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 JUNE 30, 1999
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)
(281) 873-2674
(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 AUGUST 12, 1999, 85,467,534 SHARES OF THE REGISTRANT'S COMMON STOCK
WERE OUTSTANDING. IN ADDITION, AS OF AUGUST 12, 1999, THE REGISTRANT HAD AGREED
TO DELIVER 14,400,684 SHARES OF ITS COMMON STOCK ON CERTAIN FUTURE DATES FOR NO
ADDITIONAL CONSIDERATION.
US ONCOLOGY, INC.
FORM 10-Q
JUNE 30, 1999
TABLE OF CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 16
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 18
SIGNATURES 19
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PAR VALUE)
JUNE 30, DECEMBER 31,
1999 1998
--------------- ---------------
ASSETS (UNAUDITED)
Current assets:
Cash and equivalents........................................................ $ 3,201 $ 13,691
Accounts receivable......................................................... 288,976 243,390
Prepaids and other current assets........................................... 64,659 42,581
Due from affiliated physician groups........................................ 15,409 22,354
---------- ----------
Total current assets................................................... 372,245 322,016
Property and equipment, net.................................................. 242,773 220,944
Management service agreements, net........................................... 523,597 467,214
Other assets................................................................. 22,190 23,354
---------- ----------
$1,160,805 $1,033,528
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term indebtedness................................ $ 23,035 $ 22,426
Accounts payable............................................................ 56,106 80,729
Due to affiliated physician groups.......................................... 11,778 6,606
Accrued compensation costs.................................................. 15,511 10,118
Income taxes payable........................................................ 8,095 4,066
Other accrued liabilities................................................... 28,495 19,809
---------- ----------
Total current liabilities.............................................. 143,020 143,754
Deferred income taxes........................................................ 23,060 23,537
Long-term indebtedness....................................................... 323,555 234,474
---------- ----------
Total liabilities...................................................... 489,635 401,765
---------- ----------
Minority interest............................................................ 2,172 1,965
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, 84,784 and 81,205
issued and 84,784 and 80,830 outstanding................................... 848 812
Additional paid-in capital.................................................. 411,678 404,749
Common Stock to be issued, approximately 15,226 and 16,947 shares........... 102,769 89,142
Treasury Stock, 0 and 375 shares............................................ (3,696)
Accumulated other comprehensive income (loss)............................... (120) 269
Retained earnings........................................................... 153,823 138,522
---------- ----------
Total stockholders' equity............................................. 668,998 629,798
---------- ----------
$1,160,805 $1,033,528
========== ==========
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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- ---------------------
1999 1998 1999 1998
--------- --------- --------- ---------
Revenue...................................................... $266,412 $204,744 $515,626 $392,381
Operating expenses:
Pharmaceuticals and supplies............................ 123,482 86,497 238,729 163,391
Practice compensation and benefits...................... 52,161 42,292 101,579 82,206
Other practice costs.................................... 32,838 26,722 62,352 52,352
General and administrative.............................. 8,911 9,664 17,805 18,466
Merger and integration costs............................ 24,491 24,491
Depreciation and amortization........................... 15,191 10,888 30,256 21,250
-------- -------- -------- --------
257,074 176,063 475,212 337,665
-------- -------- -------- --------
Income from operations....................................... 9,338 28,681 40,414 54,716
Interest expense, net........................................ (5,290) (3,885) (9,933) (8,073)
-------- -------- -------- --------
Income before income taxes................................... 4,048 24,796 30,481 46,643
Income taxes................................................. 5,262 9,292 15,180 17,550
-------- -------- -------- --------
Net income (loss)............................................ (1,214) 15,504 15,301 29,093
-------- -------- -------- --------
Other comprehensive income (loss), net of tax................ (269) (180) (389) 438
-------- -------- -------- --------
Comprehensive income (loss).................................. $ (1,483) $ 15,324 $ 14,912 $ 29,531
======== ======== ======== ========
Net income (loss) per share - basic.......................... $(0.01) $0.16 $0.15 $0.30
======== ======== ======== ========
Shares used in per share calculations - basic................ 99,847 98,349 99,780 96,999
======== ======== ======== ========
Net income (loss) per share - diluted........................ $(0.01) $0.15 $0.15 $0.29
======== ======== ======== ========
Shares used in per share calculations - diluted.............. 99,847 100,435 101,308 100,026
======== ======== ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THIS STATEMENT.
