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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended March 31, 1999.
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition period from _____________ to _____________.
COMMISSION FILE NUMBER: 0-19786
PHYCOR, INC.
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(Exact Name of Registrant as Specified in Its Charter)
TENNESSEE 62-1344801
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
30 BURTON HILLS BLVD., SUITE 400
NASHVILLE, TENNESSEE 37215
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (615) 665-9066
----------------
NOT APPLICABLE
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(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
---- ----
As of May 13, 1999, 76,282,267 shares of the Registrant's Common Stock
were outstanding.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, 1999 (unaudited) and December 31, 1998
(All amounts are expressed in thousands)
1999 1998
----------- -----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 73,556 $ 74,314
Accounts receivable, net 388,086 378,732
Inventories 19,980 19,852
Prepaid expenses and other current assets 73,443 55,988
Assets held for sale 42,754 41,225
----------- -----------
Total current assets 597,819 570,111
Property and equipment, net 245,397 241,824
Intangible assets, net 952,634 981,537
Other assets 62,422 53,067
----------- -----------
Total assets $ 1,858,272 $ 1,846,539
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt $ 4,995 $ 4,810
Current installments of obligations under capital leases 4,662 5,687
Accounts payable 57,997 50,972
Due to physician groups 62,435 51,941
Purchase price payable 51,966 73,736
Salaries and benefits payable 41,137 37,077
Incurred but not reported claims payable 58,443 59,333
Other accrued expenses and current liabilities 106,137 98,701
----------- -----------
Total current liabilities 387,772 382,257
Long-term debt, excluding current installments 413,078 388,644
Obligations under capital leases, excluding current installments 4,896 6,018
Purchase price payable 13,366 8,967
Deferred tax credits and other liabilities 9,017 8,663
Convertible subordinated notes payable to physician groups 22,413 47,580
Convertible subordinated debentures 200,000 200,000
----------- -----------
Total liabilities 1,050,542 1,042,129
----------- -----------
Shareholders' equity:
Preferred stock, no par value; 10,000 shares authorized: -- --
Common stock, no par value; 250,000 shares authorized; issued
and outstanding, 76,021 shares in 1999 and 75,824 shares in 1998 851,189 850,657
Accumulated deficit (43,459) (46,247)
----------- -----------
Total shareholders' equity 807,730 804,410
----------- -----------
Total liabilities and shareholders' equity $ 1,858,272 $ 1,846,539
=========== ===========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three months ended March 31, 1999 and 1998
(All amounts are expressed in thousands, except for earnings per share)
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
--------------------------
1999 1998
--------- ---------
Net revenue $ 416,544 $ 322,695
Operating expenses:
Cost of provider services 57,092 --
Salaries, wages and benefits 133,088 120,711
Supplies 60,600 53,106
Purchased medical services 10,241 9,236
Other expenses 58,232 48,902
General corporate expenses 8,643 7,456
Rents and lease expense 32,714 30,063
Depreciation and amortization 24,770 18,175
Provision for asset revaluation
and clinic restructuring 9,513 22,000
Merger expenses -- 14,196
--------- ---------
Net operating expenses 394,893 323,845
--------- ---------
Earnings (loss) from operations 21,651 (1,150)
Other (income) expense:
Interest income (1,013) (745)
Interest expense 9,865 7,522
--------- ---------
Earnings (loss) before income taxes and
minority interest 12,799 (7,927)
Income tax expense (benefit) 5,237 (3,255)
Minority interest in earnings of
consolidated partnerships 4,774 2,826
--------- ---------
Net earnings (loss) $ 2,788 $ (7,498)
========= =========
Earnings (loss) per share:
Basic $ 0.04 $ (0.12)
Diluted 0.04 (0.12)
========= =========
Weighted average number of shares and dilutive share equivalents outstanding:
Basic 75,943 64,928
Diluted 77,560 64,928
========= =========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three months ended March 31, 1999 and 1998
(All dollar amounts are expressed in thousands)
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
------------------------
1999 1998
-------- --------
Cash flows from operating activities:
Net earnings (loss) $ 2,788 $ (7,498)
Adjustments to reconcile net earnings (loss) to net cash
provided by operating activities:
Depreciation and amortization 24,770 18,175
Minority interests 4,774 2,826
Provision for asset revaluation and clinic restructuring 9,513 22,000
Merger expenses -- 14,196
Increase (decrease) in cash, net of effects
of acquisitions, due to changes in:
Accounts receivable (17,653) (21,131)
Inventories 215 282
Prepaid expenses and other current assets (12,445) (3,080)
Accounts payable 6,821 (625)
Due to physician groups 9,207 7,316
Incurred but not reported claims payable 2,194 1,800
Other accrued expenses and current liabilities (314) 2,308
-------- --------
Net cash provided by operating activities 29,870 36,569
-------- --------
Cash flows from investing activities:
Payments for acquisitions, net (30,893) (34,539)
Purchase of property and equipment (14,349) (20,155)
Payments to acquire other assets (3,093) (10,312)
-------- --------
Net cash used by investing activities (48,335) (65,006)
-------- --------
Cash flows from financing activities:
Net proceeds from issuance of stock and warrants 870 6,963
Proceeds from long-term borrowings 26,000 36,000
Repayment of long-term borrowings (3,231) (6,920)
Repayment of obligations under capital leases (2,146) (767)
Distributions of minority interests (3,015) (1,179)
Loan costs incurred (771) --
-------- --------
Net cash provided by financing activities 17,707 34,097
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Net increase (decrease) in cash and cash equivalents (758) 5,660
Cash and cash equivalents - beginning of period 74,314 38,160
-------- --------
Cash and cash equivalents - end of period $ 73,556 $ 43,820
======== ========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Three months ended March 31, 1999 and 1998
(All dollar amounts are expressed in thousands)
(Unaudited)
THREE MONTHS ENDED
MARCH 31,
------------------------
1999 1998
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SUPPLEMENTAL SCHEDULE OF INVESTING ACTIVITIES:
Effects of acquisitions, net:
Assets acquired, net of cash $ 9,055 $ 85,581
Liabilities paid (assumed), including
deferred purchase price payments 21,478 (25,518)
Issuance of convertible subordinated notes payable -- (1,317)
Reduction (issuance) of common stock and warrants 360 (21,457)
Cash received from disposition of clinic assets -- (2,750)
-------- --------
Payments for acquisitions, net $ 30,893 $ 34,539
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations incurred to acquire
equipment $ 16 $ 180
======== ========
Conversion of subordinated notes payable
to common stock $ 22 $ 2,000
======== ========
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Three months ended March 31, 1999 and 1998
(1) BASIS OF PRESENTATION
---------------------
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial reporting and in accordance with Rule 10-01 of Regulation S-X.
