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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _____________.
COMMISSION FILE NUMBER: 0-19786
PHYCOR, INC.
------------
(Exact Name of Registrant as Specified in Its Charter)
TENNESSEE 62-1344801
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
30 BURTON HILLS BLVD., SUITE 400
NASHVILLE, TENNESSEE 37215
--------------------------------------- -----------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (615) 665-9066
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NOT APPLICABLE
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(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
--- ---
As of August 12, 1998, 78,245,363 shares of the Registrant's Common
Stock were outstanding.
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PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
June 30, 1998 (unaudited) and December 31, 1997
(All dollar amounts are expressed in thousands)
JUNE 30, DECEMBER 31,
ASSETS 1998 1997
- ------- ----- -----
(Unaudited)
Current assets:
Cash and cash equivalents $ 63,336 38,160
Accounts receivable, net 436,759 391,668
Inventories 20,692 18,578
Prepaid expenses and other current assets 72,931 48,158
---------- ---------
Total current assets 593,718 496,564
Property and equipment, net 271,571 235,685
Intangible assets, net 997,057 807,726
Other assets 30,000 22,801
---------- ---------
Total assets $1,892,346 1,562,776
========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Current installments of long-term debt $ 5,526 1,144
Current installments of obligations under capital leases 3,214 3,564
Accounts payable 43,471 34,622
Due to physician groups 57,217 50,676
Purchase price payable 87,085 114,971
Salaries and benefits payable 41,979 37,141
Other accrued expenses and liabilities 120,060 51,145
---------- ---------
Total current liabilities 358,552 293,263
Long-term debt, excluding current installments 354,539 210,893
Obligations under capital leases, excluding current installments 4,153 5,093
Purchase price payable 27,646 23,545
Deferred tax credits and other liabilities 47,420 57,918
Convertible subordinated notes payable to physician groups 52,799 61,576
Convertible subordinated debentures 200,000 200,000
---------- ---------
Total liabilities 1,045,109 852,288
---------- ---------
Shareholders' equity:
Preferred stock, no par value; 10,000,000 shares authorized: -- --
Common stock, no par value; 250,000,000 shares authorized; issued
and outstanding, 71,878,000 in 1998 and 63,273,000 shares in 1997 774,222 645,288
Retained earnings 73,015 65,200
---------- ---------
Total shareholders' equity 847,237 710,488
---------- ---------
Total liabilities and shareholders' equity $1,892,346 1,562,776
========== =========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three months and six months ended June 30, 1998 and 1997
(All amounts are expressed in thousands, except for earnings per share)
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -----------------
1998 1997 1998 1997
---- ---- ---- ----
Net revenue $ 371,450 267,354 694,145 518,006
Operating expenses:
Cost of provider services 26,024 -- 26,024 --
Clinic salaries, wages and benefits 126,980 100,722 247,691 195,586
Clinic supplies 56,543 42,374 109,649 81,638
Purchased medical services 9,337 7,661 18,573 14,689
Other clinic expenses 53,657 41,284 102,559 80,307
General corporate expenses 7,685 6,672 15,141 13,159
Rents and lease expense 31,650 23,717 61,713 45,960
Depreciation and amortization 22,835 14,938 41,010 28,660
Provision for clinic restructuring
and merger expenses -- -- 36,196 --
--------- -------- -------- --------
Net operating expenses 334,711 237,368 658,556 459,999
--------- -------- -------- --------
Earnings from operations 36,739 29,986 35,589 58,007
Interest income (747) (660) (1,492) (1,713)
Interest expense 9,281 5,266 16,803 11,425
--------- -------- -------- --------
Earnings before income taxes and
minority interest 28,205 25,380 20,278 48,295
Income tax expense 8,993 8,689 5,738 16,393
Minority interest in earnings of
consolidated partnerships 3,899 2,985 6,725 5,889
--------- -------- -------- --------
Net earnings $ 15,313 13,706 7,815 26,013
========= ======== ======== ========
Earnings per share:
Basic $ .22 .22 .12 .43
Diluted .22 .20 .11 .39
========= ======== ======== ========
Weighted average number of shares and dilutive
share equivalents outstanding:
Basic 68,779 63,570 67,516 61,095
Diluted 70,857 68,191 70,024 65,932
========= ======== ======== ========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three months and six months ended June 30, 1998 and 1997
(All dollar amounts are expressed in thousands)
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -----------------
1998 1997 1998 1997
---- ---- ---- ----
Cash flows from operating activities:
Net earnings $ 15,313 13,706 7,815 26,013
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 22,835 14,938 41,010 28,660
Minority interests 3,899 2,985 6,725 5,889
Provision for clinic restructuring and merger expenses -- -- 36,196 --
Increase (decrease) in cash, net of effects
of acquisitions, due to changes in:
Accounts receivable (991) 1,522 (22,122) (13,894)
Inventories (260) (876) 22 (758)
Prepaid expenses and other current assets (5,731) (6,108) (8,811) (2,783)
Accounts payable (2,107) 2,818 (2,732) (2,667)
Due to physician groups (2,278) (2,409) 5,038 5,277
Other accrued expenses and liabilities 7,163 (1,221) 11,271 (2,496)
--------- ------- -------- --------
Net cash provided by operating activities 37,843 25,355 74,412 43,241
--------- ------- -------- --------
Cash flows from investing activities:
Payments for acquisitions, net (105,455) (31,414) (139,994) (182,373)
