SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934. FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30,
2001, OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934. FOR THE TRANSITION PERIOD FROM _______ TO ______
COMMISSION FILE NO.: 0-19786
PHYCOR, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
TENNESSEE 62-1344801
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
30 BURTON HILLS BOULEVARD, SUITE 400
NASHVILLE, TENNESSEE 37215
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (615) 665-9066
- --------------------------------------------------------------------------------
(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 November 13, 2001, 73,234,201 shares of the registrant's common
stock were outstanding.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHYCOR, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2001 (UNAUDITED) AND DECEMBER 31, 2000
(ALL AMOUNTS ARE EXPRESSED IN THOUSANDS)
2001 2000
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents - unrestricted .................................. $ 14,775 $ 286
Cash and cash equivalents - restricted .................................... 29,615 641
Accounts receivable, net .................................................. 2,540 2,389
Inventories, prepaid expenses and other current assets .................... 11,382 4,810
Notes receivable, current installments .................................... 1,019 1,514
Assets held for sale, net ................................................. -- 77,154
----------- -----------
Total current assets ...................................... 59,331 86,794
Property and equipment, net .................................................... 6,087 5,574
Intangible assets, net ......................................................... 33,999 18,754
Notes receivable, excluding current installments ............................... 13,557 31,873
Other assets ................................................................... 2,143 2,019
----------- -----------
Total assets .............................................. $ 115,117 $ 145,014
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current installments of long-term debt and capital leases ................. $ 199 $ 46,306
Current installments of convertible subordinated notes and
debentures ............................................................ 310,707 305,500
Accounts payable .......................................................... 1,745 2,403
Salaries and benefits payable ............................................. 3,405 1,909
Incurred but not reported claims payable .................................. 24,258 1,297
Current portion of accrued restructuring reserves ......................... 7,615 11,277
Other accrued expenses and current liabilities ............................ 44,306 21,601
----------- -----------
Total current liabilities ................................. 392,235 390,293
Long-term debt and capital leases, excluding current installments .............. 1,048 2,862
Accrued restructuring reserves, excluding current portion ...................... 13,383 15,578
Convertible subordinated notes payable to physician groups ..................... 175 637
----------- -----------
Total liabilities ......................................... 406,841 409,370
----------- -----------
Minority interest in earnings of consolidated partnerships ..................... 1,681 633
Shareholders' deficit:
Preferred stock, no par value, 10,000 shares authorized ................... -- --
Common stock, no par value; 250,000 shares authorized; issued
and outstanding 73,234 shares in 2001 and 73,281 shares in
2000 .................................................................. 834,168 834,168
Accumulated deficit ....................................................... (1,127,573) (1,099,157)
----------- -----------
Total shareholders' deficit .............................. (293,405) (264,989)
----------- -----------
Commitments and contingencies
Total liabilities and shareholders' deficit .............. $ 115,117 $ 145,014
=========== ===========
See accompanying notes to consolidated financial statements.
2
PHYCOR, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (ALL
AMOUNTS ARE EXPRESSED IN THOUSANDS, EXCEPT FOR EARNINGS PER SHARE)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
-------- --------- --------- -----------
Net revenue ................................................ $ 70,680 $ 211,976 $ 226,850 $ 779,482
Operating expenses:
Cost of provider services ............................... 49,166 56,358 139,600 174,292
Salaries, wages and benefits ............................ 10,716 60,145 42,724 240,593
Supplies ................................................ 611 24,668 3,956 100,504
Purchased medical services .............................. -- 3,494 312 15,781
Other expenses .......................................... 6,970 43,589 36,926 137,699
General corporate expenses .............................. 2,055 4,026 10,017 18,978
Rents and lease expense ................................. 1,155 12,874 5,826 54,153
Depreciation and amortization ........................... 1,335 9,505 6,489 42,559
Provision for (recovery of) asset revaluation,
restructuring and refinancing ......................... (672) 54,158 (1,087) 485,243
-------- --------- --------- -----------
Net operating expenses ........................... 71,336 268,817 244,763 1,269,802
-------- --------- --------- -----------
Loss from operations ............................. (656) (56,841) (17,913) (490,320)
Other (income) expense:
Interest income ......................................... (910) (1,874) (2,791) (5,083)
Interest expense ........................................ 4,316 8,071 13,025 28,049
-------- --------- --------- -----------
Loss before income taxes and minority interest ... (4,062) (63,038) (28,147) (513,286)
Income tax expense ......................................... -- 322 -- 957
Minority interest in earnings (losses) of consolidated
partnerships ............................................ (114) 1,015 269 2,529
-------- --------- --------- -----------
Net loss ......................................... $ (3,948) $ (64,375) $ (28,416) $ 516,772)
======== ========= ========= ===========
Loss per share:
Basic ................................................... $ (0.05) $ (0.87) $ (0.39) $ (7.02)
Diluted ................................................. $ (0.05) $ (0.87) $ (0.39) $ (7.02)
======== ========= ========= ===========
Weighted average number of shared and dilutive
share equivalents outstanding:
Basic ................................................... 73,234 73,841 73,240 73,623
Diluted ................................................. 73,234 73,841 73,240 73,623
======== ========= ========= ===========
See accompanying notes to consolidated financial statements.
3
PHYCOR, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (ALL
AMOUNTS ARE EXPRESSED IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
-------- -------- -------- ---------
Cash flows from operating activities:
Net loss ............................................ $ (3,948) $(64,375) $(28,416) $(516,772)
Adjustments to reconcile net loss to net cash
provided (used) by operating activities:
Depreciation and amortization ..................... 1,335 9,505 6,489 42,559
Minority interests ................................ (114) 1,015 269 2,529
Provision for (recovery of) asset revaluation,
restructuring and refinancing ................... (672) 54,158 (1,087) 485,243
Write down of notes receivable .................... -- -- 4,564 --
Accretion of convertible subordinated notes ....... 1,688 1,688 5,063 5,063
Increase (decrease) in cash, net of effects of
acquisitions and dispositions due to changes
in:
Accounts receivable, net .................... 708 10,456 5,092 27,124
Inventories, prepaid expenses and other
current assets ............................ (930) 6,259 7,961 8,126
Accounts payable ............................ (206) 2,049 (4,640) (2,226)
Due to physician groups ..................... -- (3,418) 282 (5,261)
Incurred but not reported claims payable .... 159 8,595 5,250 16,988
Accrued restructuring reserves .............. (529) (8,369) (4,525) (20,834)
Other accrued expenses and current
liabilities ............................... (134) (14,183) (11) (29,101)
-------- -------- -------- ---------
Net cash provided (used) by operating
activities ............................. (2,643) 3,380 (3,709) 13,438
-------- -------- -------- ---------
Cash flows from investing activities:
Dispositions, net ................................. -- 60,439 63,381 99,220
Purchase of property and equipment ................ (97) (2,052) (251) (18,561)
Proceeds from (payments for) other assets ......... (90) 2,722 2,981 1,551
Change in restricted cash held for sale ........... -- -- 30,378 --
-------- -------- -------- ---------
Net cash provided (used) by investing
activities ............................. (187) 61,109 96,489 82,210
-------- -------- -------- ---------
Cash flows from financing activities:
Cost of issuance of common stock and warrants ..... -- 7 -- (125)
Repayment of long-term borrowings ................. (20) (72,084) (47,975) (98,848)
Repayment of obligations under capital leases ..... (16) (675) (81) (2,713)
Distributions of minority interests ............... 146 (619) (1,261) (3,379)
Loan costs incurred ............................... -- (2,872) -- (4,965)
-------- -------- -------- ---------
Net cash provided (used) by financing
activities ................................ 110 (76,243) (49,317) (110,030)
-------- -------- -------- ---------
Net increase (decrease) in cash and cash equivalents ... (2,720) (11,754) 43,463 (14,382)
Cash and cash equivalents - beginning of period ........ 47,110 58,084 927 60,712
-------- -------- -------- ---------
Cash and cash equivalents - end of period .............. $ 44,390 $ 46,330 $ 44,390 $ 46,330
======== ======== ======== =========
See accompanying notes to consolidated financial statements.
4
PHYCOR, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS
OF CASH FLOWS (CONTINUED)
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(ALL AMOUNTS ARE EXPRESSED IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
------- -------- -------- ---------
SUPPLEMENTAL SCHEDULE OF INVESTING ACTIVITIES:
Effects of acquisitions and dispositions, net:
Assets acquired (disposed), net of cash ..................... -- 108 -- (1,161)
Liabilities paid, including deferred purchase price
payments ................................................. -- (451) (67) (7,229)
Cash received from disposition of clinic assets, net ........ -- 60,782 63,448 107,610
------- -------- -------- ---------
Dispositions, net .................................... $ -- $ 60,439 $ 63,381 $ 99,220
======= ======== ======== =========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Notes receivable received from disposition of clinic assets
$ -- $ 4,875 $ 13,796 $ 23,770
======= ======== ======== =========
See accompanying notes to consolidated financial statements.
5
PHYCOR, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in
the United States of America for interim financial reporting and in
accordance with Rule 10-01 of Regulation S-X.
In the opinion of management, the unaudited interim consolidated
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 consolidated financial statements, footnote disclosures and other
information should be read in conjunction with the consolidated
financial statements and the notes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2000.
