UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-26190
US ONCOLOGY, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 84-1213501
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER
ORGANIZATION) IDENTIFICATION NO.)
16825 NORTHCHASE DRIVE, SUITE 1300
HOUSTON, TEXAS
77060
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(832) 601-8766
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 [ ]
As of November 5, 2001, 94,785,200 shares of the Registrant's Common Stock
were outstanding. In addition, as of November 5, 2001, the Registrant had
agreed to deliver 9,188,429 shares of its Common Stock on certain future dates
for no additional consideration.
US ONCOLOGY, INC.
FORM 10-Q
SEPTEMBER 30, 2001
Table of Contents
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements....................... 3
Condensed Consolidated Balance Sheet.............................. 3
Condensed Consolidated Statement of Operations and
Comprehensive Income............................................ 4
Condensed Consolidated Statement of Cash Flows.................... 5
Notes to Condensed Consolidated Financial Statements.............. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 12
Item 3. Quantitative and Qualitative Disclosures about Market Risks....... 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 22
Item 2. Changes in Securities............................................. 23
Item 6. Exhibits and Reports on Form 8-K.................................. 24
SIGNATURES................................................................ 25
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PAR VALUE)
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
ASSETS (UNAUDITED)
Current assets:
Cash and equivalents....................................................... $ 8,756 $ 3,389
Accounts receivable........................................................ 295,743 337,360
Prepaid expenses and other current assets.................................. 42,231 44,904
Due from affiliates........................................................ 40,212 72,380
---------- ----------
Total current assets................................................... 386,942 458,033
Property and equipment, net................................................. 282,204 270,299
Management service agreements, net.......................................... 385,884 398,397
Deferred income taxes....................................................... 25,289 38,404
Other assets................................................................ 24,757 25,929
---------- ----------
$1,105,076 $1,191,062
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term indebtedness............................... $ 26,188 $ 23,910
Accounts payable........................................................... 130,165 153,980
Due to affiliates.......................................................... 12,235 8,044
Income taxes payable....................................................... 14,832 9,154
Other accrued liabilities.................................................. 78,571 73,933
---------- ----------
Total current liabilities.............................................. 261,991 269,021
Long-term indebtedness...................................................... 183,356 300,213
---------- ----------
Total liabilities...................................................... 445,347 569,234
Minority interests.......................................................... 1,518 1,506
Stockholders' equity:
Preferred Stock, $.01 par value, 1,500 shares authorized, none issued and
outstanding.............................................................
Series A Preferred Stock, $.01 par value, 500 shares authorized and
reserved, none issued and outstanding...................................
Common Stock, $.01 par value, 250,000 shares authorized, 94,744 and 93,837
issued, 91,734 and 89,299 outstanding................................... 947 939
Additional paid in capital................................................. 461,794 457,348
Common Stock to be issued, approximately 9,114 and 10,370 shares........... 62,721 69,666
Treasury Stock, 3,010 and 4,538 shares..................................... (14,545) (21,416)
Retained earnings.......................................................... 147,294 113,785
---------- ----------
Total stockholders' equity............................................. 658,211 620,322
---------- ----------
$1,105,076 $1,191,062
========== ==========
The accompanying notes are an integral part of this statement.
3
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------- -----------------------------
2001 2000 2001 2000
-------- -------- ---------- --------
Revenue.......................................... $372,742 $337,310 $1,119,221 $968,318
Operating expenses
Pharmaceuticals and supplies............... 192,515 169,249 577,147 480,164
Field compensation and benefits............ 81,005 69,680 239,983 201,206
Other field costs.......................... 43,915 40,351 135,991 114,151
General and administrative................. 11,905 13,426 35,670 38,900
Depreciation and amortization.............. 17,373 18,272 51,925 55,804
Restructuring and other charges............ - 206 5,868 3,372
-------- -------- ---------- --------
346,713 311,184 1,046,584 893,597
-------- -------- ---------- --------
Income from operations........................... 26,029 26,126 72,637 74,721
Interest expense, net............................ (5,216) (7,404) (18,596) (20,515)
Gain on investment in common stock............... - - - 27,566
-------- -------- ---------- --------
Income before income taxes....................... 20,813 18,722 54,041 81,772
Income tax provision............................. 7,909 7,114 20,536 31,073
-------- -------- ---------- --------
Net income and comprehensive income.............. $ 12,904 $ 11,608 $ 33,505 $ 50,699
======== ======== ========== ========
Net income per share - basic..................... $ 0.13 $ 0.12 $ 0.34 $ 0.50
======== ======== ========== ========
Shares used in per share calculations - basic.... 100,229 99,984 99,946 101,262
======== ======== ========== ========
Net income per share - diluted................... $ 0.13 $ 0.12 $ 0.33 $ 0.50
======== ======== ========== ========
Shares used in per share calculations - diluted.. 100,351 100,146 100,235 101,408
======== ======== ========== ========
The accompanying notes are an integral part of this statement.
4
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------------
2001 2000
--------- ---------
Cash flows from operating activities:
Net income........................................................... $ 33,505 $ 50,699
Non cash adjustments:
Restructuring and other charges...................................... 331 1,514
Realized gain on investment in common stock.......................... - (27,566)
Depreciation and amortization........................................ 51,925 55,804
Deferred income taxes................................................ 14,340 3,910
Undistributed earnings in joint ventures............................. 12 512
Changes in operating assets and liabilities.......................... 60,994 16,445
--------- ---------
Net cash provided by operating activities..................... 161,107 101,318
--------- ---------
Cash flows from investing activities:
Acquisition of property and equipment................................ (48,155) (47,428)
Net payments in affiliation transactions............................. (1,005) (11,767)
Proceeds from sale of investment in common stock..................... - 54,824
--------- ---------
Net cash used by investing activities......................... (49,160) (4,371)
--------- ---------
Cash flows from financing activities:
Proceeds from Credit Facility........................................ 25,000 56,000
Repayment of Credit Facility......................................... (122,500) (120,000)
Repayment of other indebtedness...................................... (12,518) (15,731)
Purchase of Treasury Stock........................................... - (15,532)
Proceeds from exercise of options.................................... 3,438 978
--------- ---------
Net cash used by financing activities........................ (106,580) (94,285)
--------- ---------
Increase in cash and equivalents........................................ 5,367 2,662
Cash and equivalents:
Beginning of period.................................................. 3,389 11,381
--------- ---------
End of period........................................................ $ 8,756 $ 14,043
========= =========
Interest paid........................................................... $ 17,849 $ 19,159
Taxes paid.............................................................. $ 9,100 $ 31,441
Non cash transactions:
Value of Common Stock to be issued in affiliation transactions....... $ 606 $ 5,570
Delivery of Common Stock in affiliation transactions................. 6,872 17,034
Debt issued in affiliation transactions.............................. 1,787 9,976
Debt assumed in affiliation transactions............................. - 900
Debt issued to finance insurance premiums............................ - 1,315
The accompanying notes are an integral part of this statement.
5
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial reporting and in accordance with Form 10-Q and Rule 10.01 of
Regulation S-X. 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, the unaudited condensed
consolidated financial statements contained in this report reflect all
adjustments that are normal and recurring in nature and considered necessary for
a fair presentation of the financial position and the results of operations for
the interim periods presented. The preparation of the Company's financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses, as well as disclosures on contingent
assets and liabilities. Because of inherent uncertainties in this process,
actual future results could differ from those expected at the reporting date.
