 (316) 686-5000 Charter Woods Behavioral Alabama 58-1330526 3414 Peachtree Rd., N.E. Health System, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Correctional Behavioral Delaware 58-2180940 3414 Peachtree Rd., N.E. Solutions, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Correctional Behavioral Indiana 35-1978792 3414 Peachtree Rd., N.E. Solutions of Indiana, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Correctional Behavioral New Jersey 22-3436964 3000 Atrium Way Solutions of New Jersey, Inc. Suite 410 Mount Laurel, NJ (609) 235-2339 Correctional Behavioral Ohio 34-1826431 Allen Correctional Institute Solutions of Ohio, Inc. 2338 North West Street Lima, OH 45801 (419) 224-8000 Desert Springs Hospital, Inc. Nevada 88-0117696 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, Georgia 30326 (404) 841-9200 Employee Assistance Services, Inc. Georgia 58-1501282 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Florida Health Facilities, Inc. Florida 58-1860493 21808 State Road 54 Lutz, FL 33549 (813) 948-2441 Gulf Coast EAP Services, Inc. Alabama 58-2101394 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 xiii ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Hospital Investors, Inc. Georgia 58-1182191 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Illinois Mentor, Inc. Illinois 36-3643670 313 Congress St. Boston, MA 02210 (617) 790-4800 Magellan Public Solutions, Inc. Delaware 58-2227841 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Mandarin Meadows, Inc. Florida 58-1761155 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Magellan Public Network, Inc. Delaware 51-0374654 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Massachusetts Mentor, Inc. Massachusetts 04-2799071 313 Congress St. Boston, MA 02210 (617) 790-4800 Metroplex Behavioral Healthcare Texas 58-2138596 1000 South Main Street Services, Inc. Suite 100 Grapevine, TX 76051 (817) 540-6948 National Mentor, Inc. Delaware 04-3250732 313 Congress St. Boston, MA 02210 (617) 790-4800 National Mentor Healthcare, Inc. Massachusetts 04-2893910 313 Congress St. Boston, MA 02210 (617) 790-4800 NEPA - Massachusetts, Inc. Massachusetts 58-2116751 #6 Courthouse Lane Chelmsford, MA 01863 (508) 441-2332 NEPA - New Hampshire, Inc. New Hampshire 58-2116398 29 Northwest Boulevard Nashua, NH 03063 (603) 886-5000 Nevada Behavioral Services, Inc. Nevada Applied for 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 xiv ADDITIONAL REGISTRANTS(1) Address including zip code, State or other and telephone number Exact name of jurisdiction of I.R.S. Employer including area code, registrant as specified incorporation Identification of registrant's principal in its charter or organization Number executive offices - -------------------- -------------- -------------- ------------------------ Ohio Mentor, Inc. Ohio 31-1098345 313 Congress St. Boston, MA 02210 (617) 790-4800 Pacific-Charter Medical, Inc. California 58-1336537 3414 Peachtree Rd., N.E. Suite 1400 Atlanta, GA 30326 (404) 841-9200 South Carolina Mentor, Inc. South Carolina 57-0782160 313 Congress St. Boston, MA 02210 (617) 790-4800 Southeast Behavioral Systems, Georgia 58-2100700 3414 Peachtree Rd., N.E. Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Schizophrenia Treatment and Georgia 58-1672912 209 Church Street Rehabilitation, Inc. Decatur, GA 30030 (404) 377-1986 Sistemas De Terapia Georgia 58-1181077 3414 Peachtree Rd., N.E. Respiratoria, S.A., Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Western Behavioral California 58-1662416 3414 Peachtree Rd., N.E. Systems, Inc. Suite 1400 Atlanta, GA 30326 (404) 841-9200 Wisconsin Mentor, Inc. Wisconsin 39-1840054 313 Congress St. Boston, MA 00210 (617) 790-4800
(1) The Additional Registrants listed are wholly-owned subsidiaries of the Registrant and are guarantors of the Registrant's 11 1/4% Series A Senior Subordinated Notes due 2004. The Additional Registrants have been conditionally exempted, pursuant to Section 12(h) of the Securities Exchange Act of 1934, from filing reports under Section 13 of the Securities Exchange Act of 1934. xv FORM 10-Q MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES INDEX Page No. -------- PART I - Financial Information: Condensed Consolidated Balance Sheets - September 30, 1996 and March 31, 1997................................1 Condensed Consolidated Statements of Operations - For the Six Months and the Six Months ended March 31, 1996 and 1997..3 Condensed Consolidated Statements of Cash Flows - For the Six Months ended March 31, 1996 and 1997.....................4 Notes to Condensed Consolidated Financial Statements..................5 Management's Discussion and Analysis of Financial Condition and Results of Operations.................................16 PART II - Other Information: Item 1. - Legal Preceedings..........................................23 Item 5. - Other Information..........................................23 Item 6. - Exhibits and Reports on Form 8-K...........................24 Signatures...........................................................25 MAGELLAN HEALTH SERVICES, INC. QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 PART I - FINANCIAL INFORMATION
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands) September 30, March 31, 1996 1997 ------------- ------------ ASSETS Current Assets: Cash and cash equivalents ................. $ 120,945 $ 114,245 Accounts receivable, net .................. 189,878 192,394 Supplies .................................. 4,753 4,465 Refundable income taxes ................... 1,323 -- Other current assets ...................... 21,251 25,299 ----------- ----------- Total Current Assets ................. 338,150 336,403 Property and Equipment: Land ...................................... 83,431 82,705 Buildings and improvements ................ 388,821 393,814 Equipment ................................. 146,915 154,831 ----------- ----------- 619,167 631,350 Accumulated depreciation .................. (126,053) (143,724) ----------- ----------- 493,114 487,626 Construction in progress .................. 2,276 3,735 ----------- ----------- 495,390 491,361 Assets Restricted for Settlement of Unpaid Claims and Other Long-Term Liabilities ........... 105,303 96,402 Other Long-Term Assets ........................... 30,755 32,126 Goodwill, net .................................... 128,012 125,329 Other Intangible Assets, net ..................... 42,527 40,766 ----------- ----------- $ 1,140,137 $ 1,122,387 =========== ===========
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these balance sheets.
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands, except per share data) September 30, March 31, 1996 1997 ------------- ------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable ........................................................ $ 78,966 $ 69,920 Accrued liabilities ..................................................... 189,599 165,358 Current maturities of long-term debt and capital lease obligations ............................................ 5,751 5,845 ----------- ----------- Total Current Liabilities ...................................... 274,316 241,123 Long-Term Debt and Capital Lease Obligations ................................... 566,307 580,536 Deferred Income Taxes .......................................................... 12,368 15,295 Reserve for Unpaid Claims ...................................................... 73,040 62,316 Deferred Credits and Other Long-Term Liabilities ............................... 39,769 24,211 Minority Interest .............................................................. 52,520 56,698 Commitments and Contingencies Stockholders' Equity: Preferred Stock, without par value Authorized - 10,000 shares Issued and outstanding - none ........................................ -- -- Common Stock, par value $0.25 per share Authorized - 80,000 shares Issued and outstanding - 33,007 shares at September 30, 1996 and 33,221 shares at March 31, 1997 .............................................. 8,252 8,307 Other Stockholders' Equity: Additional paid-in capital ........................................... 327,681 332,905 Accumulated deficit .................................................. (129,457) (113,374) Warrants outstanding ................................................. 54 50 Common Stock in Treasury, 4,424 shares at September 30, 1996 and March 31, 1997 .................................... (82,731) (82,731) Cumulative foreign currency adjustments .............................. (1,982) (2,949) ----------- ----------- Stockholders' Equity ........................................... 121,817 142,208 ----------- ----------- $ 1,140,137 $ 1,122,387 =========== ===========
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these balance sheets 2
MAGELLAN HEALTH SERVICES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share data) For the Three Months For the Six Months ended ended March 31, March 31, -------------------------- ------------------------ 1996 1997 1996 1997 --------- --------- -------- --------- Net revenue $ 354,953 $ 349,922 $650,618 $ 696,741 --------- --------- -------- --------- Costs and expenses: Salaries, supplies and other operating expenses .......... 275,018 282,210 506,344 566,333 Bad debt expense .......................................... 22,619 15,140 42,407 35,375 Depreciation and amortization ............................. 13,120 13,088 23,300 26,187 Interest, net ............................................. 8,572 13,153 22,394 26,722 Stock option expense (credit) ............................. (409) 829 1,414 1,433 Unusual items ............................................. -- 1,395 -- 1,395 --------- --------- --------- --------- 318,920 325,815 595,859 657,445 --------- --------- --------- --------- Income before provision for income taxes, minority interest and extraordinary item .................. 36,033 24,107 54,759 39,296 Provision for income taxes ....................................... 14,413 9,643 22,372 15,718 --------- --------- --------- --------- Income before minority interest and extraordinary item ........... 21,620 14,464 32,387 23,578 Minority interest ................................................ 1,551 2,572 2,570 4,545 --------- --------- --------- --------- Income before extraordinary item ................................. 20,069 11,892 29,817 19,033 Extraordinary item - loss on early extinquishment of debt (net of income tax benefit of $1,967) ..................... -- -- -- (2,950) --------- --------- --------- --------- Net income ....................................................... $ 20,069 $ 11,892 $ 29,817 $ 16,083 ========= ========= ========= ========= Income per common share - Primary: Income before extraordinary item .......................... $ 0.63 $ 0.41 $ 0.99 $ 0.66 Extraordinary loss on early extinguishment of debt ........ -- -- -- (0.10) --------- --------- --------- --------- Net income ....................................................... $ 0.63 $ 0.41 $ 0.99 $ 0.56 ========= ========= ========= ========= Income per common share - Fully Diluted: Income before extraordinary item .......................... $ 0.59 $ 0.41 $ 0.96 $ 0.66 Extraordinary loss on early extinguishment of debt ........ -- -- -- (0.10) --------- --------- --------- --------- Net income ....................................................... $ 0.59 $ 0.41 $ 0.96 $ 0.56 ========= ========= ========= ========= Weighted average number of common shares outstanding: Primary ................................................... 31,882 28,726 30,099 28,657 ========= ========= ========= ========= Fully Diluted ............................................. 34,715 28,726 31,851 28,657 ========= ========= ========= =========
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements. 3
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) For the Six Months ended March 31, ---------------------------- 1996 1997 --------- --------- Cash Flows from Operating Activities Net income .............................................................................. $ 29,817 $ 16,083 --------- --------- Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization .................................................... 23,300 26,187 Stock option expense ............................................................. 1,414 1,433 Non-cash interest expense ........................................................ 1,202 882 Gain on sale of assets ........................................................... (503) (3,302) Extraordinary loss on early extinguishment of debt ............................... -- 4,917 Cash flows from changes in assets and liabilities, net of effects from sales and acquisitions of businesses: Accounts receivable, net .................................................. (16,993) (2,474) Other assets .............................................................. 1,094 (4,214) Accounts payable and other accrued liabilities ............................ (10,048) (30,981) Reserve for unpaid claims ................................................. (10,625) (13,694) Income taxes payable ...................................................... 10,188 4,638 Other liabilities ......................................................... (5,669) (15,154) Minority interest, net of dividends paid .................................. 4,099 5,219 Other ..................................................................... 121 (1,063) --------- --------- Total adjustments .................................................... (2,420) (27,606) --------- --------- Net cash provided by (used in) operating activities ............. 27,397 (11,523) --------- --------- Cash Flows From Investing Activities Capital expenditures .................................................................... (12,787) (14,373) Acquisitions and investments in businesses, net of cash acquired ........................ (47,920) (12,962) Decrease (increase) in assets restricted for settlement of unpaid claims ......................................................................... (6,070) 8,626 Proceeds from sale of assets ............................................................ 653 10,386 --------- --------- Net cash used in investing activities .......................... (66,124) (8,323) --------- --------- Cash Flows From Financing Activities Proceeds from issuance of debt, net of issuance costs ................................... 68,125 126,825 Payments on debt and capital lease obligations .......................................... (80,037) (117,521) Proceeds from issuance of common stock, net of issuance costs ........................... 68,669 -- Proceeds from exercise of stock options and warrants .................................... 1,808 3,842 Income tax payments made on behalf of stock optionees ................................... (1,678) -- --------- --------- Net cash provided by financing activities ....................... 56,887 13,146 --------- --------- Net increase (decrease) in cash and cash equivalents ........................................... 18,160 (6,700) Cash and cash equivalents at beginning of period ............................................... 105,514 120,945 --------- --------- Cash and cash equivalents at end of period ..................................................... $ 123,674 $ 114,245 ========= =========
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements. 4 MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS March 31, 1997 (Unaudited) NOTE A - Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of Management, all adjustments, consisting of normal recurring adjustments considered necessary for a fair presentation, have been included. These financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended September 30, 1996, included in the Company's Annual Report on Form 10-K, as amended. NOTE B - Nature of Business The Company's hospital business is seasonal in nature, with a reduced demand for certain services generally occurring in the first fiscal quarter around major holidays, such as Thanksgiving and Christmas, and during the summer months comprising the fourth fiscal quarter. The Company's business is also subject to general economic conditions and other factors. Accordingly, the results of operations for the interim periods are not necessarily indicative of the actual results expected for the year. NOTE C - Supplemental Cash Flow Information Below is supplemental cash flow information related to the six months ended March 31, 1996 and 1997:
For the Six Months ended March 31, 1996 1997 ------- ------- (In thousands) Income taxes paid, net of refunds received ..................................... $ 2,698 $ 9,064 Interest paid, net of amounts capitalized ...................................... 28,080 28,704 Notes payable assumed in connection with acquisitions of businesses ............ 12,100 --
5 NOTE D - Long-Term Debt and Leases Information with regard to the Company's long-term debt and capital lease obligations at September 30, 1996 and March 31, 1997 is as follows:
September 30, March 31, 1996 1997 ------------ ---------- (In thousands) Revolving Credit Agreement due through 2001 (6.9375% at March 31, 1997) .......................................... $105,593 $121,000 11.25% Senior Subordinated Notes due 2004 ................................... 375,000 375,000 6.56% to 10.75% Mortgage and other notes payable through 1999 ................................................. 12,163 11,725 Variable rate secured notes due through 2013 (3.4% to 3.6% at March 31, 1997)...................................... 60,875 60,425 7.5% Swiss Bonds ............................................................ 6,443 6,443 3.6% to 15.8% capital lease obligations due through 2014 .................... 12,333 12,094 -------- -------- 572,407 586,687 Less amounts due within one year ..................................... 5,751 5,845 Less debt service funds .............................................. 349 306 -------- -------- $566,307 $580,536 ======== ========
On October 28, 1996, the Company entered into a new Credit Agreement with certain financial institutions for a five-year senior secured reducing revolving credit facility in an aggregate committed amount of $400 million (the "New Revolving Credit Agreement"). The Company borrowed approximately $121.0 million under the New Revolving Credit Agreement in October 1996 to (i) pay-off the existing borrowings outstanding under the previous Revolving Credit Agreement that was terminated and (ii) pay for fees and expenses related to the New Revolving Credit Agreement. The loans outstanding under the New Revolving Credit Agreement bear interest (subject to certain potential adjustments) at a rate per annum equal to one, two, three or six-month LIBOR plus 1.25% or the Prime Lending Rate. Interest on Prime Lending Rate Loans is payable at the end of each fiscal quarter and upon conversion to a LIBOR based loan. Interest on LIBOR based loans is payable at the end of their respective one, two, three or six-month terms. The Company recorded an extraordinary loss from the early extinguishment of debt of approximately $3.0 million, net of tax, during the quarter ended December 31, 1996 to write off unamortized deferred financing costs related to its previous Revolving Credit Agreement. NOTE E - Accrued Liabilities Accrued liabilities consist of the following (in thousands):
