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SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
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Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file 001-15699
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Concentra Operating Corporation
(Exact name of Registrant as specified in its charter)
Nevada 75-2822620
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5080 Spectrum Drive, Suite 400W 75001
Addison, Texas (Zip Code)
(address of principal executive offices)
(972) 364-8000
(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 twelve months (or 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 1, 2002, the Registrant had outstanding an aggregate of 1,054
shares of its common stock, $.01 par value. The Registrant is a wholly-owned
subsidiary of Concentra Inc., a Delaware corporation, which, as of August 1,
2002, had 31,591,509 shares outstanding of its common stock, $.01 par value.
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CONCENTRA OPERATING CORPORATION
INDEX TO QUARTERLY REPORT ON FORM 10-Q
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at June 30, 2002 (Unaudited) and December 31, 2001 3
Consolidated Statements of Operations (Unaudited) for the Three and Six Months Ended June 30, 2002 and 2001 4
Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2002 and 2001 5
Notes to Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
PART II. OTHER INFORMATION
Item 4 Submission of Matters to a Vote of Security Holders 20
Item 6. Exhibits and Reports on Form 8-K 20
Exhibit Index 22
2
ITEM 1. FINANCIAL STATEMENTS
CONCENTRA OPERATING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30, December 31,
2002 2001
----------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 44,077 $ 7,308
Accounts receivable, net 178,052 181,023
Prepaid expenses and other current assets 40,629 38,760
--------- --------
Total current assets 262,758 227,091
Property and equipment, net 129,357 132,302
Goodwill and other intangible assets, net 478,545 475,500
Other assets 35,628 32,072
--------- --------
Total assets $ 906,288 $866,965
========= ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Revolving credit facility $ -- $ 6,000
Current portion of long-term debt 5,079 4,211
Accounts payable and accrued expenses 108,213 133,908
--------- --------
Total current liabilities 113,292 144,119
Long-term portion of debt 550,212 552,270
Deferred income taxes and other liabilities 72,316 67,094
Fair value of hedging arrangements 27,068 25,883
--------- --------
Total liabilities 762,888 789,366
Stockholder's equity:
Common stock -- --
Paid-in capital 226,349 168,159
Retained deficit (82,949) (90,560)
--------- --------
Total stockholder's equity 143,400 77,599
--------- --------
Total liabilities and stockholder's equity $ 906,288 $866,965
========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
3
CONCENTRA OPERATING CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Revenue:
Health Services $ 120,868 $ 115,276 $ 222,544 $ 221,628
Network Services 56,260 45,331 113,489 87,676
Care Management Services 74,470 54,274 153,945 106,335
--------- --------- --------- ---------
Total revenue 251,598 214,881 489,978 415,639
Cost of Services:
Health Services 94,620 89,641 188,446 177,742
Network Services 35,437 27,301 68,988 53,548
Care Management Services 66,659 47,264 134,031 92,559
--------- --------- --------- ---------
Total cost of services 196,716 164,206 391,465 323,849
--------- --------- --------- ---------
Total gross profit 54,882 50,675 98,513 91,790
General and administrative expenses 26,919 19,924 49,308 38,595
Amortization of intangibles 929 3,813 1,858 7,490
--------- --------- --------- ----------
Operating income 27,034 26,938 47,347 45,705
Interest expense, net 16,520 16,753 32,941 33,663
(Gain) loss on change in fair value of
hedging arrangements 6,374 (3,646) 1,184 3,080
Loss of acquired affiliate, net of tax -- 426 -- 1,542
Other, net 256 298 624 305
--------- --------- --------- ---------
Income before income taxes 3,884 13,107 12,598 7,115
Provision for income taxes 1,418 5,802 4,987 5,248
--------- --------- --------- ---------
Net income $ 2,466 $ 7,305 $ 7,611 $ 1,867
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
4
CONCENTRA OPERATING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
Six Months Ended
June 30,
--------------------------
2002 2001
-------- --------
Operating Activities:
Net income $ 7,611 $ 1,867
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation of property and equipment 18,422 13,569
Amortization of intangibles 1,858 7,490
Write-off of fixed assets 70 13
Loss on change in fair value of hedging arrangements 1,184 3,080
Changes in assets and liabilities, net of acquired assets and liabilities:
Accounts receivable, net 2,915 (10,286)
Prepaid expenses and other assets (3,780) 1,448
Accounts payable and accrued expenses (17,644) 12,867
-------- --------
Net cash provided by operating activities 10,636 30,048
-------- --------
Investing Activities:
Acquisitions, net of cash acquired (2,810) (17,044)
Proceeds from the licensing of internally-developed software 515 684
Purchases of property and equipment (16,658) (13,122)
-------- --------
Net cash used in investing activities (18,953) (29,482)
-------- --------
Financing Activities:
Borrowings (repayments) under revolving credit facilities, net (6,000) --
Payment of deferred financing costs (1,135) --
Issuance of common stock to parent 53,274 --
Contribution from issuance of common stock by parent 162 276
Repurchase of common stock by parent (25) --
Repayments of long-term debt (1,190) (2,111)
-------- --------
Net cash provided by (used in) financing activities 45,086 (1,835)
-------- --------
Net Increase (Decrease) in Cash and Cash Equivalents 36,769 (1,269)
Cash and Cash Equivalents, beginning of period 7,308 6,549
-------- --------
Cash and Cash Equivalents, end of period $ 44,077 $ 5,280
======== ========
Supplemental Disclosure of Cash Flow Information:
Interest paid $ 31,483 $ 30,234
Income taxes paid, net $ 1,427 $ 717
Liabilities and debt assumed in acquisitions $ 400 $ 1,802
Net asset contribution from parent $ -- $ 938
The accompanying notes are an integral part of these consolidated financial
statements
5
CONCENTRA OPERATING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The accompanying unaudited consolidated financial statements have been
prepared by Concentra Operating Corporation (the "Company" or "Concentra
Operating") pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC"), and reflect all adjustments (all of which are of a normal
recurring nature) which, in the opinion of management, are necessary for a fair
statement of the results of the interim periods presented. Results for interim
periods should not be considered indicative of results for a full year. These
consolidated financial statements do not include all disclosures associated with
the annual consolidated financial statements and, accordingly, should be read in
conjunction with the attached Management's Discussion and Analysis of Financial
Condition and Results of Operations and the consolidated financial statements
and footnotes for the year ended December 31, 2001, included in the Company's
2001 Form 10-K, where certain terms have been defined. Earnings per share has
not been reported for all periods presented, as Concentra Operating is a
wholly-owned subsidiary of Concentra Inc. ("Concentra Holding") and has no
publicly held shares.
(1) Reclassifications and Change in Estimate
Certain reclassifications have been made in the 2001 financial statements
to conform to classifications used in 2002. The Company's bad debt expense for
the three months and six months ended June 30, 2001 of $3.0 million and $5.6
million, respectively, have been reclassified from revenue to cost of services
to conform to the classifications used in 2002. This reclassification resulted
from a change in the Company's process and methodology for estimating bad debt
and sales allowances. Following an extensive review of the Company's accounts
receivable history and collection experience, utilizing new data provided by
recently implemented information systems, the Company determined that additional
sales allowances and bad debt reserves of $7.1 million were required as of March
31, 2002. This reserve increase related primarily to the Company's Health
Services segment, offset by reserve reductions in other segments. Total sales
and contractual allowances on the Company's accounts receivable were $38.9
million and $29.6 million at June 30, 2002 and December 31, 2001, respectively.