These unaudited condensed consolidated financial statements, footnote
disclosures and other information should be read in conjunction with the
financial statements and the notes thereto included in US Oncology, Inc.'s Form
10-K filed with the Securities and Exchange Commission on March 28, 2001.
NOTE 2 - REVENUE
Net patient revenue for services to patients by the practices affiliated with
the Company is recorded when services are rendered based on established or
negotiated charges reduced by contractual adjustments and allowances for
doubtful accounts. Differences between estimated contractual adjustments and
final settlements are reported in the period when final settlements are
determined. Net patient revenue of the practices is reduced by amounts retained
by the practices under the Company's service agreements to arrive at the
Company's service revenue.
Amounts retained by the affiliated physician groups for physician compensation
are primarily derived under two management service agreement models. Under the
first model (the net revenue model), amounts retained by physician groups are
based upon a specified amount (typically 23% of net revenue) and, if certain
financial criteria are satisfied, an incremental amount. Under the second model
(the earnings model), amounts retained by practices are based upon a percentage
(typically 65% - 75%) of the difference between net patient revenues less direct
expenses, excluding interest expense and taxes.
The following presents the amounts included in the determination of the
Company's revenue (in thousands):
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- ----------------------------
2001 2000 2001 2000
-------- -------- ---------- ----------
Net patient revenue............................... $475,916 $441,301 $1,436,627 $1,266,566
Amounts retained by practices..................... 103,174 103,991 317,406 298,248
-------- -------- ---------- ----------
Revenue........................................... $372,742 $337,310 $1,119,221 $ 968,318
======== ======== ========== ==========
The Company's most significant service agreement, which is the only service
agreement that represents more than 10% of revenue to the Company, is with Texas
Oncology, P.A. (TOPA). TOPA accounted for approximately 21.9% and 24.9% of the
Company's total revenue for the three months ended September 30, 2001 and 2000,
respectively, and 22.1% and 24.9% for the nine months ended September 30, 2001
and 2000, respectively.
6
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
NOTE 3 - GAIN ON SALE OF INVESTMENT IN COMMON STOCK
In March 2000, the Company sold its equity investment in ILEX Oncology, Inc. in
a private sale transaction and realized proceeds of $54.8 million, or $38.8
million net of tax. Included in other income for the first nine months of 2000
is $27.6 million related to a gain on sale of this stock. A previous gain of
$14.4 million was recognized during the fourth quarter of 1999 as a result of
the Company's reclassification of the ILEX stock as a trading security.
NOTE 4 - RESTRUCTURING AND OTHER CHARGES
In the fourth quarter of 2000, the Company comprehensively analyzed its
operations and cost structure, with a view to repositioning the Company to
effectively execute its strategic and operational initiatives. This analysis
focused on non-core assets and activities of the Company to determine whether
they were still consistent with the Company's strategic direction. As a result
of this analysis, during the fourth quarter of 2000, the Company recorded the
following charges (in thousands):
RESTRUCTURING PAYMENTS TO PAYMENTS TO
EXPENSES SETTLE ASSET ACCRUAL AT SETTLE ACCRUAL AT
IN 2000 OBLIGATIONS WRITE-DOWNS DECEMBER 31, 2000 OBLIGATIONS SEPT. 30, 2001
------------- ------------ ------------ ----------------- ------------ --------------
Abandonment of IT Systems $ 6,557 $ - $ (6,557) $ - $ - $ -
Impairment of home
health business 6,463 - (6,463) - - -
Severance of employment
agreement 466 (36) - 430 (161) 269
Site closures 2,636 (562) (655) 1,419 (258) 1,161
------- ----- -------- ------ ----- ------
Total $16,122 $(598) $(13,675) $1,849 $(419) $1,430
======= ===== ======== ====== ===== ======
The Company has recognized a deferred income tax benefit for substantially all
of these charges, as many of these items will be deductible for income tax
purposes in subsequent periods.
In the first quarter of 2001, the Company announced plans to further reduce
overhead costs through reductions in corporate staff, consolidating
administrative offices, closing additional facilities and abandoning certain
software applications. The Company has recognized and accounted for these costs
in accordance with the provisions of Emerging Issues Task Force Consensus No.
94-3, "Accounting for Restructuring Costs". As a result, the Company recorded
the following pre-tax charges during the first quarter of 2001 (in thousands):
PAYMENTS TO
RESTRUCTURING SETTLE ACCRUAL AT
EXPENSES OBLIGATIONS SEPT. 30, 2001
------------- ----------- --------------
Costs related to personnel reductions $3,113 $(2,727) $ 386
Closure of facilities 2,455 (365) 2,090
Abandonment of software applications 300 (300) -
------ ------- ------
Total $5,868 $(3,392) $2,476
====== ======= ======
As indicated above, during the first quarter of 2001, the Company announced
plans to reduce corporate overhead and eliminated approximately 50 positions.
As a result, the Company recorded a charge of $3.1 million during the first
quarter. The Company also determined that it will close several sites,
abandoning leased facilities, and recognized a charge of $2.5 million for
remaining lease obligations and related improvements. In addition, the Company
decided to abandon certain software applications and recorded a charge of
$300,000.
7
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
NOTE 5 - CAPITALIZATION
In March 2000, the Board of Directors of the Company authorized the repurchase
of up to 10,000,000 shares of the Company's Common Stock in public or private
transactions. Through December 31, 2000, the Company acquired 5,057,786 shares
of Common Stock at an average price of $4.72 per share. During the first nine
months of 2001, the Company issued 1,527,454 shares from Treasury Stock to
affiliated physicians in satisfaction of the Company's obligation to issue
Common Stock in connection with affiliation transactions.
NOTE 6 - CREDIT FACILITY AND MASTER LEASE
Credit Facility
Effective June 15, 1999, in connection with the merger of Physician Reliance
Network, Inc. and a subsidiary of the Company (the Merger), the Company executed
a $275 million revolving credit facility (Credit Facility) with First Union
National Bank (First Union), individually and as Administrative Agent for eight
additional lenders ("Lenders"). The Credit Facility consisted of a $175 million
five-year revolving credit facility (Revolver) and a $100 million 364-day
revolving credit facility. The Company allowed the $100 million 364-day
revolving credit facility to terminate at its maturity in June 2000, as the
Company did not anticipate requiring any borrowings under such facility for the
remainder of 2000. Initial proceeds under the Revolver were used to refinance
existing debt and to pay certain transaction fees and expenses in connection
with the Credit Facility and the Merger. Proceeds of loans under the Credit
Facility may be used to finance affiliation transactions, to provide working
capital and for other general corporate uses. As of September 30, 2001, the
Company had an outstanding balance of $27.5 million under the $175 million
Credit Facility. The Company has classified borrowings under the Credit
Facility as long-term indebtedness due to its ability and intent to maintain the
borrowings beyond the next twelve months.
Borrowings under the Credit Facility are secured by all capital stock of the
Company's subsidiaries, all of the Company's management services agreements and
all accounts receivable of the Company. At the Company's option, funds may be
borrowed at the Base interest rate or the London Interbank Offered Rate (LIBOR)
plus an amount determined under a defined formula. The Base rate is selected by
First Union and is defined as their prime rate or Federal Funds Rate plus 1/2%.