4
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(UNAUDITED)
SIX MONTHS
ENDED JUNE 30,
1999 1998
------ ------
Cash flows from operating activities:
Net income............................................................. $ 15,301 $ 29,093
Noncash adjustments:
Depreciation and amortization......................................... 30,256 21,250
Deferred income taxes................................................. (1,180) 6,237
Non cash merger and integration costs................................. 2,300
Gain on contract termination.......................................... (3,152)
Changes in operating assets and liabilities............................ (54,699) (20,896)
--------- --------
Net cash provided by (used in) operating activities................. (11,174) 35,684
Cash flows from investing activities:
Acquisition of property and equipment.................................. (40,009) (25,107)
Net payments in medical practice transactions.......................... (32,310) (17,800)
Other.................................................................. (1,273) (1,077)
--------- --------
Net cash used in investing activities............................... (73,592) (43,984)
Cash flows from financing activities:
Proceeds from credit facilities........................................ 309,000 30,000
Repayment of credit facilities......................................... (232,120) (5,149)
Repayment of other indebtedness........................................ (6,341) (16,640)
Proceeds from exercise of options...................................... 3,737 3,231
--------- --------
Net cash provided by financing activities........................... 74,276 11,442
--------- --------
Increase (decrease) in cash and equivalents............................. (10,490) 3,142
Cash and equivalents:
Beginning of period.................................................... 13,691 7,772
--------- --------
End of period.......................................................... $ 3,201 $ 10,914
========= ========
Noncash transactions:
Tax benefit from exercise of non-qualified stock options............... $ 4,160
Value of Common Stock to be issued in medical
practice transactions................................................ $ 20,199 7,680
Debt issued in medical practice transactions........................... 18,416 11,954
Debt assumed in medical practice transactions.......................... 86
Debt issued to finance insurance premiums.............................. 649
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
8-K/A-2 filed with the Securities and Exchange Commission on August 16, 1999.
Operating segments
During 1998, the Company adopted Financial Accounting Standards Board (FASB)
Statement No. 131, "Disclosures About Segments of an Enterprise and Related
Information" (FAS 131), which requires reporting of summarized financial results
for the operating segments as well as establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Company's sole business is providing comprehensive management services,
facilities and equipment, administrative and technical support and ancillary
services necessary for physicians to establish and maintain a fully integrated
network of outpatient cancer care. The physicians affiliated with the Company
provide all aspects of care related to the diagnosis and outpatient treatment of
cancer, including comprehensive oncology services (including primarily medical,
radiation, and gynecological services), diagnostic radiology services, retail
pharmacy services and clinical research. For the first six months of 1999 and
1998, oncology related services was the only product line that exceeded the
reporting thresholds of FAS 131. The Company, therefore, has used the
aggregation criteria of FAS 131 and reports a single segment.
NOTE 2 - BUSINESS COMBINATION
On June 15, 1999, the Company, formerly American Oncology Resources, Inc. (AOR),
consummated a merger transaction pursuant to which Physician Reliance Network,
Inc. (PRN) became a wholly owned subsidiary of the Company and each outstanding
share of PRN's common stock was converted into .94 shares of the Company's
common stock (the Merger). At the time of the Merger, the Company changed its
name to US Oncology, Inc. The transaction was accounted for as a pooling of
interests and accordingly the financial statements presented herein have been
restated to conform to the presentation and accounting standards of the two
companies. In conjunction with the Merger, the Company recognized merger and
integration costs of approximately $24.5 million. Merger and integration costs
are comprised of transaction costs of approximately $17.2 million for
professional fees, costs of due diligence, severance costs and other out of
pocket expenses; restructuring costs of approximately $3.1 for leasehold and
software abandonment; and, integration costs of approximately $4.2 million for
integration consulting fees, communications, and Merger related Company
meetings.
6
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Combined and separate results of AOR and PRN during the period preceding the
Merger were as follows (in thousands):
THREE MONTHS ENDED MARCH 31, 1999
------------------------------------------------------------------------
AOR PRN ADJUSTMENTS COMBINED
------------- ------------- ------------------- ------------------
Revenue............................ $139,840 $114,274 $(4,900) $249,214
Income............................. 8,517 7,998 - 16,515
THREE MONTHS ENDED MARCH 31, 1998
------------------------------------------------------------------------
AOR PRN ADJUSTMENTS COMBINED
------------- ------------- ------------------- ------------------
Revenue............................ $100,949 $ 90,513 $(3,825) $187,637
Income............................. 6,871 6,718 - 13,589
The combined financial results presented above include adjustments made to
conform accounting policies of the two companies. No intercompany transactions
existed between the two companies during the periods presented.
NOTE 3 - REVENUE
Medical service revenue for services to patients by the physician groups
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. Medical service revenue of the affiliated physician
groups is reduced by amounts retained by the physician groups under the
Company's management services agreements to arrive at the Company's management
fee revenue.
