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 March 31, 2002
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 May 8, 2002, 95,231,689 shares of the Registrant's Common Stock were
outstanding. In addition, as of May 8, 2002, the Registrant had agreed to
deliver 5,805,917 shares of its Common Stock on certain future dates for no
additional consideration.
US ONCOLOGY, INC.
FORM 10-Q
March 31, 2002
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............................ 14
Item 3. Quantitative and Qualitative Disclosures about Market Risks......... 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................... 27
Item 2. Changes in Securities............................................... 27
Item 6. Exhibits and Reports on Form 8-K.................................... 28
SIGNATURES......................................................................... 29
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands, except par value)
March 31, 2002 December 31, 2001
-------------- -----------------
ASSETS (unaudited)
Current assets:
Cash and equivalents................................................... $ 32,726 $ 20,017
Accounts receivable.................................................... 283,645 275,884
Prepaid expenses and other current assets.............................. 41,979 35,334
Due from affiliates.................................................... 84,412 57,807
---------- ------------
Total current assets................................................ 442,762 389,042
Property and equipment, net.............................................. 287,021 286,218
Management service agreements, net....................................... 375,508 379,249
Deferred income taxes.................................................... 15,297 18,085
Other assets............................................................. 26,058 20,368
---------- ------------
$1,146,646 $ 1,092,962
========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term indebtedness........................... $ 22,890 $ 44,040
Accounts payable....................................................... 126,345 135,570
Due to affiliates...................................................... 11,819 13,537
Accrued compensation cost.............................................. 13,805 15,455
Income taxes payable................................................... 21,028 22,498
Other accrued liabilities.............................................. 41,173 47,201
---------- ------------
Total current liabilities........................................... 237,060 278,301
Long-term indebtedness................................................... 215,966 128,826
---------- ------------
Total liabilities................................................... 453,026 407,127
Minority interest........................................................ 10,325 9,067
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, 94,982 and
94,819 issued, 93,312 and 92,510 outstanding........................... 950 948
Additional paid in capital............................................... 473,948 469,999
Common Stock to be issued, approximately 6,344 and 7,295 shares.......... 51,238 56,955
Treasury Stock, 1,670 and 2,309 shares................................... (8,223) (11,235)
Retained earnings........................................................ 165,382 160,101
---------- ------------
Total stockholders' equity.......................................... 683,295 676,768
---------- ------------
$1,146,646 $ 1,092,962
========== ============
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 Ended March 31,
----------------------------
2002 2001
-------- --------
Revenue............................................................... $391,352 $367,932
Operating expenses
Pharmaceuticals and supplies.................................... 197,595 187,873
Field compensation and benefits................................. 86,101 78,319
Other field costs............................................... 47,859 44,999
General and administrative...................................... 13,562 14,267
Depreciation and amortization................................... 17,871 17,153
Restructuring charges........................................... 705 5,868
-------- --------
363,693 348,479
-------- --------
Income from operations................................................ 27,659 19,453
Interest expense, net................................................. (5,509) (6,739)
-------- --------
Income before income taxes and extraordinary loss..................... 22,150 12,714
Income tax provision.................................................. 8,417 4,831
-------- --------
Net income before extraordinary loss.................................. 13,733 7,883
Extraordinary loss on early extinguishment of debt, net of income
taxes of $5,181................................................. (8,452) --
-------- --------
Net income and comprehensive income................................... $ 5,281 $ 7,883
======== ========
Earnings per share - basic:
Net income before extraordinary loss per share........................ $ 0.14 $ 0.08
Extraordinary loss, net of income taxes, per share.................... (0.09) --
-------- --------
Net income per share.................................................. $ 0.05 $ 0.08
======== ========
Shares used in per share calculations - basic......................... 99,848 99,586
======== ========
Earnings per share - diluted:
Net income before extraordinary loss per share........................ $ 0.14 $ 0.08
Extraordinary loss, net of income taxes, per share (0.09) --
-------- --------
Net income per share.................................................. $ 0.05 $ 0.08
======== ========
Shares used in per share calculations - diluted....................... 100,305 100,049
======== ========
The accompanying notes are an integral part of this statement
-4-
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended March 31,
----------------------------
2002 2001
---------- ----------
Cash flows from operating activities:
Net income............................................................... $ 5,281 $ 7,883
Non cash adjustments:
Depreciation and amortization.................................................. 17,871 17,153
Restructuring charges.......................................................... -- 331
Extraordinary loss on early extinguishment of debt, net of income taxes........ 8,452 --
Deferred income taxes.......................................................... 2,788 302
Undistributed earnings in joint ventures....................................... 459 (16)
Changes in operating assets and liabilities:................................... (54,917) 17,200
---------- ----------
Net cash provided (used) by operating activities......................... (20,066) 42,853
---------- ----------
Cash flows from investing activities:
Acquisition of property and equipment.......................................... (14,713) (17,235)
Net payments in affiliation transactions....................................... -- (565)
---------- ----------
Net cash used by investing activities.................................... (14,713) (17,800)
---------- ----------
Cash flows from financing activities:
Proceeds from Credit Facility.................................................. 24,500 20,000
Repayment of Credit Facility................................................... (24,500) (30,000)
Proceeds from Senior Subordinated Notes........................................ 175,000 --
Repayment of other Senior Secured Notes........................................ (100,000) --
Repayment of other indebtedness................................................ (9,010) (8,155)
Deferred financing costs....................................................... (7,449) --
Proceeds from exercise of options.............................................. 678 1,229
Payment of premium upon early extinguishment of debt........................... (11,731) --
---------- ----------
Net cash provided (used) by financing activities......................... 47,488 (16,926)
---------- ----------
Increase in cash and equivalents.................................................. 12,709 8,127
Cash and equivalents:
Beginning of period............................................................ 20,017 3,389
---------- ----------
End of period.................................................................. $ 32,726 $ 11,516
========== ==========
Interest paid..................................................................... $ 3,657 $ 6,213
Taxes paid........................................................................ $ 1,920 $ --
Non cash transactions:
Value of Common Stock to be issued in affiliation transactions................. $ -- $ 337
Delivery of Common Stock in affiliation transactions........................... 5,717 3,091
Debt issued in affiliation transactions........................................ -- 1,145
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 29, 2002.
NOTE 2 - Revenue
Net operating revenue consists of net patient revenue plus the Company's other
revenue. Net patient revenue includes patient revenues of practices under the
physician practice management model and will include revenues under outpatient
cancer center operations service line agreements, since the Company bills and
collects from patients in those businesses. 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 operating revenue is reduced by amounts
retained by the practices under the Company's PPM service agreements to arrive
at the Company's revenue. Other revenue represents non-patient revenue earned by
the Company and includes revenues from research activities, revenues from the
informational services we provide to the pharmaceutical companies, and our
revenues as a group purchasing organization.
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 performance-based 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 Ended March 31,
2002 2001
---------- ----------
Net operating revenue...................... $ 500,949 $ 473,866
Amounts retained by practices.............. (109,597) (105,934)
---------- ----------
Revenue.................................... $ 391,352 $ 367,932
========== ==========
The Company's most significant service agreement, which is the only service
agreement that represents more than 10% of revenues to the Company, is with
Texas Oncology, P.A. (TOPA), which is managed under the earnings model. TOPA
accounted for approximately 24% of the Company's total revenue for both the
three months ended March 31, 2002 and 2001.