September 30, March 31, 1996 1997 ------------ --------- Salaries and wages ............................... $ 39,841 $ 35,949 Amounts due health insurance programs ............ 27,223 13,743 Medical claims payable ........................... 26,552 31,032 Interest ......................................... 20,348 20,312 Other ............................................ 75,635 64,322 -------- -------- $189,599 $165,358 ======== ========
6 NOTE F - Unusual Items Facility Closures During fiscal 1996, the Company consolidated, closed or sold nine psychiatric facilities (the "1996 Closed Facilities"). The 1996 Closed Facilities that are still owned by the Company will be sold, leased or used for alternative purposes depending on the market conditions in each geographic area. The Company recorded charges of approximately $4.1 million related to facility closures in fiscal 1996. Severance and benefits related to the 1996 Closed Facilities were fully paid as of December 31, 1996. Other exit costs paid and applied against the resulting liabilities recorded during fiscal 1996 were approximately $81,000 and $250,000 during the quarter and the six months ended March 31, 1997, respectively. During the second quarter of fiscal 1997, the Company consolidated or closed three psychiatric facilities and its one general hospital (the "1997 Closed Facilities"). The 1997 Closed Facilities which are owned by the Company are expected to be sold as part of the Crescent Transactions, as hereinafter defined. The Company recorded charges of approximately $4.2 million related to facility closures in the second quarter of fiscal 1997, which consisted of approximately $3.0 million for severance and related benefits and $1.2 million for contract terminations and other costs. Approximately 700 employees were terminated at the 1997 Closed Facilities. Severance and related benefits paid and applied against the resulting liability were approximately $2.3 million during the quarter ended March 31, 1997. Other exit costs paid and applied against the resulting liability were approximately $280,000. The following table presents net revenue, salaries, supplies and other operating expenses and bad debt expenses and depreciation and amortization of the 1996 Closed Facilities and the 1997 Closed Facilities (in thousands):
Quarter Ended March 31, Six Months Ended March 31, 1996 1997 1996 1997 ----------------------- -------------------------- Net Revenue .....................................$26,722 $ 7,687 $51,635 $18,666 Salaries, supplies and other operating expenses and bad debt expenses ........... 27,082 8,736 52,222 21,219 Depreciation and Amortization ................... 551 91 1,103 272
The Company recorded a charge of approximately $2.0 million in the fourth quarter of fiscal 1996 related to severance and related benefits for employees who were terminated pursuant to planned overhead reductions. Substantially all of such severance and benefits was paid as of December 31, 1996. Facility Sales The Company sold two psychiatric facilities during the quarter ended March 31, 1997 that were closed during fiscal 1995. The Company received approximately $5.6 million in proceeds from the sales and recorded an aggregate gain on such sales of approximately $2.8 million during the quarter ended March 31, 1997. NOTE G - Income per Common Share Primary income per common share equals net income divided by the weighted average number of shares outstanding, after giving effect to dilutive common stock equivalents. Fully diluted income per common share gives effect to dilutive common stock equivalents and other potentially dilutive securities. 7 The minority stockholders of Green Spring Health Services, Inc. ("Green Spring"), the Company's 61% owned managed care subsidiary, have the option, under certain circumstances, to exchange their ownership interests ("Exchange Option") in Green Spring for 2,831,739 shares of Magellan Common Stock or $65.1 million in subordinated notes. The Company may elect to pay cash in lieu of issuing the subordinated notes. The Exchange Option expires December 13, 1998. The Exchange Option is classified as a potentially dilutive security for the purpose of computing fully diluted income per common share. A reconciliation of the calculation of fully diluted income per common share for the three months and the six months ended March 31, 1996, assuming conversion of the Exchange Option as of the beginning of the periods presented or December 13, 1995, whichever date is later, is as follows:
Three Months Ended Six Months Ended March 31, 1996 March 31, 1996 ------------------ ----------------- (in thousands) Net income ................................................................ $ 20,069 $ 29,817 Adjustments for the assumed conversion of the Exchange Option: Minority interest .................................................. 811 1,082 Amortization ....................................................... (276) (341) -------- -------- Adjusted net income - Fully diluted income per share ...................... $ 20,604 $ 30,558 ======== ======== Three Months Ended Six Months Ended March 31, 1996 March 31, 1996 ----------------------------------------- (in thousands, except per share data) Weighted average number of common shares outstanding for fully diluted income per share, excluding the assumed conversion of the Exchange Option .................................... 31,883 30,137 Assumed conversion of the Exchange Option ................................. 2,832 1,714 ------ ------ Weighted average number of common shares outstanding - Fully diluted ........................................................ 34,715 31,851 ====== ====== Fully diluted income per common share ..................................... $ 0.59 $ 0.96 ====== ======
Common stock equivalents were less than 3% dilutive and the Exchange Option was anti-dilutive for the three months and the six months ended March 31, 1997. Accordingly, primary and fully diluted income per common share were computed excluding common stock equivalents and the Exchange Option for the three months and the six months ended March 31, 1997. In February 1997, the Financial Accounting Standards Board issued Statement No. 128 "Earnings per Share" ("FAS 128"), which is more fully described in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Accounting Pronouncements". The Company is required to adopt FAS 128 in the first quarter of fiscal 1998. Income per common share under FAS 128, if applied to the three months and the six months ended March 31, 1996 and 1997, is as follows: 8
For the Three Months For the Six Months Ended March 31, Ended March 31, ---------------------------- --------------------------- 1996 1997 1996 1997 ---------- ----------- ---------- ----------- (in thousands, expept per share data) Income per common share - Basic Income before extraordinary item ........................... $ 0.64 $ 0.41 $ 1.01 $ 0.66 Extraordinary loss on early extinguishment of debt ......... -- -- -- (0.10) ---------- ---------- ---------- ---------- Net Income ........................................................ $ 0.64 $ 0.41 $ 1.01 $ 0.56 ========== ========== ========== ========== Income per common share - Diluted Income before extraordinary item ........................... $ 0.59 $ 0.41 $ 0.96 $ 0.65 Extraordinary loss on early extinguishment of debt ......... -- -- -- (0.10) ---------- ---------- ---------- ---------- Net Income ........................................................ $ 0.59 $ 0.41 $ 0.96 $ 0.55 ========== ========== ========== ========== Weighted average number of common shares outstanding: Basic ...................................................... 31,247 28,726 29,612 28,657 ========== ========== ========== ========== Diluted .................................................... 34,714 29,343 31,813 29,155 ========== ========== ========== ========== A reconciliation of the calculation of Diluted income per common share is as follows: For the Three Months For the Six Months Ended March 31, Ended March 31, ---------------------------- ------------------------- 1996 1997 1996 1997 ---------- ------------ ---------- ---------- (in thousands, except per share data) Income before extraordinary item .................................. $ 20,069 $ 11,892 $ 29,817 $ 19,033 Adjustments for the assumed conversion of the Exchange Option: Minority interest .......................................... 811 -- 1,082 -- Amortization ............................................... (276) -- (341) -- -------- -------- -------- -------- Adjusted income before extraordinary item - Diluted ............... 20,604 11,892 30,558 19,033 Extraordinary loss on early extinguishment of debt ......... -- -- -- (2,950) -------- -------- -------- -------- Adjusted net income - Diluted ..................................... $ 20,604 $ 11,892 $ 30,558 $ 16,083 ======== ======== ======== ======== Weighted average number of common shares outstanding - Diluted: Basic ...................................................... 31,247 28,726 29,612 28,657 Common stock equivalents ................................... 635 617 487 498 Assumed conversion of the Exchange Option .................. 2,832 -- 1,714 -- -------- -------- -------- -------- 34,714 29,343 31,813 29,155 ======== ======== ======== ======== Income per common share - Diluted Income before extraordinary item ........................... $ 0.59 $ 0.41 $ 0.96 $ 0.65 Extraordinary loss on early extinguishment of debt ......... -- -- -- (0.10) -------- -------- -------- -------- Net Income ........................................................ $ 0.59 $ 0.41 $ 0.96 $ 0.55 ======== ======== ======== ========
NOTE H - Contingencies The Company is self-insured for a substantial portion of its general and professional liability risks. The reserves for self-insured general and professional liability losses, including loss adjustment expenses, are based on actuarial estimates that are discounted at an average rate of 6% to their present value based on the Company's historical claims experience adjusted for current industry trends. The reserve for unpaid claims is adjusted periodically as such claims mature, to reflect changes in actuarial estimates based on actual experience. The Company recorded reductions of expenses of approximately $7.5 million and $5.0 million during the quarter and the six months ended March 31, 1996 and 1997, respectively. These reductions resulted primarily from updates to actuarial assumptions regarding the Company's 9 expected losses for more recent policy years. These revisions are based on changes in expected values of ultimate losses resulting from the Company's claim experience, and increased reliance on such claim experience. While management and its actuaries believe that the present reserve is reasonable, ultimate settlement of losses may vary from the amount provided. The Company and certain of its subsidiaries are subject to claims, civil suits, and governmental investigations and inquiries relating to their operations and certain alleged business practices. In the opinion of management, based on consultation with counsel, resolution of these matters will not have a material adverse effect on the Company's financial position or results of operations. On August 1, 1996, the United States Department of Justice, Civil Division, filed its First Amended Complaint in a civil qui tam action initiated in November of 1994 against the Company and its Orlando South hospital subsidiary ("Charter Orlando") by two former employees. The First Amended Complaint alleges that Charter Orlando violated the civil False Claims Act (the "Act") in billing for inpatient treatment provided to elderly patients. The Court granted the Company's motion to dismiss the government's First Amended Complaint yet granted the government leave to its First Amended Complaint. The government filed a Second Amended Complaint on December 12, 1996 which, similar to the First Amended Complaint alleges that the Company and its subsidiary violated the Act in billing for the treatment of geriatric patients. Like the First Amended Complaint, the Second Amended Complaint is based on disputed clinical and factual issues which the Company believes do not constitute a violation of the Act. The Company and its subsidiary,therefore, have filed a motion to dismiss the Second Amended Complaint. The Company and its subsidiary deny the allegations made in the Second Amended Complaint and will vigorously defend against its claims. The Company does not believe this matter will have a material adverse effect on its financial position or results of operations. 10
NOTE I - Guarantor Condensed Consolidating Financial Statements MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATING BALANCE SHEETS (In thousands, except share and per share amounts) September 30, 1996 ----------------------------------------------------- Magellan Health Services, Inc. Guarantor Nonguarantor (Parent ASSETS Subsidiaries Subsidiaries Corporation) ------------ ------------ -------------- Current Assets Cash and cash equivalents .......................................... $ 29,751 $ 79,552 $ 11,642 Accounts receivable, net ........................................... 139,523 44,904 5,451 Supplies ........................................................... 4,091 394 268 Other current assets ............................................... 8,379 121 14,074 ----------- ----------- ----------- Total Current Assets ............................... 181,744 124,971 31,435 Assets restricted for settlement of unpaid claims and other long-term liabilities ........................................ -- 78,542 26,761 Property and Equipment Land ............................................................... 74,790 6,657 1,984 Buildings and improvements ......................................... 350,187 33,493 5,141 Equipment .......................................................... 112,748 25,206 8,961 ----------- ----------- ----------- 537,725 65,356 16,086 Accumulated depreciation ........................................... (111,556) (10,313) (4,184) Construction in progress ........................................... 1,586 621 69 ----------- ----------- ----------- 427,755 55,664 11,971 Other Long-Term Assets (1) ................................................ 92,978 (78,517) 1,172,069 Goodwill, net ............................................................. 20,645 94,682 12,685 Other Intangible Assets, net .............................................. 5,213 22,341 14,973 ----------- ----------- ----------- $ 728,335 $ 297,683 $ 1,269,894 =========== =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable ................................................... $ 32,644 $ 34,057 $ 12,265 Accrued liabilities and income tax payable ......................... 57,948 55,208 76,443 Current maturities of long-term debt and capital lease obligations . 2,620 3,131 -- ----------- ----------- ----------- Total Current Liabilities .......................... 93,212 92,396 88,708 Long-Term Debt and Capital Lease Obligations .............................. (455,333) 8,815 1,012,825 Deferred Income Tax Liabilities .......................................... -- (4,252) 16,620 Reserve for Unpaid Claims ................................................. -- 72,494 546 Deferred Credits and Other Long-Term Liabilities(1) ....................... 352,044 43,565 29,378 Minority interest ......................................................... -- -- -- Stockholders' Equity Common Stock, par value $0.25 per share; Authorized - 80,000 shares Issued and outstanding - 33,007 shares ............................ 2,764 (483) 8,252 Committments and contingencies Other Stockholders' Equity Additional paid-in capital ......................................... 609,627 30,237 327,681 Retained earnings (Accumulated deficit) ............................ 126,826 58,932 (129,457) Warrants outstanding ............................................... -- -- 54 Common Stock in treasury, 4,424 shares ............................. -- (4,736) (82,731) Cumulative foreign currency adjustments ............................ (805) 715 (1,982) ----------- ----------- ----------- 738,412 84,665 121,817 ----------- ----------- ----------- $ 728,335 $ 297,683 $ 1,269,894 =========== =========== =========== Consolidated Elimination Consolidated Entries Total ------------ ------------ ASSETS Current Assets Cash and cash equivalents .......................................... $ -- $ 120,945 Accounts receivable, net ........................................... -- 189,878 Supplies ........................................................... -- 4,753 Other current assets ............................................... -- 22,574 ----------- ----------- Total Current Assets ............................... -- 338,150 Assets restricted for settlement of unpaid claims and other long-term liabilities ........................................ -- 105,303 Property and Equipment Land ............................................................... -- 83,431 Buildings and improvements ......................................... -- 388,821 Equipment .......................................................... -- 146,915 ----------- ----------- -- 619,167 Accumulated depreciation ........................................... -- (126,053 Construction in progress ........................................... -- 2,276 ----------- ----------- -- 495,390 Other Long-Term Assets (1) ................................................ (1,155,775) 30,755 Goodwill, net ............................................................. -- 128,012 Other Intangible Assets, net .............................................. -- 42,527 ----------- ----------- $(1,155,775) $ 1,140,137 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable ................................................... $ -- $ 78,966 Accrued liabilities and income tax payable ......................... -- 189,599 Current maturities of long-term debt and capital lease obligations . -- 5,751 ----------- ----------- Total Current Liabilities .......................... -- 274,316 Long-Term Debt and Capital Lease Obligations .............................. -- 566,307 Deferred Income Tax Liabilities .......................................... -- 12,368 Reserve for Unpaid Claims ................................................. -- 73,040 Deferred Credits and Other Long-Term Liabilities(1) ....................... (385,218) 39,769 Minority interest ......................................................... 52,520 52,520 Stockholders' Equity Common Stock, par value $0.25 per share; Authorized - 80,000 shares Issued and outstanding - 33,007 shares ............................ (2,281) 8,252 Committments and contingencies Other Stockholders' Equity Additional paid-in capital ......................................... (639,864) 327,681 Retained earnings (Accumulated deficit) ............................ (185,758) (129,457 Warrants outstanding ............................................... -- 54 Common Stock in treasury, 4,424 shares ............................. 4,736 (82,731 Cumulative foreign currency adjustments ............................ 90 (1,982 ----------- ----------- (823,077) 121,817 ----------- ----------- $(1,155,775) $ 1,140,137 =========== ===========