The consolidated statements of income and cash flows for the three months
and six months ended June 30, 2001, have been adjusted to include recognition of
a minority interest by the Company in the net loss of National Healthcare
Resources, Inc. ("NHR"). Effective November 1, 2001, the Company acquired all of
the outstanding shares of capital stock of NHR. Because the Company is
controlled by its primary shareholder, Welsh, Carson, Anderson & Stowe VIII,
L.P. ("WCAS"), and because WCAS owned approximately a 48% portion of the common
voting equity in NHR, the acquisition was accounted for as a reorganization of
entities under common control. Accordingly, the historical costs of NHR's assets
and liabilities were utilized to the extent of WCAS' proportionate ownership
interest in NHR and the remainder of the acquisition was accounted for under the
purchase method of accounting, whereby assets and liabilities are "stepped-up"
to fair value with the remainder allocated to goodwill. The Company recognized
NHR's historical net income and loss as a non-operating item in proportion to
WCAS' investment in NHR utilizing the equity method of accounting from August
17, 1999 through October 31, 2001. As a result, the amounts reported in the
consolidated financial statements of the Company differ from amounts previously
reported in the Company's Form 10-Q for the quarterly period ended June 30,
2001.
(2) Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. ("SFAS") 143, "Accounting for
Asset Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. The
statement requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred and capitalized
as part of the carrying amount of the long-lived asset. The statement will be
effective for fiscal years beginning after June 15, 2002. The Company is
currently evaluating the effect on its consolidated financial statements of this
standard when adopted.
6
CONCENTRA OPERATING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets" ("SFAS 144") which supersedes SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of." The statement provides a single accounting model for long-lived
assets to be disposed. The Company adopted SFAS 144 on January 1, 2002. The
adoption did not have a material impact on the Company's consolidated financial
position, results of operation or cash flows.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections"
("SFAS 145"). SFAS 145 concludes that gains or losses from debt extinguishments
used as part of a company's risk management strategy should not be classified as
an extraordinary item, effective for fiscal years beginning after May 15, 2002
with early adoption encouraged. SFAS 145 also requires sale-leaseback accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions, effective for transactions occurring after May 15,
2002. This Statement also amends other existing authoritative pronouncements to
make various technical corrections, clarify meanings or describe their
applicability under changed conditions, effective for financial statements
issued on or after May 15, 2002. The Company adopted the provisions of this
pronouncement for all related transactions in the second quarter of 2002. This
adoption did not have a significant impact on the consolidated financial
statements. In July 2002, the Company redeemed $47.5 million of its $190 million
13% Senior Subordinated Notes. In accordance with SFAS 145, the related loss
from debt extinguishment will be included in income from continuing operations
in the third quarter of 2002. See "Note 4. Revolving Credit Facility and
Long-Term Debt" for further discussion of this transaction.
In June 2002, the FASB issued SFAS 146, "Accounting for Exit or Disposal
Activities" ("SFAS 146"). SFAS 146 addresses the accounting for costs to
terminate a contract that is not a capital lease, costs to consolidate
facilities and relocate employees, and involuntary termination benefits under
one-time benefit arrangements that are not an ongoing benefit program or an
individual deferred compensation contract. A liability for contract termination
costs should be recognized and measured at fair value either when the contract
is terminated or when the entity ceases to use the right conveyed by the
contract. A liability for one-time termination benefits should be recognized and
measured at fair value at the communication date if the employee would not be
retained beyond a minimum retention period (i.e., either a legal notification
period or 60 days, if no legal requirement exists). For employees that will be
retained beyond the minimum retention period, a liability should be accrued
ratably over the future service period. The provisions of SFAS 146 will be
effective for disposal activities initiated after December 31, 2002. The Company
is currently evaluating the financial impact of the adoption of this statement.
(3) Goodwill and Other Intangible Assets
In July 2001, the FASB issued SFAS 141, "Business Combinations" ("SFAS
141") and SFAS 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS
141 addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in a business combination. SFAS 142 addresses the
initial recognition and measurement of intangible assets acquired outside of a
business combination, whether acquired individually or with a group of other
assets, and the accounting and reporting for goodwill and other intangibles
subsequent to their acquisition. The Company adopted SFAS 141 and SFAS 142
effective January 1, 2002. Under SFAS 142, goodwill and indefinite life
intangible assets, such as the Company's trademarks, are no longer amortized,
but are subject to annual impairment tests. Impairment testing may be more
frequent if there are interim "triggering" events, such as adverse revenue
trends or adverse economic conditions. Other intangible assets with finite
lives, such as customer lists and non-compete agreements, will continue to be
amortized over their useful lives. In addition, assembled workforce is no longer
defined as an acquired intangible asset under SFAS 141. Accordingly, the Company
reclassified assembled workforce to goodwill in the first quarter of 2002 and,
effective January 1, 2002, ceased amortizing goodwill and assembled workforce.
Under SFAS 142, Concentra was required to test all existing goodwill and
indefinite life intangibles for impairment as of January 1, 2002, on a reporting
unit basis. A reporting unit is the operating segment unless, at businesses one
level below that operating segment (the component level), discrete financial
information is prepared and regularly reviewed by management, and the businesses
are not otherwise aggregated due to having certain common characteristics, in
which case such component is the reporting unit. A fair value approach is used
to test goodwill and indefinite life intangibles for impairment. An impairment
charge is recognized for the amount, if any, by which the carrying amount of
goodwill
7
CONCENTRA OPERATING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
and indefinite life intangibles exceeds its fair value. Fair values were
established using projected cash flows. When available and as appropriate,
comparative market multiples were used to corroborate projected cash flow
results.
The Company has completed the transitional implementation tests for
intangible assets with indefinite lives and goodwill and has determined that no
impairment existed at January 1, 2002, on a reporting unit basis. The Company's
future earnings may periodically be affected in a materially adverse manner
should particular segments of its goodwill balances become impaired pursuant to
the valuation methodology.
A reconciliation of the previously reported net income for the three months
and six months ended June 30, 2001 to the amounts adjusted for the reduction of
amortization expense, net of the related income tax effect, is as follows (in
thousands):
Three Months Ended Six Months Ended
June 30, 2001 June 30, 2001
------------------ ----------------
Net income:
As reported $ 7,305 $ 1,867
Add: amortization expense adjustment 2,275 4,468
--------- ---------
As adjusted $ 9,580 $ 6,335
========= =========
The net carrying value of goodwill and other intangible assets is comprised
of the following (in thousands):
June 30, December 31,
2002 2001
---------- ------------
Amortized intangible assets, gross:
Customer contracts $ 5,886 $ 5,886
Covenants not to compete 4,728 4,728
Customer lists 3,295 3,295
Servicing contracts 3,293 3,293
Licensing and royalty agreements 285 285
---------- ---------
17,487 17,487
Accumulated amortization of amortized intangible assets:
Customer contracts (1,008) (252)
Covenants not to compete (884) (222)
Customer lists (2,140) (1,919)
Servicing contracts (220) (55)
Licensing and royalty agreements (70) (17)
---------- ---------
(4,322) (2,465)
---------- ---------
Amortized intangible assets, net 13,165 15,022
Non-amortized intangible assets:
Goodwill 465,226 460,032
Assembled workforce -- 292
Trademarks 154 154
---------- ---------
$ 478,545 $ 475,500
========== =========
The change in the net carrying amount of goodwill during the six months
ended June 30, 2002 is due to the reclassification of assembled workforce to
goodwill of $0.3 million and $4.9 million of goodwill for acquisitions. The
change in the net carrying amount of amortized intangible assets is due to
amortization.