The following presents the amounts included in the determination of the
Company's revenue (in thousands):
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------------------- ----------------------------------
1999 1998 1999 1998
--------------- -------------- ---------------- ---------------
Medical service revenue......................... $334,441 $259,975 $624,408 $504,504
Amounts retained by affiliated physician
groups........................................ 77,055 63,139 123,445 124,851
-------- -------- -------- --------
Management fee revenue.......................... 257,386 196,836 500,963 379,653
Other revenue................................... 9,026 7,908 14,663 12,728
-------- -------- -------- --------
Revenue......................................... $266,412 $204,744 $515,626 $392,381
======== ======== ======== ========
Other revenues are primarily derived from retail pharmacy operations located in
certain of the Company's cancer centers and larger physician offices and
revenues earned under the Company's research agreement with Ilex Oncology, Inc.
(Ilex). The Company recognized approximately $3.2 million of revenue during the
three months ended June 30, 1999 related to the termination of the research
contract with Ilex.
The Company's most significant and only management service agreement to provide
more than 10% of revenues to the Company is with Texas Oncology, P.A. (TOPA).
TOPA accounted for approximately 25.1% and 32.6% for the three months ended June
30, 1999 and 1998, and 25.4% and 33.4% for the six months ended June 30, 1999
and 1998 of the Company's total revenue.
7
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 4 - CREDIT FACILITY AND MASTER LEASE
Credit Facility
On June 15, 1999, in connection with the Merger, the Company executed a $275
million revolving credit facility (Credit Facility) with First Union National
Bank (First Union) individually and as Administrative Agent for eight additional
lenders ("Lenders"). The Credit Facility consists of a $175 million five-year
revolving credit facility and a $100 million 364-day revolving credit facility.
Initial proceeds under the Revolver were used to refinance existing debt and to
pay certain transaction fees and expenses in connection with the Credit Facility
and the Merger. Proceeds of loans under the Credit Facility may be used to
finance medical practice transactions, to provide working capital and for other
general corporate uses. As of June 30, 1999, the Company had an outstanding
balance of $237 million under the Credit Facility. The Company has classified
the Credit Facility as long-term indebtedness due to its ability and intent to
maintain the borrowings beyond the next twelve months. Costs incurred in
connection with the extinguishment of the Company's previous credit facilities
were expensed in the current period as merger and integration costs.
Borrowings under the Credit Facility are secured by all capital stock of the
Company's subsidiaries, and all of the Company's management services agreements
and all accounts receivable of the Company. At the Company's option, funds may
be borrowed at the Base interest rate or the London Interbank Offered Rate
(LIBOR) up to LIBOR plus an amount determined under a defined formula. The Base
rate is selected by First Union and is defined as their prime rate or Federal
Funds Rate plus 1/2%. Interest on amounts outstanding under Base rate loans is
due quarterly while interest on LIBOR related loans is due at the end of each
applicable interest period or quarterly, if earlier. As of June 30, 1999, the
weighted average interest rate on all outstanding draws under the Credit
Facility was 6.4%.
The Company is subject to restrictive covenants under the Credit Facility,
including the maintenance of certain financial ratios. The agreement limits
certain activities such as incurrence of additional indebtedness, sales of
assets, investments, capital expenditures, mergers and consolidations and the
payment of dividends. Under certain circumstances, additional medical practice
transactions may require First Union's and the Lenders' consent.
Master Lease
On June 15, 1999, the Company amended its $75 million master lease agreement
related to integrated cancer centers to extend the construction and acquisition
period through December 2000. Under the agreement, the lessor purchases and has
title to the properties, pays for the construction costs and thereafter leases
the facilities to the Company. The initial term of the lease is for five years
and can be renewed in one year increments if approved by the lessor. The lease
provides for substantial residual value guarantees and includes purchase options
at original cost on each option. Advances under the master lease agreement as
of June 30, 1999 were $40.2 million.
8
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 5 - EARNINGS PER SHARE
The Company computes earnings per share in accordance with the provisions of
FASB Statement 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 summarizes the determination of shares used in per share calculations
(in thousands):
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------------- ------------------------------------
1999 1998 1999 1998
----------------- -------------- ----------------- ----------------
Outstanding at end of period:
Common Stock................................. 84,784 80,352 84,784 80,352
Common Stock to be issued.................... 15,226 18,253 15,226 18,253
------- ------- ------- -------
100,010 98,605 100,010 98,605
Effect of weighting.......................... (163) (256) (230) (1,446)
------- ------- ------- -------
Shares used in per share calculations-basic.. 99,847 98,349 99,780 97,159
Effect of weighting and assumed share
equivalents for grants of stock options at
less than the weighted average price and
subordinated convertible promissory notes.. - 2,086 1,528 2,867
------- ------- ------- ---------
Shares used in per share calculations-diluted 99,847 100,435 101,308 100,026
======= ======= ======= =======
Anti-dilutive stock options not included above 11,933 1,684 6,645 1,684
======= ======= ======= =======
NOTE 6 - RECENT PRONOUNCEMENTS
In June 1998, FASB issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities," (FAS 133) which is effective for the
Company's financial statements beginning with the first quarter of the year
ending December 31, 2000. FAS 133 requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and to measure those instruments at fair value. Management does not
expect such implementation to have a material effect on the Company's
operations.