(1) Elimination entry related to intercompany receivables and payables and investment in consolidated subsidiaries. The accompanying Notes to Condensed Consolidating Financial Statements are an integral part of these balance sheets. 11
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATING BALANCE SHEETS (In thousands, except share and per share amounts) March 31, 1997 ------------------------------------------ Guarantor Nonguarantor Consolidated ASSETS Subsidiaries Subsidiaries Total ------------ ------------ ------------ Current Assets Cash and cash equivalents .......................................... $ 30,800 $ 68,617 $ 14,828 Accounts receivable, net ........................................... 135,926 50,253 6,215 Supplies ........................................................... 3,838 330 297 Other current assets ............................................... 6,730 3,076 15,493 ----------- ----------- ----------- Total Current Assets ............................... 177,294 122,276 36,833 Assets restricted for settlement of unpaid claims and other long-term liabilities .................................... -- 76,153 20,249 Property and Equipment Land ............................................................... 76,306 5,385 1,014 Buildings and improvements ......................................... 357,052 31,121 5,641 Equipment .......................................................... 117,227 28,338 9,266 ----------- ----------- ----------- 550,585 64,844 15,921 Accumulated depreciation ........................................... (125,090) (13,573) (5,061) Construction in progress ........................................... 2,069 1,666 -- ----------- ----------- ----------- 427,564 52,937 10,860 Other Long-Term Assets (1) ................................................ 74,036 5,277 1,170,107 Goodwill, net ............................................................. 19,688 93,123 12,518 Other Intangible Assets, net .............................................. 4,332 23,050 13,384 ----------- ----------- ----------- $ 702,914 $ 372,816 $ 1,263,951 =========== =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable ................................................... $ 44,583 $ 18,162 $ 7,175 Accrued liabilities ................................................ 48,591 62,620 54,147 Current maturities of long-term debt and capital lease obligations . 2,715 3,130 -- ----------- ----------- ----------- Total Current Liabilities .......................... 95,889 83,912 61,322 Long-Term Debt and Capital Lease Obligations .............................. (497,042) 7,654 1,069,924 Deferred Income Tax Liabilities ........................................... -- (4,307) 19,602 Reserve for Unpaid Claims ................................................. -- 69,647 (7,331) Deferred Credits and Other Long-Term Liabilities (1) ...................... 379,347 43,911 (21,774) Minority interest ......................................................... -- -- -- Stockholders' Equity Common Stock, par value $0.25 per share; Authorized - 80,000 shares Issued and outstanding - 33,221 shares ............................. 2,756 (483) 8,307 Commitments and contingencies Other Stockholders' Equity Additional paid-in capital ......................................... 723,068 130,809 332,905 Retained earnings (Accumulated deficit) ............................ (1,721) 44,039 (113,374) Warrants outstanding ............................................... -- -- 50 Common stock in Treasury, 4,424 shares ............................. -- -- (82,731) Cumulative foreign currency adjustments ............................ 617 (2,366) (2,949) ----------- ----------- ----------- 724,720 171,999 142,208 ----------- ----------- ----------- $ 702,914 $ 372,816 $ 1,263,951 =========== =========== =========== Magellan Health Services, Inc. Consolidated (Parent Elimination Corporation) Entries -------------- -------------- ASSETS Current Assets Cash and cash equivalents .......................................... $ -- $ 114,245 Accounts receivable, net ........................................... -- 192,394 Supplies ........................................................... -- 4,465 Other current assets ............................................... -- 25,299 ----------- ----------- -- 336,403 Total Current Assets ............................... Assets restricted for settlement of unpaid claims -- 96,402 and other long-term liabilities .................................... Property and Equipment -- 82,705 Land ............................................................... -- 393,814 Buildings and improvements ......................................... -- 154,831 Equipment .......................................................... ----------- ----------- -- 631,350 -- (143,724) -- 3,735 Accumulated depreciation ........................................... ----------- ----------- Construction in progress ........................................... -- 491,361 (1,217,294) 32,126 -- 125,329 Other Long-Term Assets (1) ................................................ -- 40,766 Goodwill, net ............................................................. ----------- ----------- Other Intangible Assets, net .............................................. $(1,217,294) $ 1,122,387 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY $ -- $ 69,920 Current Liabilities -- 165,358 Accounts payable ................................................... -- 5,845 Accrued liabilities ................................................ ----------- ----------- Current maturities of long-term debt and capital lease obligations . -- 241,123 -- 580,536 Total Current Liabilities .......................... -- 15,295 Long-Term Debt and Capital Lease Obligations .............................. -- 62,316 Deferred Income Tax Liabilities ........................................... (377,273) 24,211 Reserve for Unpaid Claims ................................................. 56,698 56,698 Deferred Credits and Other Long-Term Liabilities (1) ...................... Minority interest ......................................................... Stockholders' Equity (2,273) 8,307 Common Stock, par value $0.25 per share; Authorized - 80,000 shares Issued and outstanding - 33,221 shares ............................. Commitments and contingencies (853,877) 332,905 Other Stockholders' Equity (42,318) (113,374) Additional paid-in capital ......................................... -- 50 Retained earnings (Accumulated deficit) ............................ -- (82,731) Warrants outstanding ............................................... 1,749 (2,949) Common stock in Treasury, 4,424 shares ............................. ----------- ----------- Cumulative foreign currency adjustments ............................ (896,719) 142,208 ----------- ----------- $(1,217,294) $ 1,122,387 =========== ===========
(1) Elimination entry related to intercompany receivables and payables and investment in consolidated subsidiaries. The accompanying Notes to Condensed Consolidating Financial Statements are an integral part of these balance sheets. 12
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (In thousands) For the Three Months ended March 31, 1996 ------------------------------------------- Magellan Health Services, Inc. Guarantor Nonguarantor (Parent Subsidiaries Subsidiaries Corporation) ------------ ------------ ------------- Net revenue ....................................................... $ 264,824 $ 95,161 $ (220) Costs and expenses Salaries, supplies and other operating expenses ........... 198,177 84,731 (3,078) Bad debt expense ........................................... 21,074 1,319 226 Depreciation and amortization .............................. 9,283 3,647 190 Interest, net .............................................. (10,286) (348) 19,206 Stock option expense (credit) .............................. -- -- (409) --------- --------- --------- 218,248 89,349 16,135 --------- --------- --------- Income (loss) before income taxes and equity in earnings (loss) of subsidiaries ....................... 46,576 5,812 (16,355) Provision for income taxes ....................................... 688 1,414 (61) --------- --------- --------- Income (loss) before equity in earnings (loss) of subsidiaries .... 45,888 4,398 (16,294) Equity in earnings (loss) of subsidiaries ......................... 79 (844) 36,363 --------- --------- --------- Net income (loss) ................................................. $ 45,967 $ 3,554 $ 20,069 ========= ========= ========= Consolidated Elimination Consolidated Entries Total ------------ ------------ Net revenue ....................................................... $ (4,812) $ 354,953 Costs and expenses Salaries, supplies and other operating expenses ........... (4,812) 275,018 Bad debt expense ........................................... -- 22,619 Depreciation and amortization .............................. -- 13,120 Interest, net .............................................. -- 8,572 Stock option expense (credit) .............................. -- (409) --------- --------- (4,812) 318,920 --------- --------- Income (loss) before income taxes and equity in earnings (loss) of subsidiaries ....................... -- 36,033 Provision for income taxes ....................................... 12,372 14,413 --------- --------- Income (loss) before equity in earnings (loss) of subsidiaries .... (12,372) 21,620 Equity in earnings (loss) of subsidiaries ......................... (37,149) (1,551) --------- --------- Net income (loss) ................................................. $ (49,521) $ 20,069 ========= ========= For the Three Months ended March 31, 1997 ------------------------------------------- Magellan Health Services, Inc. Guarantor Nonguarantor (Parent Subsidiaries Subsidiaries Corporation) ------------ ------------- --------------- Net revenue ...................................................... $ 243,746 $ 112,611 $ (5,735) Costs and expenses Salaries, supplies and other operating expenses .......... 184,458 90,018 8,434 Bad debt expense .......................................... 14,062 1,078 -- Depreciation and amortization ............................. 8,145 3,723 1,220 Interest, net ............................................. (13,056) (552) 26,761 Stock option expense ...................................... -- -- 829 Unusual items ............................................. 1,395 -- -- --------- --------- --------- 195,004 94,267 37,244 --------- --------- --------- Income (loss) before income taxes and equity in earnings (loss) of subsidiaries ...................... 48,742 18,344 (42,979) Provision for income taxes ...................................... 203 3,331 6,109 --------- --------- --------- Income (loss) from continuing operations before equity in earnings (loss) of subsidiaries ...................... 48,539 15,013 (49,088) Equity in earnings (loss) of continuing subsidiaries ............. (305) (2,138) 60,980 --------- --------- --------- Net income (loss) ................................................ $ 48,234 $ 12,875 $ 11,892 ========= ========= ========= Consolidated Elimination Consolidated Entries Total ------------ ------------ Net revenue ...................................................... $ (700) $ 349,922 Costs and expenses Salaries, supplies and other operating expenses .......... (700) 282,210 Bad debt expense .......................................... -- 15,140 Depreciation and amortization ............................. -- 13,088 Interest, net ............................................. -- 13,153 Stock option expense ...................................... -- 829 Unusual items ............................................. -- 1,395 --------- --------- (700) 325,815 --------- --------- Income (loss) before income taxes and equity in earnings (loss) of subsidiaries ...................... -- 24,107 Provision for income taxes ...................................... -- 9,643 --------- --------- Income (loss) from continuing operations before equity in earnings (loss) of subsidiaries ...................... -- 14,464 Equity in earnings (loss) of continuing subsidiaries ............. (61,109) (2,572) --------- --------- Net income (loss) ................................................ $ (61,109) $ 11,892 ========= =========
The accompanying Notes to Condensed Consolidating Financial Statements are an integral part of these statements. 13
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (In thousands) For the Six Months ended March 31, 1996 ---------------------------------------- Magellan Health Services, Inc. Guarantor Nonguarantor (Parent Subsidiaries Subsidiaries Corporation) ------------ ------------ -------------- Net revenue ............................................................ $ 512,578 $ 139,689 $ 7,627 Costs and expenses Salaries, supplies and other operating expenses ................. 392,023 122,091 1,506 Bad debt expense ................................................ 41,038 1,988 (619) Depreciation and amortization ................................... 18,028 4,903 369 Interest, net ................................................... (20,386) (268) 43,048 Stock option expense ............................................ -- -- 1,414 --------- --------- --------- 430,703 128,714 45,718 --------- --------- --------- Income (loss) before income taxes and equity in earnings (loss) of subsidiaries ............................ 81,875 10,975 (38,091) Provision for income taxes ............................................. 1,341 2,046 208 --------- --------- --------- Income (loss) before equity in earnings (loss) of subsidiaries ......... 80,534 8,929 (38,299) Equity in earnings (loss) of subsidiaries .............................. 368 (1,145) 54,438 ========= ========= ========= Net income (loss) ...................................................... $ 80,902 $ 7,784 $ 16,139 ========= ========= ========= CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS Cash provided by (used in) operating activities ........................ $ 14,420 $ 17,954 $ (4,977) --------- --------- --------- Cash Flows from Investing Activities: Capital expenditures ............................................ (12,043) (356) (388) Proceeds from sale of assets .................................... 653 -- -- Acquisitions and investments in businesses, net of cash acquired (256) 38,226 (85,890) Increase in assets restricted for the settlement of unpaid claims (7,615) 1,545 -- --------- --------- --------- Cash provided by (used in) investing activities ........................ (11,646) 30,255 (84,733) --------- --------- --------- Cash Flows from Financing Activities: Proceeds from the issuance of debt .............................. -- 125 68,000 Payments on debt and capital obligations ........................ (11,566) (471) (68,000) Proceeds from issuance of Common Stock, net of issuance costs ... -- -- 68,669 Income tax payments made on behalf of stock optionees ........... -- -- (1,678) Proceeds from exercise of stock option and warrants ............. -- -- 1,808 -------- --------- --------- Cash provided by (used in) financing activities ........................ (11,566) (346) 68,799 --------- --------- --------- Net increase (decrease) in cash and cash equivalents ................... (8,792) 47,863 (20,911) Cash and cash equivalents at beginning of period ....................... 60,719 10,279 34,516 --------- --------- --------- Cash and cash equivalents at end of period ............................. $ 51,927 $ 58,142 $ 13,605 ========= ========= ========= Consolidated Elimination Consolidated Entries Total ------------ ----------- Net revenue ............................................................ $ (9,276) $ 650,618 Costs and expenses Salaries, supplies and other operating expenses ................. (9,276) 506,344 Bad debt expense ................................................ -- 42,407 Depreciation and amortization ................................... -- 23,300 Interest, net ................................................... -- 22,394 Stock option expense ............................................ -- 1,414 --------- --------- (9,276) 595,859 --------- --------- Income (loss) before income taxes and equity in earnings (loss) of subsidiaries ............................ -- 54,759 Provision for income taxes ............................................. 18,777 22,372 --------- --------- Income (loss) before equity in earnings (loss) of subsidiaries ......... (18,777) 32,387 Equity in earnings (loss) of subsidiaries .............................. (56,231) (2,570) ========= ========= Net income (loss) ...................................................... $ (75,008) $ 29,817 ========= ========= CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS Cash provided by (used in) operating activities ........................ $ -- $ 27,397 --------- --------- Cash Flows from Investing Activities: Capital expenditures ............................................ -- (12,787) Proceeds from sale of assets .................................... -- 653 Acquisitions and investments in businesses, net of cash acquired -- (47,920) Increase in assets restricted for the settlement of unpaid claims (6,070) --------- --------- Cash provided by (used in) investing activities ........................ -- (66,124) --------- --------- Cash Flows from Financing Activities: Proceeds from the issuance of debt .............................. -- 68,125 Payments on debt and capital obligations ........................ -- (80,037) Proceeds from issuance of Common Stock, net of issuance costs ... -- 68,669 Income tax payments made on behalf of stock optionees ........... -- (1,678) Proceeds from exercise of stock option and warrants ............. -- 1,808 --------- --------- Cash provided by (used in) financing activities ........................ -- 56,887 --------- --------- Net increase (decrease) in cash and cash equivalents ................... -- 18,160 Cash and cash equivalents at beginning of period ....................... -- 105,514 --------- --------- Cash and cash equivalents at end of period ............................. $ -- $ 123,674 ========= =========
The accompanying Notes to Condensed Consolidating Financial Statements are an integral part of these statements. 14
