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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-Q
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(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended July 31, 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 0-27568
PhyMatrix Corp.
(Exact name of registrant as specified in its charter)
Delaware 65-0617076
(State of incorporation) (I.R.S. Employer Identification No.)
Phillips Point, Suite 1000E
777 S. Flagler Drive, West Palm Beach, Florida 33401
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (561) 655-3500
Indicate by check mark whether the registrant (1) has filed all reports
required 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 [ ]
On September 11, 1998, the number of outstanding shares of the registrant's
Common Stock, par value $0.01 per share, was 33,343,560.
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<PAGE>
PHYMATRIX CORP.
QUARTERLY REPORT ON FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Consolidated Balance Sheets - July 31, 1998 (unaudited) and January 31, 1998 3
Consolidated Statements of Operations (unaudited) - Three and Six Months 4
Ended July 31, 1998 and 1997
Consolidated Statements of Cash Flows (unaudited) - Six Months Ended July 5
31, 1998 and 1997
Notes to Consolidated Financial Statements (unaudited) -
Three and Six Months Ended July 31, 1998 and 1997 6-12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of 13-23
Operations
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 24
</TABLE>
<PAGE>
PART I - FINANCIAL INFORMATION
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Item 1. Financial Statements
PHYMATRIX CORP.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
July 31, January 31,
1998 1998
-------- --------
(unaudited)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 34,938 $ 49,536
Receivables:
Accounts receivable, net 62,777 57,252
Other receivables 16,832 14,240
Notes receivable 2,235 1,851
Prepaid expenses and other current assets 6,409 6,167
-------- --------
Total current assets 123,191 129,046
Property, plant and equipment, net 42,555 44,295
Notes receivable 14,102 7,831
Goodwill, net 109,034 93,880
Management services agreements, net 96,182 89,470
Investment in affiliates 5,222 4,944
Other assets 8,902 8,694
-------- --------
Total assets $399,188 $378,160
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current portion of debt and capital leases $ 3,972 $13,742
Accounts payable 12,787 13,101
Accrued compensation 1,793 2,282
Accrued liabilities 13,333 13,531
-------- --------
Total current liabilities 31,885 42,656
Long-term debt and capital leases, less current portion 19,805 20,617
Convertible subordinated debentures 100,000 100,000
Other long term liabilities 1,468 1,651
Minority interest 1,639 1,201
-------- --------
Total liabilities 154,797 166,125
Commitments and contingencies
Shareholders' equity:
Common Stock, par value $.01; 40,000,000 shares authorized;
33,343,560 and 31,248,474 shares issued and outstanding
at July 31, 1998 and January 31, 1998, respectively 333 312
Treasury Stock (75) (75)
Additional paid in capital 224,783 198,893
Retained earnings 19,350 12,905
-------- --------
Total shareholders' equity 244,391 212,035
-------- --------
Total liabilities and shareholders' equity $399,188 $378,160
======== ========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
-3-
<PAGE>
PHYMATRIX CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
-------------------- ---------------------
1998 1997 1998 1997
------- ------- -------- --------
<S> <C> <C> <C> <C>
Net revenues from services $48,905 $37,692 $100,762 $ 72,363
Net revenues from real estate services 1,036 5,195 8,044 10,728
Net revenue from management service agreements 45,020 40,022 87,502 75,685
------- ------- -------- --------
Total revenue 94,961 82,909 196,308 158,776
------- ------- -------- --------
Operating costs and administrative expenses:
Cost of affiliated physician management services 17,599 16,558 34,753 33,535
Salaries, wages and benefits 22,968 20,535 46,844 39,132
Professional fees 4,046 2,137 7,606 4,255
Supplies 14,879 10,909 29,031 19,900
Utilities 1,429 1,074 2,713 2,107
Depreciation and amortization 3,570 2,538 7,144 4,857
Rent 4,875 3,791 9,669 7,157
Provision for bad debts 933 1,015 1,890 2,315
Merger and other noncontinuing expenses -- 600 -- 907
Gain on sale of assets (4,506) -- (5,422) (698)
Nonrecurring expenses 5,305 -- 5,305 --
Other - primarily capitation expense 22,209 16,169 43,888 30,677
------- ------- -------- --------
Total operating costs and administrative expenses 93,307 75,326 183,421 144,144
------- ------- -------- --------
Interest expense, net 1,806 889 3,645 1,673