Purchase of property and equipment (17,815) (14,349) (37,970) (32,271)
Payments to acquire other assets (821) (373) (11,133) (2,171)
--------- ------- -------- --------
Net cash used by investing activities (124,091) (46,136) (189,097) (216,815)
--------- ------- -------- --------
Cash flows from financing activities:
Net proceeds from issuance of stock and warrants 9,497 11,231 16,460 223,796
Proceeds from long-term borrowings 103,000 27,000 139,000 182,000
Repayment of long-term borrowings (2,136) (8,127) (9,056) (218,225)
Repayment of obligations under capital leases (1,131) (203) (1,898) (2,175)
Distributions of minority interests (3,190) (2,999) (4,369) (3,675)
Loan costs incurred (276) -- (276) --
--------- ------- -------- --------
Net cash provided by financing activities 105,764 26,902 139,861 181,721
--------- ------- -------- --------
Net increase in cash and cash equivalents 19,516 6,121 25,176 8,147
Cash and cash equivalents - beginning of period 43,820 32,556 38,160 30,530
--------- ------- -------- --------
Cash and cash equivalents - end of period $ 63,336 38,677 63,336 38,677
========= ======= ======== ========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Three months and six months ended June 30, 1998 and 1997
(All dollar amounts are expressed in thousands)
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -----------------
1998 1997 1998 1997
---- ---- ---- ----
SUPPLEMENTAL SCHEDULE OF INVESTING ACTIVITIES:
Effects of acquisitions:
Assets acquired, net of cash $ 207,365 22,168 292,946 279,736
Liabilities paid (assumed), net of deferred purchase
price payments (16,212) 9,246 (41,730) (80,513)
Issuance of convertible subordinated notes payable -- -- (1,317) (8,672)
Issuance of common stock and warrants (84,517) -- (105,974) (8,178)
Cash received from disposition of clinic assets (1,181) -- (3,931) --
--------- ------ -------- --------
Payments for acquisitions $ 105,455 31,414 139,994 182,373
========= ====== ======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations incurred to acquire
equipment $ 258 146 438 310
========= ====== ======== ========
Conversion of subordinated notes payable
to common stock $ -- 3,888 2,000 11,558
========= ====== ======== ========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Three months and six months ended June 30, 1998 and 1997
(1) BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial reporting and in accordance with Rule 10-01 of Regulation S-X.
In the opinion of management, the unaudited interim financial statements
contained in this report reflect all adjustments, consisting of only
normal recurring accruals which are necessary for a fair presentation of
the financial position and the results of operations for the interim
periods presented. The results of operations for any interim period are
not necessarily indicative of results for the full year.
These financial statements, footnote disclosures and other information
should be read in conjunction with the financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K, as amended
by Form 10-K/A, for the year ended December 31, 1997.
(2) ACQUISITIONS
(A) MULTI-SPECIALTY MEDICAL CLINICS
Through June 30, 1998 and during 1997, the Company, through
wholly-owned subsidiaries, acquired certain operating assets of the
following clinics:
CLINIC EFFECTIVE DATE LOCATION
------ -------------- --------
1998:
Grove Hill Medical Center March 1, 1998 New Britain, Connecticut
Watson Clinic (A) May 1, 1998 Lakeland, Florida
Desert Valley Medical Group and Hospital May 1, 1998 Victorville, California
1997:
Vancouver Clinic January 1, 1997 Vancouver, Washington
First Physicians Medical Group February 1, 1997 Palm Springs, California
St. Petersburg-Suncoast Medical Group February 28, 1997 St. Petersburg, Florida
Greater Chesapeake Medical Group May 1, 1997 Annapolis, Maryland
Welborn Clinic June 1, 1997 Evansville, Indiana
White-Wilson Medical Center July 1, 1997 Ft. Walton Beach, Florida
Maui Medical Group September 1, 1997 Maui, Hawaii
Murfreesboro Medical Clinic October 1, 1997 Murfreesboro, Tennessee
West Florida Medical Center Clinic October 1, 1997 Pensacola, Florida
Northern California Medical Association December 1, 1997 Santa Rosa, California
Lakeview Medical Center (B) December 1, 1997 Suffolk, Virginia
(A) Watson Clinic entered into an interim management agreement effective
May 1, 1998.
(B) Lakeview Medical Center was operated under a management agreement
during December 1997. Effective January 1, 1998, the Company
completed the purchase of certain clinic operating assets and entered
into a long-term service agreement with the affiliated physician
group.
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
The acquisitions were accounted for as purchases, and the
accompanying consolidated financial statements include the results
of their operations from the dates of their respective
acquisitions. Simultaneous with each acquisition, the Company
entered into a long-term service agreement with the related clinic
physician group. The service agreements are 40 years in length. In
conjunction with certain acquisitions, the Company is obligated to
make deferred payments to physician groups.
(B) NORTH AMERICAN MEDICAL MANAGEMENT, INC. (NORTH AMERICAN)
Effective January 1, 1995, the Company completed its merger with
North American, an operator and manager of independent practice
associations (IPAs). The Company made additional payments for the
North American acquisition pursuant to an earn-out formula during
1996 and 1997 totaling $35.0 million. A final payment of $35.0
million was made in April 1998, of which $13.0 million was paid in
shares of the Company's Common Stock.