NOTE 3 - Restructuring 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
-6-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
on non-core assets and activities of the Company to determine whether
they were still consistent with the Company's strategic direction. Details of
the restructuring charge activity for the first quarter of 2002 are as
follows:
Accrual at Accrual at
December 31, 2001 Payments March 31, 2002
----------------- -------- --------------
Severance of employment agreement........ $ 215 $(18) $ 197
Site closures............................ 1,081 (80) 1,001
------ ---- ------
Total.................................... $1,296 $(98) $1,198
====== ==== ======
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 (i) eliminating approximately 50 positions, resulting in
a charge of $3.1 million, (ii) consolidating certain administrative offices and
closing additional facilities resulting in a charge of $2.5 million for
remaining lease obligations and related improvements and (iii) abandoning
certain software applications, resulting in a charge of $0.3 million. All of the
charges were recorded in the first quarter of 2001. 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". The
following table summarizes these pre-tax charges during the first quarter of
2001, with activity through March 31, 2002 (in thousands):
Accrual at Accrual at
Restructuring Asset December 31, March 31,
Expenses Payments Write-downs 2001 Payments 2002
-------- -------- ----------- ---- -------- ----
Costs related to personnel
reductions.................... $3,113 $(2,900) $ - $ 213 $(128) $ 85
Closure of facilities.......... 2,455 (1,323) - 1,132 (86) 1,046
Abandonment of software
applications.................. 300 - (300) - -
------ ------- ------ ------ ----- ------
Total.......................... $5,868 $(4,223) $ (300) $1,345 $(214) $1,131
====== ======= ====== ====== ===== ======
During the first quarter of 2002, the Company recognized charges of $0.7 million
consisting of: (i) $0.3 million in costs related to personnel reductions, and
(ii) $0.4 million in consulting fees related to the Company's conversion to the
service line model.
NOTE 4 - Extraordinary Loss
The Company recorded an extraordinary loss of $13.6 million, before income taxes
of $5.3 million, in connection with the early extinguishment of the $100 million
Senior Secured Notes due 2006 and the previously existing credit facility. The
loss consists of payment of a prepayment penalty of $11.7 million on the Senior
Secured Notes and a write-off of unamortized deferred financing costs of $1.9
million related to the terminated debt agreements.
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. The authorization for
the stock repurchase was subsequently terminated.
-7-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
During the first quarter of 2002, the Company issued 638,308 shares from
Treasury Stock to affiliated physicians in satisfaction of the Company's
obligation to issue Common Stock in connection with affiliation transactions.
Cumulatively through March 31, 2002, the Company has issued 3,387,290 shares
from Treasury Stock to affiliated physicians in satisfaction of the Company's
obligation to issue Common Stock in connection with affiliation transitions.
As of March 31, 2002, the Company held 1,670,496 shares in Treasury Stock under
this repurchase.
NOTE 6 - Indebtedness
As of March 31, 2002 and December 31, 2001, respectively, the Company's long-
term indebtedness consisted of the following (in thousands):
March 31, 2002 December 31, 2001
--------------- ------------------
8.42% Senior Secured Notes due 2006................ $ -- $ 100,000
9.625% Senior Subordinated Notes due 2012.......... 175,000 --
Notes Payable...................................... 1,968 2,733
Subordinated Notes................................. 60,102 67,438
Capital lease obligations and other................ 1,786 2,695
----------- ----------
238,856 172,866
Less: current maturities........................... (22,890) (44,040)
---------- ----------
$ 215,966 $ 128,826
========== ==========
Credit Facility
In June 1999, in connection with the AOR/PRN merger, the Company amended and
restated its existing loan agreement and revolving credit/term facility (Credit
Facility). Under the terms of that agreement, the amounts available for
borrowing were $275 million, including a $175 million revolving facility
expiring in June 2004 and a $100 million revolving facility that expired in June
2000, leaving availability of $175 million.
On February 1, 2002, the Company terminated its $175 million revolving facility
and entered into a new $100 million five-year revolving credit facility (New
Credit Facility), which expires in February 2007. Proceeds from loans under the
New Credit Facility may be used to finance development of cancer centers and new
PET facilities, to provide working capital or for other general business uses.
Costs incurred in connection with the extinguishment of the Company's previous
Credit Facility were expensed during the first quarter of 2002 and recorded as
an extraordinary loss in the Company's condensed consolidated statement of
operations and comprehensive income. Costs incurred in connection with
establishing the New Credit Facility are being capitalized and amortized over
the term of the New Credit Facility.
Borrowings under the New Credit Facility are secured by substantially all of the
Company's assets. 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
National Bank (First Union) and is defined as its prime rate or Federal Funds
Rate plus 1/2%. No amounts were borrowed or outstanding under this New Credit
Facility during the first quarter of 2002.
Senior Secured Notes
In November 1999, the Company issued $100 million in senior secured notes
(Senior Secured Notes) to a group of institutional investors. The notes bore
interest at 8.42%, mature in equal annual installments of $20 million from 2002
through 2006 and ranked equally in right of payment with all current and future
senior indebtedness of the Company. The Senior Secured
-8-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
Notes contained restrictive financial and operational covenants and were secured
by the same collateral as the Company's previous Credit Facility.
The Senior Secured Notes were repaid in full on February 1, 2002 with the
proceeds of the Company's Senior Subordinated Notes.
Senior Subordinated Notes
On February 1, 2002, the Company issued $175 million in 9.625% senior
subordinated notes (Senior Subordinated Notes) to various institutional
investors in a private offering pursuant to Rule 144A. The notes are unsecured,
bear interest at 9.625% annually and mature in February 2012. Payments under the
Senior Subordinated Notes are subordinated, in substantially all respects, to
the Company's New Credit Facility providing working capital financing.
Proceeds from the Senior Subordinated Notes were used to pay off the $100
million in borrowings under the existing Senior Secured Notes, $11.7 million
prepayment penalty on the early termination of the Senior Secured Notes and
facility fees and related expenses associated with establishing the Senior
Subordinated Notes and New Credit Facility of $4.8 million and $2.7 million,
respectively. Costs incurred in connection with extinguishment of the Company's
previous Senior Secured Notes, including the prepayment penalty were expensed in
the first quarter of 2002 and reflected as an extraordinary loss in the
Company's condensed consolidated statement of operations and comprehensive
income. Costs incurred in connection with establishing the Senior Subordinated
Notes, including facility fees are being capitalized and amortized over the term
of the notes.
Notes payable
The notes payable bear interest, which is payable annually, at rates ranging
from 5.3% to 10% and mature between 2002 to 2005. The notes are payable to
physicians with whom the Company entered into long-term service agreements and
relate to affiliation transactions. The notes payable are unsecured.
Subordinated notes
The subordinated notes are issued in substantially the same form in different
series and are payable to the physicians with whom the Company entered into
service agreements. Substantially all of the notes outstanding at March 31,
2002 bear interest at 7%, are due in installments through 2007 and are
subordinated to senior bank and certain other debt. If the Company fails to
make payments under any of the notes, the respective practice can terminate the
related service agreement.
Capital lease obligations and other indebtedness
Leases for medical and office equipment are capitalized using effective interest
rates between 6.5% and 11.5% with original lease terms between two and seven
years. Other indebtedness consists principally of installment notes and bank
debt, with varying interest rates, assumed in affiliation transactions.
-9-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
Master Leasing Facility
The Company has entered into an operating lease arrangement that involves a
special purpose entity that has acquired title to properties, paid for the
construction costs and leased to the Company the real estate and equipment at
some of the Company's cancer centers. This kind of leveraged financing
structure is commonly referred to as a "synthetic lease". The synthetic lease
was used to finance the acquisition, construction and development of cancer
centers. The facility was funded by a syndicate of financial institutions and
is secured by the property to which it relates.
The synthetic lease was entered into in December 1997 and matures in June 2004.
As of March 31, 2002, the Company had $72.0 million outstanding under the
synthetic lease facility, and no further amounts are available under that
facility. The annual lease cost of the synthetic lease is approximately $3.6
million, based on interest rates in effect as of March 31, 2002. At March 31,
2002, the lessor under the synthetic lease held real estate assets (based on
original acquisition and construction costs) of approximately $59.2 million and
equipment of approximately $12.8 million (based on original acquisition cost) at
nineteen locations. On February 1, 2002, the Company amended and restated the
synthetic lease agreement primarily to replace certain lenders.