Interest on amounts outstanding under Base rate loans is due quarterly while
interest on LIBOR related loans is due at the end of each applicable interest
period or quarterly, if earlier. As of September 30, 2001, the weighted average
interest rate on all outstanding draws under the Credit Facility was 5.42%.
The Company is subject to restrictive covenants under the Credit Facility,
including the maintenance of certain financial ratios. The agreement limits
certain activities such as incurrence of additional indebtedness, sales of
assets, investments, capital expenditures, mergers and consolidations and the
payment of dividends. Under certain circumstances, additional medical practice
transactions may require First Union's and the Lenders' consent. Terminations
of service agreements and asset sales in connection with transitioning
affiliated practices to the service line structure may require lender consent
or a refinancing of those facilities as well as the Senior Secured Notes and
Master Lease described below.
Senior Secured Notes
In November 1999, the Company issued $100 million in senior secured notes to a
group of institutional investors. The notes bear interest at 8.42%, mature in
installments from 2002 through 2006 and rank equal in right of payment with all
current and future senior indebtedness of the Company. The senior secured notes
contain restrictive financial and operational covenants and are secured by the
same collateral as the Credit Facility.
8
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
Master Lease
The Company is party to a $75 million master lease agreement relating to the
construction and leasing of integrated cancer centers. Under the agreement, the
lessor purchases and has title to the properties, pays for the construction
costs and thereafter leases the facilities to the Company under operating
leases. The construction period during which new properties could be purchased
and constructed under the lease ended in June 2001. The initial term of the
lease is through June 2004 and can be renewed in one-year increments if approved
by the lessor. The lease provides for substantial residual value guarantees and
includes purchase options at original cost on each option. Advances under the
master lease agreement as of September 30, 2001 were $74.0 million.
NOTE 7 - EARNINGS PER SHARE
The Company computes earnings per share in accordance with the provisions of
Financial Accounting Standards Board (FASB) Statement of Financial Accounting
Standards No. 128, "Earnings Per Share", which requires the Company to
disclose "basic" and "diluted" earnings per share (EPS). The computation of
basic EPS is based on a weighted average number of outstanding shares of Common
Stock and Common Stock to be issued during the periods. The Company includes
Common Stock to be issued in both basic and diluted EPS as there are no
foreseeable circumstances that would relieve the Company of its obligation to
issue these shares. The computation of the diluted EPS is based on a weighted
average number of outstanding shares of Common Stock and Common Stock to be
issued during the periods as well as all dilutive potential Common Stock
calculated under the treasury stock method.
The table below summarizes the determination of shares used in per share
calculations (in thousands):
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
2001 2000 2001 2000
------- ------- ------- -------
Outstanding at end of period:
Common Stock............................................. 91,734 91,957 91,734 91,957
Common Stock to be issued................................ 9,114 10,305 9,114 10,305
------- ------- ------- -------
100,848 102,262 100,848 102,262
Effect of weighting and Treasury Stock................... (619) (2,278) (902) (1,000)
------- ------- ------- -------
Shares used in per share calculations-basic................... 100,229 99,984 99,946 101,262
Effect of weighting and assumed share equivalents for grants
of stock options at less than the weighted average price.... 122 162 289 146
------- ------- ------- -------
Shares used in per share calculations-diluted................. 100,351 100,146 100,235 101,408
======= ======= ======= =======
Anti-dilutive stock options not included above............... 5,916 6,740 5,044 7,027
======= ======= ======= =======
NOTE 8 - COMMITMENTS AND CONTINGENCIES
As disclosed in Part II, Item 1, under the heading "Legal Proceedings," the
Company is aware that it and certain of its subsidiaries and affiliated
practices are the subject of allegations that certain practices or arrangements
may violate the Federal False Claims Act. These allegations are contained in
qui tam lawsuits filed under seal. Because the complaints are under seal, and
because the Department of Justice and the Company are in the process of
investigating the claims, the Company is unable to fully assess at this time the
materiality of these lawsuits. Because qui tam actions are filed under seal,
there is a possibility that the Company could be the subject of other qui tam
actions of which it is unaware.
9
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
NOTE 9 - RECENT PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133),
and in June 2000, issued Statement of Financial Accounting Standards No. 138
(FAS 138), an amendment of FAS 133. These statements are effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. The statements
require the recognition of derivative financial instruments on the balance sheet
as assets or liabilities, at fair value. Gains or losses resulting from changes
in the value of derivatives are accounted for depending on the intended use of
the derivative and whether it qualifies for hedge accounting. The Company has
historically not engaged in significant derivative instrument activity. Adoption
of FAS 133 has not had a material effect on the Company's financial position or
operating results.
In September 2000, the FASB issued Statement of Financial Accounting Standards
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" (FAS 140). FAS 140 is effective for fiscal
years ending after December 15, 2000. The statement replaces FASB Statement No.
125 and revises the standards for accounting and disclosure for securitizations
and other transfers of financial assets and collateral. FAS 140 carries over
most of FASB Statement No. 125's provisions without reconsideration and, as
such, the adoption of this standard has not had a material effect on the
Company's consolidated financial position or results of operations.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
141, "Business Combinations" (FAS 141), which requires that all business
combinations be accounted for using the purchase method. In addition, FAS 141
requires that intangible assets be recognized as assets apart from goodwill if
certain criteria are met. Because the provisions of this Statement apply to all
business combinations initiated after June 30, 2001, management will consider
the impact of this Statement for future combinations.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets" (FAS 142), which established
standards for reporting acquired goodwill and other intangible assets. This
Statement accounts for goodwill based on the reporting units of the combined
entity into which an acquired entity is integrated. In accordance with the
statement, goodwill and indefinite lived intangible assets will not be
amortized, goodwill will be tested for impairment at least annually at the
reporting unit level, intangible assets deemed to have an indefinite life will
be tested for impairment at least annually, and the amortization period of
intangible assets with finite lives will not be limited to forty years. The
provisions of this Statement are required to be applied starting with fiscal
years beginning after December 15, 2001 with early application permitted for
entities with fiscal years beginning after March 15, 2001. The Company has $12.0
million of goodwill included in its balance sheet at September 30, 2001.
Goodwill amortization for the nine months ended September 30, 2001 was
approximately $450,000 and is currently expected to approximate $600,000 for the
year ended December 31, 2001 before the provisions of FAS 142 are applied.
Implementation of FAS 142 by the Company would result in elimination of
amortization of goodwill from acquisition under the purchase method of
accounting. Implementation of FAS 142 will not affect the Company's
amortization of intangible assets related to its management services agreements.
In October 2001, the FASB issued Statement of Financial Accounting Standards
Nos. 143, "Accounting for Asset Retirement Obligations" (FAS 143) and No. 144,
"Accounting for the Impairment or Disposal of Long-lived Assets" (FAS 144). FAS
143 addresses financial accounting and reporting for obligations associated with
the retirement of tangible long-lived assets and the associated asset retirement
costs. It requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. The associated asset retirement costs are
capitalized as part of the carrying amount of the long-lived asset. FAS 143 is
effective for fiscal years beginning after June 15, 2002. FAS 144 supersedes
Statement of Financial Accounting Standards No. 121 (FAS 121), "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
and Accounting Principles Bulletin No. 30, "Reporting the Results of Operations-
Reporting the Effects of Disposal of a Segment of a
10
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
business, and Extraordinary, Unusual an Infrequently Occurring Events and
Transactions" (APB 30). Along with establishing a single accounting model,
based on the framework established in FAS 121, for long-lived assets to be
disposed of by sale, this standard retains the basic provisions of APB 30 for
the presentation of discontinued operations in the income statement but broadens
that presentation to include a component of an entity. FAS 144 is effective for
fiscal years beginning after December 15, 2001. Management is evaluating the
impact of these standards and has not yet determined the effect of adoption on
the Company's financial position and results of operations.