In the opinion of management, the unaudited interim financial statements
contained in this report reflect all adjustments, consisting of only
normal recurring accruals, that are necessary for a fair presentation of
the financial position and the results of operations for the interim
periods presented. The results of operations for any interim period are
not necessarily indicative of results for the full year.
These financial statements, footnote disclosures and other information
should be read in conjunction with the financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.
(2) ACQUISITION PRO FORMA INFORMATION
---------------------------------
The unaudited consolidated pro forma net revenue, net loss and per share
amounts of the Company assuming the PrimeCare International, Inc.
(PrimeCare), The Morgan Health Group, Inc. (MHG), Carewise, Inc.
(Carewise), and First Physician Care, Inc. (FPC) acquisitions had been
consummated on January 1, 1998 are as follows (in thousands, except for
earnings per share):
THREE MONTHS ENDED
MARCH 31, 1998
-----------------
Net revenue $ 408,866
Net loss (8,314)
Loss per share:
Basic (0.11)
Diluted (0.11)
The consolidated statements of operations include the results of the
above businesses from the dates of their respective acquisitions.
(3) NET REVENUE
-----------
Net revenue of the Company is comprised of net clinic service agreement
revenue, IPA management revenue, net hospital revenues and other
operating revenues. Clinic service agreement revenue is equal to the net
revenue of the clinics, less amounts retained by physician groups. Net
clinic revenue recorded by the physician groups and net hospital revenue
are 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
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
determined. With the exception of the Company's wholly owned subsidiary,
PrimeCare, and certain clinics acquired as a part of the FPC acquisition,
the physician groups, rather than the Company, enter into managed care
contracts. Through calculation of its service fees, the Company shares
indirectly in any capitation risk assumed by its affiliated physician
groups.
IPA management revenue is equal to the difference between the amount of
capitation and risk pool payments payable to the IPAs managed by the
Company less amounts retained by the IPAs. The Company has not
historically been a party to capitated contracts entered into by the
IPAs, but is exposed to losses to the extent of its share of deficits, if
any, of the capitated revenue of the IPAs. Through the PrimeCare and MHG
acquisitions, the Company became a party to certain managed care
contracts. Accordingly, the cost of provider services for the PrimeCare
and MHG contracts is not included as a deduction to net revenue of the
Company but is reported as an operating expense.
The following represent amounts included in the determination of net
revenue (in thousands):
THREE MONTHS ENDED
MARCH 31,
----------------------------
1999 1998
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Gross physician group, hospital and other revenue $922,573 $841,519
Less:
Provisions for doubtful accounts
and contractual adjustments 394,461 339,289
-------- --------
Net physician group, hospital and other revenue 528,112 502,230
IPA revenue 267,123 120,983
-------- --------
Net physician group, hospital, IPA and other revenue 795,235 623,213
Less amounts retained by physician groups and IPAs:
Physician groups 182,624 176,033
Clinic technical employee compensation 23,290 23,228
IPAs 172,777 101,257
-------- --------
Net revenue $416,544 $322,695
======== ========
(4) BUSINESS SEGMENTS
-----------------
The Company has two reportable segments: physician clinics and IPAs. The
physician clinics have been subdivided into multi-specialty and group
formation clinics for purposes of disclosure. The Company derives its
revenues primarily from operating multi-specialty medical clinics and
managing IPAs (See Note 3). In addition the Company provides health care
decision-support services and operates two hospitals that do not meet the
quantitative thresholds for reportable segments.
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
The Company evaluates performance based on earnings from operations
before asset revaluation and clinic restructuring charges, merger
expenses, minority interest and income taxes. The following is a
financial summary by business segment for the periods indicated (in
thousands):
THREE MONTHS ENDED
MARCH 31,
------------------------------
1999 1998
----------- -----------
Multi-specialty clinics:
Net revenue $ 294,418 $ 269,763
Operating expenses(1) 266,611 237,593
Interest income 335 186
Interest expense 19,070 16,995
Earnings before taxes and minority interest(1) 9,072 15,361
Depreciation and amortization 18,985 14,990
Segment Assets 1,351,683 1,299,901
Group formation clinics:
Net revenue 12,577 33,488
Operating expenses(1) 11,379 29,585
Interest income (expense) 141 (25)
Interest expense 1,390 3,522
Earnings (loss) before taxes and minority interest(1) (51) 356
Depreciation and amortization 684 1,667
Segment Assets 66,737 185,105
IPAs:
Net revenue 96,383 19,444
Operating expenses(1) 85,179 13,447
Interest income 644 93
Interest expense 2,721 1,036
Earnings before taxes and minority interest(1) 9,127 5,054
Depreciation and amortization 2,973 938
Segment Assets 317,194 125,945
Corporate and other(2):
Net revenue 13,166 --
Operating expenses(1) 22,211 7,024
Interest income (expense) (107) 491
Interest income 13,316 14,031
Earnings before taxes and minority interest(1) 4,164 7,498
Depreciation and amortization 2,128 580
Segment Assets 122,658 56,267
- ----------------------------
(1) Amounts exclude provision for asset revaluation and clinic restructuring
and merger expenses.
(2) This segment includes all real estate holdings as well as the results for
CareWise and the hospitals managed by the Company.
(Continued)
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PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(5) ASSET REVALUATION AND CLINIC RESTRUCTURING
------------------------------------------
Restructuring charges totaling approximately $9.5 million were recorded
in the first quarter of 1999 with respect to operations that are being
sold or restructured. These charges were comprised of approximately
$1,929,000 in facility and lease termination costs, $3,127,000 in
severance costs and $4,457,000 in other exit costs. During the three
months ended March 31, 1999, the Company paid approximately $240,000 in
facility and lease termination costs, $441,000 in severance costs and
$2,091,000 in other exit costs. At March 31, 1999, accrued expenses
payable included remaining reserves for clinics to be restructured and
exit costs for disposed clinic operations of $10,846,000, which included
$2,054,000 in facility and lease termination costs, $4,446,000 in
severance costs and $4,346,000 in other exit costs. Asset recoveries on
clinics whose asset revaluation occurred in the fourth quarter of 1997
and third quarter of 1998 totaled $1,900,000, and this recovery was used
in the revaluation of certain assets associated with the FPC clinics in
the first quarter of 1999.