(C) PHYCOR MANAGEMENT CORPORATION (PMC)
In June 1995, the Company purchased a minority interest of
approximately 9% in PMC and has managed PMC pursuant to a 10-year
administrative services agreement. PMC develops and manages IPAs
and provides other services to physician organizations. PhyCor
acquired the remaining interests of PMC on March 31, 1998 for an
aggregate purchase price of approximately $21.0 million paid in
shares of the Company's Common Stock.
(D) PRIMECARE INTERNATIONAL, INC. (PRIMECARE)
In May 1998, the Company acquired PrimeCare, a physician practice
management company serving southern California's Inland Empire
area, in a purchase business combination. PrimeCare's delivery
network is comprised of an integrated campus, including the Desert
Valley Medical Group, Desert Valley Hospital and Apple Valley
Surgery Center, as well as the Inland Empire area IPA network.
(3) NET REVENUE
Net revenue of the Company is comprised of net clinic service agreement
revenue, IPA management revenue, and net hospital revenues. Clinic
service agreement revenue is equal to the net revenue of the clinics,
less amounts retained by physician groups. Net clinic revenue is recorded
by the physician groups and net hospital revenue is recorded at
established rates reduced by provisions for doubtful accounts and
contractual adjustments. Contractual adjustments arise as a result of the
terms of certain reimbursement and managed care contracts. Such
adjustments represent the difference between charges at established rates
and estimated recoverable amounts and are recognized in the period the
services are rendered. Any differences between estimated contractual
adjustments and actual final settlements under reimbursement contracts
are recognized as contractual adjustments in the year final settlements
are determined. With the exception of PrimeCare, the physician groups,
rather than the Company, enter into managed care contracts. Through
calculation of its service fees, the Company shares indirectly in any
capitation risk assumed by its affiliated physician groups.
IPA management revenue is equal to the difference between the amount of
capitation and risk pool payments due to the IPAs managed by the Company
less amounts retained by the IPA. The Company has not historically been a
party to capitated contracts entered into by the IPAs, but it is exposed
to losses to the extent of its share of deficits, if any, of the
capitated revenue of the IPAs. With the acquisition of PrimeCare, the
Company became a party to certain managed care contracts. Accordingly,
the cost of provider services for the PrimeCare contracts is not included
as a deduction to net revenue of the Company but is reported as an
operating expense.
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
The following represent amounts included in the determination of net
revenue (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -----------------
1998 1997 1998 1997
---- ---- ---- ----
Gross physician group and hospital
revenue $883,479 686,126 1,724,998 1,329,283
Less:
Provisions for doubtful accounts
and contractual adjustments 351,810 260,369 691,099 503,202
-------- ------- --------- ---------
Net physician group and hospital
revenue 531,669 425,757 1,033,899 826,081
IPA revenue 176,114 98,637 297,097 185,627
-------- ------- --------- ---------
Net physician group, hospital and IPA
revenue 707,783 524,394 1,330,996 1,011,708
Less amounts retained by physician groups
and IPAs:
Physician groups 185,824 157,809 361,857 305,584
Clinic technical employee compensation 23,567 17,437 46,795 34,732
IPAs 126,942 81,794 228,199 153,386
-------- ------- --------- ---------
Net revenue $371,450 267,354 694,145 518,006
======== ======= ========= =========
(4) ASSETS TO BE DISPOSED OF AND RESTRUCTURED
In the fourth quarter of 1997, the Company recorded a pre-tax charge to
earnings of $83.4 million related to the revaluation of assets of seven
of the Company's multi-specialty clinics. Included in the seven clinics
were three clinic operations the Company determined to dispose of because
of a variety of negative operating and market-specific issues. The
Company completed the disposal of one clinic in the first quarter of
1998, a second clinic in April 1998 and the third clinic in July 1998.
Amounts received upon the dispositions approximated net book value of
those assets. Clinic net assets to be disposed of include current assets,
property and equipment, intangibles and other assets totaling $1,397,000
and $3,237,000 at June 30, 1998 and December 31, 1997, respectively. Net
losses from the clinics to be disposed of totaled $19,000 and $171,000 in
the second quarter and first six months of 1998, respectively, and
$666,000 in 1997.
In addition, restructuring charges totaling $22.0 million were recorded
in the first quarter of 1998 with respect to the seven clinics that are
being sold or restructured and included facility and lease termination
costs, severance costs and other exit costs in the amount of $15,316,000,
$4,611,000 and $2,073,000, respectively. The Company is closing,
consolidating or subleasing various leased facilities associated with the
related physician groups and expects to complete such closings or
subleases in 1998. During the second quarter of 1998 and the first six
months of 1998, the Company paid approximately $1.0 million and $2.3
million, respectively, in costs associated with the above activities.
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(5) MERGER EXPENSES
The Company recorded a pre-tax charge to earnings of approximately $14.2
million in the first quarter of 1998 relating to the termination of its
merger agreement with MedPartners, Inc. This charge represents the
Company's share of investment banking, legal, travel, accounting and
other expenses incurred during the merger negotiation process.
(6) NEW ACCOUNTING PRONOUNCEMENT
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No.130 "Reporting Comprehensive Income".
Comprehensive income generally includes all changes in equity during a
period except those resulting from investments by shareholders and
distributions to shareholders. Net income was the same as comprehensive
income for the second quarter and first six months of 1998 and 1997.