In the second quarter of 2001, the Company determined it would retain
and continue to operate the PrimeCare operations. PrimeCare accounts
for most of the revenue and earnings of the Company's independent
practice association ("IPA") business. In the fourth quarter of 2000,
the Company decided to solicit bids for the sale of PrimeCare. After
reviewing these bids, and after certain other assets were sold which
helped to alleviate PhyCor's short-term cash flow problems, in June
2001, the Company decided to retain PrimeCare. Accordingly, PrimeCare
is not accounted for as an asset held for sale at September 30, 2001 as
it was on December 31, 2000.
(2) NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued Statement No. 141, Business Combinations,
and Statement No. 142, Goodwill and Other Intangible Assets. Statement
141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001 as well as all
purchase method business combinations completed after June 30, 2001.
Statement 141 also specifies criteria intangible assets acquired in a
purchase method business combination must meet to be recognized and
reported apart from goodwill, noting that any purchase price allocable
to an assembled workforce may not be accounted for separately.
Statement 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of
Statement 142. Statement 142 will also require that intangible assets
with definite useful lives be amortized over their respective estimated
useful lives to their estimated residual values, and reviewed for
impairment in accordance with SFAS No. 144, Accounting for Impairment
or Disposal of Long-Lived Assets as discussed below.
The Company is required to adopt the provisions of Statement 141
immediately and Statement 142 effective January 1, 2002. Furthermore,
any goodwill and any intangible asset determined to have an indefinite
useful life that are acquired in purchase business combinations
completed after June 30, 2001 will not be amortized, but will continue
to be evaluated for impairment in accordance with the appropriate
pre-Statement 142 accounting literature. Goodwill and intangible assets
acquired in business combinations completed before July 1, 2001 will
continue to be amortized prior to the adoption of Statement 142.
Statement 141 will require, upon adoption of Statement 142, that the
Company evaluate its existing intangible assets and goodwill that were
acquired in a prior purchase business combination, and make any
necessary reclassifications in order to conform with the new criteria
in Statement 141 for recognition apart from goodwill. Upon adoption of
Statement 142, the Company will be required to reassess the useful
lives and residual values of all intangible assets acquired in purchase
business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In
addition,
6
to the extent an intangible asset is identified as having an indefinite
useful life, the Company will be required to test the intangible asset
for impairment in accordance with the provisions of Statement 142
within the first interim period. Any impairment loss will be measured
as of the date of adoption and recognized as the cumulative effect of a
change in accounting principle in the first interim period.
In connection with the transitional goodwill impairment evaluation,
Statement 142 will require the Company to perform an assessment of
whether there is an indication that goodwill is impaired as of the date
of adoption. To accomplish this the Company must identify its reporting
units and determine the carrying value of each reporting unit by
assigning the assets and liabilities, including the existing goodwill
and intangible assets, to those reporting units as of the date of
adoption. The Company will then have up to six months from the date of
adoption to determine the fair value of each reporting unit and compare
it to the reporting unit's carrying amount. To the extent a reporting
unit's carrying amount exceeds its fair value, an indication exists
that the reporting unit's goodwill may be impaired and the Company must
perform the second step of the transitional impairment test. In the
second step, the Company must compare the implied fair value of the
reporting unit's goodwill, determined by allocating the reporting
unit's fair value to all of its assets and liabilities in a manner
similar to a purchase price allocation in accordance with Statement
141, to its carrying amount, both of which would be measured as of the
date of adoption. This second step is required to be completed as soon
as possible, but no later than the end of the year of adoption. Any
transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's statement
of earnings.
Because of the extensive effort needed to comply with adopting
Statements 141 and 142, it is not practicable to reasonably estimate
the impact of adopting these Statements on the Company's financial
statements at the date of this report, including whether any
transitional impairment losses will be required to be recognized as the
cumulative effect of a change in accounting principle.
In August 2001, the Financial Accounting Standards Board issued FASB
Statement No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (Statement 144), which supersedes both FASB Statement
No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of (Statement 121) and the accounting
and reporting provisions of APB Opinion No. 30, Reporting the Results
of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events
and Transactions (Opinion 30), for the disposal of a segment of a
business (as previously defined in that Opinion). Statement 144 retains
the fundamental provisions in Statement 121 for recognizing and
measuring impairment losses on long-lived assets held for use and
long-lived assets to be disposed of by sale, while also resolving
significant implementation issues associated with Statement 121. For
example, Statement 144 provides guidance on how a long-lived asset that
is used as part of a group should be evaluated for impairment,
establishes criteria for when a long-lived asset is held for sale, and
prescribes the accounting for a long-lived asset that will be disposed
of other than by sale. Statement 144 retains the basic provisions of
Opinion 30 on how to present discontinued operations in the income
statement but broadens that presentation to include a component of an
entity (rather than a segment of a business). Unlike Statement 121, an
impairment assessment under Statement 144 will never result in a
write-down of goodwill. Rather, goodwill is evaluated for impairment
under Statement No. 142, Goodwill and Other Intangible Assets.
The Company is required to adopt Statement 144 no later than the year
beginning after December 15, 2001, and plans to adopt its provisions
for the quarter ending March 31, 2002. Management does not expect the
adoption of Statement 144 for long-lived assets held for use to have a
material impact on the Company's financial statements because the
impairment assessment under Statement 144 is largely unchanged from
Statement 121. The provisions of the Statement for assets held for sale
or other disposal generally are required to be applied prospectively
after the adoption date to newly initiated disposal activities.
Therefore, management cannot determine the potential effects that
adoption of Statement 144 will have on the Company's financial
statements.
7
(3) LIQUIDITY AND GOING CONCERN
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern with the
realization of assets and the settlement of liabilities and commitments
in the normal course of business. The Company's leveraged financial
structure and losses from operations, however, give rise to the fact
that such realization of assets and liquidation of liabilities is
subject to significant uncertainty. At September 30, 2001, current
liabilities exceeded the Company's current assets by $332.9 million.
The Company failed to meet the February and August 2001 interest
payment obligations totaling approximately $8.8 million under the 4.5%
convertible subordinated notes ("Notes"). The Company entered into
limited forbearance agreements relating to the interest payments with
noteholders representing a majority of the aggregate principal amount
of the Notes. Pursuant to the forbearance agreements, the holders
agreed not to take action under the Notes through November 30, 2001,
subject to automatic ten business day extensions until December 31,
2001. If the Notes were to be accelerated, a default would occur under
the Company's Zero Coupon Convertible Subordinated Notes Due 2014,
outstanding amount of approximately $114.1 million, as of September 30,
2001 (the "Warburg Notes"), held by affiliates of Warburg, Pincus & Co.
("Warburg, Pincus"). The Company obtained a waiver and forbearance
agreement from Warburg, Pincus through November 30, 2001 subject to
automatic ten business day extensions until December 31, 2001.
The default under the Notes caused a default under the Company's bank
credit facility with Citicorp USA, Inc. as agent ("Citicorp Credit
Facility"), which default was waived by the senior lenders. Under the
Citicorp Credit Facility, there are no funds available and all letters
of credit are fully collateralized with cash held by the agent bank.
The Citicorp Credit Facility terminates December 31, 2001. In October
2001, the Company entered into a one-year credit agreement with AmSouth
Bank which provides for the issuance of letters of credit up to an
aggregate of $2.65 million to replace those outstanding under the
Citicorp Credit Facility. Letters of credit aggregating $1.0 million
are outstanding under the AmSouth credit agreement and are
collateralized with cash as will any additional such letters of credit.
The Company is in negotiations with an informal committee of holders of
the Notes and Warburg, Pincus regarding the terms of a financial
restructuring plan. The Company anticipates that in connection with its
proposed financial restructuring, it will seek protection from its
creditors, and, in any event, anticipates that all of its outstanding
Common Stock will be cancelled for no consideration or otherwise
cease to have value. A restructuring would materially change the
amounts reported in the accompanying consolidated financial statements,
which do not give effect to any necessary adjustments of the carrying
value of assets or liabilities. The Company's ability to continue as a
going concern is also dependent upon, among other things, future
profitable operations and the ability to generate sufficient cash flow
from operations and to enter into financing arrangements to meet its
obligations.
(4) NET REVENUE
Net revenue of the Company for the three months and nine months ended
September 30, 2001 is comprised of IPA revenue, net revenue from demand
management services earned at the Company's wholly-owned subsidiary
CareWise, Inc. ("CareWise") through May 25, 2001 (the date CareWise was
sold), and contract management services revenue. Net revenue of the
Company for the three months and nine months ended September 30, 2000
was comprised of net clinic service agreement revenue from 24 and 38
clinics, respectively, IPA revenue, net hospital revenue, CareWise
revenue and other operating revenues.
IPA revenue consists of fees paid by IPAs to the Company for management
services and payments for healthcare costs, usually made under
capitated arrangements, received by the Company from health maintenance
organizations ("HMOs") in situations where the Company is a party to a
capitated or similar payment agreement with the HMOs. The cost of
healthcare claims incurred by the Company under these agreements is
reported as cost of provider services. At September 30, 2001, the
Company had underwritten a $0.4 million letter of credit for the
benefit of one managed care payor to ensure payment of costs for which
the Company's affiliated IPA is responsible. The Company is exposed to
losses if a letter of credit is drawn upon and the IPA fails to fulfill
its reimbursement obligation to the Company. The Company experienced
losses of approximately $1.0 million under such letters of credit in
2001 which losses were incurred in markets where the Company no longer
has any operations.