The lease is renewable in one-year increments, but only with consent of the
financial institutions that are parties thereto. In the event the lease is not
renewed at maturity, or is earlier terminated for various reasons, the Company
must either purchase the properties under the lease for the total amount
outstanding or market the properties to third parties. If the Company sells the
properties to third parties, it has guaranteed a residual value of at least 85%
of the total amount outstanding for the properties. The guarantee obligations
are secured by substantially all of the Company's assets. The synthetic lease
includes customary covenants, representations, and events of default, including
cross-defaults to material indebtedness, including the New Credit Facility and
Senior Subordinated Notes. If the properties were sold to a third party at a
price such that the Company would be required to make a residual value guarantee
payment, such amount would be recognized as an expense in the Company's
statement of operations.
A synthetic lease is a form of lease financing that qualifies for operating
lease accounting treatment and under generally accepted accounting principles
("GAAP") is not reflected on the Company's balance sheet. Thus, the obligations
are not recorded as debt and the underlying properties and equipment are not
recorded as assets on the Company's balance sheet. The Company's rental
payments (which approximate interest amounts under the synthetic lease
financing) are treated as operating rent commitments, and are excluded from the
Company's aggregate debt maturities.
On February 27, 2002, the Financial Accounting Standards Board (FASB) determined
that synthetic lease properties meeting certain criteria would be required to be
recognized as assets with a corresponding liability effective January 1, 2003.
The Company's synthetic lease meets these criteria. The determination is not
final and is subject to additional rule-making procedures, but assuming the
determination becomes a formal accounting pronouncement and assuming the Company
does not alter the arrangement to maintain off-balance sheet treatment under the
new rules, the Company would expect to recognize $72.0 million in additional
property and equipment with a corresponding liability on the Company's balance
sheet as of January 1, 2003.
If the Company were to purchase all of the properties currently covered by the
lease or if changes in accounting rules or treatment of the lease were to
require the Company to reflect the properties on the Company's balance sheet and
income statement, the impact to the consolidated financial statements would be
as follows.
-10-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
... Property and equipment would increase by $72.0 million (the purchase price
for the assets subject to the lease);
... Assuming the purchase of the properties were financed through borrowing, or
in the event the existing arrangement were required to be characterized as
debt, indebtedness would increase by $72.0 million; and
... Depreciation would increase by approximately $3.6 million per year as a
result of the assets being owned by the Company.
... Acquiring the properties would require the Company to borrow additional funds
and would likely reduce the amount the Company could borrow for other
purposes.
NOTE 7 - Earnings per Share
The Company computes earnings per share in accordance with the provisions of the
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 Ended March 31,
----------------------------
2002 2001
------- -------
Outstanding at end of period:
Common Stock................................................... 94,982 94,136
Common Stock to be issued...................................... 6,344 9,806
------- -------
101,326 103,942
Effect of weighting and Treasury Stock......................... (1,478) (4,356)
------- -------
Shares used in per share calculations-basic..................... 99,848 99,586
Effect of weighting and assumed share equivalents for grants of
stock options at less than the weighted average price.......... 457 463
------- -------
Shares used in per share calculations-diluted................... 100,305 100,049
======= =======
Anti-dilutive stock options not included above.................. 5,521 4,569
======= =======
NOTE 8 - Segment Financial Information
The Company has adopted the provisions of FASB Statement of Financial Accounting
Standards No. 131 (FAS 131), "Disclosure About Segments of an Enterprise and
Related Information". FAS 131 requires the utilization of a "management
approach" to define and report the financial results of operating segments. The
management approach defines operating segments along the lines used by
management to assess performance and make operating and resource allocation
decisions. Beginning in the first quarter of 2002, the Company has determined
that its reportable segments are those that are based on the Company's method of
internal reporting, which disaggregates its business by service line, and that
sufficient information is now available to permit such reporting. The Company's
reportable
-11-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
segments are oncology pharmaceutical management, outpatient cancer center
operations, other practice management services, and cancer research and
development. The oncology pharmaceutical management segment purchases and
manages specialty oncology pharmaceuticals for our affiliated practices. The
outpatient cancer center operations segment develops and manages comprehensive,
community-based cancer centers, which integrate all aspects of outpatient cancer
care, from laboratory and radiology diagnostic capabilities to chemotherapy and
radiation therapy. Cancer research and development services segment contracts
with pharmaceutical and biotechnology firms to provide a comprehensive range of
services relating to clinical trials. The operating results of this segment are
reflected in the "other" category. Management of the administrative aspects of
affiliated medical oncology practices is included in the other practice
management services segment. The Company's business is conducted entirely in the
United States.
The financial results of the Company's segments are presented on the accrual
basis. For the first quarter of 2002, all of the Company's oncology
pharmaceutical management revenue and outpatient cancer center revenue was
derived from the Physician Practice Management (PPM) model. To determine
results of the oncology pharmaceutical management segment with respect to
practices managed under the Company's PPM model, we have assumed that the
pharmaceuticals purchased and pharmacy management services under this segment
are provided at rates consistent with the rates at which we are offering those
services outside of the PPM model. Therefore, the financial results of that
segment include inter-segment revenues with other practice management services
reflecting PPM results after the effect of removing the oncology pharmaceutical
management results and outpatient cancer center operations results (which are
actual results of that service line within the PPM model) disclosed below. As
such, the combined operating results of the oncology pharmaceutical management
segment and other practice management segments for the three months ended March
31, 2002 represent the operating results under the Company's PPM activities
relative to the management of the non-medical aspects of affiliated medical
oncology practices.
The Company evaluates the performance of its segments and allocates resources to
them based on, among other things, earnings before interest, taxes,
depreciation, amortization, and unusual charges (EBITDA).
The Company has not disclosed prior year's segment data on a comparative basis
because management could not obtain comparative data for prior years due to
financial systems limitations.
The table below presents information about reported segments for the three
months ended March 31, 2002. Asset information by reportable segment is not
reported since the Company does not produce such information internally.
Net operating revenue:
Oncology pharmaceutical management...................... $205,632
Outpatient cancer center operations..................... 77,735
Other practice management services...................... 201,301
Other................................................... 16,281
--------
$500,949
========
Revenue:
Oncology pharmaceutical management...................... $205,632
Outpatient cancer center operations..................... 53,058
Other practice management services...................... 117,619
Other................................................... 15,043
--------
$391,352
========
EBITDA:
Oncology pharmaceutical management...................... $ 18,274
Outpatient cancer center operations..................... 15,983
Other practice management services...................... 23,487
Other................................................... 2,053
--------
59,797
General and administrative expenses..................... (13,562)
--------
$ 46,235
========
-12-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
The following is a reconciliation of net operating revenue to consolidated
revenue:
Net operating revenue............................... $ 500,949
Less: amounts retained by the practices............. (109,597)
---------
Revenue............................................. $ 391,352
=========
The following is a reconciliation of EBITDA to consolidated income from
operations:
EBITDA.............................................. $ 46,235
Depreciation and amortization....................... (17,871)
Restructuring charges............................... (705)
--------
Income from operations.............................. $ 27,659
========
NOTE 9 - 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 their billing practices 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.
NOTE 10 - Recent Pronouncements
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. The Company's adoption of FAS 141 has not had a
material effect on the Company's financial position or operating results.
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. FAS 142
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 are not amortized, goodwill is
tested for impairment at least annually at the reporting unit level, intangible
assets deemed to have an indefinite life are tested for impairment at least
annually, and the amortization period of intangible assets with finite lives is
not limited to forty years. The Company's adoption of FAS 142 has not had a
material effect on the Company's financial position or operating results.
Implementation of FAS 142 has not resulted in the elimination of amortization
for the Company's service agreement intangible assets because such assets are
excluded under the scope of this statement.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
143, "Accounting for Asset Retirement Obligations" (FAS 143), which addresses
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. FAS 143
is effective for fiscal years beginning after June 15, 2002. The Company is
currently assessing the impact of this new standard.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Impairment or Disposal of Long-Lived Assets" (FAS 144), which is effective
for fiscal years beginning after December 15, 2001. The provisions of FAS 144
provide a single accounting model for impairment of long-lived assets. The
Company's adoption of FAS 144 has not had a material effect on the Company's
financial position or operating results.