Clinic net assets to be disposed of totaled approximately $42.8 million
at March 31, 1999, and consisted of current assets, property and
equipment and other assets from three clinics associated with the fourth
quarter 1998 asset revaluation charge. The Company expects to dispose of
the assets and terminate the service agreements related to such clinics
in 1999. Net revenue and pre-tax losses from the clinics and IPA disposed
of or to be disposed of totaled $35.4 million and $811,000, respectively,
for the three months ended March 31, 1999. Net revenue and pre-tax losses
from the clinics disposed of or to be disposed of totaled $47.5 million
and $116,000, respectively, for the three months ended March 31, 1998.
(6) 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.
(7) 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 first three months of 1999 and 1998.
(8) 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 1998, amortization expense would have
increased and diluted earnings per share would have decreased by
approximately $3.3 million and $0.03, respectively, in the first quarter
of 1998.
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
PhyCor, Inc. ("PhyCor" or the "Company") is a medical network
management company that 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. In connection with multi-specialty clinic operations,
the Company manages and operates two hospitals and four health maintenance
organizations. As of March 31, 1999, the Company operated 55 medical groups with
3,579 physicians in 27 states and managed IPAs with approximately 24,000
physicians in 36 markets. On such date, the Company's affiliated physicians
provided medical services under capitated contracts to approximately 1,725,000
patients, including approximately 340,000 Medicare/Medicaid eligible patients.
The Company also provided health care decision-support services to approximately
2.4 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 groups and IPAs to be the physician component of organized health care
systems. PhyCor believes that physician organizations are a critical element of
organized health care systems because physician decisions determine the cost and
quality of care.
A substantial majority of the Company's revenue in the first three
months of 1999 and 1998 was earned under service agreements with multi-specialty
clinics. Revenue earned under substantially all of the service agreements is
equal to the net revenue of the clinics, less amounts retained by physician
groups. 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.
During the first quarter of 1999, the Company affiliated with several
smaller medical practices, adding a total of approximately $8.7 million in
assets. The principal assets acquired were property and equipment and service
agreement rights, an intangible asset. The consideration for the acquisitions
consisted of approximately 60% cash and 40% liabilities assumed. The cash
portion of the aggregate 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. The Company
continues to seek additional affiliations with multi-specialty clinics, however,
the Company anticipates that its acquisition growth will continue to be slower
than in previous years.
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The Company has historically amortized goodwill and other intangible
assets related to its service agreements over the periods during which the
agreements are expected to be 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 effect for the first quarter of 1998, amortization
expense would have increased by approximately $3.3 million. Applying the
Company's historical tax rate, diluted earnings per share would have been
reduced by $.03 in the first quarter of 1998.
RESULTS OF OPERATIONS
The following table shows the percentage of net revenue represented by
various expenses and other income items reflected in the Company's Consolidated
Statements of Operations:
THREE MONTHS
ENDED MARCH 31,
1999 1998
------ ------
Net revenue................................. 100.0% 100.0%
Operating expenses
Cost of provider services................ 13.7 --
Salaries, wages and benefits............. 31.9 37.4
Supplies................................. 14.5 16.5
Purchased medical services............... 2.4 2.9
Other expenses........................... 14.0 15.1
General corporate expenses............... 2.1 2.3
Rents and lease expense.................. 7.9 9.3
Depreciation and amortization............ 6.0 5.6
Provision for asset revaluation
and clinic restructuring.............. 2.3 6.8
Merger expenses.......................... -- 4.4
---- -----
Net operating expenses...................... 94.8 (A) 100.3 (A)
---- -----
Earnings (loss) from operations....... 5.2 (A) (0.3) (A)
Interest income............................. (0.2) (0.2)
Interest expense............................ 2.3 2.3
---- -----
Earnings (loss) before income taxes
and minority interest............. 3.1 (A) (2.4) (A)
Income tax expense (benefit)................ 1.3 (A) (1.0) (A)
Minority interest........................... 1.1 0.9
---- -----
Net earnings (loss)................... 0.7%(A) (2.3)%(A)
==== =====
- ----------------------------
(A) Excluding the effect of the provision for asset revaluation and clinic
restructuring and merger expenses in 1999 and 1998, net operating expenses,
earnings from operations, earnings before income taxes and minority interest,
income tax expense and net earnings, as a percentage of net revenue, would have
been 92.5%, 7.5%, 5.4%, 1.6% and 2.6%, respectively, for the three months ended
March 31, 1999, and 89.1%, 10.9%, 8.8%, 3.0% and 4.9%, respectively, for the
three months ended March 31, 1998.
Three Months Ended March 31, 1999 Compared to the Three Months Ended March 31,
1998
Net revenue increased $93.8 million, or 29.1%, from $322.7 million for
the first quarter of 1998 to $416.5 million for the first quarter of 1999. The
increase in clinic net revenue from the first quarter of 1998 to 1999 was $3.7
million, comprised of (i) a $6.9 million increase in service fees for
reimbursement of clinic expenses incurred by the Company and (ii) a $3.2 million
decrease in the Company's fees from clinic operating income and net physician
group
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revenue. The increases in clinic net revenue include $26.8 million from clinics
acquired during or subsequent to the first quarter of 1998 offset primarily by
reductions as a result of assets disposed of in 1998 and 1999. The increase in
IPA net revenue from the first quarter of 1998 to 1999 was $76.9 million, driven
by net revenues from the acquisitions of PrimeCare International, Inc.
("PrimeCare") and The Morgan Health Group, Inc. ("MHG") as well as additional
IPA markets entered into subsequent to the first quarter of 1998. Net revenue
from the 40 service agreements (excluding clinics being restructured or sold)
and 23 IPA markets in effect for both quarters increased by $24.7 million, or
9.7%, for the quarter ended March 31, 1999, compared with the same period in
1998. Same market growth resulted from the addition of new physicians, increases
in IPA enrollment, the expansion of ancillary services and increases in patient
volume and fees.