8
CONCENTRA OPERATING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
The net carrying value of goodwill by operating segment is as follows (in
thousands):
June 30, December 31,
2002 2001
---------- ------------
Health Services $ 231,509 $ 226,376
Network Services 187,072 187,011
Care Management Services 46,645 46,645
--------- ---------
$ 465,226 $ 460,032
========= =========
Amortization expense for intangible assets with finite lives was $0.9
million and $1.9 million, respectively, for the three months and six months
ended June 30, 2002. Estimated amortization expense on intangible assets with
finite lives for the five succeeding fiscal years is as follows (in thousands):
Years Ended
December 31,
------------
2002 $ 3,686
2003 3,612
2004 3,162
2005 2,182
2006 537
(4) Revolving Credit Facility and Long-Term Debt
The Company's long-term debt as of June 30, 2002, and December 31, 2001,
consisted of the following (in thousands):
June 30, December 31,
2002 2001
-------- -----------
Term Facilities:
Tranche B due 2006 $243,125 $243,750
Tranche C due 2007 121,563 121,875
13.0% Senior Subordinated Notes due 2009 190,000 190,000
Other 603 856
-------- --------
555,291 556,481
Less: Current maturities (5,079) (4,211)
-------- --------
Long-term debt, net $550,212 $552,270
======== ========
The Company had no revolving credit borrowings at June 30, 2002 and $6.0
million at December 31, 2001. As of June 30, 2002 and December 31, 2001, accrued
interest was $14.0 million and $13.7 million, respectively.
On June 14, 2002, the Company and its lenders amended the $475 million
credit agreement (the "Credit Facility"). Under the terms of the amended
agreement, the financial compliance ratios were modified to allow for increased
leverage coverage through September 2004 and decreased interest coverage through
December 2004, as compared to the previously amended agreement. As part of the
amendment, the Company was also required to pay a fee of $1.1 million to lenders
approving the agreement. The amendment fee was capitalized as deferred financing
costs and will be amortized over the remaining life of the Credit Facility.
On June 25, 2002, Concentra Holding entered into a $55.0 million bridge
loan agreement ("Bridge Loan") with affiliates of Salomon Smith Barney and
Credit Suisse First Boston. The loans bear interest, at Concentra Holding's
option, at the Base Rate, as defined, plus 0.50%, or the Eurodollar Rate, as
defined, plus 1.5%. The Bridge Loan matures on June 24, 2004 and requires no
cash interest payments until maturity. The Bridge Loan is guaranteed by WCAS and
WCAS Capital Partners III, L.P. As part of the agreement, Concentra Holding was
required to pay fees of $1.0 million to
9
CONCENTRA OPERATING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
the lenders approving the agreement and $0.7 million to the loan guarantors.
These fees were capitalized by Concentra Holding as deferred financing costs and
will be amortized over the life of the Bridge Loan. Pursuant to action by the
Company's Board of Directors, Concentra Operating then issued 54 shares of its
common stock to Concentra Holding for $53.3 million of cash. On July 24, 2002,
these proceeds were used to redeem $47.5 million of the Company's $190 million
13% Senior Subordinated Notes ("13% Subordinated Notes"), pursuant to the
provisions of the indenture. In connection with the July redemption, the Company
paid a $6.2 million premium over the face note amount of the redeemed bonds and
accrued interest of $2.7 million. Concurrently, the Company expensed
approximately $1.2 million of related existing deferred financing fees and other
expenses. In accordance with SFAS 145, these debt extinguishment costs will be
included in income from continuing operations in the third quarter of 2002.
The Credit Facility and the 13% Subordinated Notes contain certain
customary covenants, including, without limitation, restrictions on the
incurrence of indebtedness, the sale of assets, certain mergers and
acquisitions, the payment of dividends on the Company's capital stock, the
repurchase or redemption of capital stock, transactions with affiliates,
investments, capital expenditures and changes in control of the Company. Under
the Credit Facility, the Company is also required to satisfy certain financial
covenant ratio tests including leverage ratios, interest coverage ratios and
fixed charge coverage ratios. The Company was in compliance with its covenants,
including its financial covenant ratio tests, for the first half of 2002. While
being less restrictive than previous requirements, these amended ratio tests
become more restrictive for future quarters as compared to the levels which the
Company was required to meet for the second quarter of 2002. The Company's
ability to be in compliance with these more restrictive ratios will be dependent
on its ability to increase its cash flows over current levels. The Company's
obligations under the Credit Facility are secured by a pledge of stock in the
Company's subsidiaries and a pledge of the Company's and its subsidiaries'
assets.
The fair value of the Company's borrowings under the Credit Facility was
$368.3 million and $372.6 million, as of June 30, 2002 and December 31, 2001,
respectively. The fair value of the Company's 13% Subordinated Notes was $214.7
million and $207.1 million at June 30, 2002 and December 31, 2001, respectively.
The fair values of the financial instruments were determined utilizing available
market information. The use of different market assumptions or estimation
methodologies could have a material effect on the estimated fair value amounts.
(5) Non-Recurring Costs
During the six months ended June 30, 2002, the Company paid approximately
$3.0 million related to the non-recurring costs that occurred in the first
quarter of 1998, fourth quarter of 1998, third quarter of 1999 and fourth
quarter of 2001. At June 30, 2002, approximately $4.2 million of the accrual for
these non-recurring charges remain for facility lease obligations, personnel
reductions and other payments. The Company anticipates that the majority of this
liability will be paid over the next 18 months.
(6) Changes in Stockholder's Equity
In addition to the effects on Stockholder's Equity from the Company's
results of operations that decreased the retained deficit, the Company's paid-in
capital increased in 2002 on a year to date basis due to the $53.3 million of
proceeds from the issuance of 54 shares of common stock to Concentra Holding,
$4.1 million of tax benefits, $0.7 million of recognition of compensation
expense related to stock options and $0.1 million of assets received in
connection with issuance of common stock by Concentra Holding.
(7) Segment Information
Operating segments represent components of the Company's business that are
evaluated regularly by key management in assessing performance and resource
allocation. The Company's comprehensive services are organized into the
following segments: Health Services, Network Services and Care Management
Services.
Health Services provides specialized injury and occupational healthcare
services to employers through its network of health centers. Health Services
delivers primary and rehabilitative care, including the diagnosis, treatment and
management of work-related injuries and illnesses. Health Services also provides
non-injury, employment-related health services, including physical examinations,
pre-placement substance abuse testing, job-specific return to work evaluations
10
CONCENTRA OPERATING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
and other related programs. Health Services owns all the operating assets of the
occupational healthcare centers, including leasehold interests and medical
equipment.
The Network Services segment reflects those businesses that involve the
review and repricing of provider bills which are routinely compensated based on
the degree to which the Company achieves savings for its clients. This segment
includes our specialized preferred provider organization, provider bill
repricing and review, out-of-network bill review and first report of injury
services.
Care Management Services reflects the Company's professional services aimed
at curtailing the cost of workers' compensation and auto claims through field
case management, telephonic case management, independent medical examinations
and utilization management. These services also concentrate on monitoring the
timing and appropriateness of medical care.
Revenue from individual customers, revenue between business segments and
revenue, operating profit and identifiable assets of foreign operations are not
significant.
The Company's unaudited financial data on a segment basis was as follows
(in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Revenue:
Health Services $ 120,868 $ 115,276 $ 222,544 $ 221,628
Network Services 56,260 45,331 113,489 87,676
Care Management Services 74,470 54,274 153,945 106,335
--------- --------- --------- ---------
251,598 214,881 489,978 415,639
Gross profit:
Health Services 26,248 25,635 34,098 43,886
Network Services 20,823 18,030 44,501 34,128
Care Management Services 7,811 7,010 19,914 13,776
--------- --------- --------- ---------
54,882 50,675 98,513 91,790
Operating income:
Health Services 19,196 16,436 21,162 25,630
Network Services 13,304 12,494 29,766 23,741
Care Management Services 1,168 3,859 8,002 7,438
Corporate general and administrative expenses (6,634) (5,851) (11,583) (11,104)
--------- --------- --------- ---------
27,034 26,938 47,347 45,705
Interest expense, net 16,520 16,753 32,941 33,663
(Gain) loss on change in fair value of hedging
arrangements 6,374 (3,646) 1,184 3,080
Loss of acquired affiliate, net of tax -- 426 -- 1,542
Other, net 256 298 624 305
--------- --------- --------- ---------
Income before income taxes 3,884 13,107 12,598 7,115
Provision for income taxes 1,418 5,802 4,987 5,248
--------- --------- --------- ---------
Net income $ 2,466 $ 7,305 $ 7,611 $ 1,867
========= ========= ========= =========
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This section contains certain forward-looking statements that are based on
management's current views and assumptions regarding future events, future
business conditions and the outlook based on currently available information.