11
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (UNAUDITED)
INTRODUCTION
US Oncology, Inc. (together with its subsidiaries, "US Oncology" or the
"Company") provides comprehensive services, with the mission of expanding access
and quality of cancer care in local communities and advancing the delivery of
care. The Company offers the following services:
. Purchase and manage the inventory of cancer related drugs for affiliated
practices. Annually, the Company is responsible for purchasing, delivering
and managing more than $700 million of pharmaceuticals through a network of
more than 400 admixture sites, 31 licensed pharmacies, 51 pharmacists and 180
pharmacy technicians.
. Develop, construct and manage free standing cancer centers that provide
treatment areas and equipment for medical oncology, radiation therapy and
diagnostic radiology. The Company operates 76 integrated community-based
cancer centers and manages over one million square feet of medical oncology
space.
. In connection with its cancer centers, the Company is expanding diagnostic
capabilities of practices through installation and management of Positron
Emission Tomography (PET) technology. The Company has installed and manages
ten PET units.
. Coordinate and manage cancer drug research trials for pharmaceutical and
biotechnology companies. The Company currently manages 98 clinical trials,
with annual accruals of more than 4,000 patients, supported by its network of
over 650 participating physicians in more than 370 research locations.
The Company's network provides cancer care services to patients through oncology
practices comprising over 450 sites, with over 7,500 employees and over 870
physicians. The Company is not a provider of medical services, but it provides
comprehensive services to the practices, including management and capital
resources and data management, accounting, compliance and other administrative
services. The affiliated practices offer comprehensive and coordinated medical
services to cancer patients, integrating the specialties of medical and
gynecologic oncology, hematology, radiation oncology, diagnostic radiology and
blood and marrow stem cell transplantation.
The Company's revenue consists primarily of service fees paid by the practices.
The Company and its affiliated practices have entered into long-term agreements
under which the Company provides its comprehensive services to practices, and
the practices pay a fee and reimburse the Company for all practice costs. Under
some agreements, the fees are based on practice earnings before income taxes
known as the "earnings model". In others, the fee consists of a fixed fee, a
percentage fee (in most states) of the practice's net revenues and, if certain
performance criteria are met, a performance fee known as the "net revenue
model". Where the Company's service agreement follows the net revenue model,
the practice is entitled to retain a fixed portion of net revenue before any
service fee (other than practice operating costs) is paid to the Company.
The Company believes that the earnings model properly aligns practice priorities
with respect to appropriate business operations and cost control, with the
Company and the practice sharing proportionately in practice profitability,
while the net revenue model results in the Company's disproportionately bearing
the impact of increases or declines in operating margins. For this reason, the
Company has, during 2001, been negotiating with practices under the net revenue
model to convert to the earnings model. Since December 31, 2000, nine practices
accounting for 15.8% of the first nine months of 2001 net patient revenue have
converted to the earnings model. In addition, the Company continues to sever
its non-strategic practice relationships. During the first nine months of 2001,
the Company has negotiated separations with four such practices comprising 22
physicians and accounting for 3.5% of 2000 net patient revenue.
On October 1, 2001, US Oncology commenced a strategy to focus its operations on
three core service lines: oncology pharmaceutical management, outpatient cancer
center operations, and cancer research and
12
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED
(UNAUDITED)
development services. The Company has already begun marketing these core
services outside our network through a non-PPM (physician practice management)
model. All of our affiliated practices are being afforded the opportunity to
terminate their existing service agreements and enter into new arrangements
under the service line structure. We cannot assure you as to how many practices
will take this opportunity. If all practices transition to this service line
structure, the Company expects the financial impact to be a reduction in debt by
$140 million, restructuring and reorganization costs of $480 million, mostly
non-cash related, and a reduction in annualized EBITDA of $53 million. For those
practices that remain on the PPM model, the Company will continue to negotiate
with net revenue model practices to move to the earnings model, and otherwise to
manage those practices pursuant to existing agreements. The Company's business
strategy does not require that earnings model practices adopt and transition to
the service line structure.
We believe that our PPM business has advanced cancer care by aggregating the
nation's largest network of premier oncologists, who care for 15 percent of the
nation's new cancer cases annually. Today, the US Oncology network provides
access to advanced cancer therapeutics, diagnostic technologies and the nation's
largest integrated cancer research platform. The Company's initiatives over the
last 18 months have resulted in an improved capital structure and operating
platform for this business. However, growing the PPM business model relies on
significant and recurring capital investments in intangible assets, resulting in
a high cost of capital and limiting our return on assets. We believe that the
service line structure affords us the opportunity to continue participating in
the growth of the oncology industry by unlocking the value of our core
competencies with significantly reduced and better-focused capital needs. In
addition, the Company believes that its affiliated practices will benefit from
adoption of the service line structure: amounts retained by the practices would
increase, management control would return to the local practices and the
affiliated practices would continue to receive the benefits of the Company's
core services. However, the Company will continue to manage practices under the
PPM model, while continuing to pursue conversions of revenue practices to either
the earnings model or the service line structure. US Oncology will support
currently affiliated physicians and their practices throughout the transition
process and continue building on long-term relationships by providing and
expanding the high quality services to which physicians have become accustomed
as part of the US Oncology network. Management believes the service line
structure, without the constraints of the PPM model, creates an opportunity for
higher growth for both the Company and our network of affiliated practices. The
Company believes that either of these business models is consistent with its
long-term strategy.
With an expanded market and proven services, the Company expects to continue to
grow the network of premier oncologists. Network physicians can offer their
patients continued access to high quality cancer care in a convenient, cost-
effective, community-based, outpatient setting.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
The following statements are or may constitute forward-looking statements within
the meaning of the Federal securities laws: (i) certain statements, including
possible or assumed future results of operations of US Oncology, contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," (ii) any statements contained herein regarding the prospects for
our business or any of the Company's services; (iii) any statements preceded by,
followed by or that include the words "believes", "expects", "anticipates",
"intends", "estimates", "plans" or similar expressions; and (iv) other
statements contained herein regarding matters that are not historical facts.
US Oncology's business and results of operations are subject to risks and
uncertainties, many of which are beyond the Company's ability to control or
predict. Because of these risks and uncertainties, actual results may differ
materially from those expressed or implied by forward-looking statements, and US
Oncology stockholders are cautioned not to place undue reliance on such
statements, which speak only as of the date thereof. Factors that could cause
actual results to differ materially include, but are not limited to, conversion
of net revenue
13
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED
(UNAUDITED)
model agreements to earnings model agreements, our success in implementing the
service line structure, our ability to obtain financing, government regulation
and enforcement, reimbursement for health care services, particularly including
reimbursement for pharmaceuticals, changes in cancer therapy or the manner in
which cancer care is delivered, drug utilization, our ability to create and
maintain favorable relationships with pharmaceutical companies and other
suppliers, and the operations of the Company's affiliated physician groups.