(7) CHANGE IN ACCOUNTING POLICY
Effective April 1, 1998, the Company changed its policy with respect to
amortization of intangible assets. All existing and future intangible
assets will be amortized over a period not to exceed 25 years from the
inception of the respective intangible assets. Had the Company adopted
this policy at the beginning of 1997, amortization expense would have
increased and diluted earnings per share would have decreased by
approximately $2.8 million and $0.02, respectively, in the second quarter
of 1997 and $5.6 million and $0.05, respectively, in the first six months
of 1997. On the same basis, for the first quarter of 1998, amortization
expense would have increased by approximately $3.3 million, resulting in
a decrease in diluted earnings per share of $0.03.
(8) SUBSEQUENT EVENTS
In July 1998, the Company completed three previously announced
acquisitions. The Company acquired Seattle-based CareWise, Inc., a
nationally recognized leader in the health care decision-support industry
and Atlanta-based First Physician Care, Inc., a provider of practice
management services. Both of these transactions were accounted for as
poolings-of-interests and treated as tax free exchanges, and the Company
issued approximately 6.1 million shares of Common Stock in conjunction
with these transactions. The Company also completed its acquisition of
The Morgan Health Group, Inc., an Atlanta-based IPA.
On July 23, 1998, the Company announced it expects to record a pre-tax
asset impairment charge of approximately $65 million in the third quarter
of 1998. This expected charge relates primarily to continuing negative
operating trends for those clinic operations which were included in the
fourth quarter 1997 asset impairment charge and corresponding initiatives
to dispose of these assets.
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
PhyCor, Inc. ("PhyCor" or the "Company") is a physician practice
management company that acquires and operates multi-specialty medical clinics,
develops and manages independent practice associations ("IPAs") and provides
health care decision-support services, including demand management and disease
management services to managed care organizations, health care providers,
employers and other group associations. Including the pending transaction
discussed below, the Company currently operates 60 clinics with approximately
4,045 physicians in 29 states and manages IPAs with approximately 26,000
physicians in 36 markets. The Company's affiliated physicians provide medical
services under capitated contracts to approximately 1,517,000 patients,
including approximately 253,000 Medicare/Medicaid eligible patients. The Company
provides health care decision-support services to more than approximately 1.8
million individuals within the United States and an additional 500,000 under
foreign country license agreements.
The Company's strategy is to position its affiliated multi-specialty
medical clinics and IPAs to be the physician component of organized health care
systems. PhyCor believes physician organizations create the value in these
networks because physician decisions determine the cost and quality of health
care.
A substantial majority of the Company's revenue in the first six months
of 1998 and 1997 was earned under service agreements with multi-specialty
medical clinics. Revenue earned under substantially all of the service
agreements is equal to the net revenue of the clinics, less amounts retained by
physician groups. The service agreements contain financial incentives for the
Company to assist the physician groups in increasing clinic revenues and
controlling expenses.
To increase clinic revenue, the Company works with the affiliated
physician groups to recruit additional physicians, merge other physicians
practicing in the area into the affiliated physician groups, negotiate contracts
with managed care organizations and provide additional ancillary services. To
reduce or control expenses, among other things, PhyCor utilizes national
purchasing contracts for key items, reviews staffing levels to make sure they
are appropriate and assists the physicians in developing more cost-effective
clinical practice patterns.
The Company has increased its focus on the development of IPAs to
enable the Company to provide services to a broader range of physician
organizations, to enhance the operating performance of existing clinics and to
further develop physician relationships. The Company develops IPAs that include
affiliated clinic physicians to enhance the clinics' attractiveness as providers
to managed care organizations.
On May 11, 1998, the Company announced that it had entered into an
interim management agreement and letter of intent to acquire certain assets and
enter into a long-term service agreement with Watson Clinic, a 167-physician
multi-specialty group based in Lakeland, Florida.
On May 18, 1998, the Company acquired PrimeCare International, Inc.
("PrimeCare"), a physician practice management company serving southern
California's Inland Empire area. PrimeCare's delivery network is comprised of an
integrated campus, including the 60-physician Desert Valley Medical Group, the
83-bed Desert Valley Hospital and Apple Valley Surgical Center, as well as the
Inland Empire area IPA Network, a network of 10 IPAs consisting of 210 primary
care physicians and approximately 2,000 affiliated specialty physicians.
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In addition to the acquisition of PrimeCare, the Company affiliated
with one other multi-specialty clinic and numerous smaller medical practices and
completed its purchase of certain operating assets of Lakeview Medical Center
located in Suffolk, Virginia, which was operated under a management agreement
during December 1997, adding a total of $248.6 million in assets during the
first six months of 1998. The principal assets acquired were accounts
receivable, property and equipment, prepaid expenses, and service agreement
rights, an intangible asset. The consideration for the acquisitions consisted of
approximately 49% cash, 21% liabilities assumed, 29% Common Stock and 1%
convertible notes. The cash portion of the purchase price was funded by a
combination of operating cash flow and borrowings under the Company's bank
credit facility. Property and equipment acquired consists mostly of clinic
operating equipment.
Since June 30, 1998, the Company has completed its acquisition of The
Morgan Health Group, Inc., an Atlanta-based IPA whose network of approximately
400 primary care physicians and 1,800 specialists provide care to approximately
57,000 managed care members under capitated contracts. The Company also
completed its previously announced acquisitions of Atlanta-based First Physician
Care, Inc. ("FPC"), a provider of practice management services, and
Seattle-based CareWise, Inc. ("CareWise"), a nationally recognized leader in the
consumer decision-support industry. The FPC and CareWise transactions were
accounted for as poolings-of-interests. The Company issued approximately 6.1
million shares of Common Stock in conjunction with the FPC and CareWise
transactions.