Income from investment in affiliates (227) (195) (434) (413)
------- ------- -------- --------
1,579 694 3,211 1,260
------- ------- -------- --------
Income before provision for income taxes 75 6,889 9,676 13,372
Income tax expense 24 2,301 3,172 4,546
------- ------- -------- --------
Net income (Note 4) $ 51 $ 4,588 $ 6,504 $ 8,826
======= ======= ======== =======
Net income per share - basic $0.00 $0.16 $0.20 $0.30
Net income per share - diluted $0.00 $0.16 $0.20 $0.30
Pro forma information (Note 4):
Adjustment to income tax expense 126 252
Net income 4,462 8,574
Net income per weighted average share - basic $ 0.15 $ 0.29
Net income per weighted average share - diluted $ 0.15 $ 0.29
Weighted average shares outstanding - basic 33,508 29,471 33,026 29,068
======= ======= ======== =======
Weighted average shares outstanding - diluted 33,518 29,613 33,292 29,204
======= ======= ======== =======
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
-4-
<PAGE>
PHYMATRIX CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
July 31,
-------------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 6,504 $ 8,826
Noncash items included in net income:
Depreciation and amortization 7,144 4,857
Gain on sale of assets (5,422) (698)
Nonrecurring charges 4,401 --
Other 72 72
Changes in receivables (4,791) (11,056)
Changes in accounts payable and accrued liabilities (4,766) (2,311)
Changes in other assets (2,076) (1,755)
-------- --------
Net cash provided (used) by operating activities 1,066 (2,065)
-------- --------
Cash flows from investing activities:
Capital expenditures (4,008) (2,855)
Sale of assets 4,821 1,490
Notes receivable, net (1,800) 4,689
Other assets 16 (606)
Acquisitions, net of cash acquired (7,598) (22,250)
-------- --------
Net cash used by investing activities (8,569) (19,532)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 130 650
Borrowings under line of credit -- 1,000
Proceeds from issuance of convertible subordinated debentures -- (114)
Proceeds from issuance of debt -- 361
Release of cash collateral -- 480
Offering costs and other (94) (619)
Payment of dividends -- (737)
Repayment of debt (7,131) (1,691)
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Net cash used by financing activities (7,095) (670)
-------- --------
Decrease in cash and cash equivalents $(14,598) $(22,267)
======== ========
Cash and cash equivalents, beginning of period $ 49,536 $ 81,650
======== --------
Cash and cash equivalents, end of period $ 34,938 $ 59,383
======== ========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
-5-
<PAGE>
PHYMATRIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three and Six Months Ended July 31, 1998 and 1997 (Unaudited)
1. Organization and Basis of Presentation
The accompanying unaudited interim consolidated financial statements
include the accounts of PhyMatrix Corp. ("the Company"). These interim
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and the requirements of the Securities
and Exchange Commission. Accordingly, certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted. It
is management's opinion that the accompanying interim financial statements
reflect all adjustments (which are normal and recurring) necessary for a fair
presentation of the results for the interim periods. During October 1997, a
subsidiary of the Company merged with Clinical Studies Ltd. ("CSL"). This
business combination was accounted for as a pooling of interests. Accordingly,
the financial statements for all periods prior to the effective date of the
merger have been restated to include CSL and Clinical Marketing Ltd. ("CML")
which was merged into CSL on January 1, 1997. These interim financial statements
should be read in conjunction with the audited financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
January 31, 1998. Operating results for the three and six months ended July 31,
1998 are not necessarily indicative of results that may be expected for the
year.
2. Acquisitions and CSL Merger
Acquisitions
During February 1998, the Company purchased New England Research Center.
Located in Massachusetts, New England Research Center is a clinical research
site with over 50 ongoing studies, primarily in allergy and asthma. In
conjunction with the acquisition, the Company entered into a 40-year agreement
with the physicians and employees to manage the clinical trials at New England
Research Center. The purchase price was approximately $5,700,000. Of such
purchase price, approximately $1,450,000 was paid in cash and 333,006 shares of
Common Stock were issued having a value of $4,250,000. The purchase price was
allocated primarily to management services agreements and is currently being
amortized over 25 years.
