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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended March 31, 2000.
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition period from _____________ to
_____________.
COMMISSION FILE NUMBER: 0-19786
PHYCOR, INC.
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(Exact Name of Registrant as Specified in Its Charter)
TENNESSEE 62-1344801
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
30 BURTON HILLS BLVD., SUITE 400
NASHVILLE, TENNESSEE 37215
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (615) 665-9066
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NOT APPLICABLE
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(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
As of May 12, 2000, 73,768,467 shares of the Registrant's Common Stock
were outstanding.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, 2000 (unaudited) and December 31, 1999
(All amounts are expressed in thousands)
2000 1999
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents - unrestricted $ 39,192 $ 31,093
Cash and cash equivalents - restricted 32,127 29,619
Accounts receivable, net 215,003 230,513
Inventories 10,831 11,384
Prepaid expenses and other current assets 62,320 53,002
Assets held for sale, net 92,008 101,988
----------- -----------
Total current assets 451,481 457,599
Property and equipment, net 141,207 156,091
Intangible assets, net 500,020 522,742
Other assets 60,735 58,493
----------- -----------
Total assets $ 1,153,443 $ 1,194,925
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt $ 4,197 $ 3,424
Current installments of obligations under capital leases 3,109 3,746
Accounts payable 37,806 34,963
Due to physician groups 32,713 30,142
Purchase price payable 12,356 20,711
Salaries and benefits payable 22,884 25,544
Incurred but not reported claims payable 49,742 45,124
Accrued restructuring reserves 7,415 7,995
Other accrued expenses and current liabilities 75,232 92,843
----------- -----------
Total current liabilities 245,454 264,492
Long-term debt, excluding current installments 256,818 247,861
Obligations under capital leases, excluding current installments 1,302 1,540
Purchase price payable 265 50
Deferred credits and other liabilities 28,236 29,808
Convertible subordinated notes payable to physician groups 2,148 6,839
Convertible subordinated notes and debentures 300,438 298,750
----------- -----------
Total liabilities 834,661 849,340
Minority interest in earnings of consolidated partnerships 750 2,082
Shareholders' equity:
Preferred stock, no par value; 10,000 shares authorized: -- --
Common stock, no par value; 250,000 shares authorized; issued
and outstanding 73,515 shares in 2000 and 73,479 shares in 1999 834,378 834,276
Accumulated deficit (516,346) (490,773)
----------- -----------
Total shareholders' equity 318,032 343,503
----------- -----------
Total liabilities and shareholders' equity $ 1,153,443 $ 1,194,925
=========== ===========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three months ended March 31, 2000 and 1999
(All amounts are expressed in thousands, except for earnings per share)
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
------------------------
2000 1999
--------- ---------
Net revenue $ 309,496 $ 416,544
Operating expenses:
Cost of provider services 60,835 57,092
Salaries, wages and benefits 97,617 133,088
Supplies 40,813 60,600
Purchased medical services 7,297 10,241
Other expenses 46,333 58,232
General corporate expenses 7,584 8,643
Rents and lease expense 23,045 32,714
Depreciation and amortization 17,298 24,770
Provision for asset revaluation, restructuring and refinancing 23,777 9,513
--------- ---------
Net operating expenses 324,599 394,893
--------- ---------
Earnings (loss) from operations (15,103) 21,651
Other (income) expense:
Interest income (1,460) (1,013)
Interest expense 10,066 9,865
--------- ---------
Earnings (loss) before income taxes and
minority interest (23,709) 12,799
Income tax expense 328 5,237
Minority interest in earnings of consolidated partnerships 1,536 4,774
--------- ---------
Net earnings (loss) $ (25,573) $ 2,788
========= =========
Earnings (loss) per share:
Basic $ (0.35) $ 0.04
Diluted (0.35) 0.04
========= =========
Weighted average number of shares and dilutive share equivalents outstanding:
Basic 73,479 75,943
Diluted 73,479 77,560
========= =========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three months ended March 31, 2000 and 1999
(All amounts are expressed in thousands)
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
----------------------
2000 1999
-------- --------
Cash flows from operating activities:
Net earnings (loss) $(25,573) $ 2,788
Adjustments to reconcile net earnings (loss) to net cash
provided by operating activities:
Depreciation and amortization 17,298 24,770
Minority interests 1,536 4,774
Provision for asset revaluation, restructuring and refinancing 23,777 9,513
Accretion of convertible subordinated notes 1,688 --
Increase (decrease) in cash, net of effects of acquisitions and
dispositions, due to changes in:
Accounts receivable, net 2,844 (17,653)
Inventories (205) 215
Prepaid expenses and other current assets (4,501) (12,445)
Accounts payable (1,187) 6,821
Due to physician groups 2,838 9,207
Incurred but not reported claims payable 5,258 2,194
Accrued restructuring reserves (4,213) (2,675)
Other accrued expenses and current liabilities (17,821) 2,361
-------- --------
Net cash provided by operating activities 1,739 29,870
-------- --------
Cash flows from investing activities:
Dispositions (acquisitions), net 15,703 (30,893)
Purchase of property and equipment (8,885) (14,349)
Proceeds (payments) for other assets 1,313 (3,093)
-------- --------
Net cash provided (used) by investing activities 8,131 (48,335)
-------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock 61 870
Proceeds from long-term borrowings 10,000 26,000
Repayment of long-term borrowings (3,662) (3,231)
Repayment of obligations under capital leases (828) (2,146)
Distributions of minority interests (2,868) (3,015)
Loan costs incurred (1,966) (771)
-------- --------
Net cash provided by financing activities 737 17,707
-------- --------
Net increase (decrease) in cash and cash equivalents 10,607 (758)
Cash and cash equivalents - beginning of period 60,712 74,314
-------- --------
Cash and cash equivalents - end of period $ 71,319 $ 73,556
======== ========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Three months ended March 31, 2000 and 1999
(All amounts are expressed in thousands)
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
----------------------
2000 1999
-------- --------
SUPPLEMENTAL SCHEDULE OF INVESTING ACTIVITIES:
Effects of acquisitions and dispositions, net:
Assets acquired, net of cash $ (895) $ (9,055)
Liabilities paid, including deferred purchase price
payments (4,670) (21,478)
Cancellation of common stock -- (360)
Cash received from disposition of clinic assets 21,268 --
-------- --------
Dispositions (acquisitions), net $ 15,703 $(30,893)
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Notes receivable received from disposition of clinic assets $ 10,395 $ 4,810
======== ========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Three months ended March 31, 2000 and 1999
(1) BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial reporting and in accordance with Rule 10-01 of Regulation S-X.
In the opinion of management, the unaudited interim financial statements
contained in this report reflect all adjustments, consisting of only
normal recurring accruals, that are necessary for a fair presentation of
the financial position and the results of operations for the interim
periods presented. The results of operations for any interim period are
not necessarily indicative of results for the full year.
These financial statements, footnote disclosures and other information
should be read in conjunction with the financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1999.
(2) NET REVENUE
Net revenue of the Company is comprised of net clinic service agreement
revenue, IPA management revenue, net hospital revenues and other
operating revenues. Clinic service agreement revenue is equal to the net
revenue of the clinics, less amounts retained by physician groups. Net
clinic revenue recorded by the physician groups is recorded at
established rates reduced by provisions for doubtful accounts and
contractual adjustments. Contractual adjustments arise as a result of the
terms of certain reimbursement and managed care contracts. Such
adjustments represent the difference between charges at established rates
and estimated recoverable amounts and are recognized in the period the
services are rendered. Any differences between estimated contractual
adjustments and actual final settlements under reimbursement contracts
are recognized as contractual adjustments in the year final settlements
are determined. With the exception of certain clinics acquired as a part
of the First Physician Care, Inc. (FPC) acquisition, the physician groups
rather than the Company enter into managed care contracts. Through
calculation of its service fees, the Company shares indirectly in any
capitation risk assumed by its affiliated physician groups.
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
IPA management revenue is equal to the difference between the amount of
capitation and risk pool payments payable to the IPAs managed by the
Company less amounts retained by the IPAs. The Company has not
historically been a party to capitated contracts entered into by the
IPAs, but is exposed to losses to the extent of its share of deficits, if
any, of the capitated revenue of the IPAs. At March 31, 2000, the Company
had underwritten letters of credit totaling $2.1 million for the benefit
of certain managed care payors to help ensure payment of costs for which
the Company's affiliated IPAs are responsible. The Company is exposed to
losses if a letter of credit is drawn upon and the Company is unable to
obtain reimbursement from the IPA. Through the PrimeCare International,
Inc. (PrimeCare) and The Morgan Health Group, Inc. (MHG) acquisitions,
the Company became a party to certain managed care contracts.
Accordingly, the cost of provider services for the PrimeCare and MHG
contracts is not included as a deduction to net revenue of the Company
but is reported as an operating expense. The Company had terminated all
payor contracts relating to MHG and commenced closing its MHG operations
by April 30, 1999. The Company expects to complete the closure of MHG by
the end of 2000.
The following table represents amounts included in the determination of
net revenue (in thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------
2000 1999
-------- --------
Gross physician group, hospital and other revenue $643,704 $909,669
Less:
Provisions for doubtful accounts and contractual adjustments 284,903 383,594
-------- --------
Net physician group, hospital and other revenue 358,801 526,075
IPA revenue 269,684 269,160
-------- --------
Net physician group, hospital, IPA and other
revenue 628,485 795,235
Less amounts retained by physician group and
IPAs:
Physician groups 117,936 182,624
Clinic technical employee compensation 18,266 23,290
IPAs 182,787 172,777
-------- --------
Net revenue $309,496 $416,544
======== ========
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(3) BUSINESS SEGMENTS
The Company has two reportable segments based on the way management has
organized its operations: physician clinics and IPAs. The Company derives
its revenues primarily from operating multi-specialty medical clinics and
managing IPAs (see Note 2). In addition, the Company provides health care
decision-support services and operates two hospitals that do not meet the
quantitative thresholds for reportable segments and therefore have been
aggregated within the corporate and other category.