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
8
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 part of the First Physician Care, Inc.
("FPC") acquisition, the physician groups, rather than the Company,
entered into managed care contracts. Through calculation of its service
fees, the Company shared indirectly in any capitation risk assumed by
its affiliated physician groups.
Contract management services revenue consists of fees earned from
consulting and support services provided to independent medical
organizations and physician networks of health systems through the
Company's PhySys division. The Company does not employ the personnel or
own the assets of these organizations.
The following represents amounts included in the determination of net
revenue (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
-------- -------- -------- ----------
Gross physician group, hospital and other revenue ....... $ 2,027 $377,402 $ 38,314 $1,561,727
Less:
Provisions for doubtful accounts and contractual
adjustments ...................................... -- 180,927 10,334 715,403
-------- -------- -------- ----------
Net physician group, hospital and other revenue .... 2,027 196,475 27,980 846,324
IPA revenue 123,540 229,123 403,475 751,072
-------- -------- -------- ----------
Net physician group, hospital, IPA and other
revenue .......................................... 125,567 425,598 431,455 1,597,396
Less amounts retained by physician groups and IPAs:
Physician groups ................................... -- 65,776 5,311 279,635
Clinical technical employee compensation ........... -- 9,488 815 38,841
IPAs ............................................... 54,887 138,358 198,479 499,438
-------- -------- -------- ----------
Net revenue .................................... $ 70,680 $211,976 $226,850 $ 779,482
======== ======== ======== ==========
9
(5) BUSINESS SEGMENTS
In 2001, the Company derives its revenues primarily from operating and
managing IPAs (See Note 4). In addition, until May 25, 2001 the Company
provided health care decision-support services through CareWise, and
provided other management and consulting services that did not meet the
quantitative thresholds for reportable segments and have therefore been
aggregated within the corporate and other category. In 2000, the
Company derived revenues from the aforementioned sources as well as
from operating multi-specialty medical clinics.
The Company evaluates performance based on earnings from operations
before asset revaluation and restructuring charges, refinancing,
minority interest and income taxes. The following is a financial
summary by business segment for the periods indicated (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
2001 2000 2001 2000
------ ------- ------- -------
Multi-specialty clinics:
Net revenue................................................. $ -- $108,179 $ 8,243 $486,278
Operating expenses(1)....................................... -- 108,599 8,123 451,266
Interest income............................................. -- (1,699) (7) (4,787)
Interest expense............................................ -- 8,369 230 31,730
Earnings (loss) before taxes and minority interest(1)....... -- (7,090) (103) 8,069
Depreciation and amortization............................... -- 3,097 311 24,655
Segment assets.............................................. -- 189,240 -- 189,240
IPAs:
Net revenue ................................................ 68,653 90,765 204,996 251,634
Operating expenses (1) ..................................... 67,890 87,013 200,095 269,871
Interest income ............................................ (217) (798) (614) (2,239)
Interest expense ........................................... 552 3,281 1,594 9,236
Earnings (loss) before taxes and minority interest (1) ..... 428 1,269 3,921 (25,234)
Depreciation and amortization .............................. 675 3,419 2,624 10,588
Segment assets ............................................. 74,662 172,595 74,662 172,595
Corporate and other (2):
Net revenue ................................................ 2,027 13,032 13,611 41,570
Operating expenses (1) ..................................... 4,118 19,047 37,632 63,422
Interest income ............................................ (693) 623 (2,170) 1,943
Interest expense ........................................... 3,764 (3,579) 11,201 (12,917)
Earnings (loss) before taxes and minority interest (1) ..... (5,162) (3,059) (33,052) (10,878)
Depreciation and amortization .............................. 660 2,989 3,554 7,316
Segment assets ............................................. 40,455 78,676 40,455 78,676
(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 in 2000,
hospitals managed by the Company.
(6) ASSET REVALUATION AND RESTRUCTURING
In the third quarter of 2001, the Company recorded an asset revaluation
recovery of approximately $0.7 million related to certain asset
revaluation charges recorded previously.
In the second quarter of 2001, the Company recorded a net asset
revaluation charge of approximately $0.5 million. This charge was
comprised of a pre-tax $2.0 million asset revaluation charge less
recovery of $1.5 million related to certain asset revaluation charges
recorded previously.
In the first quarter of 2001, the Company recorded a net asset
revaluation and restructuring recovery of approximately $1.0 million.
This recovery included a net pre-tax asset revaluation charge of
approximately $0.3 million, which was comprised of a $3.6 million asset
revaluation charge less recovery of $3.3 million related to certain
asset revaluation charges recorded previously. In addition, this net
recovery included a net restructuring recovery of $1.3 million, which
was comprised of a $0.5 million restructuring charge less recovery of
$1.8 million of certain restructuring charges recorded in prior years
which will not be utilized.
10
In July 2001, the Company completed the disposition of the assets of
its Denver operations and received proceeds of $55,000 in cash and the
assumption by the purchaser of certain liabilities, which approximated
the net carrying value of these assets.
The Company has approximately $21.0 million of accrued restructuring
reserves remaining at September 30, 2001, of which approximately $7.6
million are due and payable during the next 12 months. The remaining
$13.4 million primarily relates to long term lease commitments.
The following table summarizes the restructuring accrual and payment
activity for the first nine months of 2001 (in thousands):
FACILITY & SEVERANCE & OTHER
LEASE TERMINATION RELATED EXIT
COSTS COSTS COSTS TOTAL
----------------- ----------- ------- --------
Balances at December 31, 2000 $ 18,881 $ 3,462 $ 4,512 $ 26,855
First quarter 2001 charges 500 -- -- 500
Payments (378) (1,251) (620) (2,249)
Non-utilized charges taken into income (391) (51) (1,390) (1,832)
-------- ------- ------- --------
Balances at March 31, 2001 18,612 2,160 2,502 23,274
Payments (39) (869) (839) (1,747)
Other re-allocations (167) (398) 565 --
-------- ------- ------- --------
Balances at June 30, 2001 18,406 893 2,228 21,527
Payments (170) (9) (350) (529)
Other re-allocations -- (300) 300 --
-------- ------- ------- --------
Balances at September 30, 2001 $ 18,236 $ 584 $ 2,178 $ 20,998
======== ======= ======= ========
(7) COMMITMENTS AND CONTINGENCIES
(a) Employment Agreements
The Company has entered into employment agreements with certain of its
management employees, which include, among other terms, non-compete
provisions and salary and benefits continuation. Pursuant to agreements
with certain employees, the Company paid in 2000 and the second quarter
of 2001 an aggregate of approximately $1.1 million to such employees
representing an advance of severance owed in the event of their
termination by the Company without cause. The unamortized balance of
such payments was approximately $0.5 million at September 30, 2001.
The employment agreements with the Company's two executive officers
provided for the payment of bonuses aggregating up to a maximum of
$2.25 million upon the repayment of borrowings under the Credit
Facility. Approximately $0.2 million of the bonuses were earned in 2000
and the remainder was earned during the first quarter of 2001, of which
$1.88 million was paid during the first quarter and the remainder was
paid during the second quarter of 2001.
(b) 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 (only Mr. Dent remains employed by the
Company while he and Mr. Hutts serve as directors) 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
11
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. 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 Section 11 and 12 of the Securities Act of
1933 for alleged misleading statements in a prospectus released in
connection with the CareWise acquisition. The amended complaint also
added KPMG LLP ("KPMG"), the Company's independent public auditors.
KPMG removed this case to federal court and its motion to dismiss has
been denied. On October 20, 2000, this case was consolidated with the
original federal consolidated action and a new consolidated complaint
has been filed. The Company, the individual defendants and KPMG have
filed an answer and the discovery process is nearing completion. On May
30, 2001, the court granted plaintiffs' motion for class certification.
The trial of all the consolidated cases is set for March 12, 2002. 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
knowing violation of law or (c) for an unlawful distribution.
On April 18, 2000, a jury in the case of United States of America ex
rel. William R. Benz v. PrimeCare International, Inc. ("PrimeCare") and
Prem Reddy, in the United States District Court, Central District of
California, returned a verdict in favor of the plaintiff as follows:
$0.5 million against PrimeCare on plaintiff's breach of contract
claims; $0.9 million in compensatory damages and $3 million in punitive
damages jointly and severally against PrimeCare and Prem Reddy on
plaintiff's claims for wrongful termination and intentional infliction
of emotional distress; and $0.2 million against PrimeCare on
plaintiff's claim for violations of state labor codes. The jury
returned a verdict in defendants' favor on plaintiff's claim for
retaliatory termination under the False Claims Act. The jury was unable
to reach a verdict on plaintiff's Medicare fraud claims. The court
entered a final judgment on July 13, 2000. Effective May 3, 2001, the
Company entered into a settlement agreement with Mr. Benz which
subsequently received court approval. In exchange for PrimeCare paying
Mr. Benz $2.7 million (of which $0.7 million was paid during the second
quarter of 2001 and the remainder was paid during July 2001), all
claims were dropped by Mr. Benz against the Company and its affiliates.