Please refer to the Company's Annual Report on Form 10-K for the year ended
December 31, 2000, and its subsequent Forms 10-Q and 8-K, particularly the
sections entitled "Risk Factors" in those filings, for a more detailed
discussion of certain of these risks and uncertainties.
The cautionary statements contained or referred to herein should be considered
in connection with any written or oral forward-looking statements that may be
issued by US Oncology or persons acting on its behalf. US Oncology does not
undertake any obligation to release any revisions to or to update publicly any
forward-looking statements to reflect events or circumstances after date thereof
or to reflect the occurrence of unanticipated events.
RESULTS OF OPERATIONS
The Company is affiliated with the following number of physicians by specialty:
SEPTEMBER 30,
--------------------
2001 2000
---- ----
Medical oncologists.................. 677 660
Radiation oncologists................ 127 116
Other................................ 69 88
---- ----
873 864
==== ====
The following table sets forth the sources for growth in the number of
physicians affiliated with the Company:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
2001 2000 2001 2000
------ ------ ------ ------
Affiliated physicians, beginning of
period............................. 844 835 869 806
Physician affiliations.............. 1 12 7 24
Recruited physicians................ 40 31 62 51
Physician separations............... (3) - (22) -
Retiring/other...................... (9) (14) (43) (17)
---- ---- ---- ----
Affiliated physicians, end of period 873 864 873 864
==== ==== ==== ====
14
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED
(UNAUDITED)
The following table sets forth the key operating statistics as a measure of the
volume of services provided by the practices:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ -------------------
2001 2000 2001 2000
------ ------ ------ ------
Medical oncology visits................................ 589,527 440,291 1,806,974 1,228,689
Radiation treatments................................... 157,437 148,756 480,575 438,590
PET scans.............................................. 1,747 401 4,003 1,340
Research accruals...................................... 967 934 2,916 2,859
The following table sets forth the number of cancer centers and Positron
Emission Tomography (PET) machines managed by the Company:
SEPTEMBER 30,
---------------------
2001 2000
---- ----
Cancer centers............................. 76 68
PET machines............................... 9 1
The following table sets forth the percentages of revenue represented by certain
items reflected in the Company's Statement of Operations and Comprehensive
Income. The information that follows should be read in conjunction with the
Company's unaudited condensed consolidated financial statements and notes
thereto included elsewhere herein.
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
2001 2000 2001 2000
----- ------ ----- ------
Revenue........................................... 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Pharmaceuticals and supplies..................... 51.6 50.2 51.6 49.6
Field compensation and benefits.................. 21.7 20.6 21.5 20.8
Other field costs................................ 11.8 12.0 12.1 11.8
General and administrative....................... 3.2 4.0 3.2 4.0
Restructuring and other charges.................. - 0.1 0.5 0.3
Depreciation and amortization.................... 4.7 5.4 4.6 5.8
----- ----- ----- -----
Income from operations........................... 7.0 7.7 6.5 7.7
Net interest expense.............................. 1.4 2.2 1.7 2.1
Other income...................................... - - - (2.8)
----- ----- ----- -----
Income before income taxes........................ 5.6 5.5 4.8 8.4
Income tax provision.............................. 2.1 2.1 1.8 3.2
----- ----- ----- -----
Net income........................................ 3.5% 3.4% 3.0% 5.2%
===== ===== ===== =====
15
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED
(UNAUDITED)
Overall, the Company experienced a decrease in operating margins from the first
nine months of 2000 to the first nine months of 2001, with earnings before
taxes, interest, depreciation, amortization ("EBITDA"), as a percentage of
revenue, declining from 13.8% to 11.6%, excluding restructuring and other
charges and other income. A number of factors contributed to the decrease in
operating margins, primarily the continued increase in utilization of more
expensive single source drugs and affiliated practices under the net revenue
model not bearing their proportionate share of increased operating costs.
Revenue. Revenue increased from $968.3 million for the first nine months of
2000 to $1,119.2 million for the first nine months of 2001, an increase of
$150.9 million, or 15.6%. Revenue increased from $337.3 million in the third
quarter of 2000 to $372.7 million in the third quarter of 2001, an increase of
$35.4 million, or 10.5%. The growth in revenue is attributable to the growth in
affiliated practices' medical service revenue offset by amounts retained by the
practices. The following presents the amounts included in determination of the
Company's revenue (in thousands):
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------- ------------------------
2001 2000 2001 2000
------ ------ ------ ------
Net patient revenue..................... $475,916 $441,301 $1,436,627 $1,266,566
Amounts retained by the practices....... 103,174 103,991 317,406 298,248
-------- -------- ---------- ----------
Revenue................................. $372,742 $337,310 $1,119,221 $ 968,318
======== ======== ========== ==========
Net patient revenue for services to patients by the practices are recorded when
services are rendered based on established or negotiated charges reduced by
contractual adjustments and allowances for doubtful accounts. Differences
between estimated contractual adjustments and final settlements are reported in
the period when final settlements are determined. Net patient revenue of the
practices is reduced by amounts retained by the practices under the Company
service agreements to arrive at the Company's revenue.
Net patient revenue growth is attributable to an increase in: (i) medical
oncology services, (ii) anticancer pharmaceuticals and (iii) radiation and
diagnostic revenue. The increase in medical oncology services is attributable
to an increase in medical oncology visits of existing practices, combined with
the net addition of nine physicians since September 30, 2000. The increase in
anticancer pharmaceuticals revenue is attributable to the growth in medical
oncology services, coupled with a continued increase in utilization of more
expensive, lower margin drugs, principally single-source drugs. The increase in
radiation and diagnostic revenue is primarily attributable to the opening of
eight additional cancer centers and nine PET Centers since September 30, 2000.
Amounts retained by practices increased from $298.2 million for the first nine
months of 2000 to $317.4 million for the first nine months of 2001, an increase
of $19.2 million, or 6.4%. Such increase in amounts retained by practices is
directly attributable to the growth in net patient revenue combined with the
increase in profitability of affiliated practices. The following is the net
patient revenue attributed to the Company's two principal management fee
models--the earnings model and the net revenue model (in thousands):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------- ----------------------------------------
2001 2000 2001 2000
------ ------ ------ ------
REVENUE % REVENUE % REVENUE % REVENUE %
-------- -------- ----------- ------- ---------- ----- ---------- -----
Earnings Model................... $276,106 58.0% $186,290 42.2% $ 814,277 56.7% $ 535,686 42.3%
Net Revenue Model................ 194,238 40.8% 252,164 57.1% 606,619 42.2% 725,380 57.3%
Other............................ 5,572 1.2% 2,847 0.7% 15,731 1.1% 5,500 0.4%
-------- ----- -------- ----- ---------- ----- ---------- -----
$475,916 100.0% $441,301 100.0% $1,436,627 100.0% $1,266,566 100.0%
======== ===== ======== ===== ========== ===== ========== =====
16
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED
(UNAUDITED)
56.7% of net patient revenue for the first nine months 2001 was derived from
earnings model service agreements, and 42.2% was derived from net revenue
model service agreements, as compared to 42.3% and 57.3%, respectively, in 2000.
The Company announced in November 2000 its initiative to convert net revenue
model agreements to earnings model agreements. The Company believes the earnings
model properly aligns practice priorities with proper cost control, with the
Company and the practice sharing proportionately in revenue, operating costs and
profitability. During the first nine months of 2001, nine practices accounting
for 15.8% of the first nine months of 2001 net patient revenue converted to the
earnings model. The Company continues to negotiate with practices under net
revenue model agreements in an effort to convert those agreements to earnings
model agreements. With the introduction of the service line structure, the
Company will also offer such practices the opportunity to transition to that
model.