The Company evaluates performance based on earnings from operations
before asset revaluation, restructuring and refinancing charges, minority
interest and income taxes. The following is a financial summary by
business segment for the periods indicated (in thousands):
THREE MONTHS ENDED
MARCH 31,
--------------------------
2000 1999
--------- -----------
Multi-specialty clinics:
Net revenue $ 207,258 $ 306,995
Operating expenses(1) 187,201 277,990
Interest income (1,451) (476)
Interest expense 12,557 20,460
Earnings before taxes and minority interest(1) 8,951 9,021
Depreciation and amortization 11,972 19,669
Segment assets 742,970 1,418,420
IPAs:
Net revenue 86,897 96,383
Operating expenses(1) 91,379 85,179
Interest income (636) (644)
Interest expense 2,259 2,721
Earnings (loss) before taxes and minority interest(1) (6,105) 9,127
Depreciation and amortization 3,581 2,973
Segment assets 292,785 317,194
Corporate and other(2):
Net revenue 15,341 13,166
Operating expenses(1) 22,242 22,211
Interest expense 627 107
Interest income (4,750) (13,316)
Earnings (loss) before taxes and minority interest(1) (2,778) 4,164
Depreciation and amortization 1,745 2,128
Segment assets 117,688 122,658
----------------------------
(1) Amounts exclude provision for asset revaluation, restructuring
and refinancing.
(2) This segment includes all corporate costs and real estate
holdings as well as the results for CareWise and the hospitals
managed by the Company.
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(4) ASSET REVALUATION AND RESTRUCTURING
In the first quarter of 2000, the Company recorded a net pre-tax asset
revaluation charge of approximately $19.0 million, which was comprised of
a $26.0 million charge less recovery of certain asset revaluation charges
recorded in the third quarter of 1999. The first quarter 2000 charge
related to the revaluation of certain assets associated with one clinic
held for sale, the completed sales of the operating assets of four
clinics for less than book value and the exiting of an IPA market.
At March 31, 2000, net assets held for sale and expected to be sold
during the next 12 months totaled approximately $92.0 million after
taking into account the charges discussed above relating to clinics with
which the Company intends to terminate its affiliation. These net assets
consisted of current assets, property and equipment, intangible assets
and other assets less liabilities which are expected to be assumed by the
purchasers.
Net revenue and pre-tax income from operations disposed of or closed as
of March 31, 2000 were $6.4 million and $500,000 for the three months
ended March 31, 2000, and $132.4 million and $200,000 for the three
months ended March 31, 1999, respectively. Net revenue and pre-tax income
from the operations held for sale at March 31, 2000 were $48.1 million
and $1.0 million for the three months ended March 31, 2000, and $52.2
million and $3.1 million for the three months ended March 31, 1999,
respectively.
The Company completed the disposition of six clinics, certain satellite
operations of another clinic and certain real estate during the first
quarter of 2000 and received consideration consisting of $21.3 million in
cash and $10.4 million in notes receivable, in addition to certain
liabilities assumed by the purchasers.
The Company adopted and implemented restructuring plans and recorded
pre-tax restructuring charges of approximately $3.6 million in the first
quarter of 2000 with respect to operations that were being sold or
closed. These restructuring plans include the involuntary termination of
218 local clinic and IPA management and business office personnel. These
terminations are expected to be completed over the next six months. At
March 31, 2000, accrued restructuring reserves totaled approximately $7.4
million. The Company estimates that approximately $5.6 million of the
remaining restructuring reserves at March 31, 2000 will be paid during
the next 12 months. The remaining $1.8 million relates primarily to long
term lease commitments. The following table summarizes the restructuring
accrual and payment activity for the first quarter of 2000 (in
thousands):
FACILITY &
LEASE SEVERANCE OTHER
TERMINATION & RELATED EXIT
COSTS COSTS COSTS TOTAL
------- ------- ------- -------
Balances at December 31, 1999 $ 2,644 $ 2,381 $ 2,970 $ 7,995
2000 Charges 1,886 774 979 3,639
Payments (617) (1,121) (2,481) (4,219)
Other re-allocations (211) (217) 428 --
------- ------- ------- -------
Balances at March 31, 2000 $ 3,702 $ 1,817 $ 1,896 $ 7,415
======= ======= ======= =======
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(5) REFINANCING COSTS
The Company recorded a refinancing charge of approximately $1.2 million
in the first quarter of 2000 related to the amendment and restatement of
the bank credit facility in January 2000. This charge represented
unamortized costs that were expensed as a result of lower commitment
amounts and an earlier termination date of the bank credit facility.
(6) COMMITMENTS AND CONTINGENCIES
Litigation
The Company and certain of its current and former officers and directors,
Joseph C. Hutts, Derril W. Reeves, Thompson S. Dent, Richard D. Wright
and John K. Crawford (neither Mr. Wright nor Mr. Crawford are presently
with the Company) have been named defendants in 10 securities fraud class
actions filed in state and federal courts in Tennessee between September
8, 1998 and June 24, 1999. The factual allegations of the complaints in
all 10 actions are substantially identical and assert that during various
periods between April 22, 1997 and September 22, 1998, the defendants
issued false and misleading statements which materially misrepresented
the earnings and financial condition of the Company and its clinic
operations and misrepresented and failed to disclose various other
matters concerning the Company's operations in order to conceal the
alleged failure of the Company's business model. Plaintiffs further
assert that the alleged misrepresentations caused the Company's
securities to trade at inflated levels while the individual defendants
sold shares of the Company's stock at such levels. In each of the
actions, the plaintiff seeks to be certified as the representative of a
class of all persons similarly situated who were allegedly damaged by the
defendants' alleged violations during the "class period." Each of the
actions seeks damages in an indeterminate amount, interest, attorneys'
fees and equitable relief, including the imposition of a trust upon the
profits from the individual defendants' trades. The federal court actions
have been consolidated in the U.S. District Court for the Middle District
of Tennessee. Defendants' motion to dismiss was denied and the case is
now in the discovery stage of the litigation. Defendants' unopposed
motion to set a new trial date was granted on April 19, 2000, and the
court has set the trial date for June 4, 2001. The state court actions
were consolidated in Davidson County, Tennessee. The Plaintiffs' original
consolidated class action complaint in state court was dismissed for
failure to state a claim. Plaintiffs, however, were granted leave to file
an amended complaint. The amended complaint filed by Plaintiffs asserted,
in addition to the original Tennessee Securities Act claims, that
Defendants had also violated Sections 11 and 12 of the Securities Act of
1933 for alleged misleading statements in a prospectus released in
connection with the CareWise acquisition. Defendants removed this case to
federal court and have filed an answer. Defendants anticipate that this
case will eventually be consolidated with the original federal
consolidated action. The Company believes that it has meritorious
defenses to all of the claims, and is vigorously defending against these
actions. There can be no assurance, however, that such defenses will be
successful or that the lawsuits will not have a material adverse effect
on the Company. The Company's Restated Charter provides that the Company
shall indemnify the officers and directors for any liability arising from
these suits unless a final judgment establishes liability (a) for a
breach of the duty of loyalty to the Company or its shareholders, (b) for
acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law or (c) for an unlawful
distribution.
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
On February 2, 1999, Prem Reddy, M.D., the former majority shareholder of
PrimeCare, a medical network management company acquired by the Company
in May 1998, filed suit against the Company and certain of its current
and former executive officers in the United States District Court for the
Central District of California. The complaint asserts fraudulent
inducement relating to the PrimeCare transaction and that the defendants
issued false and misleading statements which materially misrepresented
the earnings and financial condition of the Company and its clinic
operations and misrepresented and failed to disclose various other
matters concerning the Company's operations in order to conceal the
alleged failure of the Company's business model. The plaintiff is seeking
rescission of the merger agreement and return of all proceeds from the
operations of PrimeCare. In addition, the plaintiff is seeking
compensatory and punitive damages in an indeterminate amount, interest,
attorneys' fees and equitable relief, including the imposition of a trust
upon the profits from the individual defendants' trades. A trial date of
June 20, 2000 has been set for this litigation. Although the Company
believes it has meritorious defenses to all of the claims and is
vigorously defending this suit, there can be no assurance that it will
not have a material adverse effect on the Company.
Three clinics are challenging the enforceability of their service
agreements with the Company's subsidiaries in court. In August 1999,
Medical Arts Clinic Association (Medical Arts) filed suit against the
Company in the District Court of Navarro County, Texas, which complaint
has been subsequently amended. The Company removed this case to Federal
District Court for the Northern District of Texas. Medical Arts is
seeking damages for breach of contract and rescission of the service
agreement and declaratory relief regarding the enforceability of the
service agreement alleging it is null and void on several grounds,
including but not limited to, the violation of state law provisions as to
the corporate practice of medicine and fee splitting. On April 24, 2000,
the Texas District Court of Navarro County, Texas, ordered the
appointment of a receiver to rehabilitate Medical Arts. On May 10, 2000,
the same state court granted Medical Arts a temporary restraining order
against the Company and set for hearing the matters set forth in the
order. On May 12, 2000, the Company, in response to the foregoing, filed
its notice of removal of the above matters to the federal court. This
removal stays any action of the state court. In December, 1999 the
Company filed suit in Davidson County, Tennessee which currently seeks
declaratory relief that the service agreement with Murfreesboro Medical
Clinic, P.A. (Murfreesboro Medical) is enforceable or alternatively
seeking damages for breach by Murfreesboro Medical under the service
agreement and related asset purchase agreement. Murfreesboro Medical then
filed a motion to dismiss our suit which was denied. Simultaneously,
Murfreesboro Medical filed suit in Circuit Court in Rutherford County,
Tennessee, claiming breach of the service agreement by the Company and
seeking a declaratory judgment that the service agreement was
unenforceable. Pursuant to a motion by the Company, the Rutherford County
lawsuit has been dismissed. The Davidson County suit is still pending. In
January 2000, South Texas Medical Clinics, P.A. (South Texas) filed suit
against PhyCor of Wharton, L.P. in the State District Court in Fort Bend
County, Texas. South Texas is seeking a declaratory judgment that the
service agreement is unenforceable as a matter of law because it violates
the Texas Health and Safety Code relating to the corporate practice of
medicine and fee splitting. In the alternative, South Texas seeks to have
the agreements declared void alleging, among other things, fraud in the
inducement and breach of contract by the Company. The Company has filed a
motion to remove this case to Federal District Court for the Southern
District of Texas. The terms of the service agreements provide that the
agreements shall be modified if the laws are changed, modified or
interpreted in a way that requires a change in the agreements. Although
the Company is vigorously defending the enforceability of the structure
of its management fee and service agreements against these suits, there
can be no assurance that these suits will not have a material adverse
effect on the Company.