-13-
US Oncology, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
The following discussion should be read in conjunction with the financial
statements, related notes, and other financial information appearing elsewhere
in this report. In addition, see "Forward-Looking Statements and Risk Factors"
included in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission (SEC).
General
We provide comprehensive services to our network of 39 affiliated practices,
made up of over 865 affiliated physicians in over 450 sites, with the mission of
expanding access to and improving the quality of cancer care in local
communities and advancing the delivery of care. The services we offer include:
. Oncology Pharmaceutical Management. We purchase and manage specialty
oncology pharmaceuticals for our affiliated practices. Annually, we are
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.
. Outpatient Cancer Center Operations. We develop and manage
comprehensive, community-based cancer centers which integrate all
aspects of outpatient cancer care, from laboratory and radiology
diagnostic capabilities to chemotherapy and radiation therapy. We have
developed and operate 77 integrated community-based cancer centers and
manage over one million square feet of medical office space. We have
installed and manage 13 (Positron Emission Tomography (PET) units, as
well as 59 Computerized Axial Tomography (CT) units.
. Cancer Research and Development Services. We facilitate a broad range of
cancer research and development activities through our network. We
contract with pharmaceutical and biotechnology firms to provide a
comprehensive range of services relating to clinical trials. We
currently manage 98 clinical trials, with accruals of more than 3,500
patients during 2001, supported by our network of over 650 participating
physicians in more than 330 research locations.
. Other Practice Management Services. Under our physician practice
management arrangements, we act as the exclusive manager and
administrator of all day-to-day nonmedical business functions connected
with our affiliated practices. As such, we are responsible for billing
and collecting for medical oncology services, physician recruiting, data
management, accounting, systems, and capital allocation to facilitate
growth in practice operations.
Historically, we have contracted with physician groups to provide all of the
above services under the Physician Practice Management ("PPM") model. Under the
PPM Model, we enter into long term agreements with affiliated practices to
provide comprehensive management services, including all of the above service
lines, to our affiliated practices, and the practices pay us a service fee and
reimburse us for all expenses. Under some agreements, the fees are based on
practice earnings before taxes - known as the "earnings model". In others, the
fee consists of a fixed fee, a percentage of the practice's revenues (in most
states) and, if certain performance criteria are met, a performance fee - known
as the "net revenue model". Under the net revenue model, the practice is
entitled to retain a fixed portion of its net revenue before any service fee
is paid, provided that all operating expenses have been reimbursed.
-14-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -continued
(unaudited)
We believe that the earnings model properly aligns practice priorities with
respect to appropriate business operations and cost control, with us and the
practice sharing proportionately in practice profitability, while the net
revenue model results in us disproportionately bearing the impact of increases
or declines in operating margins. For this reason, we have, since 2001, been
negotiating with practices under the net revenue model to convert to the
earnings model. Since the beginning of 2002 and through March 31, 2002,
fourteen practices accounting for 22.8% of our affiliated practices' net patient
revenue in the first three months of 2002 have converted to the earnings model.
64% of net patient revenue in the first quarter of 2002 is attributable to
practices on the earnings model as of March 31, 2002.
In October 2001, we commenced a strategy to focus our operations on three core
service lines: oncology pharmaceutical management, outpatient cancer center
operations, and cancer research and development services and began marketing
these core services through a non-PPM model. Under the new model, which we refer
to as the "service line model", each of those core service lines is offered to
physician groups under a separate contract, and we do not necessarily provide
the other practice management services described above.
To implement this service line strategy, we have organized the company in three
divisions, and manage and operate our business under distinct service lines.
This report includes segment financial information (See Note 8 to Condensed
Consolidated Financial Statements), which reflect a division of our existing PPM
operations into the various service line offerings in the PPM relationship. As
we enter into new service line model agreements, we will report revenue from
those agreements in the appropriate segment.
Under the service line model, we intend to contract with physician groups
utilizing three separate service line agreements as follows:
. Oncology Pharmaceutical Management. We will be responsible for
providing comprehensive pharmaceutical management and will be paid on a
per-dose basis for the pharmaceutical agent and on a per-dose basis for
admixture services. Affiliated practices would be required to purchase
substantially all of their drugs through us. We will also act as a
group purchasing organization and will receive a fee from pharmaceutical
manufacturers for this service, as well as providing data and
informational services to pharmaceutical companies.
. Outpatient Cancer Center Operations. We will agree to develop
outpatient cancer centers under development agreements and leases with
physician groups. Under the leases, we expect to receive our economic
costs of the property plus an amount sufficient to give us a
predetermined rate of return on invested capital. In addition, we will
provide management services and receive an additional fee of 30% of net
earnings from radiation operations, subject to adjustments.
. Cancer Research and Development. We will contract with pharmaceutical
companies and others needing research services on a per trial basis. We
will pay physicians for each trial based on economic considerations
relating to that trial.
All of our PPM practices are being afforded the opportunity to terminate their
existing service agreements, repurchase certain of their operating assets, and
enter into new service line model agreements. We cannot assure you as to how
many practices will take this opportunity or the timing of transition, and we
currently expect that a large percentage of existing affiliated practices will
remain on the PPM model for the foreseeable future. As practices transition to
this service line model, we would expect the financial impact to be a reduction
in debt, recognition of restructuring and reorganization costs, mostly non-cash
related, and a reduction in our earnings related to those practices, but we are
unable to more accurately predict the magnitude or timing of this financial
impact until practices agree to change structures. For those practices that
remain on the PPM model, we 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.
-15-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
As of May 7, 2002, we have entered into service line model agreements with two
practices in new markets, although neither was effective during the first
quarter or is reflected in our statement of operations for the first quarter. We
expect to commence pharmacy operations under those agreements during the second
quarter of 2002.
During 2001, we terminated service agreements with four oncology practices. For
purposes of the following discussion and analysis, same practice revenues
exclude the results of disaffiliated practices.
Forward-looking Statements and Risk Factors
The following statements are or may constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995: (i) certain
statements, including possible or assumed future results of operations contained
in "Management's Discussion and Analysis of Financial Condition and Results of
Operations," (ii) any statements contained herein regarding the prospects for
any of our business or 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 such forward-looking statements,
and investors 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, the degree to
which practices managed by us convert to the earnings model or service line
model, our ability to attract and retain additional physicians and practices
under the service line model, government regulation and enforcement,
reimbursement for healthcare 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, 2001,
particularly the section entitled "Risk Factors," 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 the date
thereof or to reflect the occurrence of unanticipated events.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires management to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, we evaluate these estimates, including
those related to service agreements, accounts receivable, intangible assets,
income taxes, and contingencies and litigation. We base our estimates on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances. The introduction of a new business model,
the service line structure, and the coincident stress it is placing on our
network, represent changes in our business and may make our historical
experiences less informative in making future estimates. These estimates form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions.
-16-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
Our consolidated financial statements include the results of US Oncology, Inc.
and its wholly-owned subsidiaries. We do not include the results of our
affiliated practices (and the amounts they retain for physician compensation),
because we have determined that our relationships with the practices under our
service agreements do not warrant consolidation under the applicable accounting
rules.
Management believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
condensed financial statements. These critical accounting policies include our
policy of non-consolidation, revenue recognition, intangible asset amortization
and impairment, and the treatment of synthetic leases. Please refer to the notes
to our condensed consolidated financial statements, particularly Note 1, and the
"Critical Accounting Policies" section of our Annual Report on Form 10-K for the
year ended December 31, 2001 for a more detailed discussion of such policies.
Currently, there is a tentative conclusion regarding accounting treatment of
off-balance sheet financing vehicles. A change in accounting rules relating to
off-balance sheet financing might require us to change our accounting treatment
of our synthetic lease financing. On February 27, 2002, the Financial Standards
Accounting Board (FASB) determined that synthetic lease properties meeting
certain criteria would be required to be recognized as assets with a
corresponding liability effective January 1, 2003. Our synthetic lease meets
these criteria. The determination is not final and is subject to additional
rule-making procedures, but assuming the determination becomes a formal
accounting pronouncement and we do not alter the arrangement to maintain off-
balance sheet treatment under the new rules, we would expect to recognize $72.0
million in additional property and equipment with a corresponding liability on
our balance sheet as of January 1, 2003. The possible impact of such a change
is discussed below in "--Liquidity and Capital Resources."