The Company has historically amortized the goodwill and other
intangible assets related to its service agreements over the periods during
which the agreements are effective, ranging from 25 to 40 years. Effective April
1, 1998, the Company adopted a maximum of 25 years as the useful life for
amortization of its intangible assets, including those acquired in prior years.
Had this policy been in place for 1997, amortization expense would have
increased by approximately $2.8 million in the second quarter of 1997,
approximately $5.6 million in the first six months of 1997, and approximately
$11.2 million for the full year. Applying the Company's historical tax rate,
diluted earnings per share would have been reduced by $0.02 in the second
quarter of 1997, $0.05 for the first six months of 1997, and $0.10 for the full
year of 1997 . On the same basis, for the first quarter of 1998, amortization
expense would have increased by approximately $3.3 million, resulting in a
decrease in diluted earnings per share of $0.03.
RESULTS OF OPERATIONS
The following table shows the percentage of net revenue represented by
various expense and other income items reflected in the Company's Consolidated
Statements of Operations.
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
1998 1997 1998 1997
---- ---- ---- ----
Net revenue................................. 100.0% 100.0% 100.0% 100.0%
Operating expenses
Cost of provider services................ 7.0 -- 3.7 --
Clinic salaries, wages and benefits...... 34.2 37.7 35.7 37.8
Clinic supplies.......................... 15.2 15.8 15.8 15.8
Purchased medical services............... 2.5 2.9 2.7 2.8
Other clinic expenses.................... 14.4 15.4 14.8 15.5
General corporate expenses............... 2.1 2.5 2.2 2.5
Rents and lease expense................. 8.5 8.9 8.9 8.9
Depreciation and amortization............ 6.2 5.6 5.9 5.5
Provision for clinic restructuring
and merger expenses.............. -- -- 5.2 --
------ ------ ------- -------
Operating expenses.......................... 90.1 88.8 94.9 (A) 88.8
------ ------ ------- -------
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Earnings from operations.............. 9.9 11.2 5.1 (A) 11.2
Interest income............................. (0.2) (0.3) (0.2) (0.3)
Interest expense............................ 2.5 2.0 2.4 2.2
------ ------ ------- -------
Earnings before income taxes
and minority interest................ 7.6 9.5 2.9 (A) 9.3
Income tax expense.......................... 2.4 3.3 .8 (A) 3.2
Minority interest........................ 1.1 1.1 1.0 1.1
------ ------ ------ -------
Net earnings.......................... 4.1% 5.1% 1.1% (A) 5.0%
====== ====== ====== ======
(A) Excluding the effect of the provision for clinic restructuring and merger
expenses in 1998, operating expenses, earnings from operations, earnings before
income taxes and minority interest, income tax expense and net earnings, as a
percent of net revenue, would have been 89.7%, 10.3%, 8.1%, 3.0% and 4.1%,
respectively, for the six months ended June 30, 1998.
1998 Compared to 1997
Net revenue increased $104.1 million, or 38.9%, from $267.4 million for
the second quarter of 1997 to $371.5 million for the second quarter of 1998, and
from $518.0 million to $694.1 million for the first six months of 1997 compared
to 1998, an increase of 34.0%. The increase in clinic net revenue from the
second quarter of 1997 compared to 1998 was $67.2 million, including $55.2
million in service fees resulting from newly acquired clinics in 1998 or the
timing of entering into new service agreements in 1997 and was comprised of (i)
a $62.2 million increase in service fees for reimbursement of clinic expenses
incurred by the Company and (ii) a $5.0 million increase in the Company's share
of clinic operating income and net physician group revenue. The increase in
clinic net revenue from the first six months of 1997 compared to 1998 was $134.8
million, including $106.5 million in service fees resulting from newly acquired
clinics in 1998 or the timing of entering into new service agreements in 1997
and was comprised of (i) a $121.2 million increase in service fees for
reimbursement of clinic expenses incurred by the Company and (ii) a $13.6
million increase in the Company's share of clinic operating income and net
physician group revenue. The increases in clinic net revenue have been reduced
as a result of assets disposed in 1998 by $4.8 million and $5.2 million in the
second quarter and the first six months of 1998, compared to the same periods in
1997, respectively. Net revenue from the 39 service agreements and 27 IPA
markets (excluding clinics being restructured or sold) in effect for both
quarters, increased by $26.8 million, or 12.8%, for the quarter and $50.5
million, or 12.0%, for the six months ended June 30, 1998, compared with the
same period in 1997. Same market growth resulted from the addition of new
physicians, the expansion of ancillary services and increases in patient volume
and fees.
During the second quarter and first six months of 1998, most categories
of operating expenses varied as a percentage of net revenue when compared to the
same periods in 1997. The addition of cost of provider services is a result of
the acquisition of PrimeCare in the second quarter of 1998. PrimeCare manages a
network of 10 IPAs in the Inland Empire area of southern California, and is a
party to certain managed care contracts, resulting in the company presenting
such revenues on a "gross-up basis," where the cost of provider services
(payments to physicians and other providers under subcapitation and other
reimbursement contracts) is not included as a deduction to net revenue of the
Company but is reported as an operating expense. This revenue reporting has an
impact on the Company's operating expenses as a percentage of net revenue.