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
The U.S. Department of Labor (the Department) is conducting an
investigation of the administration of the PhyCor, Inc. Savings and
Profit Sharing Plan (the Plan). The Department has not completed its
investigation, but has raised questions involving certain administrative
practices of the Plan in early 1998. The Department has not recommended
enforcement action against the Company or identified an amount of
liability or penalty that could be assessed against the Company. Based on
the nature of the investigation, the Company believes that its financial
exposure is not material. The Company intends to cooperate with the
Department's investigation. There can be no assurance, however, that the
Company will not have a monetary penalty imposed against it.
Certain litigation is pending against the physician groups affiliated
with the Company and IPAs managed by the Company. The Company has not
assumed any liability in connection with such litigation. Claims against
the physician groups and IPAs could result in substantial damage awards
to the claimants which may exceed applicable insurance coverage limits.
While there can be no assurance that the physician groups and IPAs will
be successful in any such litigation, the Company does not believe any
such litigation will have a material adverse effect on the Company.
Certain other litigation is pending against the Company and certain
subsidiaries of the Company, none of which management believes would have
a material adverse effect on the Company's financial position or results
of operations on a consolidated basis.
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
PhyCor, Inc. ("PhyCor" or the "Company") is a medical network
management company that manages multi-specialty medical clinics and other
medical organizations, provides contract management services to physician
networks owned by health systems and develops and manages independent practice
associations ("IPAs"). The Company also provides health care decision-support
services, including demand management and disease management services, to
managed care organizations, health care providers, employers and other group
associations. In connection with multi-specialty clinic and physician network
operations, the Company manages and operates two hospitals and five health
maintenance organizations ("HMOs"). A majority of the Company's revenue was
earned under service agreements with multi-specialty clinics. Revenue earned
under substantially all of the service agreements is equal to the net revenue of
the clinics less amounts retained by physician groups.
At March 31, 2000, the Company managed 35 clinics with 2,218 physicians
in 20 states, of which nine clinics with 476 physicians were held for sale, and
managed IPAs with approximately 25,700 physicians in 23 markets. On such date,
the Company's affiliated physicians provided medical services under capitated
contracts to approximately 1.3 million patients, including approximately 300,000
Medicare/Medicaid eligible patients. The Company also provided health care
decision-support services to approximately 3.0 million individuals worldwide.
The Company's strategy is to enable its affiliated physician
organizations and IPAs to be competitive in the changing health care
environment. The Company focuses on better ways of providing knowledge, services
and resources to affiliated physicians in multi-specialty clinics, physician
networks and IPAs that enable them to compete and create value for purchasers
and consumers of health care services. The Company continues to believe that
physician organizations are a critical element of organized health care systems,
because physicians are the key to controlling health care costs and the quality
of care.
Historically, when the Company acquired a clinic's operating assets, it
simultaneously entered into a long-term service agreement with the affiliated
physician group. Under the service agreement, the Company provides the physician
group with the equipment and facilities used in its medical practice, manages
clinic operations, employs the clinic's non-physician personnel, other than
certain diagnostic technicians, and receives a service fee. In response to
events occurring in the market place, including a reduction in health care
reimbursement and the general difficulties being experienced by many physicians
and companies in the health care service industry, including PhyCor, the Company
is attempting to modify its existing service agreements. These discussions vary
by clinic, but generally consist of a reduction in the service fees paid by the
physician groups and may include lower ongoing capital commitments or lower
capital costs for the Company and the purchase of certain assets by the
physician groups. These discussions are ongoing and accordingly, there can be no
assurance that the Company will successfully restructure its service agreements.
The Company anticipates that pre-tax earnings will be reduced as a result of any
restructurings, although cash flow may improve in the near term from the sale of
assets.
The Company is seeking affiliations with the physician networks of
health systems and independent physician groups, including single specialty
groups. Health systems generally have experienced significant losses from the
ownership and operation of physician practices. The Company believes that its
management can provide health systems with an attractive alternative for
improving the operations of their physician networks. Pursuant to such an
arrangement, the Company will provide management services to a physician group
for a fee, but will not acquire the assets or employ the personnel of the
physician group, except certain key employees, and will not have any ongoing
obligation to provide capital to the group.
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The Company focuses on better ways of providing knowledge, services and
resources to affiliated physicians in its multi-specialty clinics, health
systems and IPAs that will enable them to compete and create value for
purchasers and consumers of health care services. To promote growth and
efficiency, the Company implements a number of programs and services at each of
its clinics. These programs include strategic planning and budgeting that focus
on, among other things, revenue enhancement, cost containment and expense
reduction. The Company negotiates managed care contracts, enters into national
purchasing agreements, conducts productivity, procedure coding and charge
capturing studies and assists the clinics in physician recruitment efforts.
The Company has increased its focus on the development of IPAs to
enable the Company to provide services to a broader range of physician
organizations, to enhance the operating performance of existing clinics and to
further develop physician relationships. The Company develops IPAs that include
affiliated clinic physicians to enhance the clinics' attractiveness as providers
to managed care organizations. Fees earned from managing the IPAs are based upon
a percentage of revenue collected by the IPAs and a share of surplus, if any, of
capitated revenue of the IPAs. The Company has not historically been a party to
the capitated contracts entered into by the IPAs, but is exposed to losses to
the extent of the Company's share of deficits, if any, of the capitated revenue
of the IPAs. Through the PrimeCare International, Inc. ("PrimeCare") and The
Morgan Health Group, Inc. ("MHG") acquisitions, the Company became a party to
certain managed care contracts. The Company had terminated all managed care
contracts of MHG by April 30, 1999. At May 12, 2000, the Company had
underwritten letters of credit totaling $3.3 million for the benefit of certain
managed care payors to help ensure payment of costs for which its affiliated
IPAs are responsible. The Company is exposed to losses if a letter of credit is
drawn upon and the Company is unable to obtain reimbursement from the IPA.
The Company continues to seek additional affiliations with
multi-specialty clinics and IPAs, but anticipates that acquisition growth will
continue to be slower than in years prior to 1999. During the first quarter of
2000, the Company affiliated with two medical practices and made an additional
investment in an IPA market, adding a total of approximately $700,000 in assets.
The principal asset acquired was goodwill, which is an intangible asset. The
consideration for the acquisitions was cash and was funded by a combination of
operating cash flow and borrowings under the Company's bank credit facility.
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RESULTS OF OPERATIONS
The following table shows the percentage of net revenue represented by
various expenses and other income items reflected in the Company's Consolidated
Statements of Operations:
THREE MONTHS
ENDED MARCH 31,
2000 1999
------ --------
Net revenue 100.0% 100.0%
Operating expenses
Cost of provider services 19.7 13.7
Salaries, wages and benefits 31.5 31.9
Supplies 13.2 14.5
Purchased medical services 2.4 2.4
Other expenses 15.0 14.0
General corporate expenses 2.4 2.1
Rents and lease expense 7.4 7.9
Depreciation and amortization 5.6 6.0
Provision for asset revaluation,
restructuring and refinancing 7.7 2.3
------ ------
Net operating expenses 104.9 (A) 94.8 (A)
------ ------
Earnings (loss) from operations (4.9) (A) 5.2 (A)
Interest income (0.5) (0.2)
Interest expense 3.3 2.3
------ ------
Earnings (loss) before income taxes
and minority interest (7.7) (A) 3.1 (A)
Income tax expense (benefit) 0.1 (A) 1.3 (A)
Minority interest 0.5 1.1
------ ------
Net earnings (loss) (8.3)%(A) 0.7%(A)
====== ======
- ----------------------------
(A) Excluding the effect of the provision for asset revaluation,
restructuring and refinancing in 2000 and 1999, net operating expenses,
earnings from operations, earnings before income taxes and minority
interest, income tax expense and net earnings (loss), as a percentage
of net revenue, would have been 97.2%, 2.8%, 0.0%, 0.1% and (0.6%),
respectively, for the three months ended March 31, 2000, and 92.5%,
7.5%, 5.4%, 1.6% and 2.6%, respectively, for the three months ended
March 31, 1999.
Three Months Ended March 31, 2000 Compared to Three Months Ended March 31, 1999
Net revenue decreased $107.0 million, or 25.7%, from $416.5 million for
the first quarter of 1999 to $309.5 million for the first quarter of 2000. Net
revenue from multi-specialty clinics ("Clinic Net Revenue") decreased by $99.7
million in 2000 from 1999, comprised of (i) a $86.3 million decrease in service
fees for reimbursement of clinic expenses incurred by the Company and (ii) a
$13.4 million decrease in the Company's fees from clinic operating income and
net physician group revenue. Excluding same clinic revenue increases discussed
below, decreases in Clinic Net Revenue included reductions of $4.1 million from
clinics whose assets are held for sale at March 31, 2000 and reductions of
$110.3 million as a result of clinic operations disposed of in 1999 and 2000.
Increases in Clinic Net Revenue included $1.7 million in fees from contract
management service agreements which were entered into in the fourth quarter of
1999 and first quarter of 2000. Included in the changes in Clinic Net Revenue is
the impact of declining reimbursement for services rendered by the physician
groups. Specifically, the provision for doubtful accounts and contractual
adjustments as a percentage of gross physician group, hospital and other revenue
increased from 42.2%
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for the three months ended March 31, 1999 to 44.3% for the three months ended
March 31, 2000. Net revenue from the service agreements (excluding clinics being
sold) in effect for both quarters increased by $13.0 million, or 9.4%, in 2000
compared with 1999. Same market service agreement net revenue growth resulted
from the addition of new physicians, the expansion of ancillary services and
increases in patient volume and fees.