Results of Operations
The Company is affiliated with the following number of physicians by specialty:
March 31,
---------
2002 2001
---- ----
Medical oncologists............. 671 658
Radiation oncologists........... 127 121
Other........................... 69 81
---- ----
867 860
==== ====
The following table sets forth the sources for growth in the number of
physicians affiliated with the Company:
Three Months Ended March 31,
----------------------------
2002 2001
------ ------
Affiliated physicians, beginning of period....... 868 869
Physician practice affiliations.................. - 6
Recruited physicians............................. 7 8
Retiring/Other................................... (8) (23)
---- ----
Affiliated physicians, end of period............. 867 860
==== ====
-17-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
The following table sets forth the number of cancer centers and Positron
Emission Tomography (PET) units managed by the Company:
March 31,
---------
2002 2001
---- ----
Cancer centers................ 77 72
PET units..................... 13 4
The following table sets forth the key operating statistics as a measure of the
volume of services provided by the practices:
Three Months Ended March 31,
----------------------------
2002 2001
-------- --------
Medical oncology visits............ 617,213 612,126
Radiation treatments............... 163,011 158,784
PET scans.......................... 2,924 1,053
New patients enrolled in research
studies........................... 848 951
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 Ended March 31,
----------------------------
2002 2001
----- -----
Revenue............................................... 100.0% 100.0%
Operating expenses:
Pharmaceuticals and supplies......................... 50.5 51.1
Practice compensation and benefits................... 22.0 21.3
Other practice costs................................. 12.2 12.2
General and administrative........................... 3.5 3.9
Restructuring charges................................ 0.2 1.6
Depreciation and amortization........................ 4.6 4.7
----- -----
Income from operations................................ 7.0 5.2
Net interest expense.................................. 1.4 1.8
----- -----
Income before income taxes, and extraordinary loss.... 5.6 3.4
Income tax provision.................................. 2.1 1.3
----- -----
Net income before extraordinary loss.................. 3.5 2.1
Extraordinary loss, net of income taxes............... 2.2 --
----- -----
Net income............................................ 1.3% 2.1%
===== =====
Revenue. Our revenue is net operating revenue, less the amount of net operating
revenue retained by our affiliated physician practices. The following presents
the amounts included in determination of the Company's revenue (in thousands):
Three Months Ended March 31,
----------------------------
2002 2001
-------- --------
Net operating revenue.............. $ 500,949 $ 473,866
Amounts retained by practices...... (109,597) (105,934)
--------- ---------
Revenue............................ $ 391,352 $ 367,932
========= =========
-18-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
Net operating revenue includes the net patient revenue of our affiliated
practices plus our other non-patient revenue, which is comprised principally of
revenues from research activities, revenues from the informational services we
provide to pharmaceutical companies and our revenues as a group purchasing
organization. Under the PPM model, most of net operating revenue is net patient
revenue of our practices.
Net operating revenue increased from $473.9 million for the first three months
of 2001 to $501.0 million for the first three months of 2002, an increase of
$27.1 million, or 5.7%. Same practice net operating revenue (which excludes the
results of practices with which we disaffiliated since March 31,2001) increased
from $457.0 million for the first three months of 2001 to $501.0 million for the
first three months of 2002, an increase of $43.9 million, or 9.6%. Revenue
growth is attributable to increases in (i) medical oncology services, (ii)
revenues attributable to pharmaceuticals, (iii) radiation and diagnostic
revenue, and (iv) non-patient revenue, primarily from research activities.
Beginning in the first quarter of 2002, we have commenced reporting our
financial results according to our reportable operating segments, which are our
various service lines. Since this is the first quarter in which we have
reportable segments, and for which sufficient information is now available to
permit such reporting, no prior year comparable information is available due to
financial systems limitations (See Note 8 to Condensed Consolidated Financial
Statements).
The following table shows our net operating revenue by segment for the three
months ended March 31, 2002 (in thousands):
Oncology pharmaceutical management............... $205,632
Outpatient cancer center operations.............. 77,735
Other practice management services............... 201,301
Other............................................ 16,281
--------
$500,949
========
Medical oncology net operating revenue (which is comprised of net operating
revenue for the oncology pharmaceutical management and other practice management
services segments) was $406.9 million for the first quarter of 2002. Medical
oncology services increased as a result of the addition of 13 medical
oncologists combined with increased utilization of certain oncology drugs.
Revenues attributable to pharmaceuticals increased as a result of increased
services and the continued increase in the utilization of certain drugs,
particularly growth factors, which assist cancer patients in regenerating blood
cells and help to mitigate adverse effects of chemotherapy agents.
Outpatient cancer center operations net operating revenue was $77.7 million for
the first quarter of 2002. Outpatient cancer center operations net operating
revenue growth is attributable to an increase over the first quarter of 2001 of
2.7% in the number of radiation treatments to 163,011 for the quarter, combined
with an increase in the number of PET scans of 178% over the same period of 2001
to 2,924. The increase in radiation treatments is attributable to the opening
of five new cancer centers since March 31, 2001. The increase in the number of
PET scans is attributable to our opening 9 PET units since March 31, 2001, as
well as growth of 22.1% in the number of treatments on the 4 PET units that were
operational during the first quarter of 2001. We currently have 17 cancer
centers and 11 PET installations in various stages of development. We expect to
open 5 cancer centers and 8 PET installations during the remainder of 2002.
The following table shows our revenue by segment for the three months ended
March 31, 2002 (in thousands):
Revenue:
Oncology pharmaceutical management...................... $205,632
Outpatient cancer center operations..................... 53,058
Other practice management services...................... 117,619
Other................................................... 15,043
--------
$391,352
========
Revenue increased from $367.9 million for the first three months of 2001 to
$391.4 million for the first three months of 2002, an increase of $23.4 million,
or 6.4%.
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 our services
agreement to arrive at the Company's revenue.
Amounts retained by practices increased from $105.9 million for the first three
months of 2001 to $109.6 million for the first three months of 2002, an increase
of $3.7 million, or 3.5%. Such increase in amounts retained by practices
-19-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
is directly attributable to the growth in net patient revenue combined with the
increase in profitability of affiliated practices. Amounts retained by practices
as a percentage of net operating revenue decreased from 22.4% to 21.9% as a
result of conversions from the net revenue model and an increase in the
percentage of non-patient revenue included in net operating revenue.
96.5% of net operating revenue for the three months ended March 31, 2002 is
comprised of net patient revenue of our practices under the PPM model as
compared to 97.8% in the same prior year period. The following is the net
patient revenue attributed to our two principal PPM fee models--the earnings
model and the net revenue model (in thousands):
Three Months Ended March 31,
----------------------------
2002 2001
-------- --------
Revenue % Revenue %
------- ------ ------- ------
Earnings Model............................ $308,083 63.8 $240,037 51.8
Net Revenue Model......................... 175,107 36.2 223,590 48.2
-------- ----- -------- -----
$483,190 100.0 $463,627 100.0
======== ===== ======== =====
63.8% of net patient revenue for the first three months of 2002 was derived from
earnings model service agreements, and 36.2% was derived from net revenue model
service agreements, as compared to 51.8% and 48.2%, respectively, in 2001.
During the first quarter of 2002, three practices accounting for 3.5% of our
affiliated practices' net patient revenue for the first three months of 2002
converted to the earnings model. Effective since the beginning of 2001 and
through March 31, 2002, fourteen practices accounting for 22.8% of net patient
revenue in the first three months of 2002 have converted from the net revenue
model to the earnings model. As of March 31, 2002, 25 service agreements were on
the earnings model and 14 service agreements were on the net revenue model.