Medicare and Medicaid are the practices' largest payors. During the first nine
months of 2001, approximately 39% of the practices' net patient revenue was
derived from Medicare and Medicaid payments and 35% was so derived in the
comparable period last year. This percentage varies among practices. No other
single payor accounted for more than 10% of the Company's revenues in the first
nine months of 2001 and 2000.
Pharmaceuticals and Supplies. Pharmaceuticals and supplies expense, which
includes drugs, medications and other supplies used by the practices, increased
from $480.2 million in the first nine months of 2000 to $577.1 million in the
first nine months of 2001, an increase of $97.0 million, or 20.2%.
Pharmaceuticals and supplies expense increased from $169.2 million in the third
quarter of 2000 to $192.5 million in the third quarter of 2001, an increase of
$23.3 million or 13.7%. As a percentage of revenue, pharmaceuticals and
supplies increased from 49.6% in the first nine months of 2000 to 51.6% for the
comparable period of 2001 and from 50.2% in the third quarter of 2000 to 51.6%
in the third quarter of 2001. This increase was primarily due to: (i) a shift
in the revenue mix to a higher percentage of revenue from drugs, (ii) increases
in acquisition prices of drugs, (iii) a shift towards increased usage of single
source, lower margin drugs and (iv) with respect to practices operating under
the net revenue model, the Company's disproportionately bearing the impact of
increasing operating costs.
Management expects that third-party payors, particularly government payors, will
continue to negotiate or mandate the reimbursement rate for pharmaceuticals and
supplies, with the goal of lowering reimbursement rates, and that such lower
reimbursement rates as well as shifts in revenue mix may continue to adversely
impact the Company's margins with respect to such items. In addition, the
Company believes that single source drugs, possibly including oral drugs, will
continue to be introduced at a rapid pace, thus further impacting margins. In
response to this decline in margin relating to certain pharmaceutical agents,
the Company has adopted several strategies. Most importantly, the successful
conversion of net revenue model practices to the earnings model will help reduce
the impact of the increasing cost of pharmaceuticals and supplies. Likewise,
the implementation of the service line structure should have a similar effect.
In addition, the Company has numerous efforts underway to reduce the cost of
pharmaceuticals by negotiating discounts for volume purchases and by
streamlining processes for efficient ordering and inventory control and is
assessing other strategies to address this trend. The Company also continues to
expand its business into areas that are less affected by lower pharmaceutical
margins, such as radiation oncology and diagnostic radiology.
Field Compensation and Benefits. Field compensation and benefits, which
includes salaries and wages of the operating units' employees, increased from
$201.2 million in the first nine months of 2000 to $240.0 million in the first
nine months of 2001, an increase of $38.8 million or 19.3%. Field compensation
and benefits increased from $69.7 million in the third quarter of 2000 to $81.0
million in the third quarter of 2001, an increase of $11.3 million, or 16.3%.
As a percentage of revenue, field compensation and benefits increased from 20.8%
in the first nine months of 2000 to 21.5% the comparable period of 2001 and
increased from 20.6% in the third quarter of 2000 to 21.7% in the third quarter
of 2001.
Other Field Costs. Other field costs, which consist of rent, utilities,
repairs and maintenance, insurance and other direct field costs, increased from
$114.2 million in the first nine months of 2000 to $136.0 million in the
17
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED
(UNAUDITED)
first nine months of 2001, an increase of $21.8 million or 19.1%. Other field
costs increased from $40.4 million in the third quarter of 2000 to $43.9 million
in the third quarter of 2001, an increase of $3.6 million, or 8.8%. As a
percentage of revenue, other field costs increased from 11.8% in the first nine
months of 2000 to 12.1% in the first nine months of 2001 and decreased from
12.0% in the third quarter of 2000 to 11.8% in the third quarter of 2001. Such
increases in other field costs are due to increased facilities and activity
levels.
General and Administrative. General and administrative expenses decreased
from $38.9 million in the first nine months of 2000 to $35.7 million in the
first nine months of 2001, a decrease of $3.2 million, or 8.3%. General and
administrative expenses decreased from $13.4 million in the third quarter of
2000 to $11.9 million in the third quarter of 2001, a decrease of $1.5 million
or 11.3%. As a percentage of revenue, general and administrative costs
decreased from 4.0% in the first nine months of 2000 to 3.2% for the first nine
months of 2001 and from 4.0% in the third quarter of 2000 to 3.2% in the third
quarter of 2001. The Company restructured general and administrative departments
in the first quarter of 2001, including eliminating approximately 50 corporate
positions, closing offices and abandoning certain software applications and is
now seeing the cost savings resulting from that restructuring.
Depreciation and Amortization. Depreciation and amortization expense
decreased from $55.8 million in the first nine months of 2000 to $51.9 million
in the first nine months of 2001, a decrease of $3.9 million, or 7.0%.
Depreciation and amortization expense decreased from $18.3 million in the third
quarter of 2000 to $17.4 million in the third quarter of 2001, a decrease of
$900,000, or 4.9%. As a percentage of revenue, depreciation and amortization
expense decreased from 5.8% in the first nine months of 2000 to 4.6% in the
comparable period of 2001 and from 5.4% in the third quarter of 2000 to 4.7% in
the third quarter of 2001. Such decreases are attributable to the $170.1
million impairment charge of certain service agreements and other assets
recorded in the fourth quarter of 2000.
Restructuring and Other Charges. In the fourth quarter of 2000, the Company
comprehensively analyzed its operations and cost structure, with a view to
repositioning the Company to effectively execute its strategic and operational
initiatives. This analysis focused on non-core assets and activities of the
Company to determine whether they were still consistent with the Company's
strategic direction. As a result of this analysis, during the fourth quarter of
2000, the Company recorded the following charges (in thousands):
RESTRUCTURING PAYMENTS TO PAYMENTS TO
EXPENSES SETTLE ASSET ACCRUAL AT SETTLE ACCRUAL AT
IN 2000 OBLIGATIONS WRITE-DOWNS DECEMBER 31, 2000 OBLIGATIONS SEPT. 30, 2001
------------- ----------- ------------ ----------------- ------------ --------------
Abandonment of IT Systems $ 6,557 $ - $ (6,557) $ - $ - $ -
Impairment of home
health business 6,463 - (6,463) - - -
Severance of employment
agreement 466 36 - 430 (161) 269
Site closures 2,636 562 (655) 1,419 (258) 1,161
------- ---- -------- ------ ----- ------
Total $16,122 $598 $(13,675) $1,849 $(419) $1,430
======= ==== ======== ====== ===== ======
During the first quarter of 2001, the Company announced plans to further reduce
overhead costs and recognized pre-tax restructuring charges of $5.9 million.
The charges are summarized in the following table and discussed in more detail
below (in thousands):
PAYMENTS TO
RESTRUCTURING SETTLE ACCRUAL AT
EXPENSES OBLIGATIONS SEPT. 30, 2001
------------- ------------ --------------
Costs related to personnel reductions $3,113 $(2,727) $ 386
Closure of facilities 2,455 (365) 2,090
Abandonment of software applications 300 (300) -
------ ------- ------
Total $5,868 $(3,392) $2,476
====== ======= ======
18
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED
(UNAUDITED)
As indicated above, during the first quarter of 2001, the Company announced
plans to reduce corporate overhead and eliminated approximately 50 positions.