During the first quarter of 1999, most categories of operating expenses
decreased as a percentage of net revenue when compared to the same period in
1998. The addition of cost of provider services is a result of the acquisitions
of PrimeCare and MHG in 1998. PrimeCare and MHG own and manage IPAs, and each
are a party to certain managed care contracts, resulting in the Company
presenting such revenue on a "grossed-up basis". Under this method, the cost of
provider services (payments to physicians and other providers under
compensation, sub-capitation 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 and
MHG's revenue reporting, supplies expense, other expenses, depreciation and
amortization, interest expense and minority interest in earnings of consolidated
partnerships increased as a percentage of net revenue. The increase in supplies
expense is a result of the continued increases in costs of drugs and
medications, the addition of pharmacies at certain existing clinics and recent
affiliations with clinics that operate pharmacies. Other expenses increased as a
result of acquisitions completed after the first quarter of 1998 with higher
levels of these expenses compared to the existing base of operations. The
increase in depreciation and amortization expense resulted from the change in
the amortization policy with respect to intangible assets and the impact of 1998
acquisitions. Excluding the impact of PrimeCare's and MHG's revenue reporting,
salaries, wages and benefits decreased as a percentage of net revenue. This
decrease is a result of the Company's continuing efforts to control overhead
costs. While general corporate expenses as a percentage of net revenue remained
comparable to the same period in 1998, the dollar amount increased as a result
of the Company's response to increasing physician group needs for practice
management services, including managed care negotiations, information systems
implementations and clinical outcomes management programs.
The provision for clinic restructuring of approximately $9.5 million in
the first quarter of 1999 relates to three of the Company's clinics, certain
First Physician Care, Inc. ("FPC") clinics and one IPA that are being
restructured or disposed of and includes facility and lease termination costs,
severance costs and other exit costs. In the fourth quarter of 1998, the Company
recorded a pre-tax charge of $110.4 million related to asset revaluation at
primarily these same clinics and the IPA. A portion of the fourth quarter 1998
charge related to adjustments of the carrying value of the Company's assets at
Holt-Krock Clinic ("Holt-Krock") and Burns Clinic Medical Center ("Burns") as a
result of agreements to sell certain assets associated with these service
agreements. The fourth quarter 1998 charge related to these clinics was $26.0
million. The Company received approximately $6.4 million in April 1999 related
to the sale of assets associated with Burns. The amounts received upon the
disposition of the assets approximated the post-charge net carrying value. The
pre-tax charge assumes the successful completion of the Holt-Krock transaction
as reflected in the agreement with this clinic. In addition, the fourth quarter
1998 charge provided for the write-off of $31.6 million of goodwill recorded in
connection with the MHG acquisition. The future operations of MHG have been
impaired, and the Company is attempting to recover its investment in MHG from
the sellers of MHG, but there can be no assurance of any recovery. Also included
in the fourth quarter 1998 pre-tax charge was $18.1 million related to certain
FPC clinics that are experiencing significant negative operating results. The
asset revaluation charge included primarily the write-down of goodwill from the
FPC acquisition to recognize the decline in expected future cash flows of the
investment. The ultimate solution in these markets will involve the sale of
certain clinic assets and discontinuation of these FPC operations. Lastly, the
Company recorded a pre-tax asset revaluation charge related to the Lexington
Clinic in the fourth quarter of 1998 of $34.7 million. This charge reduced to
net realizable value the investments in numerous satellite operations and
provided a reserve for amounts due from the Lexington Clinic based upon expected
future cash flows. For additional discussion, see "Liquidity and Capital
Resources."
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The provision for clinic restructuring of $22.0 million in the first
quarter of 1998 related to seven of the Company's clinics that were being
restructured or disposed of and included 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 addressed operating issues that developed in four of
the Company's multi-specialty clinics that 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-specific issues. Net
revenue and pre-tax loss for operations disposed of to date were $1.3 million
and $500,000 for the three months ended March 31, 1999, and $28.1 million and
$800,000 for the three months ended March 31, 1998, respectively. The Company
recorded no gain or loss resulting from the disposition of these clinics based
on adjusted asset values. Net revenue and pre-tax income (loss) from the
remaining operations to be disposed of were $34.0 million and ($400,000) for the
three months ended March 31, 1999, and $19.4 million and $700,000 for the three
months ended March 31, 1998, respectively. See "Liquidity and Capital
Resources."
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 represented 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 38% in 1999
before the tax benefit of the provision for asset revaluation and clinic
restructuring discussed above as compared to a rate of 37.6% in 1998.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999, the Company had $210.0 million in working capital,
compared to $187.9 million as of December 31, 1998. Also, the Company generated
$29.9 million of cash flows from operations for the first quarter of 1999
compared to $36.6 million for the first quarter of 1998. The decrease in cash
flows from operations compared to the first quarter of 1998 is primarily due to
the receipt of a $10.6 million income tax refund in the first quarter of 1998.
At March 31, 1999, net accounts receivable of $388.1 million amounted to 65 days
of net clinic revenue compared to $378.7 million and 64 days at the end of 1998.
In conjunction with the securities repurchase program, the Company
repurchased approximately 2.6 million shares of common stock for approximately
$12.6 million in 1998.
Option exercises, other issuances of common stock and net earnings for
the first three months of 1999 resulted in an increase of $3.3 million in
shareholders' equity compared to December 31, 1998.
Capital expenditures during the first three months of 1999 totaled
$14.3 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 $50.0 million in additional capital expenditures
during the remainder of 1999.
Deferred acquisition payments are payable to physician groups in the
event such physician groups attain predetermined financial targets during
established periods of time following the acquisitions. If each group satisfied
its applicable financial targets for the periods covered, the Company would be
required to pay an aggregate of approximately $56.0 million of additional
consideration over the next five years, of which a maximum of approximately $9.4
million would be payable during the remainder of 1999.