Net revenue from IPAs decreased $9.5 million, or 9.9%, from $96.4
million for the first quarter of 1999 to $86.9 million for the first quarter of
2000. Excluding same market revenue decreases discussed below, decreases of
approximately $13.3 million resulted from the closing of MHG in 1999 and
decreases of approximately $4.0 million resulted from the closing or
restructuring of several smaller markets. The Company had terminated all payor
contracts relating to MHG and commenced closing MHG operations by April 30,
1999. The Company expects to complete the closure of MHG by the end of 2000.
Increases in IPA net revenues were the result of approximately $1.3 million
increase in net revenues from three IPA markets and a management agreement
entered into subsequent to the first quarter of 1999 as well as a $13.2 million
increase due to the acquisition of the remaining interest in an HMO in 1999. Net
revenue from the IPA markets in effect for the first quarter of 2000 and 1999
decreased by $6.7 million, or 9.3%, in 2000 compared to 1999. Same market IPA
decreases resulted primarily from a combination of higher bed days and higher
per diem rates and lower surpluses in one market.
During the first quarter of 2000, most categories of operating expenses
were relatively stable as a percentage of net revenue when compared to the same
period in 1999. During the first quarter of 2000, cost of provider services
expense increased as a result of the Company acquiring the remaining 50%
interest in an HMO in late 1999. Supplies expense had more than a marginal
decrease as a percentage of net revenue over the same period in 1999 because the
Company divested certain clinics in 1999 whose supply costs as a percentage of
net revenue were higher than that of the current base of clinics. Other expenses
increased as a result of the Company incurring costs associated with information
systems and software conversions in its IPA markets during the fourth quarter of
1999 and the first quarter of 2000. The increase in interest expense as a
percentage of net revenue in the first quarter of 2000 compared to the same
period in 1999 is primarily due to amendments to the Company's bank credit
facility that increased interest rates.
Our managed IPAs and affiliated physician groups enter into contracts
with third party payors, many of which are based on fixed or capitated fee
arrangements. Under these capitation arrangements, health care providers receive
a fixed fee per plan member per month and providers bear the risk, generally
subject to certain loss limits, that the total costs of providing medical
services to the members will exceed the fixed fee. The IPA management fees are
based, in part, upon a share of the portion, if any, of the fixed fee that
exceeds actual costs incurred. Some agreements with payors also contain "shared
risk" provisions under which the Company, through the IPA, can share additional
fees or can share in additional costs depending on the utilization rates of the
members and the success of the IPAs. Through calculation of its service fees,
the Company also shares indirectly in capitation risk assumed by its affiliated
physician groups. In addition, the Company operates five HMOs. Incurred but not
reported claims payable ("IBNR claims payable") represents the estimated
liability for covered services that have been performed by physicians for
enrollees of various medical plans. The IBNR claims payable is based on the
Company's historical claims data, current enrollment, health service utilization
statistics and other related information. There were no material adjustments in
2000 to prior years' IBNR claims payable.
On behalf of certain of the Company's affiliated IPAs, the Company has
underwritten letters of credit to managed care payors to help ensure payment of
health care costs for which the affiliated IPAs have assumed responsibility. At
March 31, 2000, letters of credit aggregating $2.1 million were outstanding
under the bank credit facility for the benefit of managed care payors. While no
draws on any of these letters of credit have occurred to date, there can be no
assurance that draws will not occur on the letters of credit in the future. The
Company would seek reimbursement from an IPA if there was a draw on a letter of
credit. The Company is exposed to losses if a letter of credit is drawn upon and
the Company is unable to obtain reimbursement from the IPA.
The Company recorded a net asset revaluation and restructuring charge
of approximately $22.6 million in first
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quarter of 2000. The net charge was comprised of a $29.6 million charge less
recovery of certain asset revaluation charges recorded in the third quarter of
1999. See discussion of these charges in "Asset Revaluation and Restructuring"
below.
The Company recorded a refinancing charge of approximately $1.2 million
in the first quarter of 2000 related to the amendment and restatement of the
bank credit facility in January 2000. This charge represented unamortized costs
that were expensed as a result of lower commitment amounts and an earlier
termination date of the bank credit facility. See additional discussion of the
bank credit facility amendment in "Liquidity and Capital Resources."
The Company will incur no federal income tax expense and make no
federal income tax payments during the foreseeable future as a result of
available net operating loss carryforwards. Tax expense incurred for the first
quarter of 2000 represented state income tax expense.
ASSET REVALUATION AND RESTRUCTURING
Assets Held for Sale
The health care industry has undergone rapid changes that significantly
affected physicians and other health care providers. Declining reimbursement
from Medicare and commercial payors has adversely affected physician revenues
and incomes. It has taken significant time for physicians and other health care
providers to fully understand and accept the sustaining impact of changes in
reimbursement. The Company and its physicians attempted to react to this
development by implementing plans designed to reduce overhead, increase patient
volume, increase physician productivity and change payor mixes. In some clinics,
physicians have been slow to engage in necessary changes because of medical
group culture or other market factors and, as a result, these strategies have
been only marginally successful or, in some cases, unsuccessful. Many of our
affiliated physician groups experienced difficulty dealing with the impact of
these financial pressures. This difficulty has affected the relationships among
physicians within the groups and between the physician groups and the Company.
As a result, since early 1998, the Company has sold clinic operating assets and
terminated the related service agreements, or is in the process of doing so,
with many clinics affiliated with the Company.
In the third quarter of 1999, the Company determined that it was
necessary to create more stability for the Company by identifying those clinics
which the Company believed were less likely to sustain a relationship with the
Company in this changed health care environment and selling the corresponding
assets. The Company intends to maintain clinics that it believes can prosper in
the changed health care environment. This decision to downsize was intended to
allow the Company to focus on strengthening the remaining clinic operations and
to position the Company to resume its growth. The Company anticipates that these
steps will generate cash and result in a smaller company with more stable
clinics that have the ability to grow and are committed to the mutual success of
the physician groups and the Company. As part of the decision to downsize the
number of clinic operations, the Company is taking significant steps to change
its clinics relationships in order to strengthen these clinics and ensure their
long-term viability. For additional discussion of the changes in these
relationships, see "Overview" and "Liquidity and Capital Resources."
At March 31, 2000, net assets held for sale represented the net assets
of ten clinics and totaled approximately $92.0 million, including $14.9 million
of real estate property, after taking into account the charges relating to
clinics with which the Company intends to terminate its affiliation. These net
assets consisted of current assets, property and equipment, intangible assets
and other assets less liabilities which are expected to be assumed by the
purchasers. The Company expects to recover these amounts during the next 12
months as the asset sales occur; however, there can be no assurance that the
Company will recover this entire amount. As of May 12, 2000, the Company had
completed the disposition of three clinics in the second quarter of 2000 and
received proceeds totaling $16.0 million in cash and $2.5 million in notes
receivable, in addition to certain liabilities assumed by the purchasers.
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In the first quarter of 2000, the Company recorded a net pre-tax asset
revaluation charge of approximately $19.0 million, which was comprised of a
$26.0 million charge less recovery of certain asset revaluation charges recorded
in the third quarter of 1999. This net charge consisted of approximately $12.9
million related to assets held for sale, $6.0 million related to assets sold
during the quarter and $100,000 related to asset impairments (see discussion
below). The net charge related to the revaluation of certain assets associated
with one clinic, the completed sale of four clinics' operating assets and the
exiting of an IPA market. The first quarter 2000 asset revaluation charge
related to assets held for sale included current assets, property and equipment,
other assets and intangible assets of $2.3 million, $5.7 million, $2.5 million
and $2.4 million, respectively. During the first quarter of 2000, the Company
classified as held for sale four additional clinics, one of which was included
in the asset impairment charge taken in the third quarter of 1999 related to the
impairment of long-lived assets of certain of its ongoing operating units. This
determination was based upon correspondence received or discussions with the
respective medical groups in the first quarter and the decline in the groups'
stability and economic situation. The Company therefore determined to sell the
clinic operating assets and terminate the agreements related to these clinics.
As a result of calculating the estimated net realizable values of the assets of
these clinics, one clinic's assets were written down approximately $1.2 million,
which was offset by the recovery of certain asset impairment charges recorded in
the third quarter of 1999. The net assets held for sale for these four clinics
at March 31, 2000 were approximately $31.8 million and consisted primarily of
accounts receivable, property and equipment and intangible assets less certain
current liabilities.
During the first quarter of 2000, a clinic that was included in the
asset impairment charge taken in the third quarter of 1999 related to the
impairment of long-lived assets was sold with recoveries of approximately $6.1
million. Net revenue and pre-tax income from the clinic sold were approximately
$1.1 million and $400,000, respectively, for the quarter ended March 31, 2000
and $900,000 and $200,000, respectively, for the quarter ended March 31, 1999.
In the fourth quarter of 1999, the Company recorded a net pre-tax asset
revaluation charge of approximately $5.2 million, which was comprised of a $9.3
million charge less recovery of certain asset revaluation charges recorded in
the fourth quarter of 1998 and third quarter of 1999. This net charge was
comprised of approximately $4.5 million related to assets held for sale,
$300,000 related to assets sold during the quarter and $400,000 related to asset
impairments (see discussion below). This net charge related to the revaluation
of certain assets associated with one clinic, the completed sale of another
clinic's operating assets and the exiting and centralization of certain IPA
markets in Florida. The fourth quarter 1999 asset revaluation charge related to
assets held for sale included current assets, property and equipment, other
assets and intangible assets of $1.0 million, $2.8 million, $300,000 and
$700,000, respectively. During the fourth quarter of 1999, the Company
classified as held for sale two clinics that were included in the asset
impairment charge taken in the third quarter of 1999 related to the impairment
of long-lived assets of certain of its ongoing operating units. This
determination was based upon correspondence received from the respective medical
groups in the fourth quarter and the decline in each group's stability and
economic situation. The Company therefore decided to sell the clinic operating
assets and terminate the agreements related to these clinics. As a result of
calculating the estimated net realizable values of the assets of these clinics,
an additional net asset revaluation charge was taken with respect to one clinic
of approximately $4.5 million, comprised of a $6.5 million charge less recovery
of certain asset impairment charges recorded in the fourth quarter of 1998. The
Company disposed of one of these clinics in the first quarter of 2000. The net
assets held for sale for the remaining clinic at March 31, 2000 were
approximately $20.8 million and consisted primarily of accounts receivable,
property and equipment and intangible assets less certain current liabilities.