As a result, the Company recorded a charge of $3.1 million during the first
quarter. The Company also determined that it will close several sites,
abandoning leased facilities, and recognized a charge of $2.5 million for
remaining lease obligations and related improvements. In addition, the Company
decided to abandon certain software applications and recorded a charge of
$300,000.
Other Income. Other income of $27.6 million in the first nine months of 2000
represents the recognition of the remaining gain on shares of common stock of
ILEX Oncology, Inc. owned by the Company. A previous gain of $14.4 million was
recognized during the fourth quarter of 1999 as a result of the Company's
reclassification of the ILEX stock as a trading security. The stock was sold by
the Company during the first quarter of 2000.
Interest. Net interest expense decreased from $20.5 million in the first nine
months of 2000 to $18.6 million for the first nine months of 2001, a decrease of
$1.9 million, or 9.4%. Net interest expense decreased from $7.4 million in the
third quarter of 2000 to $5.2 million in the third quarter of 2001, a decrease
of $2.2 million, or 29.6%. As a percentage of revenue, net interest expense was
2.1% and 1.7% for the first nine months of 2000 and 2001, respectively, and 2.2%
and 1.4% for the third quarter of 2000 and 2001, respectively. Such decreases
are attributable to reduced borrowing levels under the Company's revolving
credit facility as a result of improved cash collections throughout 2001.
Income Taxes. For the first nine months of 2001, the Company recognized a tax
expense of $20.5 million resulting in an effective tax rate of 38.0%, which is
consistent with the same prior year period.
Net Income. Net income decreased from $50.7 million in the first nine months
of 2000 to $33.5 million in the first nine months of 2001, a decrease of $17.2
million or 33.9%. Net income increased from $11.6 million in the third quarter
of 2000 to $12.9 million in the third quarter of 2001, an increase of $1.3
million, or 11.2%. Net income as a percentage of revenue changed from 5.2% for
the first nine months of 2000 to 3.0% for the first nine months of 2001 and from
3.4% in the third quarter of 2000 to 3.5% in the third quarter of 2001.
Included in net income for the first nine months of 2000 are a $17.1 million
after-tax gain on investment in common stock offset by a $3.4 million charge for
contract separation and legal costs. Excluding these items, net income for the
nine months ended September 30, 2000 would have been $35.7 million, which
represents earnings per diluted share of $0.35. Included in net income for the
nine months ended September 30, 2001 were pre-tax restructuring charges of $5.9
million. Excluding the restructuring charges, net income for the first nine
months of 2001 would have been $37.1 million, which represents earnings per
diluted share of $0.37.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2001, the Company had net working capital of $125.0 million,
including cash and cash equivalents of $8.8 million. The Company had current
liabilities of $262.0 million, including $26.2 million in current maturities of
long-term debt, and $183.4 million of long-term indebtedness. During the first
nine months of 2001, the Company generated $161.1 million in net operating cash
flow, invested $49.2 million and used cash in financing activities in the amount
of $106.6 million.
Cash from Operating Activities
Cash from operating activities increased from $101.3 million in the first nine
months of 2000 to $161.1 million in the first nine months of 2001. The increase
is primarily attributable to the decrease in accounts receivable days
outstanding from 70 days as of September 30, 2000 to 56 days as of September 30,
2001 due to improved collection efforts. In addition, the Company was not
required to make similar levels of estimated tax payments in the first nine
months of 2001 as compared to 2000.
19
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED
(UNAUDITED)
Cash from Investing Activities
During the first nine months of 2001, the Company expended $48.2 million in
capital expenditures and financed an additional $16.8 million through various
leasing facilities. The Company expended $33.3 million on the development and
construction of cancer centers, of which $11.2 million was financed through the
Company's leasing facility during 2001. In addition, the Company expended $6.8
million on installation of PET centers, of which $5.6 million was financed
through an equipment operating lease facility. Maintenance capital expenditures
were $25.2 million and $24.8 million in the first nine months of 2001 and 2000,
respectively. In addition, in connection with affiliating with certain
practices, the Company paid total consideration of $3.4 million in the first
nine months of 2001 and $27.3 million in the first nine months of 2000, which
included cash consideration and transaction costs of $1.0 million in 2001 and
$11.8 million in 2000.
In March 2000, the Company sold its equity investment in ILEX Oncology, Inc. in
a private sale transaction and realized proceeds of $54.8 million, or $38.8
million net of tax. These proceeds were used to reduce outstanding borrowings
under the Credit Facility.
Cash from Financing Activities
During the first nine months of 2001, the Company used cash for financing
activities of $106.6 million as compared to $94.3 million in the first nine
months of the previous year, an increase of $12.3 million. Cash used to reduce
long term debt during the first nine months of 2001 was derived from improved
business office operations. In the first quarter of 2000, the Company used the
proceeds from the sale of investment in common stock to reduce long-term debt.
The Company has satisfied its development and transaction needs through debt and
equity financings and borrowings under a $175 million syndicated revolving
credit facility ("Credit Facility") with First Union National Bank ("First
Union"), as a lender and as an agent for various other lenders, which matures in
2004. The Company also uses a $75 million leasing facility in connection with
developing its integrated cancer centers. Availability of new borrowings under
the leasing facility terminated in June 2001. The Company repaid $97.5 million,
net of borrowings, under the Credit Facility during the first nine months of
2001 as a result of increased cash flow from operations. In addition, the
Company repaid $12.5 million of other indebtedness, primarily attributed to
payments on subordinated notes related to previous affiliation transactions.
In November 1999, the Company sold an aggregate of $100 million of Senior
Secured Notes to a group of institutional investors, the proceeds of which were
used to repay amounts outstanding under the Credit Facility. The Senior Secured
Notes rank equally in right of payment with the Credit Facility. The notes bear
interest at 8.42% per annum with a final maturity in 2006 and an average life of
five years.
The Company is currently in compliance with the Credit Facility, Leasing
Facility and Senior Secured Note covenants, with additional capacity under the
Credit Facility of $147.5 million. The Company has relied primarily on
profitability from its operations to fund working capital.
Borrowings under the Credit Facility bear interest at a rate equal to a rate
based on prime rate or the London Interbank Offered Rate, based on a defined
formula. The Credit Facility, Leasing Facility and Senior Secured Notes contain
affirmative and negative covenants, including the maintenance of certain
financial ratios, restrictions on sales, leases or other dispositions of
property, restrictions on other indebtedness and prohibitions on the payment of
dividends. The Company's service agreements, the capital stock of the Company's
subsidiaries and the Company's accounts receivable are pledged as security under
the Credit Facility, Leasing Facility and Senior Secured Notes. Terminations of
service agreements and asset sales in connection with transitioning affiliated
practices to the service line structure may require lender consent or a
refinancing of those facilities.
20
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, CONTINUED
(UNAUDITED)
The Company currently expects that its principal use of funds in the near future
will be in connection with the purchase of medical equipment, investment in
information systems and the acquisition or lease of real estate for the
development of integrated cancer centers and PET centers, with less emphasis
than in past years on transactions with medical oncology practices. It is
likely that the Company's capital needs in the next several years will exceed
the cash generated from operations. Thus, the Company may incur additional debt
or issue additional debt or equity securities from time to time. Capital
available for health care companies, whether raised through the issuance of debt
or equity securities, is quite limited. As a result, the Company may be unable
to obtain sufficient financing on terms satisfactory to management or at all.