The judgment of $4.6 million was recorded as other operating expenses
in the second quarter of 2000. Mr. Benz has not settled with Dr. Reddy,
and Dr. Reddy continues to maintain the Company has an indemnification
obligation to him. The Company denies Dr. Reddy's claim.
On August 31, 1999, two relators brought an action in the United States
District Court for the District of Hawaii under the False Claims Act
and for employment related claims against Straub Clinic and Hospital,
Inc. ("Straub"), PhyCor of Hawaii, Inc., and the Company. This matter
had been under seal until September 2000. On September 20, 2000, the
United States government elected to decline to intervene in the matter.
The Company sold PhyCor of Hawaii, Inc. to Straub in November 2000. On
February 21, 2001, plaintiffs filed a Second Amended Complaint, and
Straub is defending the claims against PhyCor of Hawaii, Inc. PhyCor,
Inc. lost its motion to dismiss and is defending the litigation against
it. Trial is set for June 12, 2002.
As a result of the Company's determination to exit its IPA market in
Houston, Texas, a number of providers in the market have brought
actions naming several parties, including the Company and an
IPA-management subsidiary of the Company, alleging breach of contract,
breach of fiduciary duty, and fraud, among other matters.
12
Several million dollars have been claimed in these cases. The Company
believes the plaintiffs have sued the wrong party and that the claims
are generally excessive. In addition, as a result of the Company's
financial condition, the Company and its subsidiaries have been unable
to meet certain contractual obligations including, but not limited to,
certain ongoing lease obligations and severance obligations to former
employees. There can be no assurance that the Company or its
subsidiaries will meet existing or additional contractual obligations
in the future. Several parties have sent letters to the Company and its
subsidiaries alleging breach of contract and threatening to bring
claims, and several suits have been filed. There can be no assurance
that additional actions will not be brought against the Company and its
subsidiaries as a result of the Company's actions. There can be no
assurance that if these matters are determined adversely to the Company
that such determinations would not have a material adverse effect on
the Company.
PrimeCare, its affiliated IPAs and its employed physicians are parties
to several medical malpractice cases which the Company believes will be
adjudicated within applicable insurance coverage limits. In addition,
the PrimeCare subsidiary which holds a limited Knox-Keene license has
been named in certain managed care liability cases which are not
expected to exceed insurance limits. Various PrimeCare entities have
been sued on business claims such as breach of contract,
misrepresentation, fraud and deceit. The plaintiffs in these suits are
seeking millions of dollars in damages, and the Company is vigorously
defending these suits. While there can be no assurance that the Company
will be successful in such litigation, the Company does not believe any
such litigation will result in damage awards at the levels the
plaintiffs have demanded, nor that such litigation will have a material
adverse effect on the Company. Finally, PrimeCare and the Company have
been named in litigation involving PrimeCare operations in the State of
Oklahoma that were not transferred to the Company when the Company
acquired PrimeCare. Plaintiffs are alleging that a former PrimeCare
subsidiary (which the Company did not buy) is guilty of breach of
contract, conversion and fraud, and plaintiff is seeking damages in
excess of $2.0 million in damages plus punitive damages. Since filing
the litigation, plaintiff has filed for bankruptcy. While the Company
did not own PrimeCare at the time of the alleged incidents, PrimeCare
and the Company may have liability for the actions of this entity and
do not have indemnity rights as to Dr. Reddy, the former owner (who is
also a codefendant in this matter). It is not possible to determine the
amount of exposure of the Company and its subsidiaries in this case,
but judgment against the Company or PrimeCare could have a material
adverse effect on the Company.
The Company has recently learned that in litigation filed in the
Circuit Court of the 11th Judicial Circuit in and for Miami-Dade
County, Florida, in which landlords, Busch Drive Ltd. and Lime Street
Ltd., of the Company's formerly affiliated physician group, First Coast
Medical Group, P.A., claimed the Company guaranteed the lease
obligations of the physician group, the judge has indicated she will
rule in favor of the landlord and that the amount of damages awarded
could be as much as $2,500,000. The Company disagrees with this
decision and intends to pursue its legal alternatives.
Certain litigation is pending against the physician groups which were
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.
(c) Insurance
The Company maintains managed healthcare errors and omissions insurance
on a claims made basis for all of its managed care operations and
officer and director liability insurance. These policies expired on
September 1 and September 11, respectively, but have been extended
until December 31, 2001. Insurance coverage under such policies is
contingent upon a policy being in effect when a claim is made,
regardless of when the events which caused the claim occurred. The
Company also maintains property and casualty, general liability,
worker's compensation and some umbrella coverage on an occurrence
basis. In addition, the Company is named as an additional insured on
medical malpractice
13
policies of some formerly affiliated physician groups. In other cases,
however, the Company has no insurance for malpractice claims brought
against such physician groups. There are known claims and incidents
that may result in the assertion of additional claims, as well as
claims from unknown incidents that may be asserted. The Company is not
aware of any claims against management or the Company's formerly
affiliated physician groups which might have a material adverse impact
on the Company's financial position. The cost and availability of
insurance coverage has varied widely in recent years. Management
believes its insurance policies are adequate in amount and coverage for
its operations. There can be no assurance, however, that the coverage
is sufficient to cover all future claims or will continue to be
available in adequate amounts or at a reasonable cost.
(d) Letters of Credit
At September 30, 2001, letters of credit totaling $2.7 million were
outstanding under the Credit Facility. On behalf of one of the
Company's affiliated IPAs, the Company has been required to issue a
$0.4 million letter of credit to a managed care payor to ensure payment
of health care costs for which an affiliated IPA has responsibility.
The Company is exposed to losses if the letter of credit is drawn upon
and the related IPA fails to satisfy its reimbursement obligation to
the Company. Approximately $1.0 million has been drawn on letters of
credit related to other IPAs to date in 2001 which have not been
reimbursed by the IPAs. These losses were incurred in markets where the
Company no longer has any operations. The $2.3 million remaining
letters of credit secure malpractice insurance deductibles and bonds
required for third party administrator licenses.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are a medical network management company that develops and manages
IPAs, manages physician hospital organizations ("PHOs"), provides contract
management services to physician networks owned by health systems and provides
consulting services to independent medical organizations. Through our IPAs and
PHOs, we provide healthcare related services to approximately 626,000 commercial
equivalent members ("CEMs"). Included in this total are 61,000 CEMs that are
enrolled in Medicare+ Choice plans offered by payors to individuals that qualify
for Medicare benefits. Our largest market is in California, where we provide
services to approximately 453,000 CEMs. Our second largest market is Chicago,
Illinois, where we provide services to 141,000 CEMs.
Our subsidiary, PrimeCare International, Inc. ("PrimeCare") manages
IPAs in California. PrimeCare's subsidiary, PrimeCare Medical Network, Inc.
("PMNI") holds a limited Knox-Keene license in the State of California and
contracts with payors to assume risk under certain managed care contracts, and
then delegates that risk predominantly to the PrimeCare-managed IPAs. Another
subsidiary, North American Medical Management, Inc. ("NAMM") manages, through
its subsidiaries, IPAs in northern and southern California, Kansas and
Tennessee, and several PHOs in Illinois. Through our subsidiary, PhySys, Inc.
("PhySys"), we provide management and support services to two of our formerly
affiliated multi-specialty clinics and to the physician networks of two health
systems. In addition, PhySys provides consulting services to independent medical
organizations through limited engagements.
As of the date hereof, as a result of our failure to pay the
approximately $4.4 million interest payments due on each of February 15, and
August 15, 2001 on the 4.5% convertible subordinated notes ("Notes"), we are in
default under the Notes. If the Notes were to be accelerated, a default would
occur under the Company's Zero Coupon Convertible Subordinated Notes Due 2014,
currently outstanding amount of approximately $114.9 million (the "Warburg
Notes"), held by affiliates of Warburg, Pincus & Co. ("Warburg, Pincus"). We
have also defaulted on obligations related to several equipment and facilities
leases. We obtained limited forbearance agreements relating to the interest
payments through November 30, 2001, subject to automatic ten business day
extensions until December 31, 2001, from bondholders representing approximately
50.4% of the Notes in the aggregate, and a waiver and forbearance agreement from
Warburg, Pincus through November 30, 2001 also subject to automatic ten business
day extensions until December 31, 2001. Moreover, the default under the Notes,
caused a default under the Company's bank credit facility (the "Citicorp Credit
Facility"), which default was waived by the senior lenders. We have no funds
available under the Citicorp Credit Facility which terminates December 31, 2001.
In October 2001, we entered into a one-year credit agreement with AmSouth Bank
which provides for the issuance of letters of credit up to an aggregate of $2.65
million to replace those outstanding under the Citicorp Credit Facility. Letters
of credit aggregating $1.0 million are outstanding under the AmSouth credit
agreement and are collateralized with cash as will be the case with any
additional such letters of credit.
In connection with the audit of our financial statements for the year
ended December 31, 2000, our
14
independent auditors stated in their report that our recurring losses from
operations, net capital deficiency and net working capital deficit raise
substantial doubt about our ability to continue as a going concern. We have
engaged Jefferies & Company, Inc. and Skadden, Arps, Slate, Meagher & Flom LLP
to assist us in restructuring our balance sheet. We are in negotiations with an
informal committee of holders of the Notes and Warburg, Pincus regarding the
terms of a financial restructuring plan. We anticipate that in connection with
the proposed financial restructuring, we will seek protection from our
creditors, and, in any event, anticipate that all of our outstanding common
stock will be cancelled for no consideration or otherwise cease to have value.