Wherever possible, we have identified these "forward-looking statements" (as
defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) by words and phrases such as "anticipates",
"plans," "believes," "estimates," "expects," "will be developed and
implemented," and similar expressions.
Although we believe that these forward-looking statements reasonably
reflect our plans, intentions and expectations, we can give no assurance that we
will achieve these plans, intentions or expectations. We caution readers not to
place undue reliance on these forward-looking statements. They are subject to
risks and uncertainties, and future events could cause our actual results,
performance, or achievements to differ materially from those expressed in, or
implied by, these statements. These factors include:
.. the effects of general industry and economic conditions, including declines
in nationwide employment levels and rates of workforce injuries;
.. the impact of the services provided by our competitors and the pricing of
such services;
.. our ability to manage business growth and diversification and the
effectiveness of our information systems and internal controls;
.. our ability to identify suitable acquisition candidates or joint venture
relationships for expansion and to consummate such transactions on
favorable terms;
.. our ability to integrate successfully the operations and information
systems of acquired companies;
.. our ability to attract and retain qualified professionals and other
employees;
.. the impact of changes in, and restrictions imposed by, legislative and
administrative regulations affecting the workers' compensation, insurance
and healthcare industries in general;
.. our ability to meet our debt, interest and operating lease payment and
covenant obligations;
.. possible litigation and legal liability in the course of operations;
.. fluctuations in interest and tax rates;
.. shifts in customer demand for the services we provide;
.. increases in the costs at which we can obtain goods and services we require
in order to operate our businesses; and
.. opportunities that others may present to us or that we may pursue, all of
which are difficult to predict and beyond the control of management.
All forward-looking statements attributable to us or persons acting on our
behalf are expressly qualified in their entirety by the cautionary statements
and risk factors contained herein. In light of these risks, uncertainties and
assumptions, the forward-looking events we discuss herein might not occur. Our
forward-looking statements speak only as of the date made. Other than as
required by law, we undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
From time to time, the Company may refer to computations of Earnings Before
Interest Taxes Depreciation and Amortization ("EBITDA"). To the extent these
computations are provided, their use is primarily intended to facilitate an
analysis of our performance for the holders of the Company's 13% Senior
Subordinated Notes, and other lenders, in light of our debt covenant
requirements, which are stated in the Company's debt agreements as measures
which relate to EBITDA. Our computation of this measure may differ from that
provided by other companies due to differences in the inclusion or exclusion of
certain items. EBITDA is a measure that is not prescribed for under Generally
Accepted Accounting Principles ("GAAP"). EBITDA specifically excludes changes in
working capital, capital expenditures and other items which are set forth on a
cash flow statement presentation of a company's operating, investing and
financing activities, and it also excludes the effects of interest expense,
depreciation expense, amortization expense, gain or loss on fair value of
hedging arrangements, taxes and other items which are included when determining
a company's net income. As such, we would encourage a reader not to use this
measure as a substitute for the determination of net income, operating cash
flow, or other similar GAAP-related measures, and to use it primarily for the
debt covenant compliance and the other analysis purposes described above.
Reference is hereby made to the Company's Form 10-K for the year ended
December 31, 2001, filed with the Securities and Exchange Commission, where
certain terms have been defined and for certain considerations that could cause
actual results to differ materially from those contained in this document.
Overview
Concentra Operating Corporation (the "Company") is dedicated primarily to
providing health services, network services and care management services to the
workers' compensation market and is also a provider of these services to the
occupational healthcare, group health and auto insurance markets. We currently
provide these services to employers, workers' compensation insurance companies,
third party administrators, group health plans, auto insurance companies,
insurance brokers and re-insurance companies nationwide. We also provide certain
of our care management services to customers in Canada. Our services are
organized into the following segments: Health Services, Network Services and
Care Management Services.
12
Through our Health Services segment, we provide specialized injury and
occupational healthcare services to employers through our network of health
centers. Through 231 health care centers located in 73 markets across 33 states,
Health Services delivers primary and rehabilitative care, including the
diagnosis, treatment and management of work-related injuries and illnesses.
Health Services also provides non-injury, employment-related health services,
including physical examinations, pre-placement substance abuse testing,
job-specific return to work evaluations and other related programs. For the six
months ended June 30, 2002 and 2001, Health Services derived 63.5% and 66.9% of
its net revenue from the treatment of work-related injuries and illnesses,
respectively and 36.5% and 33.1% of its net revenue from non-injury and
non-illness related medical services, respectively.
The Network Services segment primarily reflects those business units that
involve the review and repricing of provider bills. For these services, the
Company is routinely compensated based on the degree to which the Company
achieves savings for its clients. This segment includes our specialized
preferred provider organization, provider bill repricing and review,
out-of-network bill review and first report of injury services.
The Care Management Services segment reflects the Company's professional
services aimed at curtailing the cost of workers' compensation and auto claims
through field case management, telephonic case management, independent medical
examinations and utilization management. These services also concentrate on
monitoring the timing and appropriateness of medical care.
The following table provides certain information concerning our service
locations:
Six Months Ended Year Ended
June 30, December 31,
-------------------
2002 2001 2000
-------- --------- --------
Service locations at the end of the period:
Occupational healthcare centers/(1)/. 231 231 216
Network Services 32 35 34
Care Management Services 138 142 106
Occupational healthcare centers acquired during the period/(2)/ 3 15 8
_____________
/(1)/ Does not include the assets of the occupational healthcare centers that
were acquired and subsequently divested or consolidated into existing
centers within the same market during the period.
/(2)/ Represents occupational healthcare centers that were acquired during each
period presented and not subsequently divested or consolidated into
existing centers within the same market during the period.
Results of Operations for the Three and Six Months Ended June 30, 2002 and 2001
Revenue
Total revenue increased 17.1% in the second quarter of 2002 to $251.6
million from $214.9 million in the second quarter of 2001. Our Health Services
segment reflected a 4.9% increase in revenue to $120.9 million in the second
quarter of 2002 from $115.3 million in the second quarter of 2001. While our
Network Services and Care Management Services segments reflected significant
growth in their reported revenue during the quarter, these revenue increases
were largely due to our acquisition of National Healthcare Resources, Inc.
("NHR") and, to a lesser extent, the effects of our acquisition of Health
Network Systems, Inc. ("HNS"), both of which occurred in November of 2001. Had
we owned these companies in the prior year, the comparative revenue for the
Network Services segment of our business would have decreased by approximately
5.4% and the revenue from the Care Management Services would have declined by
approximately 4.7%. Including the pro forma results of NHR and HNS, our total
revenue decreased by approximately $1.4 million, or 0.5%, over the prior year.
Total revenue for the six months ended June 30, 2002 increased 17.9% to
$490.0 million from $415.6 for the six months ended June 30, 2001 despite a
change in accounting estimate that reduced revenue by approximately $5.4 million
in the first quarter of 2002. Our Health Services segment reflected a marginal
increase of 0.4% in revenue to $222.5 million in the first six months of 2002
from $221.6 million in the first half of 2001. Revenue for our Network Services
and Care Management Services segments increased significantly, primarily due to
the NHR and HNS acquisitions in
13
November of 2001. Had we owned these companies in the prior year, the
comparative revenue for the Network Services segment of its business would have
decreased approximately 2.2% and the revenue from the Care Management Services
would have increased by approximately 0.4%. In total, including the pro forma
results of NHR and HNS, our total revenue declined by approximately $1.0
million, or 0.2%, over the prior year.