In the fourth quarter of 1997, PhyCor 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, which included current assets, property and
equipment, other assets and intangible assets of $6.4 million, $4.9 million,
$5.3 million and $66.8 million, respectively. In the first quarter of 1998, the
Company also recorded an additional charge of $22.0 million relating to these
clinics that are being restructured or disposed of including facility and lease
termination, severance and other exit costs. These
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pre-tax charges were partially in response to issues that arose in four of the
Company's multi-specialty clinics that represented 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 intangible assets because 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. Three other clinics included in the charge represented clinics being
disposed of because of a variety of negative operating and market issues,
including those related to market position and clinic demographics, physician
relations, physician departure rates, declining physician incomes, physician
productivity, operating results and ongoing viability of the existing medical
group. Although these factors have been present individually from time to time
in various affiliated clinics and could occur in future clinic operations, the
combined effect of 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 practices was sold in the first
quarter of 1998 and the second sale was completed April 1, 1998. The remaining
practice was disposed of in July 1998. These clinics were sold below book value
because of the reasons noted above, and given such facts, a sale at a discount
to carrying value was considered more cost effective than a closure which would
subject the Company to additional costs.
In the third quarter of 1998, the Company recorded a net pre-tax asset
revaluation charge of $92.5 million, which is comprised of a $103.3 million
charge less the reversal of certain restructuring charges recorded in the first
quarter of 1998. This charge related to deteriorating negative operating trends
for three group formation clinic operations which were included in the fourth
quarter of 1997 asset revaluation charge and the corresponding decision to
dispose of those assets. Additionally, this charge provided for the disposition
of assets of two group formation clinics, which dispositions were not included
in the fourth quarter of 1997 asset revaluation charge, and the revaluation of
primarily intangible assets at an additional group formation clinic that may be
disposed of or restructured. The third quarter 1998 asset revaluation charge
included current assets, property and equipment, other assets and intangible
assets of $4.2 million, $3.8 million, $6.7 million and $77.8 million,
respectively. Amounts received upon the dispositions of the assets approximated
the post-charge net carrying value.
In the fourth quarter of 1998, the Company recorded a pre-tax asset
revaluation charge of $110.4 million. Approximately $26.0 million of this charge
related to adjustments of the carrying value of the Company's assets at
Holt-Krock and Burns as a result of agreements to sell certain assets associated
with these service agreements. Assets associated with Burns were sold effective
March 31, 1999 and the Company received approximately $6.4 million in the second
quarter of 1999. Amounts received upon the disposition of the assets
approximated the post-charge net carrying value. The pre-tax charge assumes the
successful completion of the Holt-Krock transaction as reflected in the
agreement with this clinic. Such completion is expected in the second quarter of
1999. In addition, this charge provided for the write-off of $31.6 million of
goodwill recorded in connection with the MHG acquisition. Subsequent to the
closing of this acquisition, MHG received claims from its major payor for costs
arising before the acquisition that revealed that MHG's costs significantly
exceeded its revenues under the payor contract prior to the date of acquisition.
PhyCor continued to fund losses under this payor contract while attempting to
renegotiate payment terms with the payor to allow for this payor contract to be
economically viable. A mutually beneficial agreement could not be reached. The
payor contract terminated by mutual agreement on April 30, 1999. PhyCor is
attempting to recover its investment in MHG but there can be no assurance of a
recovery.
Also included in the fourth quarter pre-tax charge is $18.1 million
related to certain FPC clinics that are experiencing significant negative
operating results. PhyCor recorded the asset revaluation charge primarily to
write down goodwill from the FPC acquisition to recognize the decline in future
cash flows of the investment. The Company is selling certain FPC clinic assets
and discontinuing the related clinic operations. Lastly, the Company had
invested significantly in the operation of the Lexington Clinic to support the
growth and expansion of the Lexington Clinic and its affiliated HMO. Lexington
Clinic's financial performance has been negatively impacted by the combination
of poor financial performance at a number of satellite locations, a challenging
and extended information system conversion, a potential loss arising from a
dispute with one of the HMO's payors and the repayment of funds used to finance
the
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Lexington Clinic's and the HMO's growth. In light of the existing circumstances,
realization of certain of PhyCor's assets related to the Lexington Clinic was
unlikely. Accordingly, the Company recorded an asset revaluation pre-tax charge
in the fourth quarter of approximately $34.7 million to reduce to net realizable
value of its investments in numerous satellite operations and to provide a
reserve for amounts owed by Lexington Clinic based upon expected future cash
flows. The fourth quarter 1998 asset revaluation charge included current assets,
property and equipment, other assets and intangible assets of $3.7 million, $3.7
million, $27.0 million and $76.0 million, respectively. The pre-tax
restructuring charge of approximately $9.5 million in the first quarter of 1999
related to facility and lease termination, severance and other exit costs
associated primarily with the clinics and IPA mentioned above. Additionally,
asset recoveries on clinics disposed of totaling $1.9 million were used to
revalue certain assets associated with the FPC clinics in the first quarter of
1999.
At March 31, 1999, the Company had a total of four group formation
clinics and two FPC clinics that have characteristics similar to group formation
clinics. The total assets of the remaining four group formation clinics and
similar FPC clinics were $52.6 million, including net intangible assets of $21.6
million at March 31, 1999. Net revenue and pre-tax income (loss) for the group
formation and similar FPC clinics were $17.8 million and ($200,000),
respectively, for the three months ended March 31, 1999, and $11.2 million and
$400,000, respectively, for the three months ended March 31, 1998.
At March 31, 1999, net assets currently expected to be sold in 1999,
after taking into account the charges discussed above, relating to clinics with
which the Company intends to terminate its affiliation totaled approximately
$42.8 million. These net assets consisted of current assets, property and
equipment and other assets. The Company intends to recover these amounts during
1999 as the asset sales occur. However, there can be no assurance that the
Company will recover this entire amount. Subsequent to March 31, 1999, the
Company completed the sale of two clinics and received approximately $6.4
million on those assets held for sale.
The Company continues to evaluate strategic options with certain
affiliated medical groups that may involve the potential sale or disposition of
certain clinic operations. These discussions are in the preliminary stages, but
depending on their outcome, the Company's financial results could be impacted.
The Company currently anticipates potential sales in the second quarter of 1999
involving up to $59.1 million in clinic operating assets related to three
medical groups comprised of 160 physicians as of March 31, 1999. The Company
expects to use the proceeds from these sales to reduce debt. Depending on the
form and amount of proceeds from these sales, the expected interest savings from
the use of such proceeds may not adequately offset the current earnings
contribution of these clinic operations, and the financial results of the
Company may be adversely affected. Any gain or loss on these potential
transactions or restructuring charges, if necessary, will be recorded when an
estimate of such amounts can be determined.