Operations
IPAs and PHOs
We operate IPA/PHO management companies, including PrimeCare, in four
states. In the State of California, we operate eight IPAs through PrimeCare and
an additional six IPAs through NAMM subsidiaries. These California operations
include 453,000 CEMs and constituted approximately 90% of the Company's revenues
in the third quarter of 2001. With respect to PrimeCare operations, PMNI
contracts with payors primarily on a capitated basis. The administrative and
financial responsibility for credentialing, medical management, capitation
management and claims adjudication and payment are delegated by the payors to
us. PMNI contracts primarily with PrimeCare-managed IPAs to perform the
physician services. Contractually, PMNI assumes full risk that the costs of
professional services will exceed the capitated payments, and, through
contracting with various hospitals, assumes limited risk for the institutional
(hospital) costs up to pre-defined limits of any losses. In future periods, PMNI
may assume more risk for the institutional costs.
PMNI contracts with several payors, however, contracts with Pacificare
of California represent approximately 33% of the revenue from PrimeCare
operations. The payor contracts are renewed annually on a calendar basis and
have been renewed for the 2002 calendar year.
As a result of PNMI holding a limited Knox-Keene license in the State
of California, PNMI is subject to an increased level of state oversight,
including reserve requirements by the California Department of Managed Health
Care (the "DMHC"). During the third quarter of 2000, PNMI reached an agreement
with the DMHC regarding the funding of certain cash reserve requirements for
claims payment. Under this agreement, PrimeCare agreed not to make any
distributions of cash to the Company if any such distribution would cause
PrimeCare not to be in compliance with the Knox-Keene requirements. PrimeCare
was in compliance with such requirements as of September 30, 2001, and had
restricted cash reserves of $25.5 million and outstanding healthcare claims and
liabilities of $22.5 million. Our operations would be adversely affected if we
failed to maintain compliance with the agreement and the DMHC took corrective
action. If, as expected, we seek protection from our creditors in connection
with our proposed restructuring, the operations of our IPA businesses are not
expected to be affected. For the third quarter of 2001, PrimeCare and our other
IPA companies in California, operated through NAMM subsidiaries in both northern
and southern California, had revenues of $64.3 million and earnings before
interest, taxes, depreciation and amortization ("EBITDA") of $1.6 million,
compared to revenues of $52.9 million and EBITDA of $1.4 million for the third
quarter of 2000. For the first nine months of 2001, these entities had revenues
of $190.2 million and EBITDA of $7.1 million, compared to revenues of $157.7
million and no EBITDA for the first nine months of 2000.
In addition to our California operations, NAMM manages, through its
subsidiaries, IPAs in Kansas and Tennessee and eight PHOs in Illinois. Fees
earned from managing the IPAs/PHOs are based upon a percentage of either revenue
collected by the IPAs or a per member/per month payment, and a share of surplus,
if any, of capitated revenue of the IPAs/PHO in excess of claims expense. The
management agreements are typically for a term of between three and five years,
with renewal options, and may be terminated at any time, without cause, upon 90
days notice.
A substantial portion of our revenues and profits are derived from the
61,000 CEMs we serve that qualify for Medicare benefits. In the past two years,
many payors have discontinued enrollment in Medicare+ Choice plans or abandoned
markets altogether because rate increases provided to payors by the Federal
government have not kept pace with medical inflation and the rising utilization
of healthcare services. Although this trend has not affected our
15
operations in California to date, we anticipate that our Chicago market will be
adversely affected by this trend. Our dependence on the viability of Medicare+
Choice products offered by payors is a key factor in the assessment of our
business strength and is central to our development of a long-term business
strategy.
We intend to pursue the growth of PrimeCare and NAMM. We have
identified certain acquisition candidates that management believes may add value
to PrimeCare's operations. In addition, PrimeCare is seeking to contract with
additional payors and to have additional physicians join its managed IPAs. NAMM
is also seeking to develop additional management relationships with IPAs to
enhance both capitated and non-capitated managed care contracting systems. We
anticipate continuing IPA management operations in the markets where NAMM
currently operates.
Service, Management and Consulting Agreements
Through our PhySys division, we provide management and support services
to two multi-specialty clinics that were formerly affiliated with the Company,
the Harbin Clinic in Rome, Georgia and the Lakeview Medical Center in Suffolk,
Virginia. We do not employ the personnel at these clinics, and we do not own any
clinic assets. Our fee under each agreement is a fixed monthly fee, and we are
reimbursed certain expenses. These agreements are for seven and five years,
respectively, subject to termination for various reasons. Until September 30,
2005, we are obligated under the Rome agreement to provide lease financing for
the acquisition of equipment to be used in the operation of the group up to
$750,000 annually. The financing under the lease would be at the prime rate, and
the clinic has the sole discretion whether to use us as the source of leased
equipment. To date, no such financing has been requested by the clinic. The
Suffolk Agreement may be terminated without cause upon 90 days notice, provided
that the physician group pays a termination fee based on the remaining term of
the agreement. Lakeview Medical Center may offset against any obligation it has
to the Company, amounts that are owed to it under two promissory notes, dated
January, 1998, in the current aggregate principal amount of approximately
$318,000.
In addition, through PhySys, we provide management services to the
physician networks of health systems. At present, our PhySys division provides
management and support services to the 121-physician group related to the
Rockford Health System, a health care delivery system serving northern Illinois
and southern Wisconsin. The Rockford agreement terminates on December 31, 2002,
subject to certain renewal provisions. The fee is a fixed annual fee, payable
monthly, and we are reimbursed various expenses. We are obligated to provide an
executive director, a controller and an analyst to perform services. In April
2001, PhySys entered into an agreement to provide services to MedClinic of
Sacramento, a 124-member physician group affiliated with the Mercy Health System
in Sacramento, California. PhySys is obligated to provide an executive director
and a controller to perform services, to which PhyCor, Inc. is a guarantor. The
agreement is for a three year term but is subject to earlier termination by
either party in certain circumstances, including termination prior to January 2,
2002 for any reason, with a termination fee payable to PhySys under certain
additional circumstances. The agreement provides for the reimbursement of
PhySys' expenses and payment of the greater of a fixed fee or an incentive fee
up to a maximum fee. We are pursuing additional relationships with health
systems and physician groups but there is no assurance that we will enter into
similar arrangements in the future or that such arrangements will be successful.
We believe that we can assist the health systems and independent
medical organizations in improving the operations of their physician networks by
offering the organizations a range of services to address their needs. Pursuant
to these affiliations, we provide management services to the physician networks
for a fee but do not acquire the assets or employ the personnel of the physician
groups, except certain key employees, and do not have any ongoing obligation to
provide capital to the affiliated groups. If we choose to invest capital with
these groups in the future, we may do so through a joint venture. To date, we
have not invested any capital with these groups. This modified structure enables
the physician group or health system to benefit from our management expertise,
yet retain control of its employees and decisions regarding future capital
investment.
Through PhySys we also provide consulting services to independent
medical organizations through limited engagements and intend to pursue other
similar engagements in the future. There can be no assurance that we will
continue to obtain additional engagements or that such engagements will be
profitable.
16
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2001 2000 2001 2000
------ ------ ------ ------
Net revenue ............................................. 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Cost of provider services ........................... 69.6 26.6 61.5 22.4
Salaries, wages and benefits ........................ 15.2 28.4 18.8 30.9
Supplies ............................................ 0.8 11.6 1.7 12.9
Purchased medical services .......................... 0.0 1.6 0.1 2.0
Other expenses ...................................... 9.8 20.6 16.3 17.7
General corporate expenses .......................... 2.9 1.9 4.4 2.4
Rents and lease expense ............................. 1.6 6.1 2.6 6.9
Depreciation and amortization ....................... 1.9 4.5 2.9 5.5
Provision for (recovery of) asset revaluation
and restructuring .................................. (0.9) 25.5 (0.4) 62.2
------ ------ ------ ------
Net operating expenses ................................. 100.9 126.8 107.9 162.9
------ ------ ------ ------
Loss from operations ................................ (0.9) (26.8) (7.9) (62.9)
Interest income ........................................ (1.3) (0.9) (1.2) (0.6)
Interest expenses ...................................... 6.1 3.8 5.7 3.6
------ ------ ------ ------
Loss before income taxes and minority interest ...... (5.7) (29.7) (12.4) (65.9)
Income tax expense ...................................... 0.0 0.2 0.0 0.1
Minority interest ....................................... (0.1) 0.5 0.1 0.3
------ ------ ------ ------
Net loss ............................................ (5.6)% (30.4)% (12.5)% (66.3)%
====== ====== ====== ======
2001 COMPARED TO 2000
Net revenue decreased $141.3 million, or 66.7%, from $212.0 million for
the third quarter of 2000 to $70.7 million for the third quarter of 2001, and
$552.6 million, or 70.9%, from $779.5 million for the first nine months of 2000
to $226.9 million for the first nine months of 2001.