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (In thousands) For the Six Months ended March 31, 1997 ----------------------------------------- Services, Inc. Guarantor Nonguarantor (Parent Subsidiaries Subsidiaries Corporation) ------------ ------------ -------------- Net revenue ............................................................................ $ 467,268 $ 225,202 $ 4,971 Costs and expenses Salaries, supplies and other operating expenses ................................ 361,784 190,278 14,971 Bad debt expense ................................................................ 33,086 7,473 1,952 Interest, net ................................................................... (25,162) (995) 52,879 Stock option expense (credit) ................................................... -- -- 1,433 Unusual Items ................................................................... 1,395 -- -- --------- --------- --------- 387,865 199,045 71,235 --------- --------- --------- Income (loss) before income taxes, equity in earnings (loss) of subsidiaries and extraordinary item ....................................... 79,403 26,157 (66,264) Provision for income taxes ............................................................. 1,034 6,186 8,498 --------- --------- --------- Income (loss) before equity in earnings (loss) of subsidiaries and extraordinary item .............................................................. 78,369 19,971 (74,762) Equity in earnings (loss) of continuing subsidiaries before extraordinary item ......... (358) (3,980) 93,795 --------- --------- --------- Income (loss) before extraordinary item ................................................ 78,011 15,991 19,033 Extraordinary item - loss on early extinguishment of debt (net of income tax benefit of $1,967) ........................................................ (1,193) -- (2,950) --------- --------- --------- Net income (loss) ...................................................................... $ 76,818 $ 15,991 $ 16,083 ========= ========= ========= CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS Cash provided by (used in) operating activities ........................................ $ 4,185 $ 677 $ (16,385) --------- --------- --------- Cash Flows from Investing Activities: Capital expenditures ............................................................ (8,170) (5,868) (335) Acquisitions and investments in businesses, net of cash acquired ................ (4,944) (7,614) (404) Decrease (increase) in assets restricted for the settlement of unpaid claims .... -- 2,389 6,237 Proceeds from the sale of assets ................................................ 10,386 -- -- --------- --------- --------- Cash provided by (used in) investing activities ........................................ (2,728) (11,093) 5,498 --------- --------- --------- Cash Flows from Financing Activities: Payments on debt and capital lease obligations .................................. (72,024) (519) (44,978) Proceeds from the issuance of debt .............................................. 71,616 -- 55,209 Proceeds from exercise of stock options and warrants ............................ -- -- 3,842 --------- --------- --------- Cash provided by (used in) financing activities ........................................ (408) (519) 14,073 --------- --------- --------- Net increase (decrease) in cash and cash equivalents ................................... 1,049 (10,935) 3,186 Cash and cash equivalents at beginning of period ....................................... 29,751 79,552 11,642 --------- --------- --------- Cash and cash equivalents at end of period ............................................. $ 30,800 $ 68,617 $ 14,828 ========= ========= ========= Consolidated Elimination Consolidated Entries Total ------------ ------------ Net revenue ............................................................................ $ (700) $ 696,741 Costs and expenses Salaries, supplies and other operating expenses ................................ (700) 566,333 Bad debt expense ................................................................ -- 26,187 Interest, net ................................................................... -- 26,722 Stock option expense (credit) ................................................... -- 1,433 Unusual Items ................................................................... -- 1,395 --------- --------- (700) 657,445 --------- --------- Income (loss) before income taxes, equity in earnings (loss) of subsidiaries and extraordinary item ....................................... -- 39,296 Provision for income taxes ............................................................. -- 15,718 --------- --------- Income (loss) before equity in earnings (loss) of subsidiaries and extraordinary item .............................................................. -- 23,578 Equity in earnings (loss) of continuing subsidiaries before extraordinary item ......... (94,002) (4,545) --------- --------- Income (loss) before extraordinary item ................................................ (94,002) 19,033 Extraordinary item - loss on early extinguishment of debt (net of income tax benefit of $1,967) ........................................................ 1,193 (2,950) --------- --------- Net income (loss) ...................................................................... $ (92,809) $ 16,083 ========= ========= CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS Cash provided by (used in) operating activities ........................................ $ -- $ (11,523) --------- --------- Cash Flows from Investing Activities: Capital expenditures ............................................................ -- (14,373) Acquisitions and investments in businesses, net of cash acquired ................ -- (12,962) Decrease (increase) in assets restricted for the settlement of unpaid claims .... -- 8,626 Proceeds from the sale of assets ................................................ -- 10,386 --------- --------- Cash provided by (used in) investing activities ........................................ -- (8,323) --------- --------- Cash Flows from Financing Activities: Payments on debt and capital lease obligations .................................. -- (117,521) Proceeds from the issuance of debt .............................................. -- 126,825 Proceeds from exercise of stock options and warrants ............................ -- 3,842 --------- --------- Cash provided by (used in) financing activities ........................................ -- 13,146 --------- --------- Net increase (decrease) in cash and cash equivalents ................................... -- (6,700) Cash and cash equivalents at beginning of period ....................................... -- 120,945 --------- --------- Cash and cash equivalents at end of period ............................................. $ -- $ 114,245 ========= =========
The accompanying Notes to Condensed Consolidating Financial Statements are an integral part of these statements 15 MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES March 31, 1997 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This document contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including, without limitation, statements regarding the sufficiency of the Company's liquidity and sources of capital and the statements under the heading "Outlook". Actual results may differ materially from those projected in such forward-looking statements. These forward-looking statements are subject to certain risks, uncertainties and other factors which could cause actual results to differ materially from those anticipated, including, without limitation, potential reductions in reimbursement by third-party payers and changes in hospital payer mix, governmental budgetary constraints and healthcare reform, the impact of potential hospital closures, competition in the provider business and the managed care business, and the regulatory environment for the Company's businesses, as well as the other factors discussed in Exhibit 99 hereto, which is hereby incorporated by reference. Green Spring Acquisition On December 13, 1995, the Company acquired a 51% ownership interest in Green Spring for approximately $68.9 million in cash, the issuance of 215,458 shares of Magellan Common Stock valued at approximately $4.3 million and the contribution of GPA, a wholly-owned subsidiary of the Company, which became a wholly-owned subsidiary of Green Spring. On December 20, 1995, the Company acquired an additional 10% ownership interest in Green Spring for approximately $16.7 million in cash as a result of an exercise by a minority stockholder of its Exchange Option ("Exchange Option") for a portion of the stockholder's interest in Green Spring. Green Spring provides managed behavioral healthcare services, which includes utilization management, care management and employee assistance programs through a 50-state provider network covering approximately 15.5 million people nationwide. The Company has accounted for the acquisition of Green Spring using the purchase method of accounting, which resulted in additional intangible assets of approximately $113 million. The minority stockholders of Green Spring consist of four Blue Cross/Blue Shield organizations (the "Blues") that are key customers of Green Spring. In addition, two other Blues organizations that formerly owned a portion of Green Spring have continued as customers of Green Spring. As of March 31, 1997, the minority stockholders of Green Spring have the Exchange Option, under certain circumstances, to exchange their ownership interest in Green Spring for 2,831,739 shares of the Company's Common Stock or $65.1 million in subordinated notes. The Company may elect to pay cash in lieu of issuing the subordinated notes. The Exchange Option expires December 13, 1998. Psychiatric Hospital Results Selected statistics (from the date of acquisition for acquired facilities) for the psychiatric hospitals in operation by quarter for fiscal 1996 and fiscal 1997 are as follows: 16
Fiscal Fiscal % 1996 1997 Change ---------- ---------- ----------- Hospitals in operation: December 31 ................................. 102 95 (7)% March 31 .................................... 99 93 (6) June 30 ..................................... 96 September 30 ................................ 95 Average licensed beds at: Quarter: First .................................. 9,110 8,463 (7)% Second ................................. 9,040 8,468 (6) Third .................................. 8,677 Fourth ................................. 8,469 Year ........................................ 8,805 Net revenue (in thousands): Quarter: First .................................. $ 253,565 $ 229,064 (10)% Second ................................. 257,690 225,494 (12) Third .................................. 249,145 Fourth ................................. 228,597 ---------- Year ........................................ $ 988,997 ========== Patient days: Quarter: First .................................. 432,474 392,352 (9)% Second ................................. 463,327 402,929 (13) Third .................................. 452,864 Fourth ................................. 404,346 ---------- Year ........................................ 1,753,011 ========== Equivalent patient days: Quarter: First .................................. 478,693 437,960 (9)% Second ................................. 513,502 447,551 (13) Third .................................. 503,622 Fourth ................................. 450,708 ---------- Year ........................................ 1,946,525 ========== Net revenue per equivalent patient day: Quarter: First .................................. $ 530 $ 523 (1)% Second ................................. 502 504 -- Third .................................. 495 Fourth ................................. 507 Year ........................................ 508 Admissions: Quarter: First .................................. 32,865 32,326 (2)% Second ................................. 37,966 34,643 (9) Third .................................. 35,854 Fourth ................................. 33,861 ---------- Year ........................................ 140,546 ========== Average length of stay (days): Quarter: First .................................. 12.4 11.5 (7)% Second ................................. 12.2 11.1 (9) Third .................................. 12.5 Fourth ................................. 12.5 Year ........................................ 12.4
Note: Includes Northstar Hospital in Anchorage, Alaska that is managed pursuant to a joint venture arrangement. 17 Results of Operations The following table summarizes, for the periods indicated, changes in selected operating indicators.
Percentage of Net Revenue ------------------------------------------------------------- Three Months Ended March 31, Six Months Ended March 31, ---------------------------- --------------------------- 1996 1997 1996 1997 ------------ --------- --------------------------- Net revenue ............................................... 100.0% 100.0% 100.0% 100.0% Salaries, supplies and other operating expenses ........... 77.5 80.7 77.8 81.3 Bad debt expense .......................................... 6.4 4.3 6.5 5.1 ------ ----- ----- ----- Total expenses ............................................ 83.9 85.0 84.3 86.4 Operating margin .......................................... 16.1% 15.0% 15.7% 13.6% ====== ===== ===== =====
Patient days at the Company's hospitals decreased 13.0% and 11.2% for the quarter and the six months ended March 31, 1997, respectively, as compared to the same periods of fiscal 1996. The decrease resulted primarily from patient days attributable to the hospitals closed during fiscal 1996 and 1997 and a decline in average length of stay. Total admissions decreased 8.8% and 5.5% for the quarter and the six months ended March 31, 1997, respectively, as compared to the prior year periods. The decrease resulted primarily from the hospitals closed in fiscal 1996 and 1997. The Company's net revenue for the quarter ended March 31, 1997 decreased 1.4% as compared to the prior year quarter. The decrease was primarily attributable to (i) the closure of hospitals during fiscal 1996 and 1997 and (ii) reduced equivalent patient days at the Company's operating hospitals, offset by revenue growth in the company's managed care (Green Spring) and public sector (Public Solutions) businesses. Green Spring revenues were approximately $90.6 million and $65.0 million for the quarters ended March 31, 1997 and 1996, respectively. The 39.4% increase was primarily attributable to Green Spring obtaining several new contracts, which became effective July 1, 1996 and January 1, 1997, to manage the behavioral healthcare component of certain state medicaid programs and increases in services to an insurer. Public Solutions revenues were approximately $22.4 million and $16.2 million for the quarters ended March 31, 1997 and 1996, respectively. The 38.3% increase was primarily attributable to a 44 % increase in placements in mentor homes and $1.4 million in new revenues from correctional contracts. The Company's net revenue for the six months ended March 31, 1997 increased 7.1 % as compared to the prior year period. The increase was primarily attributable to the Green Spring acquisition and related internal growth (as previously described) offset by (i) the closure of hospitals during fiscal 1996 and fiscal 1997 and (ii) reduced equivalent patient days at the Company's operating hospitals. Green Spring revenues were approximately $173.5 million and $79.0 million, for the six months ended March 31, 1997 and 1996, respectively. The Company's salaries, supplies and other operating expenses increased 2.6% and 11.8% in the quarter and the six months ended March 31, 1997 compared to the same periods in fiscal 1996. The increases resulted primarily from the Green Spring acquisition and related internal growth less the effect of hospitals closed during fiscal 1996 and 1997. Expenses incurred by Green Spring were approximately $80.4 million and $59.3 million for the quarters ended March 31, 1997 and 1996, respectively, and $154.3 million and $71.4 million for the six months ended March 31, 1997 and 1996, respectively. The Company's bad debt expense decreased 33.1% and 16.6% in the quarter and the six months ended March 31, 1997 compared to the same periods in fiscal 1996. These decreases are primarily attributable to improvement in accounts receivable agings and turnover compared to prior periods and shifts towards governmental and managed 18 care payers, which reduces the Company's credit risk associated with individual patients. Bad debt expense decreased to 4.3% and 5.1% of revenue for the quarter and the six months ended March 31, 1997, respectively. These decreases are primarily attributable to lower bad debt expense in the provider business and bad debt expense representing less than 1% of Green Spring revenues for the periods presented. Depreciation and amortization decreased 0.2% and increased 12.4% in the quarter and the six months ended March 31, 1997 compared to the same periods in fiscal 1996. The increase for the six months ended March 31, 1997 resulted primarily from depreciation and amortization related to the Green Spring Acquisition . Interest expense, net, increased $4.6 million and $4.3 million for the quarter and the six months ended March 31, 1997 compared to the same periods in fiscal 1996. These increases resulted primarily from approximately $5.0 million of interest income recorded during the quarter and the six months ended March 31, 1996 related to income tax refunds due from the State of California for the Company's income tax returns for fiscal 1982 through 1989. Stock option expense for the quarter and the six months ended March 31, 1997 increased $1.2 million and $19,000 from the previous year periods primarily due to fluctuations in the market price of the Company's common stock. The Company recorded unusual items, net, of $1.4 million, during the quarter and the six months ended March 31, 1997, which consisted of a $2.8 million pre-tax gain on the sale of two psychiatric hospitals offset by a $4.2 million charge for the closure of three psychiatric hospitals and one general hospital. See Note F for further information regarding facility closures. Minority interest increased $1.0 million and $2.0 million in the quarter and the six months ended March 31, 1997 as compared to the prior year periods. The increases are primarily due to the Company acquiring a controlling interest in Green Spring in December 1995 and Green Spring's internal growth subsequent to the acquisition date. Recent Accounting Pronouncements In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123 ("FAS 123") "Accounting for Stock-Based Compensation," which became effective for fiscal years beginning after December 15, 1995. FAS 123 established new financial accounting and reporting standards for stock-based compensation plans. Entities will be allowed to measure compensation expense for stock-based compensation under FAS 123 or APB Opinion No. 25, "Accounting for Stock Issued to Employees." Entities electing to remain with the accounting