Medicare and Medicaid are the practices' largest payors. During the first three
months of 2002, approximately 42% of the practices' net patient revenue was
derived from Medicare and Medicaid payments and 38% was so derived in the
comparable period last year. This percentage varies among practices. No other
single payor accounted for more than 10% of our revenues in the first quarter of
2002 and 2001.
Pharmaceuticals and Supplies. Pharmaceuticals and supplies expense, which
includes drugs, medications and other supplies used by the practices, increased
from $187.9 million in the first three months of 2001 to $197.6 million in the
same period of 2002, an increase of $9.7 million, or 5.2%. As a percentage of
revenue, pharmaceuticals and supplies decreased from 51.1% in the first three
months of 2001 to 50.5% in the same period in 2002. The decrease was
attributable to a number of factors, including a decrease in the percentage of
our revenue attributable to pharmaceuticals as a result of increased radiation
and diagnostic activities, and more favorable pricing on some products as a
result of (i) continued negotiation of favorable pharmaceutical acquisition
terms; (ii) a generic version of a single-source drug becoming available during
2001, enabling us to obtain more favorable pricing; and (iii) management of our
pharmaceuticals purchases to maximize the availability of rebates and favorable
pricing terms.
We expect 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 our
margins with respect to such items. Current governmental focus on average
wholesale price (AWP) as a basis for reimbursement could also lead to a wide-
ranging reduction in the way pharmaceuticals are reimbursed by payors. We also
continue to believe 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,
we have adopted several strategies. 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
-20-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
implementation of the service line model should have a similar effect, since our
revenues and earnings are not directly dependent on pharmaceutical margins under
that model. In addition, we have 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 are
assessing other strategies to address this trend. We also continue to expand our
business into areas that are less affected by lower pharmaceutical margins, such
as radiation oncology and diagnostic radiology. However, as long as
pharmaceuticals continue to become a larger part of our revenue mix as a result
of changing usage patterns (rather than growth), we believe that our overall
margins will continue to be adversely impacted.
Field Compensation and Benefits. Field compensation and benefits, which includes
salaries and wages of our field-level employees and the practices' employees
(other than physicians), increased from $78.3 million in 2001 to $86.1 million
in 2002, an increase of $7.8 million or 9.9%. As a percentage of revenue, field
compensation and benefits increased from 21.3% in 2001 to 22.0% in 2002. The
increase is attributed to increases in employee compensation rates to address
shortages of certain key personnel such as oncology nurses and radiation
technicians. We continue to experience a severe shortage of qualified radiation
personnel, with a vacancy rate of up to 20%. This scarcity of full-time
employees requires us to hire more expensive temporary employees, and to incur
significant costs in our recruitment efforts. We believe that this staff
shortage will continue to adversely affect our radiation business.
Other Field Costs. Other field costs, which consist of rent, utilities, repairs
and maintenance, insurance and other direct field costs, increased from $45.0
million in 2001 to $47.9 million in 2002, an increase of $2.9 million or 6.4%.
This increase in other field costs is due to increased facilities and activity
levels. As a percentage of revenue, other field costs remained at 12.2%.
General and Administrative. General and administrative expenses decreased from
$14.3 million in 2001 to $13.6 million in 2002, a decrease of $0.7 million, or
4.9%. As a percentage of revenue, general and administrative costs decreased
from 3.9% in 2001 to 3.5% for 2002. We restructured general and administrative
departments in the first quarter of 2001, including eliminating approximately 50
corporate positions, closing offices and abandoning certain software
applications. We anticipate incurring additional general and administrative
costs during the remainder of 2002, as we add to our sales and marketing team in
connection with our introduction of the service line model.
Overall, the Company experienced an increase in operating margins from the first
three months of 2001 to the first three months of 2002, with earnings before
taxes, interest, depreciation and amortization, excluding restructuring charges
and extraordinary loss ("EBITDA"), as a percentage of revenue, increasing from
11.5% to 11.8%. A number of factors contributed to the increase in operating
margins, including: (i) a greater percentage of affiliated practices under the
earnings model, (ii) increase in radiation and diagnostic radiology revenue and
(iii) a decrease in general and administrative expenses. Such increase in
operating margin is partially offset by an increase in field personnel costs.
The following is the EBITDA of our operations by operating segment for the three
months ended March 31, 2002 (in thousands). Since this is the first quarter in
which we have reportable segments, and for which sufficient information is now
available to permit such reporting, no prior year comparable information is
available (See Note 8 to Condensed Consolidated Financial Statements:
Oncology pharmaceutical management................... $ 18,274
Outpatient cancer center operations.................. 15,983
Other practice management services................... 23,487
Other................................................ 2,053
--------
59,797
General and administrative expenses.................. (13,562)
--------
$ 46,235
========
Restructuring charges. In the fourth quarter of 2000, we comprehensively
analyzed our operations and cost structure, with a view to repositioning the
Company to effectively execute our strategic and operational initiatives.
-21-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
This analysis focused on our non-core assets and activities to determine whether
they were still consistent with our strategic direction.
Details of the restructuring charge activity for the first quarter of 2002
are as follows (in thousands):
Accrual at Accrual at
December 31, 2001 Payments March 31, 2002
----------------- -------------------- --------------
Severance of employment agreement........... $ 215 $(18) $ 197
Site closures............................... 1,081 (80) 1,001
------ ---- ------
Total....................................... $1,296 $(98) $1,198
====== ==== ======
During the first quarter of 2001, we 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):
Accrual at Accrual at
Restructuring Asset December 31, March 31,
Expenses Payments Write-downs 2001 Payments 2002
-------- -------- ----------- ----------- --------- ----
Costs related to personnel
reductions.......................... $3,113 $(2,900) $ - $ 213 $(128) $ 85
Closure of facilities................ 2,455 (1,323) - 1,132 (86) 1,046
Abandonment of software
applications........................ 300 - (300) - - -
------ ------- ----- ------ ----- ------
Total................................ $5,868 $(4,223) $(300) $1,345 $(214) $1,131
====== ======= ===== ====== ===== ======
As indicated above, during the first quarter of 2001, we announced plans to
reduce corporate overhead and eliminated approximately 50 positions. As a
result, we recorded a charge of $3.1 million during the first quarter. We 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, we decided to abandon certain software applications
and recorded a charge of $0.3 million.
During the first quarter of 2002, we also recognized charges of $0.7 million
consisting of (i) $0.3 million in costs related to personnel reductions, and
(ii) $0.4 million in consulting fees related to our introduction of the service
line model.
Interest. Net interest expense decreased from $6.7 million in the first three
months of 2001 to $5.5 million for the first three months of 2002, a decrease of
$1.2 million or 18.3%. As a percentage of revenue, net interest expense was
1.8% and 1.4% for the first three months of 2001 and 2002, respectively. Such
decreases are due to lower borrowing levels during the first three months of
2002. On February 1, 2002, we refinanced our indebtedness by issuing $175
million in 9.625% Senior Subordinated Notes due 2012 and repaying in full our
existing senior secured notes and terminating our existing credit facility. Our
previously existing $100 million senior secured notes bore interest at a fixed
rate of 8.42% and would have matured as to $20 million in each of 2002-2006.
This increased rate of interest was offset by lower levels of debt during the
first quarter of 2002, as compared to the same period in 2001.
Income Taxes. For the first three months of 2002, we recognized tax expense of
$8.5 million resulting in an effective tax rate of 38.0%, which is consistent
with the same prior year period.
Extraordinary Loss. We recorded an extraordinary loss of $13.6 million, before
income taxes of $5.3 million, in connection with the early extinguishment of our
$100 million Senior Secured Notes due 2006 and our existing credit
-22-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
facility. The loss consisted of payment of a prepayment penalty of $11.7 million
on the Senior Secured Notes and a write-off of unamortized deferred financing
costs of $1.9 million related to the terminated debt agreements.