During February 1998, the Company completed the formation of an MSO with
Beth Israel Medical Center and the physician organizations that represent more
than 1,700 physicians of Beth Israel and its parent corporation. The Company
owns one-third of the MSO. The Company will provide management services for the
MSO which will provide the physicians and hospitals with medical management and
contract negotiation support for risk agreements with managed care payors. In
connection with the formation of the MSO, PhyMatrix Management Company, Inc.
("Management"), a subsidiary of the Company, agreed with Beth Israel Medical
Center ("Beth Israel") that Management and its affiliates (including the
Company) would not, directly or indirectly, (i) operate, manage or provide risk
contract management services to any physicians, IPAs or group practices located
in New York County, Kings County or Westchester County, New York (the
"Restricted Zone") which are affiliated with a hospital or hospital system or
any affiliate (with certain exceptions) or (ii) participate with a hospital or
hospital system or any affiliate (other than Beth Israel) in an MSO or other
person that operates, manages or provides risk contract management services
within the Restricted Zone (with certain exceptions). In addition, the owners of
two-thirds of the MSO have the right to require the Company to purchase their
interests at the option price, which is based upon earnings, during years six
and seven.
-6-
<PAGE>
PHYMATRIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three and Six Months Ended July 31, 1998 and 1997 (Unaudited)
During February 1998, the Company purchased a diagnostic imaging center
located in Delray Beach, Florida. The base purchase price was approximately
$6,570,000. The base purchase price was paid in 495,237 shares of Common Stock
of the Company. There is also a contingent payment up to a maximum of $2,000,000
based on the center's earnings before taxes during 1998, which is payable in
cash and/or Common Stock of the Company. The purchase price was allocated to the
assets at fair market value including goodwill of $6,570,000. The resulting
intangible is currently being amortized over 25 years.
During March 1998, the Company entered into an administrative services
agreement with HIA Bensonhurst Imaging Associates, LLP, a diagnostic imaging
center in Brooklyn, New York. The consideration paid was approximately
$5,100,000 of Common Stock. There is also a contingent payment up to a maximum
of $1,900,000 based on the center's earnings before taxes, which is payable in
cash and/or Common Stock of the Company. The purchase price was allocated to the
assets at fair market value including management services agreements of
$4,720,000. The resulting intangible is currently being amortized over 25 years.
During April 1998, the Company completed the formation of an MSO, which is
51% owned by the Company, with LIPH, LLC. The Company manages for the MSO the
medical risk contracting for the more than 2,600 physicians in IPAs in New York.
The base purchase price was $2,970,000. Of such purchase price, $1,470,000 was
paid in cash and 143,026 shares of Common Stock were issued having a value of
$1,500,000. There are also contingent payments up to a maximum of $5,000,000
payable in cash and Common Stock, with $4,000,000 of such amount based upon
earnings during the three years after the closing date and the remaining
$1,000,000 based upon the achievement of certain conditions during any twelve
month period during the three years after the closing date. The base purchase
price was allocated primarily to goodwill and is being amortized over 25 years.
During April 1998, the Company acquired the business and certain assets of
a clinical research company in Massachusetts. The base purchase price was
$2,640,000 plus the assumption of liabilities of approximately $425,000. Of such
purchase price, $1,500,000 was paid in 144,405 shares of Common Stock of the
Company, $70,000 is payable in shares of Common Stock on the first anniversary
of the closing date and $1,070,000 is payable in shares of Common Stock of the
Company on the second anniversary of the closing date. In addition, there is a
contingent payment up to a maximum of $2,350,000 payable in Common Stock based
on earnings before taxes during the next four years. The purchase price was
allocated to the assets at fair market value including goodwill of $2,655,000.
The resulting intangible is being amortized over 20 years.