There can be no assurance 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. For
additional discussion, see "Results of Operations - 1999 Compared to 1998".
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 represented PhyCor's share
of investment banking, legal, travel, accounting and other expenses incurred
during the merger negotiation process.
The Company 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 deductions
relating to uncollectible accounts, timing of revenue and deductions, and the
Company's relationship with affiliated physician groups. Most of the issues
originally raised by the IRS as to revenues and deductions and the Company's
relationship with affiliated physician groups have been resolved by the National
Office of the IRS in favor
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of the Company and with respect to these issues, no additional taxes, penalties
or interest are owed by the Company related to such claims. The IRS Appeals
Office raised a related issue concerning the recognition of income with respect
to accounts receivable. An agreement in principle appears to have been reached
wit the IRS Appeals Office pursuant to which the IRS will not pursue this issue
for 1988 through 1993. This agreement is not legally binding at this time. If
pursued, the Company will continue to vigorously contest any proposed
adjustments. The Company believes that any adjustments resulting from resolution
of this disagreement would not affect the reported net earnings of PhyCor, but
would defer tax benefits and change the levels of current and deferred tax
assets and liabilities. The Company does not believe the resolution of this
matter will have a material adverse effect on its financial condition, although,
until a binding report is obtained, there can be no assurance as to the outcome
of this matter. In addition, the IRS is in the process of examining the
Company's 1994 and 1995 federal tax returns. To date, the IRS has not proposed
any adjustments to the Company's reported taxable income for these two years.
The Company modified its bank credit facility in March 1999. The
Company's bank credit facility, as amended, 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 (i) the applicable
eurodollar rate plus .625% to 1.50% per annum or (ii) the agent's base rate plus
.40% to .65% per annum. The total weighted average drawn cost of outstanding
borrowings at March 31, 1999 was 6.70%. The amended bank credit facility also
provides for an increase from $25 million to $50 million for the aggregate
amount of letters of credit which may be issued by the Company and provides that
in the event of a reduced rating by certain rating agencies, the Company would
be required to pledge as security for repayment of the credit facility the
capital stock the Company holds in certain of its subsidiaries. The March 1999
amendment provides for acquisitions without bank approval of up to $25 million
individually or $150 million in the aggregate during any 12-month period and
limits the amount of its securities the Company may repurchase based upon
certain financial criteria.
The Company modified its synthetic lease facility in March 1999. The
Company's synthetic lease facility, as amended, provides off-balance sheet
financing of $60 million with an option to purchase leased facilities at the end
of the lease term. The total drawn cost under the synthetic lease facility is
.50% to 1.25% above the applicable eurodollar rate. At March 31, 1999, an
aggregate of approximately $21.7 million was drawn under the synthetic lease
facility. Of the $60 million available under the synthetic lease facility, $26.0
million has been committed to lease properties associated with two of the
Company's affiliated clinics. The amended synthetic lease facility is not
project specific but is expected to be used for, among other projects, the
construction or acquisition of certain medical office buildings related to the
Company's operations.
At March 31, 1999, notional amounts under interest rate swap agreements
totaled $210.2 million. Fixed interest rates range from 5.14% to 5.78% relative
to the one month or three month floating LIBOR. Up to an additional $15.8
million may be fixed at 5.28% as additional amounts are drawn under the
synthetic lease facility prior to April 28, 2000. The swap agreements mature at
various dates from July 2003 to April 2005. The lender may elect to terminate
the agreement covering $100 million beginning September 2000 and another $100
million beginning October 2000. The FASB has issued Statement of Financial
Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and
Hedging Activities, which the Company will be required to adopt in the first
quarter of 2000. Adoption of SFAS No. 133 will require the Company to mark
certain of its interest rate swap agreements to market due to lender optionality
features included in those swap agreements. Had the Company adopted SFAS No. 133
as of March 31, 1999, the Company estimates it would have recorded a non-cash
charge to earnings of $3.7 million. The Company has historically not engaged in
trading activities in its interest rate swap agreements and does not intend to
do so in the future.
The Company's bank credit facility and synthetic lease facility contain
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.
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At March 31, 1999, the Company had cash and cash equivalents of
approximately $73.6 million and at May 13, 1999, approximately $79.0 million
available under its current bank credit facility. The Company believes that the
combination of funds available under the Company's bank credit facility and
synthetic lease facility, together with cash reserves, cash flow from other
transactions, operations and asset dispositions, should be sufficient to meet
the Company's current planned acquisition, expansion, capital expenditure 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 may continue to incur, from time to time,
additional short-term and long-term indebtedness 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. The outcome of certain pending
legal proceedings described in Part II, Item 1 hereof may have an impact on the
Company's liquidity and capital resources.
Year 2000
The Following Material is Designated as Year 2000 Readiness Disclosure
for Purposes of the Year 2000 Information and Readiness Disclosure Act.
PhyCor has developed a program designed to identify, assess, and
remediate potential malfunctions and failures that may result from the inability
of computers and embedded computer chips within the Company's information
systems and equipment to appropriately identify and utilize date-sensitive
information relating to periods subsequent to December 31, 1999. This issue is
commonly referred to as the "Year 2000 issue" and affects not only the Company,
but virtually all companies and organizations with which the Company does
business. The Company is dependent upon Year 2000 compliant information
technology systems and equipment in applications critical to the Company's
business. The Company's information technology systems ("IT systems") can be
broadly categorized into the following areas: (i) practice management, (ii)
managed care information, (iii) consumer decision support system that supports
the operations of CareWise, (iv) ancillary information systems, including
laboratory, radiology, pharmacy and clinical ancillary systems, and (v) other
administrative information systems including accounting, payroll, human resource
and other desktop systems and applications.
The Company generally owns and provides to its various affiliated
multi-specialty clinics the IT systems in use at those locations, and such
systems represent a variety of vendors. In addition, the Company generally owns
and provides biomedical equipment (laboratory equipment, radiology equipment,
diagnostic equipment and medical treatment equipment) for use by its affiliated
physician groups and by its Company-owned hospitals, as well as other equipment
in use at Company-owned or leased facilities such as telephone and HVAC systems.
Such non-information technology ("Non-IT") equipment often contains embedded
computer chips that could be susceptible to failure or malfunction as a result
of the Year 2000 issue.