Net revenue from IPAs decreased $22.1 million, or 24.4%, from $90.8
million for the third quarter of 2000 to $68.7 million for the third quarter of
2001 and $46.6 million, or 18.5%, from $251.6 million for the first nine months
of 2000 to $205.0 million for the first nine months of 2001. IPA Net Revenue
decreased approximately $33.7 million and $79.9 million in the third quarter and
first nine months of 2001, respectively, compared to the same periods in 2000
primarily as a result of the decisions to restructure and close the Houston,
Dallas and various other IPA markets and to place our HMO in Kentucky in
voluntary rehabilitation with the Commonwealth of Kentucky Department of
Insurance, during the fourth quarter of 2000. IPA Net Revenue from the IPA
markets in effect for the third quarter and first nine months of 2001 and 2000
increased by $11.6 million, or 20.2%, and $33.3 million, or 19.5%, respectively,
compared to the same periods in 2000. Net revenue from PrimeCare and our other
IPA companies in California increased $11.4 million to $64.3 million for the
third quarter of 2001 and $32.5 million to $190.2 million for the first nine
months of 2001 compared to the same periods in 2000 primarily as a result of
increased enrollment.
Net revenue from clinics decreased $108.2 million in the third quarter
of 2001 and $478.0 million for the first nine months of 2001 compared to the
same periods in 2000 due to the disposal of clinic operations. Net revenue from
consulting engagements for the third quarter and first nine months of 2001
increased $1.0 million and $2.5 million, respectively, compared to the same
periods in 2000.
Comparing operating expense ratios between the third quarter and first
nine months of 2001 and the corresponding periods in 2000 is difficult given the
large decrease in and change in composition of net revenue between the periods.
Net revenue from our IPA operations were 97% and 90% of our total net revenue
for the third quarter and first nine months of 2001, respectively, compared to
43% and 32% for the third quarter and first nine months of 2000, respectively.
As such, cost of provider services as a percentage of net revenue significantly
17
increased during the third quarter and first nine months of 2001 compared to the
same periods in 2000 because cost of provider services relates primarily to our
IPA operations. Conversely, salaries, wages and benefits decreased as a
percentage of net revenues because our multi-specialty clinic operations, which
required more personnel to operate, comprised only 3% of our total net revenue
for the first nine months of 2001 compared to 51% and 62% of our total net
revenue for the third quarter and first nine months in 2000, respectively. Other
operating expenses decreased as a percentage of net revenue for the third
quarter of 2001 compared to the third quarter of 2000 because of a $8.5 million
expense recorded on the discount of a certain notes receivable in the third
quarter of 2000.
On behalf of certain of our affiliated IPAs, we have underwritten
letters of credit to managed care payors to ensure payment of health care costs
for which the affiliated IPAs have responsibility. As of September 30, 2001, a
letter of credit for $0.4 million was outstanding under the Credit Facility for
the benefit of one managed care payor. To date in 2001, draws on such letters of
credit totaled approximately $1.0 million which have not been reimbursed by the
IPAs.
The asset revaluation recovery for the quarter ending September 30,
2001 totaled approximately $0.7 million. See discussion of these recoveries in
"Asset Revaluation and Restructuring" below.
We 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.
ASSET REVALUATION AND RESTRUCTURING
General
In the third quarter of 2001, we recorded an asset revaluation recovery
of approximately $0.7 million of certain asset revaluation charges recorded
previously.
In the second quarter of 2001, we recorded a net asset revaluation
charge of approximately $0.5 million. This charge was comprised of a $2.0
million asset revaluation charge less recovery of $1.5 million related to
certain asset revaluation charges recorded previously.
In the first quarter of 2001, we recorded a net asset revaluation and
restructuring recovery of approximately $1.0 million. This net recovery included
a net pre-tax asset revaluation charge of approximately $0.3 million, which was
comprised of a $3.6 million asset revaluation charge less recovery of $3.3
million of certain asset impairment charges recorded in prior years. The net
recovery also included a net restructuring reserve recovery of approximately
$1.3 million, which was comprised of a $0.5 million restructuring charge less
recovery of $1.8 million of restructuring reserves recorded in prior years which
will not be utilized.
Assets Held for Sale
At September 30, 2001, we had no material assets classified as held for
sale. In the third quarter 2001, we completed the disposition of the assets of
our Denver operations and received proceeds totaling $55,000 in cash, in
addition to certain liabilities assumed by the purchasers, which approximated
the net carrying value of these assets. In the second quarter of 2001, we
completed the disposition of the assets of our last two owned clinics and our
CareWise operations and received consideration consisting of $10.4 million in
cash and $1.8 million in notes receivable, in addition to certain liabilities
assumed by the purchasers.
We completed the disposition of the assets of four clinics, certain
real estate holdings and other assets during the first quarter of 2001 and
received consideration consisting of $54.7 million in cash and $12.0 million in
notes receivable, in addition to certain liabilities assumed by the purchasers.
Restructuring Charges
We did not adopt or implement any restructuring plans in the second or
third quarters of 2001. In the first quarter of 2001, we adopted and implemented
restructuring plans and recorded a net pre-tax restructuring reserve
18
recovery of approximately $1.3 million. This recovery was comprised of a
$500,000 restructuring charge related to the disaffiliation with one of our
multi specialty groups and the recovery of approximately $1.8 million related to
restructuring charges recorded in prior years which will not be utilized.
During the third quarter and first nine months of 2001, we paid
approximately $0.2 million and $0.6 million in facility and lease termination
costs, respectively, $8,000 and $2.1 million in severance costs, respectively,
and $0.3 million and $1.8 million in other exit costs, respectively, related to
2000, 1999 and 1998 restructuring charges. At September 30, 2001, accrued
restructuring reserves totaled approximately $21.0 million, which included $18.2
million in facility and lease termination costs, $0.6 million in severance costs
and $2.2 million in other exit costs. We estimate that approximately $7.6
million of the remaining liabilities at September 30, 2001 are due and payable
during the next 12 months. The remaining $13.4 million primarily relates to long
term lease commitments.
LIQUIDITY AND CAPITAL RESOURCES
General
In 2000, as a result of the outcome of discussions with our affiliated clinics,
we determined to sell the remaining assets of our medical clinic business and to
apply the proceeds to the amounts outstanding under the Citicorp Credit
Facility. In April 2001, we completed the disposition of all remaining owned
clinics. The proceeds were used to pay down outstanding borrowings under the
Citicorp Credit Facility and to cash collateralize certain letters of credit
issued under the Citicorp Credit Facility. We failed to meet the February and
August 2001 interest payment obligations under the Notes totaling approximately
$8.8 million. The default under the Notes created a default under the Citicorp
Credit Facility, which default was waived by the senior lenders. The Company has
no funds available under its Citicorp Credit Facility which terminates December
31, 2001. In October 2001, we entered into a one-year credit agreement with
AmSouth Bank which provides for the issuance of letters of credit up to an
aggregate of $2.65 million to replace those outstanding under the Citicorp
Credit Facility. Letters of credit aggregating $1.0 million are outstanding
under the AmSouth credit agreement and are collateralized with cash as will be
the case with any additional such letters of credit.
If the Notes were to be accelerated, a default would occur under the
Warburg Notes. We have also defaulted on obligations related to several
equipment and facility leases. We obtained limited forbearance agreements
respecting the interest payments on the Notes through November 30, 2001, subject
to automatic ten business day extensions until December 31, 2001, from
bondholders representing approximately 50.4% of the Notes in the aggregate, and
a waiver and forbearance agreement from Warburg, Pincus through November 30,
2001 with automatic ten business day extensions until December 31, 2001. We have
engaged Jefferies & Company, Inc. and Skadden, Arps, Slate, Meagher & Flom LLP
to assist us in restructuring our balance sheet. We are in negotiations with an
informal committee of holders of the Notes and Warburg, Pincus regarding the
terms of a financial restructuring plan. We anticipate that in connection with
our proposed financial restructuring, we will seek protection from our
creditors, and in any event, anticipate that all of our outstanding common stock
will be cancelled for no consideration or otherwise cease to have value.
At September 30, 2001, current liabilities exceeded our current assets
by $332.9 million, compared to $305.8 million at December 31, 2000. At September
30, 2001, we had $44.4 million in cash and cash equivalents, of which $14.8
million was available for general corporate purposes, compared to $0.9 million
and $0.3 million, respectively, at December 31, 2000. The significant change in
the cash balance is a result of PrimeCare being held for sale at December 31,
2000, with all of its cash and restricted cash recorded as assets held for sale
on the accompanying consolidated balance sheet and PrimeCare not being held for
sale at September 30, 2001. Restricted cash and cash equivalents include amounts
held by IPA partnerships, the use of which is restricted to operations
of the IPA partnerships or to meet other contractual requirements and $2.7
million of cash collateralizing letters of credit.
Operating activities used $2.6 million and $3.7 million of cash in the
third quarter and first nine months of 2001, respectively, compared to
generating $3.4 million and $13.4 million of cash in the third quarter and first
nine months of 2000. Cash flows from operations of clinics that were disposed of
or closed at September 30, 2001 resulted in a decrease of $1.1 million and $34.3
million for the third quarter and first nine months of 2001, respectively,
compared to the same periods in 2000. Our IPA management division experienced
losses in certain markets in 2000. We ceased operations in eleven IPA markets in
2000, including the Houston and Dallas managed IPA markets in the fourth quarter
of 2000. Cash flows related to our IPA operations decreased $4.7 in the third
quarter of 2001 compared to the third quarter of 2000 due to decreased cash flow
from our PrimeCare operations of which $2.0 million of this decrease was a
result of the payment of the Benz litigation settlement (see Part II, Item 1,
Legal Proceedings). Cash flows related to our IPA operations increased $21.7
million in the first nine months of 2001 compared to the
19
first nine months of 2000 primarily as a result of the disposition or closing of
the aforementioned underperforming markets.