in APB Opinion No. 25 will be required to make pro forma disclosures of net income and earnings per share as if the provisions of FAS 123 had been applied. The Company is adopting FAS 123 in fiscal 1997 on a proforma disclosure basis. In February 1997, the Financial Accounting Standards Board ("FASB") issued FAS 128, which applies to entities with publicly held common stock or potential common stock. FAS 128 replaces APB Opinion 15, "Earnings per Share" and related interpretations. APB Opinion 15 required that entities with simple capital structures present a single "earnings per common share" ("EPS") on the face of the income statement, whereas those with complex capital structures present both "primary" and "fully diluted" EPS. Primary EPS shows the amount of income attributed to each share of common stock if every common stock equivalent were converted into common stock. Fully diluted EPS considers common stock equivalents and all other securities that could be converted into common stock. Statement 128 simplifies the computation of EPS by replacing the presentation of primary EPS with a presentation of basic EPS. The Statement requires dual presentation of basic and diluted EPS by entities with complex capital structures. Basic EPS includes no dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings of an entity, similar to fully diluted EPS under APB Opinion 15. FAS 128 becomes effective for financial statements for both interim and annual periods ending after December 19 15, 1997. Earlier application is not permitted. The Company will adopt FAS 128 during the quarter ended December 31, 1997, which is the first quarter of the fiscal year ended September 30, 1998. The Company has disclosed pro forma EPS amounts computed using FAS 128 in Note G to the financial statements for the quarter and the six months ended March 31, 1996 and 1997. After the effective date, all prior-period EPS data presented will be restated to conform with the provisions of FAS 128. The primary effect of FAS 128 on the Company's financial statements is the required dual presentation of basic and diluted income per common share for each interim and annual reporting period. APB Opinion No. 15 allowed entities with complex capital structures to present income per common share excluding common stock equivalents and other potentially dilutive securities if the dilution was less than three percent. Liquidity and Sources of Capital Operating Activities. The Company's net cash provided by operating activities was approximately $27.4 million for the six months ended March 31, 1996. Net cash used in operating activities was approximately $11.5 million for the six months ended March 31,1997. The decrease in operating cash flows for the six months ended March 31, 1997 was primarily the result of (i) higher insurance settlement payments ($14.0 million and $21.2 million for the six months ended March 31, 1996 and 1997, respectively), (ii) higher income tax payments and (iii) reduced cash flows from its provider business. Management believes that the Company will have positive cash flows from operations for the remainder of fiscal 1997, which will be adequate to fund operations, capital expenditures and debt service obligations. Investing Activities. The Company acquired a 61% ownership interest in Green Spring during the first quarter of fiscal 1996. The consideration paid for Green Spring and related acquisition costs resulted in the use of cash of approximately $87.2 million compared to approximately $13.0 million for acquisitions and investments in businesses during the six months ended March 31, 1997. Management believes that its cash on hand, future cash flows from operations, borrowing capacity under the New Revolving Credit Agreement and its ability to issue debt and equity securities under current market conditions will provide adequate capital resources to support the Company's anticipated investing strategies. Financing Activities. The Company borrowed approximately $68.1 million and $15.4 million (excluding borrowings of approximately $115.6 million to pay off the previous Revolving Credit Agreement), respectively, during the six months ended March 31, 1996 and 1997, primarily to fund the acquisition of Green Spring in fiscal 1996 and to fund working capital needs and fees and expenses related to the New Revolving Credit Agreement in fiscal 1997. The Company believes that its businesses will generate sufficient cash flows from operations to meet its future debt service requirements. On September 27, 1996, the Company repurchased approximately 4.0 million shares of its Common Stock for approximately $73.5 million, including transaction costs, pursuant to a "Dutch Auction" self-tender offer to its stockholders. On November 1, 1996, the Company announced that its board of directors approved the repurchase of an additional 3.0 million shares of its Common Stock from time to time subject to the terms of the New Revolving Credit Agreement. The Company expects to use cash on hand, future cash flows from operations and borrowings under its New Revolving Credit Agreement to fund any future treasury stock purchases. As of March 31, 1997, the Company had approximately $209 million of availability under the New Revolving Credit Agreement. The Company was in compliance with all debt covenants at March 31, 1997. Outlook Crescent Transactions On January 30, 1997, the Company announced that it had signed definitive agreements for a series of transactions (the "Crescent Transactions") with Crescent Real Estate Equities Limited 20 Partnership ("Crescent"), which are described in "Item 5 - Other Information" and incorporated herein by reference. The Company expects to close the Crescent Transactions in the third quarter of fiscal 1997. The Crescent Transactions, if consummated, would result in the Company relinquishing control of substantially all of its domestic provider business. The Company expects to record a loss before income taxes of approximately $45 million to $55 million as a result of the Crescent Transactions. In addition, the Company believes that the Crescent Transactions would allow the holders of the Company's 11.25% Senior Subordinated Notes (the "Notes") to put their notes to the Company at 101% of face value. If the Company is required to repurchase all of the Notes, it would record an extraordinary loss for the early extinguishment of debt of approximately $7.5 million to $8.0 million, net of tax. The Company expects to have approximately $272 million of net proceeds remaining from the Crescent Transactions ("Remaining Proceeds"), assuming consummation of the sale of the European Hospitals, after paying off long-term debt, excluding any Notes repurchased. The Company also expects to enter into a new credit agreement with a group of commercial banks simultaneous with the closing of the Crescent Transactions. Under the terms of the new credit agreement, the Company may borrow up to $200 million to repurchase all of the Notes, if necessary. The Company anticipates that the Crescent Transactions could result in reduced net income until the Remaining Proceeds are used to repurchase Notes or are reinvested at an acceptable rate of return to the Company. If the Company is required to repurchase all the Notes as a result of the Crescent Transactions, it would result in increased net income. However, the Company's liquidity and capital resources would be significantly reduced, which would limit the level of investing activities (e.g., acquisitions) the Company may choose or be able to pursue. Sale of European Hospitals. On March 19, 1997, the Company announced that it signed definitive agreements with Priory Hospitals Holdings Limited and Priory Hospitals Europe Limited for the sale of its two psychiatric hospitals in London and its psychiatric hospital in Nyon, Switzerland. The sale of the European Hospitals is subject to regulatory approval. In a separate agreement, Magellan will allow Priory to continue to use the "Charter" name at the facilities for seven years and the "Charter System", comprised of certain intellectual and proprietary rights, for a six month period pending negotiation of a potential franchise relationship. The total purchase price for the European Hospitals and the license agreement is $76 million. These transactions will provide the Company with approximately $72.5 million to reduce long-term debt. The Company expects to record a gain before income taxes of approximately $45 million to $50 million as a result of selling the European Hospitals. The Transaction is expected to close in the third quarter of fiscal 1997. Net Operating Loss Carryforwards. The Company expects to record a gain for federal income tax purposes of approximately $100 million to $110 million as a result of the Crescent Transactions and the sale of the European Hospitals. The Company intends to utilize net operating loss carryforwards ("NOLs") to offset such taxable gains to the extent NOLs are available. The expected utilization of NOLs as a result of the Crescent Transactions and the sale of the European hospitals will accelerate the payment of federal income taxes in future periods, resulting in lower cash flows from operations. Existing Operations. The remaining portion of "Outlook" is prepared with a view toward the existing operating structure of the Company as of March 31, 1997 before the effects of the Crescent Transactions and the sale of the European Hospitals: Management continually assesses events and changes in circumstances that could affect its business strategy and the viability of its provider facilities. During fiscal 1995 and 1996, the Company consolidated, closed or sold 15 and 9 psychiatric hospitals, respectively. During fiscal 1997, the Company has consolidated or closed three psychiatric hospitals and its one general hospital. See Note F for further information regarding facility closures in fiscal 1996 and 1997. The Company plans to pursue acquisitions in its provider segment during fiscal 1997 in markets 21 where it does not currently have a presence and in markets where it has existing hospital operations. Management expects to consolidate services in selected markets as a result of acquisitions or overcapacity and to close or sell additional facilities in future periods depending on market conditions and evolving business strategies. If the Company closes additional psychiatric hospitals in future periods, it could result in additional charges to income for the costs necessary to exit the hospital operations. During fiscal 1995 and fiscal 1996, the Company recorded impairment losses on property and equipment and intangible assets of approximately $27.0 million and $1.2 million, respectively. Such impairment losses resulted from changes in the manner that certain of the Company's assets will be used in future periods and from historical operating losses at certain of the Company's operating facilities combined with projected future operating losses. The affected businesses that were operating as of March 31, 1997 had operating income of approximately $100,000 (net revenue less salaries, supplies and other operating expenses and bad debt expense) in aggregate during fiscal 1996, and operating income of approximately $1.0 million in aggregate during the six months ended March 31, 1997, excluding the normal settlement of reimbursement issues. When events or changes in circumstances are present that indicate the carrying amount of long-lived assets may not be recoverable, the Company assesses the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through future cash flows expected from the use of the asset and its eventual disposition. The Company may record additional impairment losses in future periods as circumstances warrant. The Company's hospitals continue to experience a shift in payer mix to managed care payers from other payers, which contributed to a reduction in revenue per equivalent patient day and average length of stay in fiscal 1996. Management anticipates continued shifting in its hospitals' payer mix towards managed care payers as a result of changes in the healthcare marketplace and the synergies created by the Green Spring acquisition. Future shifts in the Company's hospital payer mix to managed care payers could result in lower revenue per equivalent patient day and average length of stay in future periods for the Company's hospital operations. In addition, the Company's hospitals experienced pricing pressure in fiscal 1996, which management expects to continue in fiscal 1997, which could result in lower revenue per equivalent patient day in future periods. During fiscal 1994, 1995 and 1996, the Company recorded revenue of $32.1 million, $35.6 million and $28.3 million, respectively, for settlements and adjustments related to reimbursement issues. During the quarter and the six months ended March 31, 1997, the Company recorded revenue of $2.8 million and $13.8 million, respectively, for settlements and adjustments related to reimbursement issues compared to $3.3 million and $11.1 million, respectively, for the prior year periods. The settlements in fiscal 1994, 1995 and 1996 related primarily to certain reimbursable costs associated with the Company's financial reorganization in fiscal 1992 and costs related to the early extinguishment of long-term debt in fiscal 1994. Management anticipates that revenue related to such settlements will decline in fiscal 1997, and that the decline will be comparable to the reduction experienced in fiscal 1996. During fiscal 1996, the Company recorded reductions of expenses of approximately $15.3 million as a result of updated actuarial estimates related to malpractice claim reserves. The Company recorded reductions of expenses of approximately $7.5 million and $5.0 million during the quarter and the six months ended March 31, 1996 and 1997, respectively. These reductions resulted primarily from updates to actuarial assumptions regarding the Company's expected losses for more recent policy years. These revisions are based on changes in expected values of ultimate losses resulting from the Company's claim experience, and increased reliance on such claim experience. While Management and its actuaries believe that the present reserve is reasonable, ultimate settlement of losses may vary from the amount recorded and result in additional fluctuations in income in future periods. 22 PART II - OTHER INFORMATION Item 1. - Legal Proceedings The Company and certain of its subsidiaries are subject to or parties to claims, civil suits and governmental investigations and inquiries relating to their operations and certain alleged business practices. In the opinion of management, based on consultation with counsel, resolution of these matters will not have a material adverse effect on the Company's financial position or results or operations. Item 5. - Other Information On January 30, 1997, the Company announced that it had entered into a definitive agreement to sell substantially all of its domestic hospital real estate and related personal property (the "Assets") to Crescent. In addition, the Company's domestic portion of its provider business segment will be operated as a joint venture ("CBHS") that is initially owned equally by Magellan and an affiliate of Crescent ("COI"). The Company will receive $400 million in cash, subject to adjustment, and warrants in COI for the purchase of 2.5% of COI's common stock, exercisable over 12 years, as consideration for the assets. In addition to the Assets, Crescent and COI will each receive 1,283,311 warrants to purchase Magellan Common Stock at $30 per share, exercisable over 12 years. In related agreements, (i) Crescent will lease the real estate and related assets to CBHS for annual rent beginning at $40 million, subject to adjustment, with a 5% annual escalation clause compounded annually and (ii) CBHS will pay Magellan approximately $81 million in annual franchise fees, subject to increase, for the use of assets retained by Magellan and for support in certain areas. The franchise fees to be paid by CBHS to the Company will be subordinated to the lease obligations in favor of Crescent. The assets retained by Magellan include, but are not limited to, the "CHARTER" name, intellectual property, protocols and procedures, clinical quality management, operating processes and the "1-800-CHARTER" telephone call center. Magellan will provide CBHS ongoing support in areas including managed care contracting services, advertising and marketing assistance, risk management services, outcomes monitoring, and consultation on matters relating to reimbursement, government relations, clinical strategies, regulatory matters, strategic planning and business development. The Company intends to initially use the proceeds from the sale of the Assets to reduce its long-term debt, including borrowings under the New Revolving Credit Agreement. Under the terms of the Notes indenture, the Noteholders will have the right to put their Notes to the Company at 101% of face value as a result of the Crescent transactions. The Company intends to maintain adequate cash reserves and borrowing capacity to extinguish all the Notes, if necessary. The Noteholder's right to put the Notes will expire up to 70 days subsequent to the consummation of the Crescent Transactions. The Company intends to use the remaining proceeds from the sale of the Assets, if any after debt reductions, to pursue acquisitions in its managed care and public sector business segments, develop new products and increase managed care and public sector marketing efforts. The Company will account for its 50% investment in CBHS under the equity method of accounting. The Company expects to record a loss before income taxes of approximately $45 million to $55 million as a result of these proposed transactions, including, but not limited to, the write-off of certain hospital-based intangible assets, collection fees associated with accounts receivable and certain commitments and exit costs offset by the expected gain or loss on the sale of the Assets. These transactions are subject to approval by Magellan stockholders and other customary closing conditions, including the negotiation of certain financing matters. 23 Item 6. - Exhibits and Reports on Form 8-K (a) Exhibits 11 Statement re computation of per share earnings 27 Financial Data Schedule 99 Safe Harbor for Forward-Looking Statements under the Private Litigation Reform Act of 1995: Certain Cautionary Statements. (b) Report on Form 8-K There were no current reports on Form 8-K filed by the Registrant with the Securities and Exchange Commission during the quarter ended March 31, 1997. 24 FORM 10-Q MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MAGELLAN HEALTH SERVICES, INC. (Registrant) Date: May 12, 1997 /s/ Craig L. McKnight ------------------- --------------------- Craig L. McKnight Executive Vice President and Chief Financial Officer Date: May 12, 1997 /s/ Howard A. McLure ------------------- -------------------- Howard A. McLure Senior Vice President and Controller (Principal Accounting Officer) 25