To address the Year 2000 issue, the Company has formed a Year 2000
committee comprised of representatives from a cross-section of the Company's
operations as well as the Company's senior management. Beginning in August 1997,
the committee, with the assistance of outside consultants, developed a
comprehensive plan to address the Year 2000 issue within all facets of the
Company's operations. The plan includes processes to inventory, assess,
remediate or replace as necessary, and test the Company's IT and Non-IT systems
and equipment. In addition, the Company has appointed local project coordinators
at all Company-owned facilities who are responsible for overseeing and
implementing the comprehensive project management activities at the local
subsidiary level. Each project coordinator is responsible for developing a local
project plan that includes processes to inventory, assess, remediate or replace
as necessary, and test the Company's IT and Non-IT systems and equipment. Each
local project coordinator is also responsible for assessing the compliance of
the electronic trading partners and business critical vendors for that
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location. However, the compliance of certain vendors providing business critical
IT systems in wide use within the Company is being addressed by the Company's
senior management.
The Company has completed the inventory and assessment phase of
business critical IT systems and is in the process of upgrading or replacing
those business critical IT systems found not to be compliant, either internally
or through the upgrades provided by the Company's vendors. In certain cases, the
Company's plan provides for verification of Year 2000 compliance of
vendor-supplied IT systems by obtaining warranties and legal representations of
the vendors. Much of the remediation is being accomplished as a part of the
Company's normal process of standardizing various IT systems utilized by its
affiliated clinics and IPAs, although in certain cases the standardization
process is moving at an accelerated pace as a result of the Year 2000 issue. As
of March 31, 1999, management believed approximately 70% of the Company's
business critical IT systems at the Company and its subsidiaries to be Year 2000
compliant as a result of upgrades, replacements or testing. The Company
anticipates that all remediation and testing of its business critical IT systems
will be completed by October 1999.
The Company is in the process of completing the inventory and
assessment phase of its Non-IT systems and equipment, which are comprised
primarily of medical equipment with embedded chip technology that are located
throughout the subsidiaries' facilities. The Company is relying primarily on its
local project coordinators and on the equipment vendors' representations in
order to complete the inventory and assessment phase and either remediate or
replace non-compliant equipment. As of March 31, 1999, substantially all of the
Company's subsidiaries had completed the inventory and assessment phase, and
those facilities had completed approximately 70% of the remediation and testing
of Non-IT systems and equipment. The Company estimates that substantially all of
its subsidiaries will have substantially completed remediation and testing of
Non-IT systems and medical equipment by October 1999.
The Company is substantially dependent on a wide variety of third
parties to operate its business. These third parties include medical equipment
and IT software and hardware vendors, medical claims processors that act as
intermediaries between the Company's medical practice subsidiaries and the
payors of such claims, and the payors themselves, which includes HCFA. HCFA paid
to the Company Medicare claims that comprised approximately 18% of the Company's
net revenue in the first quarter of 1999. In most cases, these third party
relationships originate and are managed at the local clinic level. The Company
estimates that information concerning the Year 2000 readiness of the most
significant third parties will be received and analyzed by the Company by
October 1999. Together with its trade associations and other third parties the
Company is monitoring the status and progress of HCFA's Year 2000 compliance.
HCFA has represented that its systems are or will soon be Year 2000 compliant.
As of April 5, 1999, HCFA will require all Medicare providers that submit
Medicare claims electronically to do so in an approved Year 2000 compliant
format. The process of billing and collecting for Medicare claims involves a
number of third parties that the Company does not control, including
intermediaries and HCFA independent contractors. The Company believes that most
of these third parties are able to comply with HCFA billing requirements. The
Company is in the process of verifying the Year 2000 compliance of third parties
upon which the Company relies to process claims, including significant third
party payors.
The Company currently is working at the parent company level and with
local project coordinators in each of its subsidiary locations to develop
contingency plans for business critical IT systems and Non-IT medical equipment
to minimize business interruptions and avoid disruption to patient care as a
result of Year 2000 related issues. The Company anticipates that contingency
plans for non-compliant business critical IT systems and non-compliant Non-IT
medical equipment will be completed by October 1999.
There are a number of risks arising out of Year 2000 related failure,
any of which could have a material adverse effect on the Company's financial
condition or results of operations. These risks include (i) failures or
malfunctions in practice management applications that could prevent automated
scheduling, accounts receivable management and billing and collection on which
each of the subsidiary locations is substantially dependent, (ii) failures or
malfunctions of claims processing intermediaries or payors that may result in
substantial payment delays that could negatively impact
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cash flows, or (iii) the failure of certain critical pieces of medical equipment
that could result in personal injury or misdiagnosis of patients treated at the
Company's affiliated clinics or hospitals. The Company has a number of ongoing
obligations that could be materially adversely impacted by one or more of the
above described risks. If the Company has insufficient cash flow to meet its
expenses as a result of a Year 2000 related failure, it will need to borrow
available funds under its credit lines or obtain additional financing. There can
be no assurance that such funds or any other additional financing will be
available in the future when needed.
To date, the Company estimates that it has spent approximately $16.0
million on the development and implementation of its Year 2000 compliance plan.
In addition, the Company believes that it will need to spend a total of
approximately $28 million to complete all phases of its plan, which amounts will
be funded from cash flows from operations and, if necessary, with borrowings
under the Company's primary credit facility. Of those costs, an estimated $24
million is expected to be incurred to acquire replacement systems and equipment,
including amounts spent in connection with standardizing certain of the
Company's IT systems that it would have spent regardless of the Year 2000
initiative.
The foregoing estimates and conclusions regarding the Company's Year
2000 plan contain forward looking statements and are based on management's best
estimates of future events. Risks to completing the Year 2000 plan include the
availability of resources, the Company's ability to discover and correct
potential Year 2000 problems that could have a serious impact on specific
systems, equipment or facilities, the ability of material third party vendors
and trading partners to achieve Year 2000 compliance, the proper functioning of
new systems and the integration of those systems and related software into the
Company's operations. Some of these risks are beyond the Company's control.
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 items, could be affected by a number of risks,
uncertainties, and other factors described in the Company's Annual Report on
Form 10-K for the year ended December 31, 1998.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
During the three months ended March 31, 1999, 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, 1998.