9
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
INTRODUCTION
US Oncology, Inc. (the "Company") is a cancer management company which provides
comprehensive management services under long-term agreements to its affiliated
oncology practices, including operational and clinical research services and
data management, and furnishes personnel, facilities, supplies and equipment.
These affiliated practices provide a broad range of medical services to cancer
patients, integrating the specialties of medical and gynecological oncology,
hematology, radiation oncology, diagnostic radiology and stem cell
transplantation. Substantially all of the Company's revenue consists of
management fees and includes all medical practice operating costs for which the
Company is contractually responsible.
The Company believes that the coordinated delivery of comprehensive cancer care
in an outpatient setting offers high quality care that is more cost-effective
than traditional approaches and is increasingly preferred by patients, payors
and physicians. The Company believes that many oncology practices recognize the
need for outside managerial, financial and business expertise to more
efficiently manage the increasingly complex, burdensome and time-consuming
nonmedical aspects of their practices and that practices will increasingly elect
to enter into management relationships with entities such as the Company.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
The statements contained in this report, in addition to historical information,
are forward-looking statements based on the Company's current expectations, and
actual results may vary materially. Forward-looking statements often include
words like "believe", "plan", "expect", "intend" or "estimate". The Company's
business and financial results are subject to various risks and uncertainties,
including the Company's continued ability to enter into affiliations with new
physician practices and to successfully integrate such practices, the results of
operations of groups currently affiliated with the Company including results of
operations impacted by changes in cancer therapies or the manner in which cancer
care is delivered, the ability to construct integrated cancer centers and to
operate them profitably, competition, reductions in third-party reimbursement
for services rendered by physician groups affiliated with the Company, health
care regulation and other risks generally affecting the health care industry.
Please refer to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998 and the joint proxy statement and prospectus distributed in
connection with the Merger, each of which was filed with the Securities and
Exchange Commission (SEC), and the Company's subsequent filings with the SEC for
a more detailed discussion of such risks and uncertainties. Many of these risks
and uncertainties are beyond the Company's ability to control or predict. These
forward-looking statements are provided as a framework for the Company's results
of operations. The Company does not intend to provide updated information other
than as otherwise required by applicable law.
RESULTS OF OPERATIONS
Medical service revenue for services to patients by the physician groups
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. Medical service revenue of the affiliated physician
groups is reduced by amounts retained by the physician groups under the
Company's management services agreements to arrive at the Company's management
fee revenue.
10
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
The following presents the amounts included in the determination of the
Company's revenue (in thousands):
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------------------- ----------------------------------
1999 1998 1999 1998
--------------- -------------- ---------------- ---------------
Medical service revenue......................... $334,441 $259,975 $624,408 $504,504
Amounts retained by affiliated physician
groups........................................ 77,055 63,139 123,445 124,851
-------- -------- -------- --------
Management fee revenue.......................... 257,386 196,836 500,963 379,653
Other revenue................................... 9,026 7,908 14,663 12,728
-------- -------- -------- --------
Revenue......................................... $266,412 $204,744 $515,626 $392,381
======== ======== ======== ========
Other revenues are primarily derived from retail pharmacy operations located in
certain of the Company's cancer centers and larger physician offices and
revenues earned under the Company's research agreement with Ilex Oncology, Inc.
(Ilex). The Company recognized approximately $3.2 million of revenue during the
three months ended June 30, 1999 related to the termination of the research
contract with Ilex.
The Company's most significant and only management service agreement to provide
more than 10% of revenues is with Texas Oncology, P.A. (TOPA). TOPA accounted
for approximately 25.1% and 32.6% for the three months ended June 30, 1999 and
1998, and 25.4% and 33.4% for the six months ended June 30, 1999 and 1998 of the
Company's total revenue.
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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------- ----------------------------
1999 1998 1999 1998
------------- ------------- ------------- ------------
Revenue.............................................. 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Pharmaceuticals and supplies........................ 46.4 42.2 46.3 41.6
Practice compensation and benefits.................. 19.6 20.7 19.7 21.0
Other practice costs................................ 12.3 13.1 12.1 13.3
General and administrative.......................... 3.3 4.7 3.5 4.7
Merger and integration costs........................ 9.2 - 4.7 -
Depreciation and amortization....................... 5.7 5.3 5.9 5.4
Net interest expense................................ 2.0 1.9 1.9 2.1
----- ----- ----- -----
Income before income taxes........................... 1.5 12.1 5.9 11.9
----- ----- ----- -----
Income taxes......................................... 2.0 4.5 2.9 4.5
----- ----- ----- -----
Net income (loss).................................... (0.5)% 7.6% 3.0% 7.4%
===== ===== ===== =====
11
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
1999 COMPARED TO 1998
The Company entered into new affiliation agreements with ten oncology groups in
the first six months of 1999 and nine oncology groups in the first six months of
1998, respectively. The results of the new affiliated oncology practices are
included in the Company's operating results from the dates of affiliation.