Due to a change in accounting estimate for accounts receivable reserves, in
the first quarter of this year we increased sales allowances and correspondingly
reduced revenue by $5.4 million. Following an extensive review of our accounts
receivable history and collection experience, utilizing new data provided by
recently implemented information systems, we determined that additional sales
allowances were required as of March 31, 2002. This increase in accounts
receivable reserves related primarily to the Company's Health Services segment,
which reduced its revenue by $7.9 million in the first quarter, and was
partially offset by receivables reserve adjustments of $1.3 million in Network
Services and $1.2 million in Care Management Services.
Health Services' revenue increased 4.9% in the second quarter of 2002 and
4.0% for the first half of 2002, excluding the effect of the $7.9 million
accounts receivable reserve adjustment, from the same respective periods of the
prior year. These increases are due to acquisitions of healthcare centers during
the past eighteen months and growth in our on-site and ancillary services. The
Company acquired four new centers in the last half of 2001 and three new centers
in the first half of 2002. A number of these centers were subsequently
consolidated with other centers we previously owned in the same markets. The
number of total patient visits per day to Health Services' centers in the second
quarter of 2002 increased 1.8% compared with the second quarter of 2001 and
decreased 2.1% on a same-market basis. For the six months ended June 30, 2002,
visits increased 0.5% in total and decreased 4.1% on a same-market basis. During
the first six months of the current year, we experienced a decline in non-injury
related visits as compared to the same period in the prior year, primarily due
to a decrease in the number of new-hires being made by our clients. This lower
level of new-hire activity has reduced the number of pre-employment drug screens
and physical exams from the levels we experienced when the economy was stronger.
However, we did have a 2.2% increase in non-injury related visits in the second
quarter of 2002 as compared to the prior year's quarter as our client's new-hire
rate appeared to begin increasing. For both the second quarter and the
year-to-date, we had decreases in injury visits as compared to the prior year
due primarily to a decline in the number of injuries occurring in our clients'
workplaces. We believe that increases in our same market injury visits will
resume once nationwide employment and economic output increases to more
traditional rates of growth. On a same-market basis, average revenue per visit
decreased 0.1% for the quarter and increased 0.6% for the first six months of
2002 as compared to the same respective periods in the prior year, primarily due
to increases in the average prices charged for our services, offset by a smaller
percentage of our visits being injury visits in 2002. The average fees charged
for injury visits are generally higher than those charged for non-injury related
visits. Excluding on-site and ancillary services, injury-related visits
constituted 46.7% and 47.5% of same-market visits in the second quarter and
first half of 2002, respectively, as compared to 48.9% and 49.3% for the same
respective periods in 2001.
The significant increase in Network Services' revenue is primarily
attributable to our acquisitions of NHR and HNS in November 2001. On a pro forma
basis including NHR and HNS, revenue from our Network Services segment decreased
by approximately 5.4% and 2.2% for the second quarter and first half of 2002 as
compared to the same respective prior year periods. On a pro forma basis, this
revenue decrease was primarily due to lower comparative revenue from our
workers' compensation based preferred provider organization, provider bill
repricing and review and first notice of loss services. These decreases relate
primarily to the decline in nationwide workers' compensation claim volumes
discussed above. We believe these year over year decreases relate primarily to
the lower comparative employment levels and associated injury rates, which have
been caused by the decline in the nationwide economic trends over the past year.
To a lesser extent, we believe that a portion of the revenue decline in our
provider bill review services relates to a reduction in the amount of workers'
compensation claims being underwritten by several of our larger client accounts.
We also believe that growth in these lines of service will resume once the
nationwide economy improves and levels of employment resume their more
traditional rates of growth. These decreases were partially offset by increases
in our out-of-network bill review services. This growth was primarily due to an
increase in the amount of gross charges reviewed as compared to the prior year
and the amount of savings achieved through our review of medical charges.
Revenue growth for Care Management Services was due primarily to our NHR
acquisition in November 2001. On a pro forma basis, including the NHR
acquisition in prior year results, revenue from our Care Management Services
segment decreased by approximately 4.7% for the second quarter of 2002 and
increased 0.4% for the first half of 2002 from the same prior year periods.
14
Like our other business segments, a greater majority of our Care Management
Services are provided to clients in the workers' compensation market. In a
manner similar to those other segments, we have experienced declines in referral
trends which we believe relate to the overall drop in nationwide employment and
related rates of workplace injuries. Generally, our Health Services segment,
since it sees patients at the initial time of injury, is the first segment to be
affected by economic downturns and upturns, our Network Services segment, since
it involves the review of bills generated from injury-related visits, is the
second segment to be affected, and our Care Management segment, since it
receives referrals for service a number of months after the initial injury
occurs, is the final segment to experience the effects of changing injury
trends. Accordingly, we believe a primary cause of the decline in revenue
experienced in our Care Management Services segment as this year has progressed
is related to the effects of declines in workplace injuries which we first
experienced in our Health Services business during 2001. As we are currently
seeing gradual improvements in the relative visit amounts in our Health Services
business, we would anticipate that we could experience a similar future recovery
in the rates of referrals in our Care Management Services segment based on the
degree to which employment trends stabilize and return to historical rates of
growth.
In addition to the economic effects described above, to a lesser extent, we
have encountered some revenue declines in our independent medical exams services
associated with client referral volume decreases due to the integration of NHR's
operations with those of our own.
Cost of Services
Total cost of services increased 19.8% in the second quarter of 2002 to
$196.7 million from $164.2 million in the second quarter of 2001. Cost of
services for our Health Services segment grew 5.6% in the second quarter of 2002
to $94.6 million from $89.6 million in the second quarter of 2001, primarily due
to an increase in the number of health centers as compared to the prior year.
Increases in our Care Management Services and Network Services segments related
primarily to the acquisition of NHR in November of 2001. If the Company had
owned NHR and HNS in the prior year, the cost of services for our Network
Services segment would have declined approximately $1.8 million on a comparative
basis, and the cost of services of our Care Management segment would have
decreased by approximately $0.6 million.
For the six months ended June 30, 2002, total cost of services increased
20.9% to $391.5 million from $323.8 million for the same period in the prior
year. As part of the review of our accounts receivable history and collection
experience, Health Services recorded an adjustment of $1.7 million in the first
quarter of 2002 to increase its bad debt reserves. Excluding this adjustment,
the cost of services for our Health Services segment would have increased by
$9.0 million, or 5.1%, primarily due to an increase in the number of health
centers as compared to the prior year. Increases in our Care Management Services
and Network Services segments related primarily to the acquisitions of NHR and
HNS in November of 2001. If the Company had owned NHR and HNS in the prior year,
the cost of services for our Network Services segment would have declined
approximately $3.5 million on a comparative basis, and the cost of services of
our Care Management segment would have increased by approximately $1.4 million.
Total gross profit increased 8.3% to $54.9 million in the second quarter of
2002 from $50.7 million in the second quarter of 2001, while gross profit as a
percentage of revenue decreased to 21.8% in the second quarter of 2002 compared
to 23.6% in the second quarter of 2001. For the six months of 2002, total gross
profit increased 7.3% to $98.5 million from $91.8 million for the first six
months of 2002. Due primarily to the acquisition of NHR in November 2001 and the
change in our accounting estimate for accounts receivable reserves in the first
quarter of 2002, gross profit as a percentage of revenue for the first six
months of 2002 decreased to 20.1% compared to 22.1% in the first half of 2001.