Net revenue and pre-tax income (losses) from the clinic sold were approximately
$3.1 million and $(300,000), respectively, for the quarter ended March 31, 2000
and $9.4 million and $0, respectively, for the quarter ended March 31, 1999. The
Company completed the sale of the remaining clinic during the second quarter of
2000 and received consideration consisting of $12.5 million in cash and $2.5
million in notes receivable, in addition to certain liabilities assumed by the
purchasers.
In the third quarter of 1999, the Company recorded a pre-tax asset
revaluation charge of approximately $390.3 million, consisting of $195.6 million
related to assets held for sale, $2.2 million related to assets sold during the
quarter and $192.5 million related to asset impairments (see discussion below)
in conjunction with its decision to downsize. The Company recorded $195.6
million of asset revaluation charges related to 17 clinics whose net assets the
Company had classified as held for sale. The third quarter 1999 asset
revaluation charge related to assets held for sale included
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current assets, property and equipment, other assets and intangible assets of
$9.2 million, $19.8 million, $13.3 million and $153.3 million, respectively.
Three of the 17 clinics represented all of the Company's remaining
operations considered to be "group formation clinics." Group formation clinics
represented the Company's attempt to create multi-specialty groups by combining
the operations of several small physician groups or individual physician
practices. The Company was not able to successfully consolidate the operations
of these clinics as a result of a variety of factors including lack of medical
group governance or leadership, inability to agree on income distribution plans,
separate information systems, redundant overhead structures and lack of group
cohesiveness. The Company therefore determined to sell the clinic operating
assets and terminate the agreements related to these clinics. The asset
revaluation charge related to these clinics in the third quarter of 1999 was
$13.8 million. The Company completed the sale of these clinics in the fourth
quarter of 1999 and received proceeds totaling approximately $17.5 million in
cash and $1.7 million in notes receivable, in addition to certain liabilities
being assumed by the purchaser. Net revenue and pre-tax income from these group
formation clinics were $11.0 million and $300,000, respectively, for the quarter
ended March 31, 1999.
The remaining 14 clinics represent multi-specialty clinics that are
being disposed because of a variety of negative operating and market issues,
including those related to declining reimbursement for Medicare and commercial
patient services, market position and clinic demographics, physician relations,
physician turnover rates, declining physician incomes, physician productivity,
operating results and ongoing viability of the existing medical group. Although
these factors have been present individually from time to time in various
affiliated clinics and could occur in future clinic operations, the combined
effect of these factors at the clinics held for sale resulted in clinic
operations that were difficult to effectively manage. Therefore, the Company
determined in the third quarter of 1999 to sell the clinic operating assets and
terminate the agreements related to these clinics. The asset revaluation charge
related to these clinics in the third quarter of 1999 was $181.8 million. The
Company completed the sale of five of these groups during the fourth quarter of
1999, receiving consideration consisting of approximately $32.6 million in cash
and $22.0 million in notes receivable, in addition to certain liabilities being
assumed by the purchasers. The Company completed the sale of four of these
groups and certain satellite operations of another group during the first
quarter of 2000, receiving consideration consisting of approximately $13.2
million in cash and $10.4 million in notes receivable, in addition to certain
liabilities being assumed by the purchasers. Included in these 14 clinics were
the net assets of the clinics operating in Lexington, Kentucky and Sayre,
Pennsylvania. In the second quarter of 1999, the Company disclosed that it did
not expect to extend the interim management agreement with the Guthrie Clinic in
Sayre, Pennsylvania, beyond November 1999 and discussed certain risks associated
with the Lexington Clinic operation. In the third quarter of 1999, the Company
reached agreements on the sales of these assets to the respective physician
groups. The Company completed the sales of these assets in the fourth quarter
and recorded a net asset impairment charge of approximately $300,000, comprised
of a $2.2 million charge less recovery of certain asset impairment charges
recorded in the third quarter of 1999. The net assets held for sale for the
remaining clinics at March 31, 2000 were approximately $24.5 million and
consisted primarily of accounts receivable, property and equipment, other assets
and intangible assets less certain current liabilities. Net revenue and pre-tax
income (losses) from the nine clinics sold as of March 31, 2000 were
approximately $1.9 million and $(700,000), respectively, for the quarter ended
March 31, 2000 and $60.3 million and $700,000, respectively, for the quarter
ended March 31, 1999. The Company completed the disposition of two of these
groups during the second quarter of 2000 and, as of May 12, 2000, had received
consideration of $3.5 million in cash.
In the second quarter of 1999, the Company recorded a pre-tax asset
revaluation charge of $13.7 million related to the sale of one clinic's
operating assets and pending sale of two clinics' operating assets and the
termination of the related agreements with the affiliated physician groups. This
asset revaluation charge included current assets, property and equipment, and
intangible assets of $2.0 million, $1.5 million and $10.2 million, respectively.
At June 30, 1999 the Company was also in negotiations relating to the sale of
the assets of three additional clinics (including Holt-Krock which is discussed
below). The factors impacting the decision to sell these assets and terminate
the agreements with the affiliated physician groups is consistent with the
factors described in the discussion of the third quarter of 1999
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asset revaluation charge above. The Company completed the sale of one of these
groups during the second quarter of 1999 and four of these groups during the
third quarter of 1999. The remaining group was sold during the first quarter of
2000 and is included with the 14 clinics discussed above. With respect to the
Holt-Krock sale, certain proceeds were being held in escrow pending resolution
of certain disputed matters. These matters were resolved in the third quarter of
1999 and the Company recorded an additional asset revaluation charge of $2.2
million in the third quarter. Total consideration received from these
terminations in 1999 consisted of approximately $45.5 million in cash and $3.3
million in notes receivable, in addition to certain liabilities being assumed by
the purchasers. Net revenue and pre-tax income (losses) from the five clinics
that were sold in 1999 were approximately $20.2 million and $(900,000),
respectively, for the quarter ended March 31, 1999.
In summary, net revenue and pre-tax income from operations disposed of
or closed as of March 31, 2000 were $6.4 million and $500,000, respectively, for
the quarter ended March 31, 2000 and $132.4 million and $200,000, respectively,
for the quarter ended March 31, 1999. Net revenue and pre-tax income from the
operations held for sale at March 31, 2000 were $48.1 million and $1.0 million,
respectively, for the quarter ended March 31, 2000 and $52.2 million and $3.1
million, respectively, for the quarter ended March 31, 1999.
There can be no assurance that in the future a similar combination of
negative characteristics will not develop at clinics affiliated with the Company
and result in the termination of service agreements or that in the future
additional clinics will not terminate relationships with the Company in a manner
that may adversely affect the Company.
Asset Impairments
As previously discussed in "Asset Revaluation and Restructuring -
Assets Held for Sale," rapid changes in the health care industry have
significantly affected physicians and other health care providers. Factors such
as unexpected physician departures, declining Medicare and commercial
reimbursement, changing market conditions, demographics, group governance and
leadership, and continued increasing pressure on operating costs have
contributed to stagnant and, in some cases, declines in physician incomes and
operating results of these clinic operations. It has taken significant time for
physicians and other health care providers to fully understand and accept the
sustaining impact of changes in reimbursement. The Company and its physicians
have continued to attempt to react to this development by devising and
implementing plans to reduce overhead, increase patient volume, increase
physician productivity and change payor mixes. In some clinics, physicians have
been slow to engage in necessary changes because of medical group culture or
other market factors, therefore making these strategies only marginally
successful or in some cases not successful.
In the first quarter of 2000, the Company recorded approximately
$100,000 of asset revaluation charges related to the impairment of certain
long-lived assets an IPA market. The Company determined to exit one market in
the state of Tennessee as a result of insufficient enrollment volume.
Accordingly, the Company recorded a charge in the first quarter of 2000
primarily to reduce to net realizable value its investments in equipment
associated with the market.
In the fourth quarter of 1999, the Company recorded approximately
$400,000 of asset revaluation charges related to the impairment of certain
long-lived assets in three IPA markets in Florida. The Company determined to
exit certain markets in the state of Florida and centralize the remaining
operations as a result of a variety of factors, including mounting deficits and
strained relations with payors. Accordingly, the Company recorded a charge in
the fourth quarter of 1999 primarily to reduce to net realizable value its
investments in software licenses associated with three markets.
In the third quarter of 1999, events such as the anticipated downsizing
of some clinics, changes in the Company's expectations relative to efforts to
change business mix and improve margins within certain markets, the failure of
certain joint venture or ancillary consolidation opportunities, and ongoing
local market economic pressure, impacted the Company's estimate of future cash
flows for certain long-lived assets and, in some cases, caused the
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Company to change the estimated remaining useful life for certain long-lived
assets. The change in the Company's view on recovery of certain long-lived
assets was also evidenced by the recognition in the third quarter of 1999 of the
need to change its overall business model for its relationship with medical
groups to decrease cash flow to the Company and therefore increase cash flow to
the medical group. Fair value for the long-lived assets was determined by
utilizing the results of both a discounted cash flow analysis and an earnings
before interest, taxes, depreciation and amortization ("EBITDA") sales multiple
analysis based on the Company's actual past experience with asset dispositions
in similar market conditions.
In the third quarter of 1999, the Company recorded approximately $192.5
million of asset revaluation charges related to the impairment of long-lived
assets of certain of its ongoing operating units. Approximately $172.5 million
of these charges relate to certain clinic operations with the remainder relating
to the operations of PhyCor Management Corporation ("PMC"), an IPA management
company acquired in the first quarter of 1998. The Company determined to exit
the most significant market in which PMC operates as a result of a variety of
factors, including the loss of relationships with physicians in that market in
the current quarter. In addition, of the remaining markets in which PMC
operates, one was closed in the fourth quarter of 1999 and the others are not
expected to generate significant cash flow as certain operations in these
markets were closed in the fourth quarter of 1999 or are expected to be closed
during 2000. These events are expected to impair the estimated future cash flows
from the PMC acquisition and resulted in an asset impairment charge of
approximately $20.0 million. In the fourth quarter of 1999, the Company
classified as held for sale two clinics included in the third quarter 1999 asset
impairment charge. In the first quarter of 2000, the Company classified as held
for sale one clinic included in the third quarter 1999 asset impairment charge
and completed the sale of two clinics included in the third quarter 1999 asset
impairment charge.