Changes in results of operations for the first six months of 1998 compared to
the first six months of 1999 were caused, in part, by affiliations with these
oncology practices.
Revenue. Revenue increased from $392.4 million in the first six months of
1998 to $515.6 million in 1999, an increase of $123.2 million, or 31.4% and from
$204.7 million in the second quarter of 1998 to $266.4 million in the second
quarter of 1999, an increase of $61.7 million or 30.1%. Revenue for markets
under management in the first six months of 1998 and 1999 increased $114.4
million or 30.3% over the same period from the prior year and $60.3 million or
30.8% in the second quarter of 1999. This growth was the result of expansion of
services, increases in patient volume, and recruitment of or affiliation with
additional physicians. In addition, the Company recognized revenue of $3.2
million in the second quarter of 1999 from the termination of its research
services contract with Ilex.
Pharmaceuticals and Supplies. Pharmaceuticals and supplies expense, which
includes drugs, medications and other supplies used by the affiliated physician
groups, increased from $163.4 million for the first six months of 1998 to $238.7
million for the first six months of 1999, an increase of $75.3 million, or 46.1%
and from $86.5 million in the second quarter of 1998 to $123.5 million in the
second quarter of 1999 an increase of $37.0 million or 42.8%. As a percentage
of revenue, pharmaceuticals and supplies increased from 41.6% for the first six
months of 1998 to 46.3% for the comparable period of 1999 and from 42.2% in the
second quarter of 1998 to 46.4% in the second quarter of 1999. This increase
was primarily due to a shift in the revenue mix to a higher percentage of drug
revenue, the introduction of a number of new chemotherapy agents and, to a
lesser extent, lower reimbursement from payors. Management expects that third-
party payors will continue to negotiate the reimbursement rate for
pharmaceuticals and supplies, with the goal of lowering reimbursement rates, and
that such lower reimbursement rates as well as shifts in revenue mix may
continue to adversely impact the Company's margins with respect to such items.
Merger and Integration Costs. In the second quarter of 1999 the Company
recognized merger and integration costs of approximately $24.5 million. Merger
and integration costs are comprised of transaction costs of approximately $17.2
million for professional fees, costs of due diligence, severance costs and other
out of pocket expenses; restructuring costs of approximately $3.1 million for
leasehold and software abandonment; and, integration costs of approximately $4.2
million for integration consulting fees, communications, and Merger related
Company meetings.
Income Taxes. Income tax expense decreased from the prior year as a result of
merger and integration costs expensed in the current period. For the first six
months of 1999 the Company recognized a tax provision of $15.2 million resulting
in an effective tax rate of 49.8% compared to 37.6% for the same prior year
period. The increased effective tax rate is the result of certain non-deductible
Merger related costs.
Net Income. Net income decreased from $29.1 million in the first six months
of 1998 to $15.3 million in the first six months of 1999, a decrease of $13.8
million or 47.4% and decreased from $15.5 million for the second quarter of 1998
to a loss of $1.2 million for the second quarter of 1999. Such decreases were
primarily the result of merger and integration costs of $24.5 million.
Excluding the merger costs, net income for the first six months of 1999 would
have been $34.4 million which represents earnings per share of $0.34 and for the
second quarter of 1999 net income would have been $17.8 million which represents
earnings per share of $0.18. Net income as a percentage of revenue decreased
from 7.4% for the six months ended June 30, 1998 to 6.7% for the six months
ended June 30, 1999 excluding merger and integration costs and decreased from
7.6% for the second quarter of 1998 to 6.7% for the second quarter of 1999
excluding merger and integration costs. Such decreases are attributable to the
shift in the revenue mix to a higher percentage of drug revenue as discussed
above, the change in amortization period for management services agreements from
40 years to 25 years, effective July 1, 1998 and, to a lesser extent, the
introduction of a number of new, lower margin chemotherapy agents.