Excluding these effects, on a pro forma basis total gross profit for the first
six months of 2002 decreased by $2.5 million, or 2.3%.
Health Services' gross profit increased 2.4% to $26.2 million in the second
quarter of 2002 from $25.6 million in the second quarter of 2001, and its gross
profit margin decreased by 0.5% to 21.7% from 22.2% for the same respective
periods. For the six months ended June 30, 2002, Health Services' gross profit
decreased 22.3% to $34.1 million from $43.9 million, and its gross profit margin
decreased by 4.5% to 15.3% from 19.8% for the same respective periods. The
primary factor in this gross profit decrease for the first half of 2002 was a
$9.6 million increase in accounts receivable reserves related to the change in
accounting estimate in the first quarter of 2002, consisting of a $7.9 million
reduction in revenue and a $1.7 million increase in cost of services. Without
these adjustments, Health Services' gross profit for the first half of 2002
decreased 0.5%, while the gross profit margin decreased 0.8% to 19.0% over the
same prior year
15
period. The decrease in underlying gross margins in 2002 relates primarily to
the generally lower relative margins from acquired centers. Also, this division
has been impacted by national economic and hiring trends, resulting in a
decrease in the productivity levels of its centers as compared to the prior
year. This division's costs were also affected by increases in insurance and
information technology costs. Efforts to improve the management of expenses
associated with physician costs and medical supplies did not fully offset the
gross profit margin impact of the lower than anticipated volumes. The Company
currently believes these trends will improve once the growth in nationwide
employment levels resumes.
Network Services' gross profit increased by 15.5% in the second quarter of
2002 to $20.8 million from $18.0 million in the second quarter of 2001, and its
gross profit margin decreased by 2.8% to 37.0% in the second quarter of 2002
from 39.8% in the second quarter of 2001. For the first half of 2002, Network
Services' gross profit increased by 30.4% to $44.5 million from $34.1 million in
the first six months of 2001, and its gross profit margin increased by 0.3% to
39.2% in the first half of 2002 from 38.9% for the first half of 2001. These
increases in gross profit primarily relate to the acquisition of NHR in 2001.
Had we owned NHR and HNS in the prior year and excluding the adjustment to the
sales allowance in the first quarter of 2002, the comparative gross profit for
the Network Services segment would have decreased by 6.6% and by 0.6% for the
quarter and year-to-date, respectively, and the comparative gross profit margins
would have decreased 0.5% and increased 1.0%, respectively. The underlying
increases in our year-to-date pro forma gross margins relate primarily to
synergies from our acquisition of NHR and to increased revenue from our existing
out-of-network bill review services. These increases were partially offset by
lower margins in the second quarter of 2002 primarily due to decreased revenue
from our workers' compensation based preferred provider organization, provider
bill repricing and review and first notice of loss services.
Care Management Services' gross profit margin of 10.5% in the second
quarter of 2002 decreased 2.4% from 12.9% in the second quarter of 2001, and the
gross profit increased by 11.4% to $7.8 million in the second quarter of 2002
from $7.0 million in the second quarter of 2001. For six months ended June 30,
2002, Care Management Services' gross profit margin decreased 0.1% to 12.9% from
13.0% in the first half of 2002, and the gross profit contribution increased by
44.6% to $19.9 million from $13.8 million in the first half of 2001. Without the
adjustment in the sales allowance in the first quarter of 2002, the gross profit
for the first half of 2002 increased 35.9%, while the gross profit margin
decreased 0.4% to 38.5% from the first half of the prior year. The increases in
gross profit in 2002 were primarily due to the 2001 acquisition of NHR. Had we
owned NHR in the prior year, the comparative gross profit from our Care
Management segment would have decreased by 28.3% and 9.7% for the second quarter
and first half of 2002, respectively, and the gross profit margin would have
decreased by 3.4% and 1.3%, respectively. At this time, we anticipate that the
margin percentage of this segment will continue to remain consistent with second
quarter levels. Declines in the Company's gross margin percentage during the
second quarter related to reductions in revenue for which there were not
corresponding reductions in costs. The Company is currently evaluating potential
initiatives which may assist in lowering the administrative cost structure of
its case management services and which could contribute to improvements in its
Care Management Services margins as a whole.
General and Administrative Expenses
General and administrative expenses for the quarter were $26.9 million, or
10.7% of revenue. This compares to approximately $27.2 million, or 10.7% of
revenue, had the Company owned NHR and HNS during the prior year. General and
administrative expenses for the second quarter of 2002 included $0.8 million in
expenses associated with the separation of the Company's former Chief Operating
Officer.
For the first six months of 2002, general and administrative expenses were
$49.3 million, or 10.1% of revenue. This compares to approximately $53.3
million, or 10.9% of revenue, had the company owned NHR and HNS during the prior
year. Expenses for year-to-date 2002 were decreased by the one-time effect of a
$3.9 million reduction in employee benefits associated with a reduction in the
amount of employee contributions we matched in our defined contribution plan as
compared to prior years.
Amortization of Intangibles
Amortization of intangibles decreased in the second quarter of 2002 to $0.9
million from $3.8 million in the second quarter of 2001, or 0.4% and 1.8% as a
percentage of revenue for the second quarters of 2002 and 2001, respectively.
For the six months ended June 30, 2002, amortization of intangibles decreased to
$1.9 million, or 0.4% of revenue, from $7.5 million, or 1.8% of revenue for the
first six months of 2001. These decreases are substantially all the result of
the
16
implementation of Statement of Financial Accounting Standards No. ("SFAS") 142
"Goodwill and Other Intangible Assets" ("SFAS 142") on January 1, 2002, which
discontinued the amortization of goodwill and intangible assets with an
indefinite life, partially offset by the amortization of other intangibles
associated with the NHR acquisition in November 2001. Had we owned NHR in the
prior year, the comparative amortization of intangibles would have been
approximately the same under this new standard.
Interest Expense, net
Interest expense decreased $0.3 million in the second quarter of 2002 to
$16.5 million from $16.8 million in the second quarter of 2001. For the first
six months of 2002 and 2001, interest expense was $32.9 million and $33.7
million, respectively. These decreases in 2002 from the same periods in 2001 are
due primarily to lower interest rates in 2002. As discussed further below, the
Company redeemed $47.5 million of its $190 million 13% Senior Subordinated Notes
in July 2002. Accordingly, interest expense related to these notes will decrease
by approximately $6.3 million on an annual basis in future periods. As of June
30, 2002, approximately 65.7% of our debt contains floating rates. Although we
utilize interest rate hedges to manage a significant portion of this market
exposure, rising interest rates would negatively impact our results. See
"Liquidity and Capital Resources" and "Item 3. Quantitative and Qualitative
Disclosures About Market Risk."
Interest Rate Hedging Arrangements
We utilize interest rate collars to reduce our exposure to variable
interest rates and, in part, because such arrangements are required under our
current senior secured credit agreement. These collars generally provide for
certain ceilings and floors on interest payments as the three-month LIBOR rate
increases and decreases, respectively. The changes in fair value of this
combination of ceilings and floors are recognized each period in earnings. We
recorded losses of $6.4 million and $1.2 million in the second quarter and first
half of 2002, respectively, as compared to a gain of $3.6 million and a loss of
$3.1 million for the same respective periods of the prior year. These gains and
losses were based upon the change in the fair value of our interest rate collar
agreements. This earnings impact and any subsequent changes in our earnings as a
result of the changes in the fair values of the interest rate collars are
non-cash charges or credits and do not impact cash flows from operations or
operating income. There have been, and may continue to be, periods with
significant non-cash increases or decreases to our earnings relating to the
change in the fair value of the interest rate collars. Further, if we hold these
collars to maturity (2004 and 2005), the earnings adjustments will offset each
other on a cumulative basis and will ultimately equal zero.