As we previously announced in September 2001, introduction of, and conversion
to, the service line will cause us to record unusual charges of up to
approximately $480 million, depending on how many of our practices choose to
adopt the service line model. This extraordinary loss is part of that aggregate
amount since the refinancing was necessitated by our introduction of the service
line. Other charges are expected to consist primarily of write-offs of assets
relating to terminations of existing service agreements for practices converting
to the service line, as well as other restructuring and unusual charges relating
to the introduction of our service line model.
Net Income. Net income decreased from $7.9 million, or $0.08 per share, in the
first three months of 2001 to $5.3 million, or $.05 per share, in the first
three months of 2002, a decrease of $2.6 million or 33.0%. Net income as a
percentage of revenue changed from 2.1% for the first three months of 2001 to
1.3% for the first three months of 2002. Included in net income for the first
three months of 2002 are restructuring and other charges of $0.7 million and an
extraordinary loss on early extinguishment of debt of $8.5 million, net of
income taxes. Excluding the extraordinary loss and restructuring and other
charges, net income for the three months ended March 31, 2002 would have been
$14.2 million, which represents earnings per share of $0.14. Included in net
income for the three months ended March 31, 2001 were pre-tax restructuring
charges of $5.9 million. Excluding the restructuring charges, net income for
the first three months of 2001 would have been $11.5 million, which represents
earnings per share of $0.12.
Liquidity and Capital Resources
As of March 31, 2002, we had net working capital of $205.7 million, including
cash and cash equivalents of $32.7 million. We had current liabilities of
$237.1 million, including $22.9 million in current maturities of long-term debt,
and $216.0 million of long-term indebtedness. During the first quarter of 2002,
we used $20.1 million in net operating cash flow, invested $14.7 million, and
provided cash from financing activities in the amount of $47.5 million. As of
May 7, 2002 we had cash and cash equivalents of $82.0 million.
Cash Flows from Operating Activities
Cash flows from operating activities decreased from proceeds of $42.9 million in
the first quarter of 2001 to cash used of $20.1 million in the first quarter of
2002. The decrease was primarily attributed to large pharmaceutical purchases
made during the first quarter to obtain favorable pricing and qualify for
certain rebates. In addition, our accounts receivable days outstanding as of
March 31, 2002 increased slightly to 53 from 50 as of December 31, 2001.
Cash Flows from Investing Activities
During the first quarter of 2002, we expended $14.7 million in capital
expenditures and financed an additional $0.6 million through various leasing
facilities. We expended $7.4 million on the development and construction of
cancer centers. In addition, we spent $1.0 million on installation of PET
centers, of which $0.6 million was financed through an equipment operating lease
facility. Maintenance capital expenditures were $6.9 million and $9.6 million
in the first quarter of 2002 and 2001, respectively. In addition, in connection
with affiliating with certain practices, we paid total consideration of $2.0
million in the first quarter of 2001, which included cash consideration and
transaction costs of $0.6 million. For all of 2002, we anticipate expending a
total of approximately $30-$35 million on maintenance capital expenditures and
approximately $50-$60 million on development of new cancer centers and PET
installations.
-23-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
Cash Flows from Financing Activities
During the first quarter of 2002, we provided cash from financing activities of
$47.5 million as compared to cash used of $16.9 million in the first quarter of
2001. Such increase in cash flow is primarily attributed to the proceeds from
the issuance of our Senior Subordinated Notes due 2012, net of the cash payments
for the retirement of our previously existing indebtedness, including a
prepayment premium paid as a result of early extinguishment of our Senior
Secured Notes due 2006.
Historically, we satisfied our development and transaction needs through debt
and equity financings and borrowings under a $175 million syndicated revolving
credit facility with First Union National Bank ("First Union"), as a lender and
as an agent for various other lenders. We also used a $75 million synthetic
leasing facility in connection with developing integrated cancer centers.
Availability of new advances under the leasing facility terminated in June 2001.
We discuss this in more detail below.
On February 1, 2002, we entered into a five-year $100 million revolving credit
facility. Proceeds under that credit facility may be used to finance the
development of cancer centers and new PET facilities, to provide working capital
or for other general business purposes. No amounts have been borrowed under
that facility. Our credit facility bears interest at a variable rate that floats
with a referenced interest rate. Therefore, to the extent we have amounts
outstanding under the credit facility in the future, we would be exposed to
interest rate risk under our credit facility.
In November 1999, we 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 our credit facility. The Senior Secured Notes ranked
equally in right of payment with the credit facility. The notes bore interest at
8.42% per annum and matured in equal annual installments of $20 million in 2002
through 2006. The notes were repaid in full on February 1, 2002.
On February 1, 2002, we issued $175 million in 9.625% Senior Subordinated Notes
due 2012 to various institutional investors in a private offering under Rule
144A under the Securities Act of 1933. The notes are unsecured, bear interest
at 9.625% annually and mature in February 2012. Payments under those notes are
subordinated in substantially all respects to payments under our new credit
facility and certain other debt.
We used the proceeds from the Senior Subordinated Notes to repay in full our
existing $100 million in Senior Secured Notes due 2006, including payment of a
prepayment penalty of $11.7 million due as a result of our repayment of the
notes before their scheduled maturity. We also used proceeds from the Senior
Subordinated Notes to pay fees and related expenses of $4.8 million associated
with issuing those notes and to pay fees and related expenses of $2.7 million in
connection with the new credit facility. During the first quarter of 2002, we
recognized the prepayment penalty of $11.7 million and a write-off of
unamortized deferred financing costs related to the terminated debt agreements
of $1.9 million, which were recorded as an extraordinary item during the first
quarter of 2002.
Our introduction of the service line structure, in particular our offering
existing affiliated practices the opportunity to terminate service agreements,
repurchase their assets and enter into service line agreements, required an
amendment or refinancing of our existing facilities. The new credit facility
and Senior Subordinated Notes give us flexibility in this regard. In addition,
we believe that the longer maturity of the Senior Subordinated Notes adds
stability to our capital structure.
We have entered into an operating lease arrangement that involves a special
purpose entity that has acquired title to properties, paid for the construction
costs and leased to us the real estate and equipment at some of our cancer
centers. This kind of leveraged financing structure is commonly referred to as
a "synthetic lease." The synthetic lease was used to finance the acquisition,
construction and development of cancer centers. The facility was funded by a
syndicate of financial institutions and is secured by the property to which it
relates. A synthetic lease is preferable to a conventional real estate lease
since the lessee benefits from attractive interest rates, the ability to claim
depreciation under tax laws and the ability to participate in the development
process.
-24-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
The synthetic lease was entered into in December 1997 and matures in June 2004.
As of December 31, 2001, we had $72.0 million outstanding under the synthetic
lease facility, and no further amounts are available under that facility. The
annual lease cost of the synthetic lease is approximately $3.6 million, based on
interest rates in effect as of March 31, 2002. The lessor under the synthetic
lease holds real estate assets (based on original acquisition and construction
costs) of approximately $59.2 million and equipment of approximately $12.8
million (based on original acquisition cost) at nineteen locations. On February
1, 2002, we amended and restated our synthetic lease agreement primarily to
replace certain lenders.
The lease is renewable in one-year increments, but only with consent of the
financial institutions that are parties thereto. In the event the lease is not
renewed at maturity, or is earlier terminated for various reasons, we must
either purchase the properties under the lease for the total amount outstanding
or market the properties to third parties. If we sell the properties to third
parties, we have guaranteed a residual value of at least 85% of the total amount
outstanding for the properties. The guarantees are secured by substantially all
of our assets. If the properties were sold to a third party at a price such
that we were required to make a residual value guarantee payment, such amount
would be recognized as an expense in our statement of operations.
A synthetic lease is a form of lease financing that qualifies for operating
lease accounting treatment and under accounting principles generally accepted in
the United States ("GAAP") is not reflected on our balance sheet. Thus, the
obligations are not recorded as debt and the underlying properties and equipment
are not recorded as assets on our balance sheet. Our rental payments (which
approximate interest amounts under the synthetic lease financing) are treated as
operating rent commitments, and are excluded from our aggregate debt maturities.