CSL Merger
Effective October 15, 1997, a subsidiary of the Company merged with CSL in
a transaction that was accounted for as a pooling of interests. The Company
exchanged 5,204,305 shares of its Common Stock for all of the outstanding common
stock of CSL. The Company's historical financial statements for all periods have
been restated to include the results of CSL. As a result of the merger, certain
costs that were incurred by CSL are noncontinuing. During the three and six
months ended July 31, 1997, the noncontinuing costs represented management fees
paid to the principal shareholders of CSL.
The following table reflects in the As Reported column, the restated
consolidated net revenues, merger and other noncontinuing costs, net income, net
income per share and weighted average number of shares outstanding for the
indicated periods. The Pro Forma column adjusts the historical net income for
CSL to reflect the results of operations as if CSL had been a C corporation
rather than an S corporation for income tax purposes. The Adjusted Pro Forma
column adjusts the Pro Forma column by eliminating merger costs and certain
noncontinuing charges incurred by CSL.
-7-
<PAGE>
PHYMATRIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three and Six Months Ended July 31, 1998 and 1997 (Unaudited)
<TABLE>
<CAPTION>
(B)
(A) Adjusted
As Reported Pro Forma Pro Forma
----------- ------------- --------------
(In thousands, except per share data)
<S> <C> <C> <C>
FOR THE THREE MONTHS ENDED JULY 31, 1997
Net revenue $ 82,909 $ 82,909 $ 82,909
Merger and other noncontinuing costs 600 600 --
Net income 4,588 4,462 4,822
Net income per share - basic $ 0.16 $ 0.15 $ 0.16
Net income per share - diluted $ 0.16 $ 0.15 $ 0.16
Weighted average number of shares outstanding - basic 29,471 29,471 29,471
Weighted average number of shares outstanding - diluted 29,613 29,613 29,613
FOR THE SIX MONTHS ENDED JULY 31, 1997
Net revenue $158,776 $158,776 $158,776
Merger and other noncontinuing costs 907 907 --
Net income 8,826 8,574 9,118
Net income per share - basic $ 0.30 $ 0.29 $ 0.31
Net income per share - diluted $ 0.30 $ 0.29 $ 0.31
Weighted average number of shares outstanding - basic 29,068 29,068 29,068
Weighted average number of shares outstanding - diluted 29,204 29,204 29,204
</TABLE>
(A) Adjusts the As Reported results for CSL to reflect the operations of CSL as
if CSL had been a C corporation rather than an S corporation for income tax
purposes.
(B) Adjusts the As Reported results by eliminating CSL merger expenses and
certain noncontinuing costs of CSL and providing for income tax expense as
if CSL had been a C corporation rather than an S corporation for income tax
purposes.
3. Supplemental Cash Flow Information
During the six months ended July 31, 1998 and 1997, the Company acquired
the assets and/or stock, entered into management and employment agreements,
and/or assumed certain liabilities of various physician practices, ancillary
service companies, networks and organizations. In addition, during the six
months ended July 31, 1998 and 1997, the Company issued shares of stock which
had been committed to be issued in conjunction with acquisitions completed
during the year ended January 31, 1998, sold certain assets and terminated
several physician management and employment agreements. The transactions had the
following non-cash impact on the balance sheets of the Company as of the
indicated dates:
-8-
<PAGE>
PHYMATRIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three and Six Months Ended July 31, 1998 and 1997 (Unaudited)
<TABLE>
<CAPTION>
July 31,
-----------------------
1998 1997
-------- --------
<S> <C> <C>
Current assets $ 1,351 $ 4,250
Property, plant and equipment (2,809) 1,879
Intangibles 25,963 35,355
Other noncurrent assets 5,836 886
Current liabilities (4,409) 1,158
Noncurrent liabilities (80) (98)
Debt 3,451 (1,270)
Equity (26,772) (19,910)
</TABLE>
4. Pro Forma Information
Prior to the CSL merger, CSL was treated as an S corporation under the
Internal Revenue Code (the "Code") and its stockholders recognized its income
for income tax purposes. Accordingly, the Company's statements of operations do
not include provisions for income taxes for income related to CSL. Prior to the
CSL merger, dividends were paid primarily to reimburse stockholders for income
tax liabilities incurred by them.
The pro forma net income and net income per share information in the
consolidated statement of operations reflect the effect on historical results as
if CSL had been a C corporation rather than an S corporation and had paid income
taxes.