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US ONCOLOGY, INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
In the normal course of business, the financial position of the Company is
routinely subjected to a variety of risks. Among these risks is the market risk
associated with interest rate movements on outstanding debt. The Company
regularly assesses these risks and has established policies and business
practices to protect against the adverse effects of these and other potential
exposures.
The Company's borrowings under the Credit Facility contain an element of market
risk from changes in interest rates. Historically, the Company has managed this
risk, in part, through the use of interest rate swaps; however, no such
agreements have been entered into in 2001. The Company does not enter into
interest rate swaps or hold other derivative financial instruments for
speculative purposes. The Company was not obligated under any interest rate
swap agreements during the first nine months of 2001.
For purposes of specific risk analysis, the Company uses sensitivity analysis to
determine the impact that market risk exposures may have on the Company. The
financial instruments included in the sensitivity analysis consist of all of the
Company's cash and equivalents, long-term and short-term debt and all derivative
financial instruments.
To perform sensitivity analysis, the Company assesses the risk of loss in fair
values from the impact of hypothetical changes in interest rates on market
sensitive instruments. The market values for interest rate risk are computed
based on the present value of future cash flows as impacted by the changes in
the rates attributable to the market risk being measured. The discount rates
used for the present value computations were selected based on market interest
rates in effect at September 30, 2001. The market values that result from these
computations are compared with the market values of these financial instruments
at September 30, 2001. The differences in this comparison are the hypothetical
gains or losses associated with each type of risk. A one percent increase or
decrease in the levels of interest rates on variable rate debt with all other
variables held constant would not result in a material change to the Company's
results of operations or financial position or the fair value of its financial
instruments.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The provision of medical services by the Company's affiliated practices entails
an inherent risk of professional liability claims. The Company does not control
the practice of medicine by the clinical staff or the compliance with regulatory
and other requirements directly applicable to practices. Because the practices
purchase and resell pharmaceutical products, they face the risk of product
liability claims. The Company maintains insurance coverage that it believes to
be adequate both as to risks and amounts. In addition, pursuant to the services
agreements with the affiliated practices, the practices and the Company are
required to maintain comprehensive liability insurance. Successful malpractice,
regulatory or product liability claims asserted against the Company or one of
the practices could, however, have a material adverse effect on the Company.
The Company disclosed in November 1999, that it and a formerly affiliated
practice are the subject of allegations that the practice's billing practices
may violate the Federal False Claims Act. These allegations are contained in
two qui tam complaints, commonly referred to as "whistle-blower" lawsuits, filed
under seal prior to the AOR/PRN merger. The U.S. Department of Justice has
determined that it will not intervene in those qui tam suits. In these suits,
the individual who filed the complaint may choose to continue to pursue
litigation in the absence of government intervention, but has not yet indicated
an intent to do so.
The Company has become aware that it and certain of its subsidiaries and
affiliated practices are the subject of additional qui tam lawsuits that remain
under seal, meaning that they were filed on a confidential basis with a United
States federal court and are not publicly available or disclosable. To date,
the United States has not intervened in any such suit against the Company.
Because the complaints are under seal, and because the Department of Justice and
the Company are in the process of investigating the claims, the Company is
unable to
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US ONCOLOGY, INC.
LEGAL PROCEEDINGS, CONTINUED
assess at this time the materiality of these lawsuits. Because qui tam actions
are filed under seal, there is a possibility that the Company could be the
subject of other qui tam actions of which it is unaware. The Company intends to
continue to investigate and vigorously defend itself against any and all such
claims, and the Company continues to believe that it conducts its operations in
compliance with law.
Qui tam suits are brought by private individuals, and there is no minimum
evidentiary or legal threshold for bringing such a suit. However, the
Department of Justice is legally required to investigate all such claims. The
subject matter of many such claims may relate both to alleged actions of the
Company and alleged actions of an affiliated practice. Because the affiliated
practices are separate legal entities not controlled by the Company, such claims
necessarily involve a more complicated, higher cost defense, and may adversely
impact the relationship between the Company and the practices. If the
individuals who file complaints and/or the United States were to prevail in
these claims against the Company, and the magnitude of the alleged wrongdoing
were determined to be significant, the resulting judgment could have a material
adverse financial and operational effect on the Company including potential
limitations in future participation in governmental reimbursement programs. In
addition, addressing complaints and government investigations requires the
Company to devote significant financial and other resources to the process,
regardless of the ultimate outcome of the claims.
The Company and its affiliated physicians are defendants in a number of lawsuits
involving employment and other disputes and breach of contract claims. Although
the Company believes the allegations are customary for the Company's size and
scope of operations, adverse judgments, individually or in the aggregate, could
have a material adverse effect on the Company.
ITEM 2. CHANGES IN SECURITIES
In connection with each affiliation transaction between the Company and a
physician group, the Company purchases the nonmedical assets of, and enters into
a long-term management services agreement with, that physician group. In
consideration for that arrangement, the Company typically pays cash, issues
subordinated promissory notes (in general, payable in equal installments on the
third through seventh anniversaries of the closing date at an annual interest
rate of seven percent) and unconditionally agrees to deliver shares of Common
Stock at future specified dates (in general, on each of the third through fifth
anniversaries of the closing date). The price per share is the lower of the
average of the closing price per share for the five days preceding the date of
the letter of intent or the closing date with respect to such affiliation
transaction.
During the first nine months of 2001, the Company affiliated with five physician
groups consisting of nine physicians. In conjunction with these transactions
the Company agreed to issue 86,509 shares of Common Stock and issued $1.8
million of subordinated promissory notes. Each sale was a private placement
made in connection with an affiliate transaction, as described in general in the
preceding paragraph. All of the physicians involved in such transactions during
the first nine months of 2001 are accredited investors. No underwriter was
involved in any such sale, and no commission or similar fee was paid with
respect thereto. Each sale was not registered under the Securities Act of 1933
in reliance on Section 4(2) of such Act and Rule 506 enacted thereunder.
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US ONCOLOGY, INC.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
3.1 Amended and Restated Certificate of Incorporation (filed as Exhibit 3.1
to the Company's Form 8-K/A filed June 17, 1999 and incorporated herein
by reference)
3.2 Amended and Restated By-Laws (filed as Exhibit 3.2 to the Company's
Form 8-K/A filed June 17, 1999 and incorporated herein by reference)
4.1 Rights Agreement between the Company and American Stock Transfer &
Trust Company (filed as exhibit 4 to Form 8-A filed June 2, 1997 and
incorporated herein by reference)
4.2 Form of 8.42% Senior Secured Note due 2006 (filed as Exhibit 4.2 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1999 and incorporated herein by reference)
(b) Reports on Form 8-K
A report on Form 8-K dated September 30, 2001 including Item 5, Other Event
and Item 9, Regulation FD disclosure was filed by the Company on October 1,
2001.
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US ONCOLOGY, INC.
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.
Date: November 14, 2001 US ONCOLOGY, INC.
By: /s/ R. Dale Ross
-------------------------------
R. Dale Ross, Chief Executive Officer
(duly authorized signatory)
By: /s/ Bruce D. Broussard
-------------------------------
Bruce D. Broussard, Chief Financial Officer
(principal financial and accounting officer)
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