Excluding the impact of PrimeCare's revenue reporting, most categories of
operating expenses as a percentage of net revenue during the second quarter and
first six months of 1998 were comparable to the percentages in the same periods
in 1997. Excluding the impact of PrimeCare's revenue reporting, clinic salaries,
wages and benefits decreased as a percentage of net revenue resulting from the
acquisition of clinic operations with lower levels of these expenses compared to
the existing base of clinics and continued focus on efficiently staffing the
existing clinic operations. The increase in depreciation and amortization
expense as a percentage of net revenue resulted from the change in the
amortization policy with respect to intangible assets. The addition of
pharmacies at certain existing clinics and new clinics which operate pharmacies
also resulted in increased clinic supplies expense, excluding the impact of
PrimeCare's revenue reporting. While general corporate expenses decreased as a
percentage of net revenue, the dollar amount of general corporate expenses
increased as a result of the
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addition of corporate personnel to accommodate growth and to respond to
increasing physician group needs for support in managed care negotiations,
information systems implementation and clinical outcomes management programs.
The provision for clinic restructuring of $22.0 million in the first
quarter of 1998 relates to seven of the Company's clinics that are being
restructured or sold and includes facility and lease termination costs,
severance and other exit costs. In the fourth quarter of 1997, the Company
recorded a pre-tax charge of $83.4 million related to asset revaluation at these
same clinics. The charges address operating issues which developed in four of
the Company's multi-specialty clinics which represent the Company's earliest
developments of such clinics through the formation of new groups. Three other
clinics included in the 1997 charge represent clinics disposed of during 1998
because of a variety of negative operating and market issues. Losses on the
three clinics divested approximated the amounts accrued. For additional
discussion, see "Liquidity and Capital Resources."
The Company also recorded a pre-tax charge to earnings of approximately
$14.2 million in the first quarter of 1998 relating to the termination of its
merger agreement with MedPartners, Inc. This charge represents PhyCor's share of
investment banking, legal, travel, accounting and other expenses incurred during
the merger negotiation process.
The Company expects an effective tax rate of approximately 37.0% in
1998 before the tax benefit of the provision for clinic restructuring and merger
expenses discussed above as compared to a rate of 38.5% in 1997.
PhyCor has assessed its practice management systems, managed care
information systems, business information systems and other clinic systems for
compliance with the Year 2000 issue. The Company is in its normal process of
standardizing the various systems utilized by its clinics and IPAs. This
standardization includes implementation of Year 2000 compliant systems. The
Company has performed an assessment of its various clinics and IPAs to identify
which systems specifically require replacement or upgrade because of the Year
2000 issue in order to ensure timely upgrade or installation. The Company
believes it has a replacement strategy in place such that the Year 2000 issue
will not have a significant effect on its operations. Total capital costs to
implement new systems and to address the Year 2000 issue are expected to be less
than $20.0 million.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company had $235.2 million in working capital,
compared to $203.3 million as of December 31, 1997. Also, the Company generated
$37.8 million of cash flow from operations for the second quarter of 1998
compared to $25.4 million for the second quarter of 1997 and $74.4 million for
the first six months of 1998 compared to $43.2 for the same period in 1997. At
June 30, 1998, net accounts receivable of $436.8 million amounted to 70 days of
net clinic revenue compared to $391.7 million and 72 days at the end of 1997.
In the first six months of 1998, $2.0 million of convertible
subordinated notes issued in connection with physician group asset acquisitions
were converted into Common Stock. These conversions, option exercises, other
issuances of Common Stock and net earnings for the first six months of 1998
resulted in an increase of $136.7 million in shareholders' equity compared to
December 31, 1997.
Capital expenditures during the first six months of 1998 totaled $38.0
million. The Company is responsible for capital expenditures at its affiliated
clinics under the terms of its service agreements. The Company expects to make
approximately $31.0 million in capital expenditures during the remainder of
1998.
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In June 1995, the Company purchased a minority interest of
approximately 9% in PhyCor Management Corporation ("PMC") and has managed PMC
pursuant to a 10-year administrative services agreement. PMC develops and
manages IPAs and provides other services to physician organizations. PhyCor
acquired the remaining interests of PMC on March 31, 1998 for approximately
956,300 shares of the Company's Common Stock.
Effective January 1, 1995, the Company completed its acquisition of
North American Medical Management, Inc. ("North American"). The Company paid
$20.0 million at closing and has made additional payments pursuant to an
earn-out formula during 1996 and 1997 totaling $35.0 million. A final payment of
$35.0 million was made pursuant to the earnout formula in April 1998. Of the
final payment, $13.0 million was made in shares of the Company's Common Stock.
In addition, deferred acquisition payments are payable to physician
groups in the event such physician groups attain predetermined financial targets
during established periods of time following acquisition. If each group
satisfied its applicable financial targets for the periods covered, the Company
would be required to pay an aggregate of approximately $82.9 million of
additional consideration over the next five years, of which a maximum of $16.7
million would be payable during the remainder of 1998.
In the fourth quarter of 1997, the Company recorded a pre-tax charge to
earnings of $83.4 million related to the revaluation of assets of seven of the
Company's multi-specialty clinics. In the first quarter of 1998, the Company
also recorded an additional charge of approximately $22.0 million relating to
these clinics that are being restructured or sold. The pre-tax charge was
partially in response to issues which arose in four of the Company's
multi-specialty clinics which represent the Company's earliest developments of
such clinics through the formation of new groups. The clinics were considered to
have an impairment of certain current assets, property and equipment, other
assets and, primarily, intangible assets as a result of certain groups of
physicians within a larger clinic terminating their relationship with the
medical group affiliated with the Company and therefore affecting future cash
flows. On July 23, 1998, the Company announced it expects to record a pre-tax
asset impairment charge of approximately $65 million in the third quarter of
1998, primarily related to the same group formation multi-specialty clinics.