5. Nonrecurring Charge
During the six months ended July 31, 1998, the Company terminated several
of its physician management and employment agreements which resulted in a pretax
charge of approximately $5.3 million. The charge is composed primarily of the
write-off of the remaining intangible assets.
6. Gain on Sale of Assets
During the six months ended July 31, 1998 the Company sold real estate and
a radiation therapy center for $7.6 and $2.5 million, respectively. These sales
resulted in gains of $4.5 million and $0.9 million, respectively. In connection
with the sale of real estate, $2.4 million was paid in cash and the Company
recorded a note receivable for the balance of $5.2 million. The note bears
interest at 9.5% and has a final maturity of August 2008. During the six months
ended July 31, 1997 the Company sold a radiation therapy center for $1.5
million, resulting in a gain of $0.7 million.
7. Net Income per Share
The following is a reconciliation of the numerators and denominators of the
basic and fully diluted earnings per share computations for net income:
-9-
<PAGE>
PHYMATRIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three and Six Months Ended July 31, 1998 and 1997 (Unaudited)
<TABLE>
<CAPTION>
Per Share
(In thousands, except per share data) Income Shares Amount
---------- ---------- -------------
<S> <C> <C> <C>
Three Months Ended July 31, 1998
- --------------------------------
Basic earnings per share
Income available to common stockholders $ 51 33,508 $0.00
Effect of dilutive securities
Stock options -- 10 0.00
------ ------ -----
Diluted earnings per share $ 51 33,518 $0.00
====== ====== =====
Three Months Ended July 31, 1997
- --------------------------------
Basic earnings per share
Income available to common stockholders $4,588 29,471 $0.16
Effect of dilutive securities
Stock options -- 142 0.00
------ ------ -----
Diluted earnings per share $4,588 29,613 $0.16
====== ====== =====
Six Months Ended July 31, 1998
- ------------------------------
Basic earnings per share
Income available to common stockholders $6,504 33,026 $0.20
Effect of dilutive securities
Stock options -- 28
Convertible debt 49 238 0.00
------ ------ -----
Diluted earnings per share $6,553 33,292 $0.20
====== ====== =====
Six Months Ended July 31, 1997
- ------------------------------
Basic earnings per share
Income available to common stockholders $8,826 29,068 $0.30
Effect of dilutive securities
Stock options -- 136 0.00
------ ------ -----
Diluted earnings per share $8,826 29,204 $0.30
====== ====== =====
</TABLE>
-10-
<PAGE>
PHYMATRIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three and Six Months Ended July 31, 1998 and 1997 (Unaudited)
For the three and six months ended July 31, 1998 and 1997, no related
adjustments to income were made for the common stock equivalents related to the
Debentures since the effect would be antidilutive.
8. Ratio of Earnings to Fixed Charges
For the three and six months ended July 31, 1998, the ratio of earnings to
fixed charges was 1.0 and 2.1, respectively. For purposes of computing the ratio
of earnings to fixed charges, earnings represent income from operations before
minority interest and income taxes, plus fixed charges. Earnings also includes
the equity in less-than-fifty-percent-owned investments only to the extent of
distributions. Fixed charges include interest, amortization of financing costs
and the portion of operating rental expense which management believes is
representative of the interest component of the rental expense.
9. Accounting Changes and Pronouncements
Effective February 1, 1998, management changed its policies regarding
amortization of its management services agreement intangible assets. The Company
adopted a maximum of 25 years (from the inception of the respective intangible
asset) as the useful life for amortization of its management services agreement
intangible assets. Using the unamortized portion of the intangible at January
31, 1998, the Company began amortizing the intangible over the remainder of the
25 year useful life. These costs had historically been charged to expense
through amortization using the straight line method over the periods during
which the agreements are effective, generally 30 to 40 years. This change
represents a change in accounting estimate and, accordingly, does not require
the Company to restate reported results for prior years. This change increases
amortization expense relating to existing intangible assets at January 31, 1998,
by approximately $740,000 annually.