12
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
In response to this decline in margin relating to certain pharmaceutical agents,
the Company has adopted several strategies. Most importantly, the Company has
formed a number of preferred pharmaceutical relationships and continues to
pursue others. In addition, the Company routinely considers and implements
measures to control general and administrative costs to enable it to achieve
greater economies of scale. Lastly, the Company seeks opportunities to expand
its business in areas that are less affected by lower pharmaceutical margins,
such as radiation oncology. The Company believes that its results of operations
and financial condition have benefited from each of these strategies.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital primarily to enter into management services
agreements with, and to purchase the nonmedical assets of, medical and radiation
oncology practices. During the first six months of 1999, the Company paid total
consideration of $70.9 million in connection with affiliations with ten
physician groups including cash and transaction costs of $32.3 million. During
the comparable period of the prior year, the Company paid total consideration of
$37.4 million for affiliations with nine physician groups including cash and
transaction costs of $17.8 million.
To fund its growth and development, the Company has satisfied its transaction
and working capital needs through borrowings under a $275 million syndicated
revolving credit facility ("Credit Facility") with First Union National Bank of
North Carolina ("First Union"), as agent for the various lenders. In addition,
the Company has obtained a $75 million end-loaded leasing facility (Leasing
Facility) for its integrated cancer centers.
During the first six months of 1999, the Company borrowed $77.0 million, net,
under the Credit Facility to fund medical practice transactions, pay merger
related expenses and the acquisition of property and equipment. Borrowings
under the Credit Facility bear interest at a rate equal to a rate based on prime
rate or the London Interbank Offered Rate, based on a defined formula. The
Credit Facility and Leasing Facility contain affirmative and negative covenants,
including the maintenance of certain financial ratios, restrictions on sales,
leases or other dispositions of property, restrictions on other indebtedness and
prohibitions on the payment of dividends. The Company's management services
agreements, the capital stock of the Company's subsidiaries and the Company's
accounts receivable are pledged as security under the Credit Facility and
Leasing Facility. The Company is currently in compliance with the Credit
Facility and Leasing Facility covenants, with additional capacity under the
Credit Facility of $38 million and Leasing Facility of approximately $34 million
at June 30, 1999. The Company has relied primarily on management fees received
from its affiliated physician groups to fund its operations.
Cash used in operations was $11.2 million in the first six months of 1999, a
change of $46.9 million from the comparable period in 1998. The decrease was
due primarily to Merger related expenditures of $16.3 million and the timing of
certain working capital payments. Excluding merger related expenditures, cash
provided from operations would have been $5.1 million. Cash used in investing
activities was $73.6 million for the first six months of 1999, an increase of
$29.6 million from the same period of 1998. Such increase is due primarily to
greater activity in medical practice transactions in 1999. Cash provided by
financing activities was $74.3 million for the first six months of 1999, an
increase of $62.9 million from the comparable prior year period. Such increase
is due to borrowings to pay merger and integration costs as well as fund medical
practice transaction costs. Incremental borrowings of $77.0 million under the
Credit Facility were incurred in the first six months of 1999.
As of June 30, 1999, the Company had net working capital of $229.2 million and
cash and cash equivalents of $3.2 million. The Company's also had $143.0
million of current liabilities, including approximately $23.0 million of long-
term indebtedness maturing before June 30, 2000. The Company currently expects
that its principal use of funds in the near future will be in connection with
anticipated medical practice transactions, merger and integration expenses and
purchases of medical equipment.
13
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
YEAR 2000 ISSUE
The "Year 2000 problem" describes computer programs that use two rather than
four digits to define the applicable year, and thus cannot distinguish between
the year 1900 and the year 2000. The Company's computer hardware and software,
building infrastructure components (e.g., alarm systems and HVAC systems) and
medical equipment (e.g., linear accelerators, which are used to provide
radiation therapy) that are date sensitive may contain programs with the Year
2000 problem. If uncorrected, the problem could result in computer system and
program failure or equipment malfunctions that could disrupt business
operations.
Project. The Company has divided its Year 2000 Project into six phases:
development, awareness, assessment, remediation, validation and implementation.
In connection with its Year 2000 Project, the Company is assessing information
technology software and hardware, medical equipment, third-party payors and
third-party suppliers. The Company's strategy also includes development of
contingency plans to address potential disruption of operations arising from the
Year 2000 problems.
Information Systems. The Company recognizes that investment in information
systems and state-of-the-art medical equipment is integral to its operations.
The majority of the Company's technology expenditures for 1998 and 1999 relate
to the development and implementation of a clinical information system. This
system provides an interactive electronic format for capturing the spectrum of
patient care and creates an electronic medical record. This system is believed
to be Year 2000 compliant. The costs of the clinical information system are
expected to be capitalized and amortized over the life of the asset.
In 1994, the Company began a project to replace the existing practice management
systems (billing and collection systems) with a common system to improve
efficiency and consistency among its affiliated practices of this common
practice management system. The common practice management system being
implemented is believed to be Year 2000 compliant. Any remaining practice
management systems not replaced by the new system have been modified with
vendor-supplied upgrades to make them Year 2000 compliant. Costs to upgrade the
practice management systems that are not converted to the common system would be
expensed; however, such costs are not expected to be material.