EXHIBIT 11 MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES COMPUTATION OF PER SHARE EARNINGS Three Months Three Months Six Months Six Months Ended Ended Ended Ended March 31, 1996 March 31, 1997 March 31, 1996 March 31, 1997 -------------- -------------- -------------- -------------- (in thousands, except per share data) Income before extraordinary item ............................ $ 20,069 $ 11,892 $ 29,817 $ 19,033 ============== ============== ============== ============== Weighted average number of common shares outstanding: Common shares outstanding .......................... 31,247 28,726 29,612 28,657 Stock Options and Rights ........................... 615 -- 468 -- Warrants ........................................... 20 -- 19 -- -------------- -------------- -------------- ------------- 31,882 28,726 30,099 28,657 ============== ============== ============== ============= Primary income per share before extraordinary item ..... $ 0.63 $ 0.41 $ 0.99 $ 0.66 ============== ============== ============== ============= Net income .................................................. $ 20,069 $ 11,892 $ 29,817 $ 16,083 ============== ============== ============== ============= Weighted average number of common shares outstanding ........ 31,882 28,726 30,099 28,657 ============== ============== ============== ============= Primary income per share ............................... $ 0.63 $ 0.41 $ 0.99 $ 0.56 ============== ============== ============== ============= Income before extraordinary item ............................ $ 20,069 $ 11,892 $ 29,817 $ 19,033 Adjustments for the assumed conversion of the Exchange Option: Minority interest .................................. 811 -- 1,082 -- Amortization ....................................... (276) -- (341) -- ------------- --------------- -------------- ------------- Adjusted income before extraordinary item ............. $ 20,604 $ 11,892 $ 30,558 $ 19,033 ============= =============== ============== ============= Weighted average number of common shares outstanding: Common shares outstanding .......................... 31,247 28,726 29,612 28,657 Stock Options and Rights ........................... 616 -- 505 -- Warrants ........................................... 20 -- 20 -- Assumed conversion of the Exchange Option .......... 2,832 -- 1,714 -- ------------ --------------- -------------- ------------ 34,715 28,726 31,851 28,657 ============ =============== ============== ============ Fully diluted income per share before extraordinary item $ 0.59 $ 0.41 $ 0.96 $ 0.66 ============ =============== ============== ============ Adjusted net income ......................................... $ 20,604 $ 11,892 $ 30,558 $ 16,083 ============ =============== ============== ============ Weighted average number of common shares outstanding ........ $ 34,715 $ 28,726 31,851 28,657 ============ =============== ============== ============ Fully diluted income per share ......................... $ 0.59 $ 0.41 $ 0.96 $ 0.56 ============ =============== ============== ============
Note: Common stock equivalents(stock options,rights and warrants) were less than three percent dilutive for the three months the six months ended March 31, 1997. Accordingly, they are not presented herein. The Exchange Option was anti-dilutive for the three months and the six months ended March 31, 1997.
 