Restructuring Charges
In the first quarter of 2000, the Company adopted and implemented
restructuring plans and recorded pre-tax restructuring charges of approximately
$3.6 million with respect to operations that were sold or are being closed.
These charges were comprised of approximately $1.9 million in facility and lease
termination costs, $700,000 in severance costs and $1.0 million in other exit
costs. These restructuring plans include the involuntary termination of 218
local clinic and IPA management and business office personnel. These
terminations are expected to be completed over the next six months. During the
first quarter of 2000, the Company paid approximately $200,000 in facility and
lease termination costs, $400,000 in severance costs and $500,000 in other exit
costs related to the 2000 charge.
In 1999, the Company adopted and implemented restructuring plans and
recorded net pre-tax restructuring charges of approximately $21.8 million with
respect to operations that were being sold or closed, of which approximately
$9.5 million was recorded in the first quarter, $675,000 was recorded in the
second quarter, a net $3.1 million was recorded in the third quarter and $8.5
million was recorded in the fourth quarter. The net third quarter charge of $3.1
million was comprised of a $4.2 million charge less recovery of certain asset
revaluation charges recorded in the third quarter of 1998 due to sales proceeds
exceeding carrying value. These net charges were comprised of approximately $4.4
million in facility and lease termination costs, $5.1 million in severance costs
and $12.3 million in other exit costs. These restructuring plans included the
involuntary termination of 382 local clinic and IPA management and business
office personnel and such terminations are expected to be completed over the
next three months. During the first quarter of 2000, the Company paid
approximately $400,000 in facility and lease termination costs, $700,000 in
severance costs and $2.0 million in other exit costs related to the 1999
charges. During 1999, the Company paid approximately $1.4 million in facility
and lease termination costs, $3.1 million in severance costs and $10.6 million
in other exit costs related to the 1999 charges.
The fourth quarter of 1999 charge primarily related to IPA operations
where management adopted plans in the fourth quarter of 1999 to cease operations
and exit the related markets. Of these IPA charges, approximately $8.1 million
related to certain Florida markets and were comprised of approximately $400,000
in facility and lease termination costs, $100,000 in severance costs and $7.6
million in other exit costs. Due to mounting deficits and
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strained relations with payors in several Florida IPA markets, the Company
adopted and implemented restructuring plans in the fourth quarter of 1999 to
terminate the agreements with these payors and exit the related markets and
centralize the remaining Florida IPA operations. In conjunction with terminating
the payor relationships, the Company agreed to pay final settlements of
approximately $7.4 million to obtain full release from future claims. These
restructuring plans included the involuntary termination of 21 local management
and business office personnel and such terminations are expected to be completed
over the next three months. During the first quarter of 2000, the Company paid
approximately $100,000 in facility and lease termination costs and $1.6 million
in exit costs related to the fourth quarter 1999 Florida IPA charge. During
1999, the Company paid approximately $100,000 in severance costs and $5.9
million in exit costs related to the fourth quarter 1999 Florida IPA charge.
In summary, during the first quarter of 2000, the Company paid
approximately $600,000 in facility and lease termination costs, $1.1 million in
severance costs and $2.5 million in other exit costs related to 1998, 1999 and
2000 charges. At March 31, 2000, accrued restructuring reserves totaled
approximately $7.4 million and consisted of approximately $3.7 million in
facility and lease termination costs, $1.8 million in severance costs and $1.9
million in other exit costs. The Company estimates that approximately $5.6
million of the remaining restructuring reserves at March 31, 2000 will be paid
during the next 12 months. The remaining $1.8 million relates primarily to long
term lease commitments.
The Company currently anticipates recording restructuring charges in
the second quarter of 2000 as the assets of clinics are sold and the related
service agreements are terminated.
There can be no assurance that in the future a similar combination of
negative characteristics will not develop at clinics affiliated with the Company
and result in the termination of service agreements and a resulting material
adverse effect on the Company or that in the future additional clinics will not
terminate their relationships with the Company in a manner that may materially
adversely affect the Company.
LIQUIDITY AND CAPITAL RESOURCES
General
At March 31, 2000, the Company had $206.0 million in working capital,
compared to $193.1 million at December 31, 1999. At March 31, 2000, the Company
had $32.1 million in restricted cash and cash equivalents, compared to $29.6
million at December 31, 1999. Restricted cash and cash equivalents include
amounts held by IPA partnerships and HMOs whose use is restricted to operations
of the IPA partnerships or to meet regulatory deposit requirements. At March 31,
2000, net accounts receivable of $215.0 million amounted to 55 days of net
clinic revenue compared to $230.5 million and 55 days at the end of 1999.
The Company generated $1.7 million of cash flow from operations for the
first quarter of 2000 compared to $29.9 million for the first quarter of 1999.
The significant decrease in cash flow from operations is a result of the
reduction of hospital risk pool amounts in certain affiliated IPA markets. These
risk pool reductions are the result of increased bed days per thousand members
and increased per diem rates. In certain IPA markets, hospital contracts were
renegotiated in late 1999 resulting in increased institutional costs. Also,
information system conversion costs and the resulting labor cost increase
further reduced operating cash flow in the first quarter of 2000.
Capital expenditures during the first three months of 2000 totaled $8.9
million. The Company is responsible for capital expenditures at its affiliated
clinics under the terms of its service agreements. The Company expects to make
approximately $22.0 million in additional capital expenditures during the
remainder of 2000.
Deferred acquisition payments are payable to certain physician groups
in the event such physician groups attain predetermined financial targets during
established periods of time following the acquisitions. If each group satisfied
its
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applicable financial targets for the periods covered, the Company would be
required to pay an aggregate of approximately $23.8 million of additional
consideration over the next four years, of which a maximum of approximately
$15.0 million would be payable during the next 12 months.
During 1999, the Company favorably resolved its outstanding Internal
Revenue Service ("IRS") examinations for the years 1988 through 1995. The IRS
had proposed adjustments relating to the timing of recognition for tax purposes
of certain revenue and deductions related to accounts receivable, the Company's
relationship with affiliated physician groups, and various other timing
differences. The tax years 1988 through 1995 have been closed with respect to
all issues without a material financial impact. The Company is currently under
examination by the IRS for the years 1996 through 1998. Additionally, two
subsidiaries are currently under examination for the 1995 and 1996 tax years.
The Company acquired the stock of these subsidiaries during 1996. For the years
under audit, and potentially, for subsequent years, any such adjustments could
result in material cash payments by the Company. Any successful adjustment by
the IRS would cause an interest expense to be incurred. PhyCor does not believe
the resolution of these matters will have a material adverse effect on its
financial condition, although there can be no assurance as to the outcome of
these matters. In August 1999, the Company received a $13.7 million tax refund
as a result of applying the 1998 loss carryback to recover taxes paid in 1996
and 1997. The Company has approximately $297.0 million in net operating loss
carryforwards; accordingly, the Company does not expect to pay current federal
income taxes for the foreseeable future.
Capital Resources
The Company modified its bank credit and synthetic lease facilities in
January 2000. The Company's bank credit facility, as amended, provides for an
initial $355.0 million revolving line of credit. Net cash proceeds from asset
sales are required to be prepaid against outstanding borrowings under the
facility. The commitment is reduced by 50% of net cash proceeds from asset sales
up to $30.0 million and 100% of any additional such proceeds. Irrespective of
asset sales, the commitment reduces to $330.0 million on September 30, 2000 and
quarterly thereafter to $200.0 million on June 30, 2002. The facility terminates
on September 30, 2002. The credit facility may be used by the Company for
acquisitions, working capital, capital expenditures and general corporate
purposes. The total drawn cost under the credit facility at March 31, 2000 was
either (i) the applicable eurodollar rate plus 1.50% to 3.00% per annum or (ii)
the agent's base rate plus .325% to .50% per annum. The total weighted average
drawn cost of outstanding borrowings at March 31, 2000 was 8.35%. The amended
bank credit facility includes a $60 million sub-limit for letters of credit that
may be issued by the Company. The Company's synthetic lease facility, as
amended, provides off balance sheet financing with an option to purchase the
leased facilities at the end of the lease term. The total drawn cost under the
synthetic lease facility at March 31, 2000 was 1.50% to 3.00% above the
applicable eurodollar rate. At March 31, 2000, an aggregate of $26 million was
drawn under the synthetic lease facility.
Outstanding borrowings under the bank credit facility and synthetic
lease facility are secured by the capital stock the Company holds in its
significant subsidiaries (as defined in the bank credit facility), certain real
property of the Company and the personal property held by the significant
subsidiaries. Both facilities contain covenants which, among other things,
require the Company to maintain minimum financial ratios and impose limitations
or prohibitions on the Company with respect to (i) the incurring of certain
indebtedness, (ii) the creation of security interests on the assets of the
Company, (iii) the payment of cash dividends on, and the redemption or
repurchase of, securities of the Company, (iv) investments and (v) acquisitions.
The Company recorded a pre-tax refinancing charge of approximately $1.2
million in the first quarter of 2000 related to the amendment and restatement of
the bank credit facility in January 2000. This charge represented unamortized
costs that were expensed as a result of lower commitment amounts and an earlier
termination date of the bank credit facility.
In 1997, the Company entered into an interest rate swap agreement to
reduce the exposure to fluctuating
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interest rates with respect to $100 million of its bank credit facility. During
1998, the Company amended the previous interest rate swap agreement and entered
into additional swap agreements. At March 31, 2000, notional amounts under
interest rate swap agreements totaled $230.0 million. Fixed interest rates range
from 5.14% to 5.78% relative to the one month or three month floating LIBOR. The
swap agreements mature at various dates from July 2003 to April 2005. The lender
may elect to terminate the agreement covering $100 million beginning September
2000 and another $100 million beginning October 2000. The FASB has issued
Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities, which the Company will be
required to adopt in the first quarter of 2001. Adoption of SFAS No. 133 will
require the Company to mark certain of its interest rate swap agreements to
market due to lender optionality features included in those swap agreements. Had
the Company adopted SFAS No. 133 as of March 31, 2000, the Company estimates it
would have recorded pre-tax non-cash earnings of approximately $2.9 million for
the quarter ended March 31, 2000. The Company has historically not engaged in
trading activities in its interest rate swap agreements and does not intend to
do so in the future.