This expected charge relates to continuing negative operating trends and
corresponding initiatives to dispose of these assets. At June 30, 1998, the
Company had a total of nine group formation multi-specialty clinics, which
includes the four clinics associated with the charges discussed above. The total
assets and intangible assets of the remaining five group formation clinics not
included in the asset impairment charges totaled $80.4 million and $50.4 million
at June 30, 1998, respectively. The Company has limited its growth through new
group formations, and believes recent group formations have been more
successful.
Three other clinics included in the fourth quarter of 1997 charge
represent clinics disposed of because of a variety of negative operating and
market issues including those related to market position and clinic
demographics, physician relations, operating results and ongoing viability of
the existing medical group. Although these factors have been present
individually from time to time in various affiliated clinics and could occur in
future clinic operations, the combined effect of the existence of these factors
at the clinics disposed of resulted in clinic operations that made it difficult
for the Company to effectively manage the clinics. One of these clinics was sold
in the first quarter of 1998, the second clinic in April 1998 and the third
clinic in July 1998. These assets were sold below carrying value for the reasons
noted above, and given such facts, a sale at a discount to original carrying
value was considered more cost-effective than a liquidation which might have
subjected the Company to additional costs. The Company recorded no gain or loss
on the final disposition of these assets.
The Company does not believe that the clinics included in the
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charges are indicative of a trend in the Company's operations or the industry in
which the Company operates. There can be no assurance, however, that in the
future a similar combination of negative characteristics will not develop at a
clinic affiliated with the Company and result in the termination of the service
agreement or that in the future additional clinics will not terminate their
relationships with the Company in a manner that may materially adversely affect
the Company.
PhyCor has been the subject of an audit by the Internal Revenue Service
("IRS") covering the years 1988 through 1993. The IRS has proposed adjustments
relating to the timing of recognition for tax purposes of certain revenue and
deductions relating to uncollectible accounts and a recharacterization of the
Company's relationship with affiliated physician groups. PhyCor disagrees with
the positions asserted by the IRS including any recharacterization and is
vigorously contesting these proposed adjustments. The Company believes that any
adjustments resulting from resolution of this disagreement would not affect
reported net earnings of PhyCor but would defer tax benefits and change the
levels of current and deferred tax assets and liabilities. For the years under
audit, and potentially, for subsequent years, any such adjustments could result
in material cash payments by the Company. PhyCor does not believe the resolution
of this matter will have a material adverse effect on its financial condition,
although there can be no assurance as to the outcome of this matter.
In April 1998, the Company completed modifications to its bank credit
facility which included the revision of certain terms and conditions. The
Company's bank credit facility provides for a five-year, $500.0 million
revolving line of credit for use by the Company prior to April 2003 for
acquisitions, working capital, capital expenditures and general corporate
purposes. The total drawn cost under the facility is either .275% to .75% above
the applicable eurodollar rate or the agent's base rate plus .10% to .225% per
annum. The total drawn cost of outstanding borrowings at June 30, 1998 was
6.36%. On October 17, 1997, the Company entered into an interest rate swap
agreement to fix the interest rate on $100 million of debt at 5.85% relative to
the three month floating LIBOR. The interest rate swap agreement matures in
October 2002 with a lender's option to terminate beginning October 1999.
The Company's bank credit facility contains covenants which, among
other things, require the Company to maintain certain financial ratios and
impose certain limitations or prohibitions on the Company with respect to (i)
the incurring of certain indebtedness, (ii) the creation of security interests
on the assets of the Company, (iii) the payment of cash dividends on, and the
redemption or repurchase of, securities of the Company, (iv) investments and (v)
acquisitions. The Company is required to obtain bank consent for an acquisition
with an aggregate purchase price of $75.0 million or more. The Company was in
compliance with such covenants at June 30, 1998.
At June 30, 1998, the Company had cash and cash equivalents of
approximately $63.3 million, and as of August 12, 1998, $154.7 million available
under its bank credit facility. The Company believes that the combination of
funds available under the Company's bank credit facility, together with cash
reserves and cash flow from operations, should be sufficient to meet the
Company's current planned capital expenditures and working capital needs over
the next year.
In addition, in order to provide the funds necessary for the continued
pursuit of the Company's long-term acquisition and expansion strategy, the
Company expects to continue to incur, from time to time, additional short-term
and long-term indebtness and to issue equity and debt securities, the
availability and terms of which will depend upon market and other conditions.
There can be no assurance that such additional financing will be available on
terms acceptable to the Company.
Forward-looking statements of PhyCor included herein or incorporated by
reference including, but not limited to, those regarding future business
prospects, the acquisition of additional clinics, the development of additional
IPAs, the adequacy of PhyCor's capital resources, the adequacy of recent and
proposed asset impairment and restructuring charges, the future profitability of
capitated fee arrangements and other statements regarding trends relating to
various revenue and expense
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items, could be affected by a number of risks, uncertainties, and other factors
described in the Company's Annual Report on Form 10-K, as amended on Form
10-K/A, for the year ended December 31, 1997.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
No disclosure required.