5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON PAGES 1, 2, AND 3 OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENS. 6-MOS SEP-30-1997 MAR-31-1997 114,245,000 0 192,394,000 0 4,465,000 336,403,000 635,085,000 143,724,000 1,122,387,000 241,123,000 580,536,000 8,307,000 0 0 133,901,000 1,122,387,000 696,741,000 696,741,000 0 566,333,000 29,015,000 35,375,000 26,722,000 39,296,000 15,718,000 19,033,000 0 2,950,000 0 16,083,000 .56 0



                                   EXHIBIT 99

            SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS UNDER PRIVATE
          SECURITIES LITIGATION REFORM ACT OF 1995; CERTAIN CAUTIONARY
                                   STATEMENTS


         Magellan Health Services,  Inc. (the "Company") and its representatives
may make  forward  looking  statements  (as such term is defined in the  Private
Securities Litigation Reform Act) from time-to-time. The Company wants to invoke
to  the  fullest  extent  possible  the  protection  of the  Private  Securities
Litigating  Reform Act and the judicially  created  "bespeaks  caution" doctrine
with respect to such statements. Accordingly, the Company is filing this Exhibit
99,  which  lists  certain  factors  that may  cause  actual  results  to differ
materially from those in such forward looking statements.

         This list is not  necessarily  exhaustive.  The  Company  operates in a
rapidly changing business,  and new risk factors emerge periodically.  There can
be no assurance that this Exhibit lists all material risks to the Company at any
specific point in time.  Readers are also referred to the risk factor disclosure
contained in the Company's  Proxy  Statement on Schedule 14A, filed on April 24,
1997.

         On  January  30,  1997,  the  Company  announced  that  it  had  signed
definitive agreements for a series of transactions (the "Crescent Transactions")
with Crescent Real Estate Equities Limited Partnership  ("Crescent"),  which are
described  in "Item 5 - Other  Information".  The  Company  expects to close the
Crescent  Transactions  in the third quarter of fiscal 1997.  The following risk
factors are prepared with a view toward the existing operating  structure of the
Company as of March 31, 1997 before the effects of the Crescent Transaction:

Limitations Imposed by the New Revolving Credit Agreement
and Senior Note Indenture

         In May 1994,  the Company  entered  into a Second  Amended and Restated
Credit Agreement (the "Credit  Agreement") with certain  financial  institutions
and issued $375 million of Senior  Subordinated  Notes (the  "Senior  Notes") to
institutional investors. The Credit Agreement was terminated in October 1996 and
the Company  entered  into a new Credit  Agreement  (the "New  Revolving  Credit
Agreement"). The New Revolving Credit Agreement and the indenture for the Senior
Notes contain a number of restrictive covenants which, among other things, limit
the  ability of the  Company  and  certain of its  subsidiaries  to incur  other
indebtedness,  enter into certain joint venture transactions,  incur liens, make
certain  restricted  payments  and  investments,  enter  into  certain  business
combination and asset sale  transactions  and make capital  expenditures.  These
restrictions  could  adversely  affect the  Company's  ability  to  conduct  its
operations,   finance  its  capital  needs  or  to  pursue  attractive  business
combinations  and joint  ventures  if such  opportunities  arise.  Under the New
Revolving  Credit  Agreement,  the Company also is required to maintain  certain
specified  financial  ratios.  Failure by the Company to maintain such financial
ratios or to comply with the restrictions  contained in the New Revolving Credit
Agreement and the  indenture for the Senior Notes could cause such  indebtedness
(and by reason of cross-acceleration  provisions,  other indebtedness) to become
immediately  due and payable  and/or could cause the  cessation of funding under
the New Revolving Credit Agreement.

Acquisition Growth Strategy

         The Company has historically grown through  acquisitions.  There can be
no assurance that the Company will be able to make  successful  acquisitions  in
the future or that any such  acquisitions  will be successfully  integrated into
its operations.  In addition,  future  acquisitions could have an adverse effect
upon the  Company's  operating  results,  particularly  in the  fiscal  quarters
immediately  following the consummation of such transactions  while the acquired
operations are being integrated into its operations.










Historical Operating Losses

         The  Company  experienced  losses  from  continuing  operations  before
reorganization items,  extraordinary items and the cumulative effect of a change
in  accounting  principle  during  each fiscal  year since the  completion  of a
management  buyout in 1988 through  fiscal 1995.  Such losses  amounted to $81.7
million for the  ten-month  period  ended July 31,  1992,  $8.1  million for the
two-month  period ended September 30, 1992 and $39.6 million,  $47.0 million and
$43.0  million for the fiscal years ended  September  30,  1993,  1994 and 1995,
respectively.  The Company  reported  net  revenue  and income  from  continuing
operations of approximately $1.35 billion and $32.4 million,  respectively,  for
the year ended  September  30, 1996.  The Company also  reported net revenue and
income from continuing  operations before  extraordinary  items of approximately
$650.6  million  and $29.8  million  for the six months  ended  March 31,  1996,
respectively,  compared to net revenue and income from continuing  operations of
$696.7 million and $19.0 million,  respectively,  for the six months ended March
31, 1997.  There can be no assurance  that the Company's  profitability  for the
year ended  September  30,  1996 and the six months  ended  March 31,  1997 will
continue  in future  periods.  The  Company's  history  of losses  could have an
adverse effect on its operations.

Potential Hospital Closures

         The Company  continually  assesses events and changes in  circumstances
that could  effect its  business  strategy  and the  viability  of its  provider
facilities.  During fiscal 1995 and 1996,  the Company  consolidated,  closed or
sold 15 and 9  psychiatric  hospitals,  respectively.  During  fiscal 1997,  the
Company has  consolidated,  closed or sold three  psychiatric  hospitals and one
general  hospital.  The Company records  charges against income,  as a result of
these  consolidations,  closures and sales. The Company may elect to consolidate
services  in  selected  markets and to close or sell  additional  facilities  in
future periods depending on market conditions and evolving business  strategies.
If the Company closes  additional  psychiatric  hospitals in future periods,  it
could  result in charges to income for the cost  necessary  to exit the hospital
operations.

Potential Reductions in Reimbursement by
Third-Party Payers and Changes in Hospital Payer Mix

         The  Company's  hospitals  have  been  adversely  affected  by  factors
influencing the entire psychiatric  hospital industry.  Factors which affect the
Company  include  (i)  the  imposition  of more  stringent  length  of stay  and
admission  criteria  and other cost  containment  measures  by payers;  (ii) the
failure of reimbursement  rate increases from certain payers that reimburse on a
per diem or other  discounted basis to offset increases in the cost of providing
services;  (iii) an increase in the  percentage of its business that the Company
derives from payers that reimburse on a per diem or other discounted basis; (iv)
a trend toward higher deductibles and co-insurance for individual patients;  (v)
pricing  pressure  related to increasing  rate of claims  denials by third party
payers;  and (vi) a trend toward  limiting  employee  health  benefits,  such as
reductions in annual and lifetime limits on mental health coverage. Any of these
factors could result in  reductions in the amounts that the Company's  hospitals
can expect to collect per patient day for services provided.

         For the fiscal year ended  September  30,  1996,  the  Company  derived
approximately 21% of its gross psychiatric  patient service revenue from managed
care organizations  (primarily HMOs and PPOs, as hereinafter defined),  25% from
other private payers (primarily  commercial  insurance and Blue Cross), 28% from
Medicare, 17% from Medicaid, 3% from the Civilian Health and Medical Program for
the  Uniformed  Services  ("CHAMPUS")  and 6% from  other  government  programs.
Changes  in  the  mix  of  the  Company's   patients   among  the  managed  care
organizations,  Medicare and Medicaid  categories,  and among different types of
private-pay sources, can significantly affect the profitability of the Company's
hospital  operations.  Therefore,  there can be no assurance that payments under
governmental  and  private  third-party  payer  programs  will  remain at levels
comparable to present levels or will, in the future,  be sufficient to cover the
costs of providing care to patients covered by such programs.

Previous Bankruptcy Reorganization

         The Company was reorganized pursuant to Chapter 11 of the United States
Bankruptcy Code, effective on July 21, 1992 (the "Reorganization"). Prior to the
Reorganization, the Company's total indebtedness was approximately $1.8 billion.
From February 1991 until July 1992, the Company was in default in the payment of
interest and principal, or






both, on substantially all such  indebtedness.  The indebtedness was incurred by
the Company in connection with a management buy-out of the Company in 1988 and a
hospital-construction program. As a result of the Reorganization,  the Company's
long-term  debt was reduced by  approximately  $700  million and its  redeemable
preferred  stock of $233  million was  eliminated.  The holders of such debt and
preferred  stock  received   approximately   97%  of  Magellan's   Common  Stock
outstanding on July 21, 1992.

Dependence on Healthcare Professionals

         Physicians  traditionally have been the source of a significant portion
of the patients treated at the Company's  hospitals.  Therefore,  the success of
the  Company's  hospitals  is dependent in part on the number and quality of the
physicians on the medical staffs of its hospitals and their admission practices.
A small  number of  physicians  account  for a  significant  portion  of patient
admissions at some of the Company's  hospitals.  There can be no assurance  that
the  Company  can  retain its  current  physicians  on staff or that  additional
physician relationships will be developed in the future.  Furthermore,  hospital
physicians  generally are not  employees of the Company and in general  Magellan
does not have contractual  arrangements with hospital physicians restricting the
ability of such physicians to practice elsewhere.

Potential General and Professional Liability

         Effective June 1, 1995, Plymouth Insurance Company, Ltd.  ("Plymouth"),
a wholly-owned Bermuda subsidiary of the Company,  provides general and hospital
professional  liability  insurance  up to $25  million  per  occurrence  for the
Company's hospitals.  All of the risk of losses from $1.5 million to $25 million
per occurrence has been reinsured with unaffiliated  insurers.  The Company also
insures  with an  unaffiliated  insurer  100% of the risk of losses  between $25
million and $100 million per occurrence, subject to an annual aggregate limit of
$75  million.  The  Company's  general and  professional  liability  coverage is
written on a "claims made or circumstances reported" basis. For reinsured claims
between $10 and $25 million per occurrence,  the Company has an annual aggregate
limit of coverage of $30 million.  For reinsured claims between $1.5 million and
$10 million per  occurrence,  the Company has no significant  limitations on the
aggregate dollar amounts of coverage.

         For the six years from June 1, 1989 through May 31,  1995,  the Company
had a similar general and hospital professional liability insurance program. For
those years,  the per occurrence  deductible  (with respect to which the Company
was self-insured) was $2.5 million for the years ended May 31, 1990 and 1991, $2
million for the years ended May 31, 1992 and 1993 and $1.5 million  (relating to
the Company's  general  hospitals sold on September 30, 1993) for the year ended
May 31, 1994. For psychiatric  hospitals,  Plymouth's coverage did not contain a
per occurrence deductible for the years ended May 31, 1994 and 1995. In December
1994,  the per  occurrence  deductible for the years ended May 31, 1989 and 1990
was eliminated. Plymouth provides coverage with no per occurrence deductible for
hospital  system  claims  which had not been paid prior to  December  31,  1994.
Plymouth does not underwrite any insurance  policies with any parties other than
the Company or its affiliates and subsidiaries.

         The amount of expense relating to Magellan's  malpractice insurance may
materially increase or decrease from year to year depending, among other things,
on the nature and number of new reported claims against  Magellan and amounts of
settlements of previously reported claims. To date, Magellan has not experienced
a loss in excess of policy limits.  Management believes that its coverage limits
are adequate.  However,  losses in excess of the limits  described  above or for
which insurance is otherwise  unavailable  could have a material  adverse effect
upon the Company.

Potential Expiration and Realization Uncertainties Related
to Estimated Tax Net Operating Loss Carryforwards

         As of September  30, 1996,  the Company had estimated tax net operating
loss ('NOL")  carryforwards  of approximately  $250 million  available to reduce
future federal taxable income.  These NOL  carryforwards  expire in 2006 through
2010 and are subject to  adjustment  upon  examination  by the Internal  Revenue
Service.  Due  to  the  ownership  change  which  occurred  as a  result  of the
Reorganization,  the  Company's  utilization  of  NOLs  generated  prior  to the
effective date of the  Reorganization  is limited.  Based on this limitation and
certain  other  factors,  the Company  has  recorded a  valuation  allowance  of
approximately  $102.2  million  against the amount of the NOL deferred tax asset
that






in  Management's  opinion,  is  not  likely  to be  recovered.  There  can be no
assurance that these NOL  carryforwards  will not expire,  be reduced or be made
subject to further  limitations  prior to their potential  utilization in future
periods.

Governmental Budgetary Constraints and Healthcare Reform

         In the 1995 and 1996 sessions of the United States Congress,  the focus
of healthcare  legislation has been on budgetary and related  funding  mechanism
issues. Both the Congress and the Clinton  Administration have made proposals to
reduce the rate of increase in projected Medicare and Medicaid  expenditures and
to change funding  mechanisms  and other aspects of both  programs.  If enacted,
these proposals would generally reduce Medicare and Medicaid  expenditures.  The
Company cannot predict the effect of any such  legislation,  if adopted,  on its
operations;  but the Company  anticipates  that,  although  overall Medicare and
Medicaid  funding  may be reduced  from  projected  levels,  the changes in such
programs may provide  opportunities to the Company to obtain increased  Medicare
and Medicaid  business through  risk-sharing or partial  risk-sharing  contracts
with managed care plans and state Medicaid programs.