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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, Richard D. Wright (who is no
longer with the Company), Thompson S. Dent, and John K. Crawford have been named
defendants in nine securities fraud class actions filed between September 8 and
October 23, 1998. The factual allegations of the complaints in all nine 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 nine 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 is pending before that
court. The state court actions have been consolidated in Davidson County,
Tennessee. The Company believes that it has meritorious defenses to all of the
claims, and intends to vigorously defend against these actions. There can be no
assurance, however, that such defenses will be successful or that the lawsuits
will not have a material adverse effect on the Company. The Company's Restated
Charter provides that the Company shall indemnify the officers and directors for
any liability arising from these suits unless a final judgment establishes
liability (a) for a breach of the duty of loyalty to the Company or its
shareholders, (b) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law or (c) for an unlawful
distribution.
On January 23, 1999, the Company and Holt-Krock Clinic, P.L.C.
("Holt-Krock") entered into a settlement agreement with Sparks Regional Medical
Center and Sparks Regional Medical Center Foundation (collectively, "Sparks") to
resolve their lawsuits and all related claims between the parties and certain
former Holt-Krock physicians. As a result, Sparks is expected to acquire certain
assets from PhyCor, offer employment to a substantial number of Holt-Krock
physicians and enter into a long-term agreement whereby PhyCor will provide
physician practice management resources to Sparks. These transactions are
expected to be completed during the second quarter of 1999, upon execution of
definitive agreements, however, there can be no assurance that the transaction
will be completed or that it will be completed on the terms described above.
On February 2, 1999, Prem Reddy, M.D., the former majority shareholder
of PrimeCare, a medical network management company acquired by the Company in
May 1998, filed suit against the Company and certain of its current and former
executive officers in United States District Court for the Central District of
California. The complaint asserts fraudulent inducement relating to the
PrimeCare transaction and that the defendants issued false and misleading
statements which materially misrepresented the earnings and financial condition
of the Company and its clinic operations and misrepresented and failed to
disclose various other matters concerning the Company's operations in order to
conceal the alleged failure of the Company's business model. The Company
believes that it has meritorious defenses to all of the claims and intends to
vigorously defend this suit, however, there can be no assurance that if the
Company is not successful in litigation, that this suit will not have a material
adverse effect on the Company.
On February 6, 1999, White-Wilson Medical Center, P.A. ("White -
Wilson") filed suit against PhyCor of Fort Walton Beach, Inc., the PhyCor
subsidiary with which it is a party to a service agreement, in the United States
District Court for the Northern District of Florida. White-Wilson is seeking a
declaratory judgment regarding the enforceability
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of the fee arrangement in light of the Florida Board of Medicine opinion and OIG
Advisory Opinion 98-4. Additionally, on March 17, 1999, the Clark-Holder Clinic,
P.A. filed suit against PhyCor of LaGrange, Inc., the PhyCor subsidiary with
which it is a party to a service agreement, in Georgia Superior Court for Troup
County, Georgia similarly questioning the enforceability of the fee arrangement
in light of OIG Advisory Opinion 98-4. On April 27, 1999, the Company filed a
motion to remove the case to the federal district court in Georgia. The terms of
the service agreements provide that the agreements shall be modified if the laws
are changed, modified or interpreted in a way that requires a change in the
agreements. PhyCor intends to vigorously defend the enforceability of the
structure of the management fee against these suits, however, there can be no
assurance that if the Company is not successful in such litigation, that these
suits will not have a material adverse effect on the Company.
Certain litigation is pending against the physician groups affiliated
with the Company and IPAs managed by the Company. The Company has not assumed
any liability in connection with such litigation. Claims against the physician
groups and IPAs could result in substantial damage awards to the claimants that
may exceed applicable insurance coverage limits. While there can be no assurance
that the physician groups and IPAs will be successful in any such litigation,
the Company does not believe any such litigation will have a material adverse
effect on the Company. Certain other litigation is pending against the Company
and certain subsidiaries of the Company, none of which management believes would
have a material adverse effect on the Company's financial position or results of
operations on a consolidated basis.
The U.S. Department of Labor (the "Department") is conducting an
investigation of the administration of the PhyCor, Inc. Savings and Profit
Sharing Plan (the "Plan"). The Department has not completed its investigation,
but has raised questions involving certain administrative practices in early
1998. The Department has not recommended enforcement action against PhyCor, nor
has it identified an amount of liability or penalty that could be assessed
against PhyCor. Based on the nature of the investigation, PhyCor believes that
its financial exposure is not material. PhyCor intends to cooperate with the
Department's investigation. There can be no assurance, however, that PhyCor will
not have a monetary penalty imposed against it.
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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
From time to time, the Company issues subordinated convertible notes
and warrants to purchase shares of the Company's Common Stock in connection with
the acquisition of the assets of multi-specialty clinics and physician practice
groups. In general, the subordinated convertible notes are convertible into
shares of the Company's Common Stock following the anniversary of the issuance
of the notes at a conversion price based on the market price of the Common Stock
at the time the note was issued. The Company issues subordinated convertible
notes, warrants, and shares of Common Stock upon conversion of notes and
exercise of warrants in transactions intended to be exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to Sections
3(a)(11), 3(b) or 4(2) thereunder. During the first quarter of 1999, the Company
issued the following shares of Common Stock upon conversion of notes:
On March 15, 1999, the Company issued 733 shares of Common Stock to
Medical Arts Clinic, P.C. upon conversion of subordinated convertible
notes in the principal amount of $21,869.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
EXHIBIT
NUMBER
DESCRIPTION OF EXHIBITS
3.1 -- Restated Charter of 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 -- Amendment No. 2 and Consent to the Second Amended and Restated
Revolving Credit Agreement, dated as of March 10, 1999, among the
Registrant, the Banks named therein and Citibank, N.A.
27 -- 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.
(B) REPORTS ON FORM 8-K.
The Company filed a Current Report on Form 8-K on February 23, 1999
announcing year-end results, adjusted earnings expectations, a pre-tax charge to
earnings in the fourth quarter of 1998, and an expected pre-tax charge to
earnings in the first quarter of 1999 pursuant to Item 5 of Form 8-K.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHYCOR, INC.
By: /s/ John K. Crawford
---------------------------------
John K. Crawford
Executive Vice President and
Chief Financial Officer
Date: May 17, 1999
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