In 1996, the Company's management incorporated a business strategy to
accommodate the rapid growth of its operations. One component of this strategy
was the investment in developing an integrated financial system throughout its
network of affiliated physicians. This financial system is believed to be Year
2000 compliant and has been implemented in several locations. The Company
intends to complete the implementation of this financial system by the first
quarter of 2000. The costs incurred in developing this financial system have
been capitalized through the initial implementation date. Any legacy financial
systems not replaced before the end of 1999 are believed to be Year 2000
compliant.
Medical Equipment. The Company has reviewed the Year 2000 readiness of the
linear accelerators and associated equipment used in the affiliated radiation
oncology practices. The suppliers of the radiation oncology equipment have
certified that, with minor upgrades, these systems will be Year 2000 compliant
by the end of the third quarter. The Company has determined that all other
medical equipment is Year 2000 compliant. Costs incurred to upgrade medical
equipment have been expensed.
Third-Party Payors. The Company bills and collects for medical services from
numerous third party payors in operating its business. These third parties
include fiscal intermediaries on behalf of the Medicare program, as well as
insurance companies, HMOs and other private payors. As part of the Company's
Year 2000 strategy, a comprehensive survey has been sent to all significant
payors to assess their timeline for Year 2000 compliance and the impact to the
Company. The response rate for compliance is over 90% and non-respondants are
being contacted directly. All major payors who have responded to the Company's
requests have declared that they are or will be Year 2000 compliant.
14
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
Third-Party Suppliers. The Company is currently evaluating third party
vendors of medical supplies and pharmaceuticals in order to determine whether
their services and products will be interrupted or malfunction due to the Year
2000 problem. The Company's pharmaceutical ordering system is a proprietary
system developed by a third party vendor and is utilized under the Company's
purchasing contract with such vendor. This relationship has been identified and
prioritized as the most critical in the vendor evaluation process. The third
party vendor has upgraded its pharmaceuticals purchase ordering system at no
cost to the Company. The upgraded system has been certified as Year 2000
compliant by the vendor and is scheduled for implementation by the third quarter
of 1999.
Risks. The failure to correct a material Year 2000 problem could result in an
interruption in, or failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of third-party payors and third-party
suppliers, the Company is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the Company's
results of operations, liquidity or financial condition. The Company has
received compliance certification from all major payors and its key third party
supplier of pharmaceutical agents which reduces the Company's level of
uncertainly considerably. The Company has also developed contingency plans to
use alternative business practices in the event of unexpected Year 2000 related
failures of third-party systems. However, there can be no assurance that
unexpected Year 2000 related failures will not occur or that such contingency
plans will be sufficient in the event of such failures. Any such failure
affecting the Company or any third party could have a material adverse effect on
the Company's results of operations, liquidity and financial condition.
Costs. The Company estimates that total costs to be incurred in the execution
of its Year 2000 Project are approximately $10.7 million, including
approximately $600,000 relating to laboratory and medical equipment upgrades and
replacements. The Company estimates that approximately $8.2 million of the
costs will be capitalized and amortized over the useful life of the assets as
they represent new applications and expanded capabilities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
In the normal course of business, the financial position of the Company is
routinely subjected to a variety of risks. Among these risks is the market risk
associated with interest rate movements on outstanding debt. The Company
regularly assesses these risks and has established policies and business
practices to protect against the adverse effects of these and other potential
exposures.
The Company's borrowings under the Credit Facility and subordinated notes due to
affiliated physicians contain an element of market risk from changes in interest
rates. The Company manages this risk, in part, through the use of interest rate
swaps. The Company does not enter into interest rate swaps or hold other
derivative financial instruments for speculative purposes.
For purposes of specific risk analysis, the Company uses sensitivity analysis to
determine the impact that market risk exposures may have on the Company. The
financial instruments included in the sensitivity analysis consist of all of the
Company's cash and equivalents, long-term and short-term debt and all derivative
financial instruments.
To perform sensitivity analysis, the Company assesses the risk of loss in fair
values from the impact of hypothetical changes in interest rates on market
sensitive instruments. The market values for interest rate risk are computed
based on the present value of future cash flows as impacted by the changes in
the rates attributable to the market risk being measured. The discount rates
used for the present value computations were selected based on market interest
rates in effect at June 30, 1999. The market values that result from these
computations are compared with the market values of these financial instruments
at June 30, 1999. 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.
15
US ONCOLOGY, INC.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company held its Annual Meeting of Stockholders on June 15, 1999
(b) No disclosure required.