The employment agreements with the Company's two executive officers
provided for the payment of bonuses aggregating up to a maximum of $2.25 million
upon the repayment of borrowings under the Credit Facility. Approximately $0.2
million of the bonuses were earned in 2000 and the remainder was earned during
the first quarter of 2001 of which $1.88 million was paid during the first
quarter and the remainder was paid during the second quarter of 2001.
Capital expenditures during the third quarter and first nine months of
2001 totaled $97,000 and $251,000, respectively. We expect to make less than
$0.5 million in capital expenditures in 2001, which we anticipate will be funded
primarily from cash reserves.
During 2000, we resolved the outstanding Internal Revenue Service
("IRS") examination for the years 1996 through 1998. The IRS examinations
resulted in an adjustment to the 1998 loss carryback and, accordingly, we repaid
approximately $1.2 million plus interest as a result of revisions in the
alternative minimum tax calculation. The tax years 1988 through 1998 have been
closed with respect to all issues without a material financial impact.
Additionally, two subsidiaries are currently under examination for the 1995 and
1996 tax years. We 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. We cannot determine at
this time the resolution of these matters, however, we do not believe the
resolution of these matters will have a material adverse effect on our financial
condition, although there can be no assurance as to the outcome of these
matters. As of December 31, 2000, we had approximately $557.8 million in net
operating loss carryforwards; accordingly, we do not expect to pay current
federal income taxes for the foreseeable future.
Capital Resources
We have $196.5 million in principal amount outstanding under the Notes
which mature in 2003. Our failure to make the February 15, 2001 interest payment
on the Notes resulted in an Event of Default under the terms of the related
indenture on March 17, 2001. We also failed to make the August 15, 2001 interest
payment on the Notes. We entered into limited forbearance agreements relating to
the interest payments with noteholders representing 50.4% of the aggregate
principal amount of the Notes. Pursuant to the forbearance agreements, the
holders have agreed not to take action under the Notes through November 30,
2001, subject to automatic ten business day extensions until December 31, 2001.
If the principal due under the Notes were to be accelerated, an event of default
would occur under the Warburg Notes. We also obtained a waiver and forbearance
agreement through November 30, 2001 subject to automatic ten business day
extensions until December 31, 2001, from Warburg, Pincus relating to the
possible default under the Warburg Notes.
We are in negotiations with an informal committee of holders of the
Notes and Warburg, Pincus regarding the terms of a financial restructuring plan.
We anticipate that in connection with the proposed financial restructuring, we
will seek protection from our creditors, and, in any event, anticipate that all
of our outstanding common stock will be cancelled for no consideration or
otherwise cease to have value.
Our Citicorp Credit Facility and synthetic lease facility were modified
several times in 2000. The Citicorp Credit Facility, as amended August 25, 2000,
provided for the conversion of outstanding balances under the previous revolving
credit and synthetic lease facilities and outstanding letters of credit to a
term loan ("Term Loan") and a $25 million revolving loan ("Revolving Loan").
Amounts were available under this Revolving Loan only to the extent repayments
were made from our excess cash flows. The restated Citicorp Credit Facility also
included a senior secured revolving loan of up to $10 million ("New Revolving
Loan"). Under the terms of this amended Citicorp Credit Facility, net cash
proceeds from asset sales were required to be prepaid against outstanding
borrowings under the Term Loan, the Revolving Loan and the New Revolving Loan
and then to cash collateralize outstanding letters of credit. Pursuant to the
March 30, 2001 amendment, irrespective of asset sales, the aggregate
uncollateralized letters of credit were required to be reduced on an established
timetable until maturity on December 31, 2001. During the first quarter of 2001,
all borrowings under the Citicorp Credit Facility were repaid and during the
second quarter of 2001, all outstanding letters of credit were fully
collateralized with cash held by the agent bank. No additional borrowings are
available under the Citicorp Credit Facility.
20
Letters of credit issued under the Citicorp Credit Facility totaling
$1.7 million are fully secured by cash in addition to the capital stock the
Company holds in certain of its subsidiaries (as defined in the Citicorp Credit
Facility) and the personal property held by the Company and its subsidiaries.
The Credit Facility terminates December 31, 2001. The Company does not
anticipate having any additional access to capital in the near future. In
October 2001, we entered into a one-year credit agreement with AmSouth Bank
which provides for the issuance of letters of credit up to an aggregate of $2.65
million to replace those outstanding under the Citicorp Credit Facility. Letters
of credit aggregating $1.0 million are outstanding under the AmSouth credit
agreement and are collateralized with cash as will any additional such letters
of credit.
Summary
The completed asset sales will substantially reduce our revenue and
earnings in the future. The outcome of certain legal proceedings described in
Part II, Item 1 hereof may have a negative impact on our liquidity and capital
reserves.
At September 30, 2001, we had cash and cash equivalents of
approximately $44.4 million, of which $14.8 million was available for general
corporate purposes, and currently have no availability under the Credit
Facility. We defaulted on our obligation to make interest payments due February
15, 2001 and August 15, 2001 totaling approximately $8.8 million on the Notes.
If the Notes were to be accelerated, a default would occur under the Warburg
Notes. We have also defaulted on obligations related to several equipment and
facility leases. We obtained limited forbearance agreements respecting the
interest payments Notes through November 30, 2001, subject to automatic ten
business day extensions until December 31, 2001, from bondholders representing a
majority of the Notes in the aggregate and Warburg, Pincus. Failure of the
bondholders or Warburg, Pincus to continue the forbearance agreements could have
a material adverse effect on our operations. At present, we could not satisfy
any acceleration demand by the noteholders or Warburg, Pincus.
In their report on the audit of our consolidated financial statements
for the fiscal year ended December 31, 2000, our auditors stated that our
recurring losses from operations, net capital deficiency and net working capital
deficit raise substantial doubts about our ability to continue as a going
concern. We have engaged Jefferies & Co., Inc. and Skadden, Arps, Slate, Meagher
& Flom LLP to assist us in restructuring our balance sheet. The Company is in
negotiations with an informal committee of holders of the Notes and Warburg,
Pincus regarding the terms of a financial restructuring plan. We anticipate that
in connection with the proposed financial restructuring, we will seek protection
from our creditors, and, in any event, anticipate that all of our outstanding
common stock will be cancelled for no consideration or otherwise cease to have
value. In the event that, as expected, we seek protection from our creditors, we
believe that our continuing IPA businesses, which are adequately capitalized and
cash flow positive, will remain outside of any protective actions. Our objective
over the past several months has been to ensure that the continuing IPA
businesses are positioned within their markets to remain financially viable and
independent from the financial difficulty of the parent company, PhyCor.
FORWARD-LOOKING STATEMENTS
The disclosure and analysis in this report and other information that
is provided by PhyCor, Inc. ("PhyCor," the "Company" "we," "our" or "us")
contain some forward-looking statements. Forward-looking statements give our
current expectations or forecasts of future events. These statements do not
relate solely to historical or current facts and can be identified by the use of
words such as "may," "believe," "will," "expect," "project," "estimate,"
"anticipate," "plan," "should" or "continue." From time to time, we also may
provide oral or written forward-looking statements in other materials we release
to the public.
Any of our forward-looking statements in this report and in any other
public statements we make may turn out to be incorrect. These statements can be
affected by inaccurate assumptions we might make or by known or unknown risks
and uncertainties. Such risks and uncertainties include our ability to operate
as a going concern, to reach agreement with the holders of the Notes and
Warburg, Pincus regarding the terms of a financial restructuring plan, the
ability of the IPA businesses to remain outside of any protective actions, the
adequacy of our capital resources, the impact on the value of the Company's
common stock as a result of any restructuring, the impact on
21
earnings and the possibility of additional charges to earnings resulting from
terminating or restructuring our relationships with our IPAs and their payors
and our ability to operate IPAs and other physician organizations profitably.
Changes in contractual relationships, competition in the health care industry,
regulatory developments and changes, the nature of capitated fee arrangements
and other methods of payment for medical services, the risk of professional
liability claims, and the outcome of pending litigation will also be important
in determining future results. Consequently, actual future results may vary
materially from the forward-looking statements made in this document. For a more
detailed discussion of the factors that could affect the results of operations
and financial condition of the Company, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Risk Factors."
We undertake no obligation to publicly update any forward-looking
statements, whether as a result of new information, future events or otherwise.
You are advised, however, to consult any further disclosures we make on related
subjects in our 10-Q, 8-K and 10-K reports to the SEC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
During the third quarter and first nine months ended September 30,
2001, 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, 2000.