         A number of states in which the  Company  has  operations  have  either
adopted or are  considering  the  adoption of  healthcare  reform  proposals  of
general  applicability  or  Medicaid  reform  proposals,  partly in  response to
possible  changes in Medicaid law. Where  adopted,  these state reform laws have
often not yet been fully  implemented.  The Company cannot predict the effect of
these state healthcare reform and Medicaid reform laws on its operations.

Provider Business-Competition

         Each of the Company's hospitals competes with other hospitals,  some of
which are larger and have greater financial resources.  Some competing hospitals
are  owned  and  operated  by   governmental   agencies,   others  by  nonprofit
organizations supported by endowments and charitable contributions and others by
proprietary hospital  corporations.  The hospitals frequently draw patients from
areas outside their immediate  locale and,  therefore,  the Company's  hospitals
may,  in certain  markets,  compete  with both local and distant  hospitals.  In
addition,  the  Company's  hospitals  compete  not only with  other  psychiatric
hospitals,  but also with psychiatric units in general hospitals, and outpatient
services  provided by the Company may compete  with  private  practicing  mental
health  professionals and publicly funded mental health centers. The competitive
position of a hospital is, to a significant  degree,  dependent  upon the number
and quality of  physicians  who  practice at the hospital and who are members of
its medical staff. The Company has entered into joint venture  arrangements with
other healthcare  providers in certain markets to promote more efficiency in the
local delivery system.  The Company believes that its provider business competes
effectively with respect to the aforementioned factors. However, there can be no
assurance  that  Magellan will be able to compete  successfully  in the provider
business in the future.

         Competition among hospitals and other healthcare providers for patients
has intensified in recent years.  During this period,  hospital  occupancy rates
for inpatient  behavioral  care patients in the United States have declined as a
result  of  cost  containment   pressures,   changing  technology,   changes  in
reimbursement,  changes  in  practice  patterns  from  inpatient  to  outpatient
treatment  and other  factors.  In recent  years,  the  competitive  position of
hospitals has been affected by the ability of such hospitals to obtain contracts
with   Preferred   Provider   Organizations   ("PPO's"),    Health   Maintenance
Organizations ("HMO's") and other managed care programs to provide inpatient and
other services.  Such contracts  normally involve a discount from the hospital's
established  charges,  but provide a base of patient referrals.  These contracts
also  frequently  provide for  pre-admission  certification  and for  concurrent
length of stay reviews.  The importance of obtaining contracts with HMO's, PPO's
and other managed care companies varies from market to market,  depending on the
individual  market strength of the managed care companies.  State certificate of
need  laws  regulate  the  Company  and its  competitors'  ability  to build new
hospitals and to expand existing hospital facilities and services. These laws do
provide  some  protection  from  competition,  as their  interest  is to prevent
duplication of services.  In most cases,  these laws do not restrict the ability
of the Company or its competitors to offer new outpatient services.  As of March
31, 1997,  the Company  operated 38 hospitals in 12 states  (Arizona,  Arkansas,
California,  Colorado,  Indiana,  Kansas,  Louisiana,  Nevada, New Mexico, South
Dakota, Texas and Utah) which do not have certificate of need laws applicable to
hospitals.








Managed Care Business - Competition

          The managed healthcare  industry is being affected by various external
factors including rising healthcare costs, intense price competition, and market
consolidation by major managed care companies. Magellan faces competition from a
number of sources  including other behavioral  health managed care companies and
traditional  full  service  managed  care  companies  that  contract  to provide
behavioral  healthcare  benefits.  Also, to a lesser extent,  competition exists
from fully  capitated  multi-specialty  medical groups and  individual  practice
associations  that  directly  contract  with  managed care  companies  and other
customers to provide and manage all  components  of  healthcare  for the members
including the behavioral  healthcare  component.  The Company  believes that the
most  significant  factors in a  customer's  selection  of a managed  behavioral
healthcare  company include price, the extent and depth of provider networks and
quality of services.  The Company also  believes that the  acquisition  of Green
Spring  creates  opportunities  to enhance its  revenues  through  managed  care
contracts  utilizing the continuum of care and through  information systems that
support  care  management  and  at-risk  pricing  mechanisms,  although  no such
assurance  can be given.  Management  believes  that its managed  care  business
competes  effectively  with respect to these factors.  However,  there can be no
assurance that Magellan will be able to compete successfully in the managed care
business in the future.

Regulatory Environment

         The federal  government  and all states in which the  Company  operates
regulate various aspects of the Company's  businesses.  Such regulations provide
for periodic  inspections or other reviews of the Company's provider  operations
by, among others,  state  agencies,  the United States  Department of Health and
Human Services (the "Department") and CHAMPUS to determine compliance with their
respective  standards of care and other  applicable  conditions of participation
which is necessary  for  continued  licensure  or  participation  in  identified
healthcare  programs,  including,  but not limited to,  Medicare,  Medicaid  and
CHAMPUS. The Company is also subject to state regulation regarding the admission
and treatment of patients and federal regulations  regarding  confidentiality of
medical records of substance abuse patients.  Although the Company  endeavors to
comply with such  regulatory  requirements,  there can be no assurance  that the
Company  will always be in full  compliance.  The failure to obtain or renew any
required   regulatory   approvals  or  licenses  or  to  qualify  for  continued
participation  in identified  healthcare  programs  could  adversely  affect the
Company's operations.

         The  Company  is also  subject to  federal  and state laws that  govern
financial and other arrangements between healthcare providers.  These laws often
prohibit certain direct and indirect payments between healthcare  providers that
are  designed  to induce  overutilization  of  services  paid for by Medicare or
Medicaid.  Such  laws  include  the anti-  kickback  provisions  of the  federal
Medicare  and  Medicaid  Patients  and  Program  Protection  Act of 1987.  These
provisions  prohibit,  among other things, the offer,  payment,  solicitation or
receipt of any form of  remuneration  in return for the referral of Medicare and
Medicaid  patients.   GPA,  the  Company's   subsidiary  that  owns  or  manages
professional  group  practices,  is subject to the federal and the state illegal
remuneration,  practice of medicine  and certain  other laws which  prohibit the
subsidiary from owning, but not managing,  professional  practices. In addition,
some states prohibit business corporations from providing, or holding themselves
out as a provider of,  medical  care.  The Company  endeavors to comply with all
federal and state laws applicable to its business. However, a violation of these
federal and state laws may result in civil or criminal penalties for individuals
or entities or exclusion from participation in identified healthcare programs.

         Magellan's  managed  care  business  operations,  in some  states,  are
subject  to  utilization   review,   licensure  and  related  state   regulation
procedures.  Green Spring provides  managed  behavioral  healthcare  services to
various Blue Cross/Blue  Shield plans that operate  Medicare and Medicaid health
maintenance  organizations  or other  at-risk  managed  care  programs  and that
participate in the Blue Cross Federal Employees health program.  As a contractor
to these Blue  Cross/Blue  Shield plans,  Green Spring is indirectly  subject to
federal  and,  with  respect  to the  Medicaid  program,  state  monitoring  and
regulation  of  performance  and  financial  reporting  requirements.   Although
Magellan  believes that it is in  compliance  with all current state and federal
regulatory  requirements  applicable  to the managed care  business it conducts,
failure to do so could adversely affect its operations.

         Physician  ownership of or investment  in healthcare  entities to which
they refer patients has come under increasing scrutiny at both state and federal
levels. Congress passed legislation (commonly referred to as "Stark I")






which  prohibits  physicians  from  referring  Medicare  patients  for  clinical
laboratory  services  to an entity  with  which the  physician  has a  financial
relationship.  The Department  recently  published  final Stark I regulations on
August 14,  1995.  Such  regulations  will govern how the  Department  views and
reviews these financial relationships. Additionally, Congress passed legislation
(commonly  referred to as "Stark II") which prohibits  physicians from referring
Medicare or Medicaid patients for certain designated health services,  including
inpatient and outpatient  hospital  services,  to entities in which they have an
ownership  or  investment  interest  or  with  which  they  have a  compensation
arrangement. The entity is also prohibited from billing the Medicare or Medicaid
programs for such services  rendered pursuant to a prohibited  referral.  To the
extent  designated  services are provided by the Company's  provider and managed
care operations,  physicians who have a financial  relationship with the Company
and the Company will be subject to the  provisions of Stark II. Some states have
passed similar legislation which prohibits the referral of private pay patients.
To date, the Department has not published  Stark II  regulations.  However,  the
Department  indicated  that  it  will  review  referrals  involving  any  of the
designated  services  under the  language and  interpretations  set forth in the
Stark I rule.

         The  Company's  acquisitions  and  joint  venture  activities  are also
subject to federal antitrust laws. The healthcare  industry has recently been an
active area of antitrust  enforcement  action by the United States Federal Trade
Commission  (the "FTC") and the  Department  of Justice  ("DOJ").  The Company's
acquisitions and joint venture  arrangements could be the subject of a DOJ or an
FTC enforcement action which, if determined adversely to the Company, could have
a material adverse effect upon the Company's operations.

         Changes in laws or regulations or new  interpretations of existing laws
or regulations  can have an adverse effect on the Company's  operating  methods,
costs,  reimbursement  amounts and acquisition and joint venture activities.  In
addition,  the  healthcare  industry  is  subject  to  increasing   governmental
scrutiny, and additional laws and regulations may be enacted which could require
changes in the  Company's  operations.  A federal or state  agency  charged with
enforcement of such laws and regulations  might assert an interpretation of such
laws and  resolutions  or may increase  scrutiny of a previously  ignored  area,
which may require changes in the Company's operations.

Capitation Arrangements

         The Company's  managed care business  contracts with companies  holding
state HMO or insurance  company licenses on a capitated or "at-risk" basis where
the risk of patient care is assumed by the Company in exchange for a monthly fee
per member regardless of utilization level. As of March 31, 1997,  approximately
35% of Green Spring's  managed care members were under  capitated  arrangements.
During  fiscal 1996,  approximately  70% of Green  Spring's  revenues  were from
at-risk contracts.  Increases in utilization levels under capitated  contractual
arrangements could adversely effect the operations of the managed care business.

         Some jurisdictions are taking the position that capitated agreements in
which the provider bears the risk should be regulated by insurance laws. In this
regard, Green Spring's primary customers are comprised of Blue Cross/Blue Shield
Plans and other insurance entities which are licensed insurance organizations in
their respective states.  Green Spring offers "carved out" managed mental health
benefits,  on a  wholesale  basis,  as  a  vendor  to  the  regulated  insurance
organizations.  Most current  employer group  relationships  are also contracted
through the respective regulated insurance  organizations.  However, as Magellan
and Green  Spring  develop  more  direct  risk  arrangements  on a retail  basis
directly with  employer  groups or other  non-insurance  entity  customers,  the
Company may be required to obtain  insurance  licenses in the respective  states
where the direct risk arrangements are to be pursued.  There can be no assurance
that the Company can obtain the insurance  licenses  required by the  respective
states in a timely or cost effective manner to respond to market demand.

Mental Health Parity Legislation

         In October 1996,  President Clinton signed a bill submitted by the U.S.
Congress  that  prohibits  health plans from setting  annual or lifetime caps on
mental  health  coverage  ("parity")  at  levels  below  those  set for  general
medical/surgical healthcare services. The bill does not require a health plan to
offer or provide  mental  health  services  and does not affect  other terms and
conditions of health plans,  such as inpatient day or outpatient visit limits or
scope of benefits, nor does this bill prohibit health plans from utilizing other
forms of cost containment.  The definition of mental health services in the bill
excludes  substance  abuse and chemical  dependency.  The effective date for the
parity





legislation is January 1, 1998.  Other key components of the parity  legislation
are as follows:

1)   Employers   with  50  or  fewer   employees  are  exempt  from  the  parity
     legislation.

2)   Health  plans that incur  increased  costs of 1% or more as a result of the
     parity legislation will be exempt.

3)   The parity  legislation  expires on September  30, 2001 unless  extended by
     Congress.

     The Company views the parity  legislation as an  acknowledgment  by the
Federal  government of the  importance  of effective  treatment of mental health
disorders for society in general.  The parity  legislation  could result in cost
containment  mechanisms by third party payers such as the  elimination of mental
health   benefit  plans  or   encouraging   the   utilization  of  managed  care
organizations to administer mental health benefit plans, which could both result
in lower demand and lower  revenue per  equivalent  patient day in the Company's
provider business.  However, this bill is subject to administrative and judicial
interpretation, neither of which the Company is able to predict. There can be no
assurance  that such  interpretations  will not  adversely  effect the Company's
businesses.

Possible Volatility of Stock Price

         The Company  believes  factors  such as  announcements  with respect to
healthcare  reform  measures,   reductions  in  government   healthcare  program
projected  expenditures,  acquisitions and  quarter-to-quarter  and year-to-year
variations in financial  results could cause the market price of Magellan Common
Stock to fluctuate substantially.  Any such adverse announcement with respect to
healthcare  reform  measures  or  program  expenditures,   acquisitions  or  any
shortfall in revenue or earnings  from levels  expected by  securities  analysts
could have an immediate and  significant  adverse effect on the trading price of
Magellan Common Stock in any given period. As a result,  the market for Magellan
Common  Stock may  experience  price and volume  fluctuations  unrelated  to the
operating performance of Magellan.