(c) The following matters were voted upon at the Annual Meeting:
Election of Directors
WITHHELD
NOMINEE VOTES FOR AUTHORITY
------- --------- ---------
Russell L. Carson, as a Class III director 33,164,929 188,966
James E. Dalton, as a Class I director 33,164,929 188,966
Stanley A. Marks, M.D., as a Class II director 33,164,929 188,966
Richard B. Mayor, as a Class III director 33,164,929 188,966
Robert A. Ortenzio, as a Class II director 33,164,929 188,966
Edward E. Rogoff, M.D., as a Class I director 33,164,929 188,966
R. Dale Ross, as a Class III director 33,164,929 188,966
Other Matters
VOTES AGAINST OR
VOTES FOR ABSTAINED
--------- ----------------
Approval of the issuance of up to 50,000,000 shares of
the Company's common stock (together with associated
Series A Preferred Stock Purchase Rights) to
stockholders of Physician Reliance Network, Inc.
("PRN") pursuant to the Agreement and Plan of Merger,
dated as of December 11, 1998, by and among the 24,404,511 271,903
Company, PRN and Diagnostic Acquisition, Inc.
Approval of the Company's Amended and Restated
Certificate of Incorporation 18,893,202 5,120,234
Approval of an amendment to the Company's 1993 Affiliate
Stock Option Plan 18,634,689 6,041,725
Approval of amendments to the Company's 1993
Non-Employee Director Stock Option Plan 20,136,464 4,539,950
Approval of an amendment to the Company's 1993 Key
Employee Stock Option Plan 19,050,357 5,626,057
Ratification of the Appointment of PricewaterhouseCoopers LLP
as the Company's independent accountants 33,278,834 75,061
No broker non-votes were recorded.
(d) No disclosure required.
16
U.S. ONCOLOGY, INC.
PART II. OTHER INFORMATION
ITEM 2. Changes in Securities
In connection with each affiliation transaction between the Company and a
physician group, the Company purchases the nonmedical assets of, and enters into
a long-term management services agreement with, that physician group. In
consideration for that arrangement, the Company typically pays cash, issues
subordinated promissory notes (in general, payable in equal installments on the
third through seventh anniversaries of the closing date at an annual interest
rate of seven percent) and unconditionally agrees to deliver shares of Common
Stock at future specified dates (in general, on each of the third through fifth
anniversaries of the closing date). The price per share is the lower of the
average of the closing price per share for the five days preceding the date of
the letter of intent or the closing date with respect to such affiliation
transaction.
The following table describes all unregistered sales by the Company of the
Company's securities during the first six months of 1999. Each sale was a
private placement made in connection with a physician transaction, as described
in general in the preceding paragraph. The overwhelming majority of the
affiliated physicians are accredited investors. No underwriter was involved in
any such sale, and no commission or similar fee was paid with respect thereto.
Each sale was not registered under the Securities Act of 1933 in reliance on
Section 4(2) of such Act and Rule 506 enacted thereunder.
Number of Shares Aggregate Principal Amount
Date of Transaction Number of Physicians of Common Stock(1) of Notes
- -------------------------- --------------------------- ------------------ ---------------------------
1/99 8 819,665 $6,316,000
1/99 4 283,568 2,558,000
1/99 2 47,611 233,000
1/99 1 24,426 640,000
1/99 1 18,609 186,000
1/99 1 96,366 680,000
2/99 1 12,881 217,000
3/99 1 33,381 686,000
6/99 10 402,209 2,990,000
(1) In connection with each affiliation transaction, the Company unconditionally
agrees to deliver shares of Common Stock at specified future dates.
17
US ONCOLOGY, INC.
OTHER INFORMATION - CONTINUED
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
3.1 Amended and Restated Certificate of Incorporation (incorporated by
reference from the Company's Form 8-K/A, filed June 17, 1999)
3.2 Amended and Restated By-Laws (incorporated by reference from the
Company's Form 8-K/A filed June 17, 1999)
4.1 Rights Agreement between the Company and American Stock Transfer & Trust
Company (incorporated by reference from Form 8-A filed June 2, 1997)
10.1 Fourth Amended and Restated Loan Agreement dated May 11, 1999 among
First Union National Bank, various Lenders and the Company
10.2 Third Amendment to Certain Operative Agreements dated as of May 14, 1999
by and among the Company, various of its subsidiaries, First Security
Bank, National Association as owner trustee, various Lenders and Holders
(as defined herein) and First Union National Bank, as Agent
10.3 Termination Agreement by and between Ilex Oncology, Inc. and PRN
Research, Inc. (a subsidiary of the Company)
27 Financial Data Schedule
(b) Reports on Form 8-K
On June 17, 1999, the Company filed an amendment to Form 8-K in connection
with the consummation of the Merger.
18
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: August 16, 1999 US ONCOLOGY, INC.
By: /s/ L. FRED POUNDS
----------------------------------------
L. Fred Pounds, Chief Financial Officer
and Treasurer (duly authorized signatory
and Principal Financial Officer)
19