PART II
OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The annual meeting of shareholders of the Company was held on Tuesday, June 2,
1998. At this meeting, the following matters were voted upon by the Company's
shareholders:
(A) AMENDMENT AND RESTATEMENT OF THE COMPANY'S AMENDED 1988 INCENTIVE STOCK
PLAN
The Company's shareholders rejected the amendment and restatement of the
Company's Amended 1988 Incentive Stock Plan to (i) increase from 17,000,000 to
18,300,000 the number of shares of Common Stock authorized thereunder, (ii)
limit the number of Awards that can be made to any employee during the calendar
year, (iii) modify the restriction on the transfer of Plan awards, other than
incentive options, to allow transfers approved by the Compensation Committee of
the Board of Directors, (iv) appoint the Compensation Committee as administrator
of the Plan, and (v) make other administrative modifications with respect to the
grant of options.
Votes Cast in Favor Votes Cast Against Abstentions
------------------- ------------------ -----------
15,647,107 26,823,726 145,898
(B) ADOPTION OF THE COMPANY'S 1998 INCENTIVE STOCK PLAN
The shareholders of the Company rejected the adoption of the Company's 1998
Incentive Stock Plan.
Votes Cast in Favor Votes Cast Against Abstentions
------------------- ------------------ -----------
15,765,207 26,702,786 148,938
(C) ELECTION OF CLASS I DIRECTORS
Winfield Dunn, C. Sage Givens, Joseph A. Hill and Richard D. Wright were elected
to serve as Class I directors of the Company. The vote was as follows:
Names Votes Cast in Favor Votes Cast Against or Withheld
----- ------------------- ------------------------------
Winfield Dunn 54,182,989 503,335
C. Sage Givens 54,195,750 490,574
Joseph A. Hill 54,090,736 595,588
Richard D. Wright 54,095,463 590,861
(D) SELECTION OF AUDITORS
The shareholders of the Company ratified the appointment of KPMG Peat Marwick
LLP as the Company's independent auditors for the fiscal year ended December 31,
1998, by the following vote:
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Votes Cast in Favor Votes Cast Against Abstentions
------------------- ------------------ -----------
54,539,130 105,880 41,314
ITEM 5. OTHER INFORMATION.
The deadline for delivering to the Company notice of shareholder proposals,
other than proposals to be included in the proxy statement, for the 1999 Annual
Meeting of Shareholders will be March 16, 1999, pursuant to Rule 14a-4. The
persons named as proxies in the proxy statement may exercise discretionary
authority to vote on any proposals received after such date.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
3.1 -- Restated Charter of Registrant(1)
3.2 -- Amendment to Restated Charter of the Registrant (2)
3.3 -- Amendment to Restated Charter of the Registrant (3)
3.4 -- Amended Bylaws of the Registrant (1)
4.1 -- Specimen of Common Stock Certificate (4)
4.2 -- Shareholder Rights Agreement, dated February 18, 1994, between the
Registrant and First Union National Bank of North Carolina (5)
10.1 -- $500,000,000 Second Amended and Restated Credit Agreement, dated
as of April 2, 1998, among the Registrant, the Banks named therein
and Citibank, N.A .
10.2 -- Registrant's Nonqualified Stock Option Plan (6)
27.1 -- Financial Data Schedule (for SEC use only)
27.2 -- Financial Data Schedule (for SEC use only)
- -------------
(1) Incorporated by reference to exhibits filed with the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1994, Commission No.
0-19786.
(2) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-3, Registration No. 33-93018.
(3) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-3, Registration No. 33-98528.
(4) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-1, Registration No. 33-44123.
(5) Incorporated by reference to exhibits filed with the Registrant's Current
Report on Form 8-K dated February 18, 1994, Commission No. 0-19786.
(6) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-8, Registration No. 333-58709.
(B) REPORTS ON FORM 8-K.
The Company filed a Current Report on Form 8-K on April 29, 1998
announcing the change in its policy with respect to amortization of intangible
assets pursuant to Item 5 of Form 8-K; and a Current Report on Form 8-K on June
3, 1998 announcing the acquisition of PrimeCare International, Inc. pursuant to
Item 2 of Form 8-K.
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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/ John K. Crawford
------------------------------
John K. Crawford
Chief Financial Officer
Date: August 14, 1998
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Exhibit Index
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
3.1 -- Restated Charter of Registrant(1)
3.2 -- Amendment to Restated Charter of the Registrant (2)
3.3 -- Amendment to Restated Charter of the Registrant (3)
3.4 -- Amended Bylaws of the Registrant (1)
4.1 -- Specimen of Common Stock Certificate (4)
4.2 -- Shareholder Rights Agreement, dated February 18, 1994, between the
Registrant and First Union National Bank of North Carolina (5)
10.1 -- $500,000,000 Second Amended and Restated Credit Agreement, dated
as of April 2, 1998, among the Registrant, the Banks named therein
and Citibank, N.A .
10.2 -- Registrant's Nonqualified Stock Option Plan (6)
27.1 -- Financial Data Schedule (for SEC use only)
27.2 -- Financial Data Schedule (for SEC use only)
- -------------
(1) Incorporated by reference to exhibits filed with the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1994, Commission No.
0-19786.
(2) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-3, Registration No. 33-93018.
(3) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-3, Registration No. 33-98528.
(4) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-1, Registration No. 33-44123.
(5) Incorporated by reference to exhibits filed with the Registrant's Current
Report on Form 8-K dated February 18, 1994, Commission No. 0-19786.
(6) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-8, Registration No. 333-58709.