Provision for Income Taxes
We recorded a tax provision of $1.4 million and $5.0 million in the second
quarter and first six months of 2002, which reflects effective tax rates of
36.5% and 39.6%, respectively. For the second quarter and first six months of
2001, we recorded a tax provision of $5.8 million and $5.2 million,
respectively, reflecting effective tax rates of 44.3% and 73.8%, respectively.
The effective rate differs from the statutory rate due to the non-deductibility
of goodwill and certain fees and expenses associated with acquisition costs, and
to a lesser extent, the impact of state income taxes. Due to our current
relationship of taxable book income as compared to net income, our effective tax
rate can vary significantly from one period to the next depending on relative
changes in net income. As such, we currently expect further variation in our
effective tax rate in 2002.
Acquisitions and Divestitures
Periodically, we evaluate opportunities to acquire or divest of businesses
when we believe those actions will enhance the future growth and financial
performance of our Company. Currently, to the extent we consider acquisitions,
they are typically businesses that operate in the same markets or along the same
service lines as those in which we currently operate. Our evaluations are
subject to our availability of capital, our debt covenant requirements and a
number of other financial and operating considerations. The process involved in
evaluating, negotiating, gaining required approvals and other necessary
activities associated with individual acquisition or divestiture opportunities
can be extensive and involve a significant passage of time. It is also not
uncommon for discussions to be called off and anticipated acquisitions or
divestitures to be terminated shortly in advance of the date upon which they
were to have been consummated. As such, we generally endeavor to announce
material acquisitions and divestitures based on their relative size and effect
on our Company, once we believe they have reached a state in the acquisition or
divestiture process where
17
we believe that their consummation is reasonably certain and with consideration
of other legal and general business practices.
We are currently considering the acquisition of Em3 Corporation ("Em3") and
OccMed Systems, Inc. ("OccMed"), two companies who each have the same principal
stockholders as our parent company, Concentra Inc. ("Concentra Holding"). Em3 is
a company engaged in providing a proprietary internet-based system for the
management of work-related injuries. OccMed is a company engaged in developing
new, freestanding, primary care occupational healthcare centers. To the extent
that we acquire one or both of these companies, we currently believe the
purchase price paid to the equity holders would be in the form of Concentra
Holding common stock. However, we have not determined the number of shares which
we would pay, nor have we received approval from our Board of Directors, or
completed other evaluation, negotiation, documentation, approval requirements
and other activities necessary to the completion of these acquisitions. For the
six-month period ending June 30, 2002, Em3 had operating and EBITDA losses of
approximately $3.9 million and $2.1 million, respectively. For the same
year-to-date period, OccMed reported operating and EBITDA losses of
approximately $1.9 million and $1.4 million, respectively. The difference
between operating and EBITDA losses is depreciation expense. As stated above, we
are evaluating these potential acquisitions in light of their ability to enhance
the future growth and financial performance of our Company.
Liquidity and Capital Resources
We provided $10.6 million in cash from operating activities for the six
months ended June 30, 2002, and provided $30.0 million for the same six-month
period last year. The decrease in cash from operating activities in the first
half of 2002 as compared to the same period in 2001 was primarily a result of
decreased accounts payable and accrued liabilities and increased prepaid
expenses and other assets, partially offset by decreased accounts receivable.
During the first six months of 2002, $18.5 million of cash was used for working
capital purposes, primarily related to a decrease in accounts payable and
accrued expenses of $17.6 million and increased prepaid expenses and other
assets of $3.8 million, partially offset by decreases in accounts receivable of
$2.9 million. During the first half of 2002, accounts payable and accrued
expenses decreased due to changes in the Company's cash position associated with
its issuance of 54 shares of common stock to Concentra Holding for $53.3
million, and the timing of certain payments, including payment of accrued
interest in our debt and payroll-related items. The 2002 decrease in net
accounts receivable primarily relates to a $7.1 million net adjustment to
increase sales allowances and bad debt reserves in the first quarter of 2002,
partially offset by increases in accounts receivable due to revenue growth. The
first quarter 2002 adjustment was a result of the change in accounting estimate
for accounts receivable reserves discussed earlier. During the first half of
2001, $4.0 million of cash was provided by working capital, primarily related to
an increase in accounts payable and accrued expenses of $12.9 million and a
decrease in prepaid expenses and other assets of $1.4 million, partially offset
by an increase in accounts receivable of $10.3 million. During the first half of
2001, accounts receivable increased primarily due to continued revenue growth,
while accounts payable and accrued expenses increased primarily due to the
timing of certain payments, including payment of accrued interest on the
Company's debt and payroll-related items.
During the six months ended June 30, 2002, we made approximately $3.0
million in cash payments related to the non-recurring charges that occurred in
the first quarter of 1998, fourth quarter of 1998, third quarter of 1999 and
fourth quarter of 2001. At June 30, 2002 approximately $4.2 million of the
non-recurring charges remained for facility lease obligations, personnel
reduction costs and other payments. We anticipate that the majority of this
liability will be paid over the next 18 months.
In the first half of 2002, we used net cash of $2.8 million in connection
with acquisitions and $16.7 million of cash to purchase property and equipment,
the majority of which was spent on new computer hardware and software
technology, as well as leasehold improvements. Cash flows from investing
activities also included $0.5 million of cash received from the sale of
internally-developed software. As required by accounting pronouncements, the
proceeds were offset against the amount capitalized on the consolidated balance
sheet and were not recognized as revenue. For the six months ended June 30,
2001, we used net cash of $17.0 million in connection with acquisitions and
$13.1 million of cash to purchase property and equipment during the first half
of 2001, the majority of which was spent on new computer hardware and software
technology, as well as leasehold improvements. Cash flows from investing
activities also included $0.7 million of cash received from the sale of
internally-developed software which was offset against the amount capitalized on
the balance sheet and was not recognized as revenue.
Cash flows provided by financing activities in the first six months of 2002
of $45.1 million was primarily due to the $53.3 million of proceeds from the
issuance of 54 shares of common stock to Concentra Holding. On July 24, 2002,
the Company used these proceeds and $0.4 million of its cash balances to redeem
$47.5 million of its then outstanding $190 million 13% Senior Subordinated Notes
("13% Subordinated Notes") and to pay a premium of $6.2 million to facilitate
this redemption. In advance of this date, at June 30, 2002, these proceeds
enabled the Company to eliminate its borrowings under its revolving credit
facility at the quarter's close, which is reflected as a year-to-date decrease
of $6.0 million on the Company's statement of cash flows. At the time of this
report, due to the semi-annual payment of interest on its 13% Subordinated Notes
and other working capital requirements, the Company believes it could have
borrowings under its revolving credit facility of $20 million at the close of
the third quarter of 2002. Additionally, cash flows from financing activities in
2002 reflect the payment of $1.1 million in deferred financing fees to the
Company's senior lenders in connection with gaining their approval for the
redemption discussed above and in establishing revised covenant requirements as
described below. Cash flows from financing activities for the year-to-date also
reflect the repayment of $1.2 million in principal, primarily
18
We were in compliance with our covenants, including our financial covenant
ratio tests, for the first six months of 2002. In June 2002, we amended our debt
agreement to include less restrictive financial covenant ratio tests as compared
to our previous requirements. While being less restrictive than our previous
requirements, these amended ratio tests become more restrictive in future
quarters as compared to the levels which we were required to meet for the second
quarter of 2002. Our ability to be in compliance with these more restrictive
ratios will be dependent on our ability to increase cash flows over current
levels. While we currently believe we will be in compliance with our covenants
in future periods, due to the decreases in our rate of earnings growth caused by
the current economic and other trends which we have previously discussed, we
anticipate that our ability to meet these covenants will be directly dependent
on our ability to establish higher future revenue and cash flow growth rates
than those which we achieved in the first half of the year. In future periods,
to the extent we believe we will not meet our covenant requirements, the Company
may be required to seek waivers or additional amendments of these requirements
from our lenders.