During the second quarter of 1999, the Company announced a definitive
agreement allowing for a strategic investment in the Company of up to $200.0
million by funds managed by E.M. Warburg, Pincus and Co., LLC ("Warburg,
Pincus"). The agreement allows for the issuance of two separate series of zero
coupon convertible subordinated notes, each resulting in gross proceeds to
PhyCor of $100 million. Both series of notes are non-voting, have a 6.75% yield
and are convertible at an initial conversion price of $6.67 at the option of the
holder into approximately 15.0 million shares of PhyCor common stock. Each
series of notes will accrete to a maturity value of approximately $266.4 million
at the 15-year maturity date and includes an investor option to put the notes to
PhyCor at the end of ten years. The first of these series ("Series A Notes") was
issued on September 3, 1999. The Company used the net proceeds of $92.5 million
from the Series A Notes to repay indebtedness outstanding under the Company's
credit facility. Issuance of the second series of notes ("Series B Notes") under
the current terms is dependent upon market conditions and shareholder approval.
There is no assurance that the Series B Notes will be issued or any other
investment in the Company by Warburg, Pincus will be made.
In conjunction with our securities repurchase program, the Company
repurchased approximately 2.6 million shares of common stock for approximately
$12.6 million in 1998 and approximately 2.9 million shares of common stock for
approximately $13.5 million in 1999. During the third quarter of 1999, the
Company repurchased $3.5 million of its convertible subordinated debentures for
a total consideration of approximately $2.5 million, resulting in an
extraordinary gain of approximately $1.0 million. The Company's amended bank
credit facility prohibits additional securities repurchases.
Asset Sales and Restructuring Costs
During 1998, 1999 and 2000, the Company sold clinic operating assets
and real estate and terminated the related service agreements with a number of
clinics affiliated with the Company. For additional discussion related to these
clinics and the asset revaluation and restructuring charges associated with
these clinics, see "Asset Revaluation and Restructuring - Assets Held for Sale"
and "Asset Revaluation and Restructuring Restructuring Charges". For the three
months ended March 31, 2000, the Company received consideration which consisted
of approximately $21.3 million in cash and $10.4 million in notes receivable, in
addition to certain liabilities assumed by the purchasers, related to the sale
of clinic assets and real estate. An additional asset impairment charge of $6.0
million was recorded in the in the first quarter of 2000 related to clinic
dispositions. For the year ended December 31, 1999, the Company received
consideration which consisted of approximately $103.1 million in cash and $31.9
million in notes receivable, in addition to certain liabilities being assumed by
the purchasers, related to the sale of clinic assets. The amounts received upon
disposition of the assets in 1999 approximated the post-charge net carrying
value, with the exception of Holt-Krock Clinic, for which an additional asset
impairment charge of $2.2 million was recorded in the third quarter of 1999, a
clinic for which an additional net asset impairment charge of $300,000 was
recorded in the fourth quarter of 1999, and another clinic whose sales proceeds
exceeded carrying value and resulted in the recovery of $1.1 million against the
third quarter 1999 restructuring charge. The Company intends to seek recovery of
certain of its remaining
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assets through litigation against several physicians formerly affiliated with
Holt-Krock who did not join Sparks Regional Medical Center. For the year ended
December 31, 1998, the Company received consideration which consisted of
approximately $16.1 million in cash and $5.6 million in notes receivable, in
addition to certain liabilities being assumed by the purchasers, related to the
sale of clinic assets. The amounts received upon disposition of the assets in
1998 approximated the post-charge net carrying value. During the first quarter
of 2000, the Company received payments on notes receivable of approximately $2.0
million. During 1999 and 1998, the Company received payments on notes receivable
of approximately $3.9 million and $70,000, respectively.
As of May 12, 2000, the Company had received consideration which
consisted of $16.0 million in cash and $2.5 million in notes receivable, in
addition to certain liabilities assumed by the purchasers, related to the sale
of clinic assets in the second quarter of 2000.
During 1998, 1999 and 2000, the Company has recorded restructuring
charges related to operations that are being sold or closed. These charges
related to facility and lease termination costs, severance costs, and other exit
costs incurred or expected to be incurred when these assets are sold or closed.
For additional discussion, see "Asset Revaluation and Restructuring
- -Restructuring Charges." During the first three months of 2000, the Company paid
approximately $600,000 in facility and lease termination costs, $1.1 million in
severance costs and $2.5 million in other exit costs. During 1999, the Company
paid approximately $1.8 million in facility and lease termination costs, $4.9
million in severance costs and $12.3 million in other exit costs. During 1998,
the Company paid approximately $3.0 million in facility and lease termination
costs, $2.7 million in severance costs and $1.4 million in other exit costs. The
Company estimates that approximately $5.6 million of the remaining restructuring
charges at March 31, 2000 will be paid during the next twelve months.
Summary
During the third quarter of 1999, the Company concluded that it would
begin taking significant steps to change the relationships with the clinics by
offering to restructure the current service agreements in order to better align
incentives and strengthen these groups. The Company anticipates that these
restructuring efforts should be completed by the end of 2000. The ultimate
impact of the changes to the service agreements on pre-tax earnings and cash
flow is expected to be determined during 2000 and any such changes may
substantially reduce the earnings of the Company in 2000 and beyond. There can
be no assurance that the Company can restructure its clinic relationships or can
effect these changes in the manner or time in which it currently anticipates.
At March 31, 2000, the Company had cash and cash equivalents of
approximately $71.3 million and at May 12, 2000, approximately $74.1 million
available under its bank credit facility. The Company believes that the
combination of funds available under the Company's bank credit facility,
together with cash reserves, cash flow from operations and proceeds from asset
dispositions, should be sufficient to meet the Company's current planned
acquisition, expansion, capital expenditure and working capital needs over the
next year. The disposition of assets is expected to generate short-term
liquidity, but these dispositions are likely to negatively affect the Company's
financial ratios. In such event, the Company may be unable to comply with the
minimum ratios contained in the bank credit facility and the Company's long-term
liquidity would be negatively impacted. Availability under the bank credit
facility is reduced by net cash proceeds from asset sales. Irrespective of asset
sales, the commitment reduces to $330.0 million on September 30, 2000 and
quarterly thereafter to $200.0 million on June 30, 2002. There can be no
assurance that the Company will be able to meet the financial obligations
contained in the bank credit facility. Such failure would have a negative effect
on the Company.
In order to provide the funds necessary for the continued pursuit of
the Company's long-term strategy, the Company may continue to incur, from time
to time, additional short-term and long-term indebtedness and issue equity and
debt securities, the availability and terms of which will depend upon market and
other conditions. The bank credit facility restricts the Company's ability to
incur additional senior indebtedness. There can be no assurance that such
additional financing will be available on terms acceptable to the Company. The
Company's current stock price and
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growth expectations could negatively impact its ability to issue equity and
other debt securities, which could increase the Company's dependence on its bank
credit facility as a source of capital. There can be no assurance that in the
future a similar combination of negative characteristics discussed above will
not develop at a clinic affiliated with the Company and result in the
termination of the service agreement, or that in the future additional clinics
will not terminate their relationships with the Company in a manner that may
materially adversely affect the Company and its liquidity. The outcome of
certain pending legal proceedings described in Part II, Item 1 hereof may have
an impact on the Company's liquidity and capital resources.
Year 2000
The Following Material is Designated as Year 2000 Readiness Disclosure
for Purposes of the Year 2000 Information and Readiness Disclosure Act.
Our operations and those of the medical groups which we manage have not
experienced material problems with date sensitive information relating to
periods subsequent to December 31, 1999. The Company does not anticipate
material problems from Year 2000 issues in the future; however, there can be no
assurance that such problems will not occur, particularly at certain key dates
such as the end of quarters or the end of the fiscal year. The Company estimates
that it spent approximately $29.0 million on the development and implementation
of its Year 2000 compliance plan. The Company will continue to monitor
compliance with Year 2000 issues and remediate any issues that arise throughout
Year 2000 and will incur certain additional expenses associated with the
monitoring and remediation program. The Company does not anticipate incurring
significant additional expenses related to Year 2000 compliance, but there can
be no assurance that additional spending will not be necessary.
FORWARD-LOOKING STATEMENTS
Forward-looking statements of PhyCor included herein or incorporated by
reference including, but not limited to, those regarding future business
prospects, including the future stability and strength of clinics to be retained
by PhyCor and the profitability and acceptance by the physicians of the proposed
restructuring of the relationships between the PhyCor and its physician groups,
the acquisition of additional clinics, the development of additional IPAs, the
adequacy of PhyCor's capital resources, the adequacy of recent and proposed
asset impairment and restructuring charges, the possibility of additional losses
and charges to earnings resulting from restructurings of PhyCor's relationships
with its physician groups and the future profitability of capitated fee
arrangements and other statements regarding trends relating to various revenue
and expense items, could be affected by a number of risks, uncertainties, and
other factors described in the Company's Annual Report on Form 10-K for the year
ended December 31, 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
During the three months ended March 31, 2000, there were no material
changes to the Company's quantitative and qualitative disclosures about the
market risks associated with financial instruments as described in the Company's
Annual Report on Form 10-K for the year ended December 31, 1999.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS. -
The Company and certain of its current and former officers and
directors, Joseph C. Hutts, Derril W. Reeves, Thompson S. Dent, Richard D.