On February 27, 2002, the FASB determined that synthetic lease properties
meeting certain criteria would be required to be recognized as assets with a
corresponding liability effective January 1, 2003. Our synthetic lease meets
these criteria. The determination is not final and is subject to additional
rule-making procedures, but assuming the determination becomes a formal
accounting pronouncement and assuming we do not alter our arrangement to
maintain off-balance sheet treatment under the new rules, we would expect to
recognize $72.0 million in additional property and equipment with a
corresponding liability on our balance sheet as of January 1, 2003.
If we were to purchase all of the properties currently covered by the lease or
if changes in accounting rules or treatment of the lease were to require us to
reflect the properties on our balance sheet and income statement, the impact to
the consolidated financial statements would be as follows:
. Property and equipment would increase by $72.0 million (the purchase
price for the assets subject to the lease);
. Assuming the purchase of the properties were financed through
borrowing, or in the event the existing arrangement were required to be
characterized as debt, indebtedness would increase by $72.0 million; and
. Depreciation would increase by approximately $3.6 million per year as a
result of the assets being owned by us.
Acquiring the properties would require us to borrow additional funds and would
likely reduce the amount we could borrow for other purposes.
There are additional risks associated with the synthetic lease arrangement. A
deterioration in our financial condition that would cause an event of default
under the synthetic lease facility, including a default on material
indebtedness, including our New Credit Facility and Senior Subordinated Notes,
would give the parties under the synthetic lease the right to terminate that
lease, and we would be obligated to purchase or remarket the properties. In
such an event, we may not be able to obtain sufficient financing to purchase the
properties. In addition, changes in future operating decisions or changes in
the fair market values of underlying leased properties or the associated rentals
could result in significant charges or acceleration of charges in our statement
of operations for leasehold abandonments or residual
-25-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - continued
(unaudited)
value guarantees. Because the synthetic lease payment floats with a referenced
interest rate, we are also exposed to interest rate risk under the synthetic
lease. A 1% increase in the referenced rate would result in an increase in lease
payments of $0.7 million annually.
We are currently in compliance with covenants under our synthetic leasing
facility, revolving credit facility and Senior Subordinated Notes, with no
borrowings currently outstanding under the revolving credit facility. We have
relied primarily on cash flows from our operations to fund working capital.
Borrowings under the revolving credit facility and advances under the synthetic
leasing 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, synthetic leasing facility and Senior Subordinated 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. Events of default include cross-defaults to all material
indebtedness. Substantially all of our assets, including certain real property,
are pledged as security under the credit facility and synthetic leasing
facility. We currently expect that our 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, as well as
implementation of the service line structure, with less emphasis than in past
years on transactions with medical oncology practices. It is likely that our
capital needs in the next several years will exceed the cash generated from
operations. Thus, we 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, we may be unable to obtain sufficient financing on
terms satisfactory to management or at all.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
In the normal course of business, our financial position is routinely subjected
to a variety of risks. Among these risks is the market risk associated with
interest rate movements on outstanding debt. We regularly assess these risks
and have established policies and business practices to protect against the
adverse effects of these and other potential exposures.
The Company's borrowings under its synthetic leasing facility and its New Credit
Facility contain an element of market risk from changes in interest rates. We
have, in the past managed this risk, in part, through the use of interest rate
swaps; however, no such agreements have been entered into in the first quarter
of 2002. We do not enter into interest rate swaps or hold other derivative
financial instruments for speculative purposes. We were not obligated under any
interest rate swap agreements during the first quarter period ended March 31,
2002. No amounts are currently outstanding under the Credit Facility, nor were
any amounts outstanding under the Credit Facility during the first quarter.
$72.0 million is outstanding under the Master Lease Facility. Our Senior
Subordinated Notes due 2012 bear interest at a fixed rate of 9.625%.
For purposes of specific risk analysis, we use 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 March 31, 2002. The market values that result from these
computations are compared with the market values of these financial instruments
at March 31, 2002. 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.
-26-
US ONCOLOGY, INC.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The provision of medical services by our affiliated practices entails an
inherent risk of professional liability claims. We do not control the practice
of medicine by the clinical staff or their compliance with regulatory and other
requirements directly applicable to practices. In addition, because the
practices purchase and resell pharmaceutical products, they face the risk of
product liability claims. Although we maintain insurance coverage, successful
malpractice, regulatory or product liability claims asserted against us or one
of the practices could have a material adverse effect on us.
In November 1999, we disclosed that we and one of our formerly affiliated
practices were 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.
We have become aware that we and certain of our 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 U.S. federal court
and are not publicly available or disclosable. To date, the United States has
not intervened in any such suit against us. Because the complaints are under
seal, and because the Department of Justice and we are in the process of
investigating the claims, we are unable to assess at this time the materiality
of these lawsuits. Because qui tam actions are filed under seal, there is a
possibility that we could be the subject of other qui tam actions of which we
are unaware. We intend to continue to investigate and vigorously defend
ourselves against any and all such claims, and we continue to believe that we
conduct our 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 the allegations in
these suits. The subject matter of many such claims may relate both to our
alleged actions and alleged actions of an affiliated practice. Because the
affiliated practices are separate legal entities not controlled by us, such
claims necessarily involve a more complicated, higher cost defense, and may
adversely impact the relationship between us and the practices. If the
individuals who file complaints and/or the United States were to prevail in
these claims against us, 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 us including potential limitations
in future participation in governmental reimbursement programs. In addition,
addressing complaints and government investigations requires us to devote
significant financial and other resources to the process, regardless of the
ultimate outcome of the claims.
We and our network physicians are defendants in a number of lawsuits involving
employment and other disputes and breach of contract claims. In addition, we
are involved from time to time in disputes with, and claims by, our affiliated
practices against us. Although we believe the allegations are customary for the
size and scope of our operations, adverse judgments, individually or in the
aggregate, could have a material adverse effect on us.
Item 2. Changes In Securities
Not Applicable
-27-
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 (incorporated by reference from Form 8-A filed
June 2, 1997).
4.2 Indenture dated February 1, 2002 among US Oncology, Inc., the
Guarantors named therein, and JP Morgan Chase Bank as Trustee
(filed as Exhibit 3 to, and incorporated by reference from, the
Company's Form 8-K filed February 5, 2002).
4.3 Registration Rights Agreement dated as of February 1, 2002 by and
among US Oncology, Inc., the Guarantors named therein and UBS
Warburg LLC, Deutsche Banc Alex. Brown Inc. and First Union
Securities, Inc. as Initial Purchasers (filed as Exhibit 4 to,
and incorporated by reference from, the Form 8-K filed February
5, 2002).
10.1 Credit Agreement dated as of February 1, 2002 among the Company
and First Union National Bank, as administrative agent, UBS
Warburg LLC, as syndication agent, GE Capital Healthcare
Financial Services, as documentation agent and the various
Lenders named therein (filed as Exhibit 10.1 to the Company's
Form 10-K for the year ended December 31, 2001 and incorporated
herein by reference.)
10.2 Amended and Restated Participation Agreement dated as of February
1, 2002 among AOR Synthetic Real Estate, Inc., the Company, First
Union National Bank and the other parties identified therein
(filed as Exhibit 10.2 to the Company's Form 10-K for the year
ended December 31, 2001 and incorporated herein by reference.)
10.3 Amended and Restated Credit Agreement dated as of February 1,
2002 among the Company, First Security Bank, First Union National
Bank and the other parties identified therein (filed as Exhibit
10.3 to the Company's Form 10-K for the year ended December 31,
2001 and incorporated herein by reference.)
(b) Reports on Form 8-K
(i) On January 14, 2002, the Company filed a Current Report on Form
8-K dated January 11, 2002 disclosing Item 5, Other Events,
relating to a proposed private placement of approximately $175
million in senior subordinated notes.
(ii) On February 5, 2002, the Company filed a Current Report on Form
8-K dated February 1, 2002 disclosing Item 5, Other Events,
relating to the completion of a private placement of $175 million
in senior subordinated notes due 2012.
-28-
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: May 14, 2002 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)
-29-