We currently believe that our cash balances, the cash flow generated from
operations and our borrowing capacity under our revolving credit facility will
be sufficient to fund our working capital, occupational healthcare center
acquisitions and capital expenditure requirements for the foreseeable future.
Our long-term liquidity needs will consist of working capital and capital
expenditure requirements, the funding of any future acquisitions, and repayment
of borrowings under our revolving credit facility and the repayment of
outstanding indebtedness. We intend to fund these long-term liquidity needs from
the cash generated from operations, available borrowings under our revolving
credit facility and future debt or equity financing. However, our ability to
generate cash is subject to our performance and general economic and industry
conditions that are beyond our control. Therefore, it is possible that our
business will not generate sufficient cash flow from operations. Additionally,
we cannot be certain that any future debt or equity financing will be available
on terms favorable to us, or that our long-term cash generated from operations
will be sufficient to meet our long-term obligations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have fixed rate and variable rate debt instruments. Our variable rate
debt instruments are subject to market risk from changes in the level or
volatility of interest rates. In order to hedge a portion of this risk under our
current credit agreements, we have utilized interest rate collars. We have
performed sensitivity analyses to assess the impact of changes in the interest
rates on the value of market-risk sensitive financial instruments. A
hypothetical 10% movement in interest rates would not have a material impact on
our future earnings, fair value or cash flow relative to our debt instruments.
However, the same hypothetical 10% movement in interest rates would change the
fair value of our hedging arrangements and pretax earnings by $1.4 million as of
June 30, 2002. Market rate volatility is dependant on many factors that are
impossible to forecast and actual interest rate increases could be more or less
severe than this 10% increase. For more information on the interest rate
collars, see Note 5 in the audited consolidated financial statements of the
Company's 2001 Form 10-K.
19
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
On June 20, 2002, the board of directors of Concentra Operating Corporation
("Concentra Operating") as previously reported to the Securities and Exchange
Commission was re-elected in its entirety. On that date, Concentra Inc.
("Concentra Holding"), as sole stockholder of the Concentra Operating, by
written consent in lieu of annual meeting of stockholders, voted all of
Concentra Operating's outstanding stock in favor of the re-election of the
following persons to serve as the directors of Concentra Operating until the
next annual meeting of stockholders: John K. Carlyle, Carlos A. Ferrer, D. Scott
Mackesy, James T. Kelly, Steven E. Nelson, Paul B. Queally and Daniel J. Thomas.
The board of directors of Concentra Operating did not solicit proxies.
Also on June 20, 2002, at the annual meeting of stockholders of Concentra
Holding, the board of directors of Concentra Holding as previously reported to
the Securities and Exchange Commission was re-elected in its entirety and the
stockholders of Concentra Holding approved certain amendments to the Concentra
Managed Care, Inc. 1999 Stock Option and Restricted Stock Purchase Plan (the
"1999 Stock Plan"). The board of directors of Concentra Holding did not solicit
proxies. At the annual meeting of Concentra Holding:
. By a vote of 19,576,373 shares in favor, none opposed, none
abstaining, the common stockholders of Concentra Holding
re-elected the following persons to serve as directors of
Concentra Holding until the next annual meeting of stockholders:
John K. Carlyle, D. Scott Mackesy, James T. Kelly, Steven E.
Nelson, Paul B. Queally and Daniel J. Thomas;
. By a vote of 2,032,514 shares in favor, none opposed, none
abstaining, the Class A common stockholders of Concentra Holding,
voting as a separate class, re-elected Carlos A. Ferrer to serve
as a director of Concentra Holding until the next annual meeting
of stockholders; and
. By a vote of 21,608,887 shares in favor, none opposed, and none
abstaining, the stockholders of Concentra Holding approved
amendments to the Concentra Managed Care, Inc. 1999 Stock Option
and Restricted Stock Purchase Plan (1) increasing from 3,750,000
to 5,250,000 the maximum total number of shares of common stock
for which awards may be granted thereunder, and (2) increasing
from 500,000 to 700,000 the maximum number of shares of common
stock that may be awarded thereunder to an individual in a
calendar year.
Item 6. Exhibits and reports on form 8-K
(a) Exhibits:
Exhibit No. Description
3.1 Amended and Restated Bylaws of Concentra Operating, as
further amended and restated June 20, 2002
4.1 Supplemental Indenture dated as of June 25, 2002,
between Concentra Holding and The Bank of New York, as
Trustee, relating to the 14% Senior Discount Debentures
due 2010 of Concentra Holding
10.1 Bridge Loan Agreement dated as of June 25, 2002, among
Concentra Holding, the lenders party thereto, Citicorp
North America, Inc., as Administrative Agent, and
Salomon Smith Barney Inc., as Book Manager and Arranger
10.2 Second Amendment and Waiver dated as of June 14, 2002,
by and among Concentra Holding, Concentra Operating,
the Several Lenders from time to time parties to the
Credit Agreement, JP Morgan Chase Bank (f/k/a The Chase
Manhattan Bank), as Administrative Agent, Fleet
National Bank, as Documentation Agent, and Credit
Suisse First Boston, as Syndication Agent
20
10.3 Concentra Managed Care, Inc. 1999 Stock Option and
Restricted Stock Purchase Plan, as amended June 20,
2002
10.4 Employment Agreement dated as of August 5, 2002,
between Concentra Holding and Fred Dunlap
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
(b) Reports on Form 8-K during the quarter ended June 30, 2002:
Form 8-K filed May 9, 2002 reporting under Item 5 the Company's press
release announcing the Company's earnings for the quarter ended March
31, 2002.
Form 8-K filed June 27, 2002 reporting under Item 5 the Company's press
release announcing the Company's intention to redeem $47.5 million of
its 13% Series A and Series B Senior Subordinated Notes, Concentra
Holding's borrowing of $55 million in a bridge loan facility to
facilitate the redemption, and the modification of certain financial
covenants under the Company's $475 million Senior Credit Facility.
SIGNATURE
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.
CONCENTRA OPERATING CORPORATION
August 14, 2002 By: /s/ Thomas E. Kiraly
------------------------------------------------
Thomas E. Kiraly
Executive Vice President,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
21
EXHIBIT INDEX
Exhibit No. Description
3.1 Amended and Restated Bylaws of Concentra Operating, as
further amended and restated June 20, 2002
4.1 Supplemental Indenture dated as of June 25, 2002,
between Concentra Holding and The Bank of New York, as
Trustee, relating to the 14% Senior Discount Debentures
due 2010 of Concentra Holding
10.1 Bridge Loan Agreement dated as of June 25, 2002, among
Concentra Holding, the lenders party thereto, Citicorp
North America, Inc., as Administrative Agent, and
Salomon Smith Barney Inc., as Book Manager and Arranger
10.2 Second Amendment and Waiver dated as of June 14, 2002,
by and among Concentra Holding, Concentra Operating,
the Several Lenders from time to time parties to the
Credit Agreement, JP Morgan Chase Bank (f/k/a The Chase
Manhattan Bank), as Administrative Agent, Fleet
National Bank, as Documentation Agent, and Credit
Suisse First Boston, as Syndication Agent
10.3 Concentra Managed Care, Inc. 1999 Stock Option and
Restricted Stock Purchase Plan, as amended June 20,
2002
10.4 Employment Agreement dated as of August 5, 2002,
between Concentra Holding and Fred Dunlap
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
22