Wright and John K. Crawford (neither Mr. Wright nor Mr. Crawford are presently
with the Company) have been named defendants in 10 securities fraud class
actions filed in state and federal courts in Tennessee between September 8, 1998
and June 24, 1999. The factual allegations of the complaints in all 10 actions
are substantially identical and assert that during various periods between April
22, 1997 and September 22, 1998, the
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defendants issued false and misleading statements which materially
misrepresented the earnings and financial condition of the Company and its
clinic operations and misrepresented and failed to disclose various other
matters concerning the Company's operations in order to conceal the alleged
failure of the Company's business model. Plaintiffs further assert that the
alleged misrepresentations caused the Company's securities to trade at inflated
levels while the individual defendants sold shares of the Company's stock at
such levels. In each of the actions, the plaintiff seeks to be certified as the
representative of a class of all persons similarly situated who were allegedly
damaged by the defendants' alleged violations during the "class period." Each of
the actions seeks damages in an indeterminate amount, interest, attorneys' fees
and equitable relief, including the imposition of a trust upon the profits from
the individual defendants' trades. The federal court actions have been
consolidated in the U.S. District Court for the Middle District of Tennessee.
Defendants' motion to dismiss was denied and the case is now in the discovery
stage of the litigation. Defendants' unopposed motion to set a new trial date
was granted on April 19, 2000, and the court has set the trial date for June 4,
2001. The state court actions were consolidated in Davidson County, Tennessee.
The Plaintiffs' original consolidated class action complaint in state court was
dismissed for failure to state a claim. Plaintiffs, however, were granted leave
to file an amended complaint. The amended complaint filed by Plaintiffs
asserted, in addition to the original Tennessee Securities Act claims, that
Defendants had also violated Sections 11 and 12 of the Securities Act of 1933
for alleged misleading statements in a prospectus released in connection with
the CareWise acquisition. Defendants removed this case to federal court and have
filed an answer. Defendants anticipate that this case will eventually be
consolidated with the original federal consolidated action. The Company believes
that it has meritorious defenses to all of the claims, and is vigorously
defending against these actions. There can be no assurance, however, that such
defenses will be successful or that the lawsuits will not have a material
adverse effect on the Company. The Company's Restated Charter provides that the
Company shall indemnify the officers and directors for any liability arising
from these suits unless a final judgment establishes liability (a) for a breach
of the duty of loyalty to the Company or its shareholders, (b) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law or (c) for an unlawful distribution.
On February 2, 1999, Prem Reddy, M.D., the former majority shareholder
of PrimeCare, a medical network management company acquired by the Company in
May 1998, filed suit against the Company and certain of its current and former
executive officers in the United States District Court for the Central District
of California. The complaint asserts fraudulent inducement relating to the
PrimeCare transaction and that the defendants issued false and misleading
statements which materially misrepresented the earnings and financial condition
of the Company and its clinic operations and misrepresented and failed to
disclose various other matters concerning the Company's operations in order to
conceal the alleged failure of the Company's business model. The plaintiff is
seeking rescission of the merger agreement and return of all proceeds from the
operations of PrimeCare. In addition, the plaintiff is seeking compensatory and
punitive damages in an indeterminate amount, interest, attorneys' fees and
equitable relief, including the imposition of a trust upon the profits from the
individual defendants' trades. A trial date of June 20, 2000 has been set for
this litigation. Although the Company believes it has meritorious defenses to
all of the claims and is vigorously defending this suit, there can be no
assurance that it will not have a material adverse effect on the Company.
Three clinics are challenging the enforceability of their service
agreements with the Company's subsidiaries in court. In August 1999, Medical
Arts Clinic Association ("Medical Arts") filed suit against the Company in the
District Court of Navarro County, Texas, which complaint has been subsequently
amended. The Company removed this case to Federal District Court for the
Northern District of Texas. Medical Arts is seeking damages for breach of
contract and rescission of the service agreement and declaratory relief
regarding the enforceability of the service agreement alleging it is null and
void on several grounds, including but not limited to, the violation of state
law provisions as to the corporate practice of medicine and fee splitting. On
April 24, 2000, the Texas District Court of Navarro County, Texas, ordered the
appointment of a receiver to rehabilitate Medical Arts. On May 10, 2000, the
same state court granted Medical Arts a temporary restraining order against the
Company and set for hearing the matters set forth in the order. On May 12, 2000,
the Company, in response to the foregoing, filed its notice of removal of the
above matters to the federal court. This removal stays any action of the state
court. In December 1999, the Company filed suit in Davidson County, Tennessee
which currently seeks declaratory relief that the service agreement with
Murfreesboro Medical Clinic, P.A. ("Murfreesboro Medical") is enforceable or
alternatively seeking damages for
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breach by Murfreesboro Medical under the service agreement and the related asset
purchase agreement. Murfreesboro Medical then filed a motion to dismiss our suit
which was denied. Simultaneously, Murfreesboro Medical filed suit in Circuit
Court in Rutherford County, Tennessee, claiming breach of the service agreement
by the Company and seeking a declaratory judgment that the service agreement was
unenforceable. Pursuant to a motion by the Company, the Rutherford County
lawsuit has been dismissed. The Davidson County suit is still pending. In
January 2000, South Texas Medical Clinics, P.A. ("South Texas") filed suit
against PhyCor of Wharton, L.P. in the State District Court in Fort Bend County,
Texas. South Texas is seeking a declaratory judgment that the service agreement
is unenforceable as a matter of law because it violates the Texas Health and
Safety Code relating to the corporate practice of medicine and fee splitting. In
the alternative, South Texas seeks to have the agreements declared void
alleging, among other things, fraud in the inducement and breach of contract by
the Company. The Company has filed a motion to remove this case to Federal
District Court for the Southern District of Texas. The terms of the service
agreements provide that the agreements shall be modified if the laws are
changed, modified or interpreted in a way that requires a change in the
agreements. Although the Company is vigorously defending the enforceability of
the structure of its management fee and service agreements against these suits,
there can be no assurance that these suits will not have a material adverse
effect on the Company.
The U.S. Department of Labor (the "Department") is conducting an
investigation of the administration of the PhyCor, Inc. Savings and Profit
Sharing Plan (the "Plan"). The Department has not completed its investigation,
but has raised questions involving certain administrative practices of the Plan
in early 1998. The Department has not recommended enforcement action against the
Company or identified an amount of liability or penalty that could be assessed
against the Company. Based on the nature of the investigation, the Company
believes that its financial exposure is not material. The Company intends to
cooperate with the Department's investigation. There can be no assurance,
however, that the Company will not have a monetary penalty imposed against it.
Certain litigation is pending against the physician groups affiliated
with the Company and IPAs managed by the Company. The Company has not assumed
any liability in connection with such litigation. Claims against the physician
groups and IPAs could result in substantial damage awards to the claimants which
may exceed applicable insurance coverage limits. While there can be no assurance
that the physician groups and IPAs will be successful in any such litigation,
the Company does not believe any such litigation will have a material adverse
effect on the Company. Certain other litigation is pending against the Company
and certain subsidiaries of the Company, none of which management believes would
have a material adverse effect on the Company's financial position or results of
operations on a consolidated basis.
The Company's forward-looking statements relating to the
above-described litigation reflect management's best judgment based on the
status of the litigation to date and facts currently known to the Company and
its management and, as a result, involve a number of risks and uncertainties,
including the possible disclosure of new facts and information adverse to the
Company in the discovery process and the inherent uncertainties associated with
litigation.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
3.1 -- Restated Charter of the Company (1)
3.2 -- Amendment to Restated Charter of the Company (2)
3.3 -- Amendment to Restated Charter of the Company (3)
3.4 -- Amended Bylaws of the Company (1)
4.1 -- Specimen of Common Stock Certificate (4)
4.2 -- Shareholder Rights Agreement, dated February 18, 1994, between
the Company and First Union National Bank of North Carolina (5)
10.1 -- PhyCor, Inc. Supplemental Executive Retirement Plan as Amended and
Restated Effective January 1, 2000 (6)
10.2 -- Employment Agreement between the Company and Tarpley B. Jones,
dated as of February 1, 2000 (6)
27 -- Financial Data Schedule (for SEC use only)
- ----------
(1) Incorporated by reference to exhibits filed with the Company's Annual
Report on Form 10-K for the year ended December 31, 1994, Commission No.
0-19786.
(2) Incorporated by reference to exhibits filed with the Company's Registration
Statement on Form S-3, Registration No. 33-93018.
(3) Incorporated by reference to exhibits filed with the Company's Registration
Statement on Form S-3, Registration No. 33-98528.
(4) Incorporated by reference to exhibits filed with the Company's Registration
Statement on Form S-1, Registration No. 33-44123.
(5) Incorporated by reference to exhibits filed with the Company's Current
Report on Form 8-K dated February 18, 1994, Commission No. 0-19786.
(6) Filed herewith.
(B) REPORTS ON FORM 8-K.
The Company filed a Current Report on Form 8-K on January 31, 2000
announcing the amendment and restatement of its bank credit facility pursuant to
Item 5 of Form 8-K.
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.
PHYCOR, INC.
By: /s/ Tarpley B. Jones
----------------------------------------
Tarpley B. Jones
Executive Vice President and
Chief Financial Officer
Date: May 15, 2000
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
3.1 -- Restated Charter of the Company (1)
3.2 -- Amendment to Restated Charter of the Company (2)
3.3 -- Amendment to Restated Charter of the Company (3)
3.4 -- Amended Bylaws of the Company (1)
4.1 -- Specimen of Common Stock Certificate (4)
4.2 -- Shareholder Rights Agreement, dated February 18, 1994, between
the Company and First Union National Bank of North Carolina (5)
10.1 -- PhyCor, Inc. Supplemental Executive Retirement Plan as Amended and
Restated Effective January 1, 2000 (6)
10.2 -- Employment Agreement between the Company and Tarpley B. Jones,
dated as of February 1, 2000 (6)
27 -- Financial Data Schedule (for SEC use only)
(1) Incorporated by reference to exhibits filed with the Company's Annual
Report on Form 10-K for the year ended December 31, 1994, Commission No.
0-19786.
(2) Incorporated by reference to exhibits filed with the Company's Registration
Statement on Form S-3, Registration No. 33-93018.
(3) Incorporated by reference to exhibits filed with the Company's Registration
Statement on Form S-3, Registration No. 33-98528.
(4) Incorporated by reference to exhibits filed with the Company's Registration
Statement on Form S-1, Registration No. 33-44123.
(5) Incorporated by reference to exhibits filed with the Company's Current
Report on Form 8-K dated February 18, 1994, Commission No. 0-19786.
(6) Filed herewith.
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