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 (only Mr. Dent remains employed by the
Company while he and Mr. Hutts serve as directors) 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. 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 Section 11 and
12 of the Securities Act of 1933 for alleged misleading statements in a
prospectus released in connection with the CareWise acquisition. The
amended complaint also added KPMG LLP ("KPMG"), the Company's
independent public auditors. KPMG removed this case to federal court
and its motion to dismiss has been denied. On October 20, 2000, this
case was consolidated with the original federal consolidated action and
a new consolidated complaint has been filed. The Company, the
individual defendants and KPMG have filed an answer and the discovery
process is nearing completion. On May 30, 2001, the court granted
plaintiffs' motion for class certification. The trial of all the
consolidated cases is set for March 12, 2002. 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
22
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 knowing violation
of law or (c) for an unlawful distribution.
On April 18, 2000, a jury in the case of United States of America ex
rel. William R. Benz v. PrimeCare International, Inc. ("PrimeCare") and
Prem Reddy, in the United States District Court, Central District of
California, returned a verdict in favor of the plaintiff as follows:
$0.5 million against PrimeCare on plaintiff's breach of contract
claims; $0.9 million in compensatory damages and $3 million in punitive
damages jointly and severally against PrimeCare and Prem Reddy on
plaintiff's claims for wrongful termination and intentional infliction
of emotional distress; and $0.2 million against PrimeCare on
plaintiff's claim for violations of state labor codes. The jury
returned a verdict in defendants' favor on plaintiff's claim for
retaliatory termination under the False Claims Act. The jury was unable
to reach a verdict on plaintiff's Medicare fraud claims. The court
entered a final judgment on July 13, 2000. Effective May 3, 2001, the
Company entered into a settlement agreement with Mr. Benz which
subsequently received court approval. In exchange for PrimeCare paying
Mr. Benz $2.7 million (of which $0.7 million was paid during the second
quarter of 2001 and the remainder was paid during July 2001), all
claims were dropped by Mr. Benz against the Company and its affiliates.
The judgment of $4.6 million was recorded as other operating expenses
in the second quarter of 2000. Mr. Benz has not settled with Dr. Reddy,
and Dr. Reddy continues to maintain the Company has an indemnification
obligation to him. The Company denies Dr. Reddy's claim.
On August 31, 1999, two relators brought an action in the United States
District Court for the District of Hawaii under the False Claims Act
and for employment related claims against Straub Clinic and Hospital,
Inc. ("Straub"), PhyCor of Hawaii, Inc., and the Company. This matter
had been under seal until September 2000. On September 20, 2000, the
United States government elected to decline to intervene in the matter.
The Company sold PhyCor of Hawaii, Inc. to Straub in November 2000. On
February 21, 2001, plaintiffs filed a Second Amended Complaint, and
Straub is defending the claims against PhyCor of Hawaii, Inc. PhyCor,
Inc. lost its motion to dismiss and is defending the litigation against
it. Trial is set for June 12, 2002.
As a result of the Company's determination to exit its IPA market in
Houston, Texas, a number of providers in the market have brought
actions naming several parties, including the Company and an
IPA-management subsidiary of the Company, alleging breach of contract,
breach of fiduciary duty, and fraud, among other matters. Several
million dollars have been claimed in these cases. The Company believes
the plaintiffs have sued the wrong party and that the claims are
generally excessive. In addition, as a result of the Company's
financial condition, the Company and its subsidiaries have been unable
to meet certain contractual obligations including, but not limited to,
certain ongoing lease obligations and severance obligations to former
employees. There can be no assurance that the Company or its
subsidiaries will meet existing or additional contractual obligations
in the future. Several parties have sent letters to the Company and its
subsidiaries alleging breach of contract and threatening to bring
claims, and several suits have been brought. There can be no assurance
that additional actions will not be brought against the Company and its
subsidiaries as a result of the Company's actions. There can be no
assurance that if these matters are determined adversely to the Company
that such determinations would not have a material adverse effect on
the Company.
PrimeCare, its affiliated IPAs and its employed physicians are parties
to several medical malpractice cases which the Company believes will be
adjudicated within applicable insurance coverage limits. In addition,
the PrimeCare subsidiary which holds a limited Knox-Keane license has
been named in certain managed care liability cases which are not
expected to exceed insurance limits. Various PrimeCare entities have
been sued on business claims such as breach of contract,
misrepresentation, fraud and deceit. The plaintiffs in these suits are
seeking millions of dollars in damages, and the Company is vigorously
defending these suits. While there can be no assurance that the Company
will be successful in such litigation, the Company does not believe any
such litigation will result in damage awards at the levels the
plaintiffs have
23
demanded, nor that such litigation will have a material adverse effect
on the Company. Finally, PrimeCare and the Company have been named in
litigation involving PrimeCare operations in the State of Oklahoma that
were not transferred to the Company when the Company acquired
PrimeCare. Plaintiffs are alleging that a former PrimeCare subsidiary
(which the Company did not buy) is guilty of breach of contract,
conversion and fraud, and plaintiff is seeking damages in excess of
$2.0 million in damages plus punitive damages. Since filing the
litigation, plaintiff has filed for bankruptcy. While the Company did
not own PrimeCare at the time of the alleged incidents, PrimeCare and
the Company may have liability for the actions of this entity and do
not have indemnity rights as to Dr. Reddy, the former owner (who is
also a codefendant in this matter). It is not possible to determine the
amount of exposure of the Company and its subsidiaries in this case,
but judgment against the Company or PrimeCare could have a material
adverse effect on the Company.
The Company has recently learned that in litigation filed in the
Circuit Court of the 11th Judicial Circuit in and for Miami-Dade
County, Florida, in which landlords, Busch Drive Ltd. and Lime Street
Ltd., of the Company's formerly affiliated physician group, First Coast
Medical Group, P.A., claimed the Company guaranteed the lease
obligations of the physician group, the judge has indicated she will
rule in favor of the landlord and that the amount of damages awarded
could be as much as $2,500,000. The Company disagrees with this
decision and intends to pursue its legal alternatives.
Certain litigation is pending against the physician groups which were
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.
24
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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As stated previously in this report, as a result of our failure to
pay the interest payments, totaling approximately $8.8 million, due February 15,
2001 and August 15, 2001, on the 4.5% convertible subordinated notes ("Notes"),
we are in default under the Notes. The principal amount outstanding under the
Notes, which mature in 2003, is $196.5 million. The Company entered into limited
forbearance agreements related to the interest payments with noteholders
representing a majority of the aggregate principal amount of the Notes and
Warburg, Pincus. Pursuant to the forbearance agreements, the holders agreed not
to take action under the Notes through November 30, 2001, subject to automatic
ten business day extensions until December 31, 2001. Also Warburg, Pincus
entered into a waiver and forbearance through November 30, 2001 subject to
automatic ten business day extensions until December 31, 2001 relating to the
possible default under the Warburg Notes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
3.1 -- Amended Bylaws of the Company (1)
3.2 -- Restated Charter of the Company (1)
3.3 -- Amendment to Restated Charter of the Company (2)
3.4 -- Amendment to Restated Charter of the Company (3)
4.1 -- Form of 4.5% Convertible Subordinated Debenture due 2003
(4)
4.2 -- Form of Indenture by and between the Company and First
American National Bank, N.A. (4)
10.1 -- Credit and Security Agreement between PhyCor, Inc. and
AmSouth Bank (5)
10.2 -- Form of IPA Commercial Risk Services Agreement between
Pacificare of California and a Company Subsidiary (5)
10.3 -- Form of IPA Medicare Partial Risk Services Agreement
between Pacificare of California and a Company
Subsidiary (5)
(1) Incorporated by reference to exhibits filed with the Annual Report on
Form 10-K for the year ended December 31, 1994, Commission No. 0-19786.
(2) Incorporated by referenced to exhibits filed with the Company's
Registration Statement on Form S-3, Commission No. 33-93018.
(3) Incorporated by referenced to exhibits filed with the Company's
Registration Statement on Form S-3, Commission No. 33-98528.
(4) Incorporated by reference to exhibits filed with the Company's
Registration Statement on Form S-3, Registration No. 333-328.
(5) Filed herewith.
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the quarter ended
September 30, 2001.
25
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: November 14, 2001
26
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
3.1 -- Amended Bylaws of the Company (1)
3.2 -- Restated Charter of the Company (1)
3.3 -- Amendment to Restated Charter of the Company (2)
3.4 -- Amendment to Restated Charter of the Company (3)
4.1 -- Form of 4.5% Convertible Subordinated Debenture due 2003
(4)
4.2 -- Form of Indenture by and between the Company and First
American National Bank, N.A. (4)
10.1 -- Credit and Security Agreement between PhyCor, Inc. and
AmSouth Bank (5)
10.2 -- Form of IPA Commercial Risk Services Agreement between
Pacificare of California and a Company Subsidiary (5)
10.3 -- Form of IPA Medicare Partial Risk Services Agreement
between Pacificare of California and a Company
Subsidiary (5)
(1) Incorporated by reference to exhibits filed with the Annual Report on
Form 10-K for the year ended December 31, 1994, Commission No. 0-19786.
(2) Incorporated by referenced to exhibits filed with the Company's
Registration Statement on Form S-3, Commission No. 33-93018.
(3) Incorporated by referenced to exhibits filed with the Company's
Registration Statement on Form S-3, Commission No. 33-98528.
(4) Incorporated by reference to exhibits filed with the Company's
Registration Statement on Form S-3, Registration No. 333-328.
(5) Filed herewith.