In 1997, the Emerging Issues Task Force of the Financial Accounting
Standards Board issued EITF 97-2 concerning the consolidation of physician
practice revenues. Physician practice management companies ("PPMs") will be
required to consolidate financial information of a physician where the PPM
acquires a "controlling financial interest" in the practice through the
execution of a contractual management agreement even though the PPM does not own
a controlling equity interest in the physician practice. EITF 97-2 outlines six
requirements for establishing a controlling financial interest. The Company will
adopt EITF 97-2 in the fourth quarter of this fiscal year. The Company does not
believe that the implementation of EITF 97-2 will have a material impact on its
financial condition or its earnings. However, the impact of this statement would
have resulted in a reduction of reported revenues and expenses for the three and
six months ended July 31, 1998, by a maximum of $17.6 million and $34.8 million,
respectively. The Company has implemented EITF 97-2 for all transactions
occurring after November 20, 1997.
The FASB recently issued Statement No. 131, "Disclosures About Segments of
an Enterprise and Related Information," which is effective for the Company's
financial statements as of and for the year ending January 31, 1999. This
Statement requires reporting of summarized financial results for operating
segments as well as established standards for related disclosures about products
and services, geographic areas and major customers. Primary disclosure
requirements include total segment revenues, total segment profit or loss and
total segment assets. The Company has not yet completed its evaluation of the
impact of this Statement on the Company's financial statements.
-11-
<PAGE>
PHYMATRIX CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three and Six Months Ended July 31, 1998 and 1997 (Unaudited)
10. Legal Proceedings
On October 18, 1997, the Florida Board of Medicine, which governs
physicians in Florida, declared that the payment of percentage-based fees by a
physician to a physician practice management company in connection with
practice-enhancement activities subjects a physician to disciplinary action for
a violation of a statute which prohibits fee-splitting. Some of the Company's
contracts with Florida physicians include provisions providing for such
payments. The Company is currently in the process of appealing the ruling to a
Florida District Court of Appeals and the Board has stayed the enforceability of
its ruling pending the appeal. In the event the Board of Medicine's ruling is
eventually upheld, the Company may be forced to renegotiate those provisions of
the contracts which are affected by the ruling. While these contracts call for
renegotiation in the event that a provision is not found to comply with state
law, there can be no assurance that the Company would be able to renegotiate
such provisions on acceptable terms.
11. Subsequent Events
During May 1998, the Company announced that the Board of Directors had
instructed management to explore various strategic alternatives for the Company
that could maximize shareholder value, including possible mergers, asset sales,
management buy back, other business combinations or strategic transactions.
During July 1998, the Company hired an investment banker in conjunction with its
decision to pursue strategic alternatives. During August 1998, the Company's
Board of Directors approved several strategic alternatives to enhance
stockholder value. The Board authorized a series of initiatives designed to
establish the Company as a preeminent market share leader in pharmaceutical
contract research, specifically clinical trials site management and outcomes
research. The Company will link its nationally focused expanding hospital
affiliations and its 92 physician networks with the clinical trials site
management and healthcare outcomes research operations.
During August 1998, the Board also approved, consistent with achieving its
stated restructuring goal, its plan to divest and exit its Physician Practice
Management (PPM) and ancillary services businesses, which include diagnostic
imaging, home health, lithotripsy, and radiation therapy. The revenue and pretax
income (prior to corporate overhead) of these businesses which have been
identified to be divested for the six months ended July 31, 1998 were $93.5
million and $10.2 million, respectively. The net book value of these businesses
was approximately $178 million at July 31, 1998. The Company is currently
working with its investment banker in order to complete the divestiture of these
businesses. In addition, the Company expects to terminate several employed
physician agreements during the third quarter ended October 31, 1998 and expects
to record a nonrecurring pretax charge related to these expected terminations of
approximately $15 million to $17 million (which includes approximately $10
million in cash which is expected to be required to be funded by the Company).
During August 1998, the Company also announced that as part of its
restructuring, it plans to establish an integrated development company. The
Company will expand into non-healthcare development as well as continue
medical-related projects through its wholly-owned subsidiary, DASCO Companies.
The Board of Directors of the Company and its investment banker are currently
exploring the option of a spin off of this integrated development company to the
stockholders to operate as a separate company.
The Board of Directors of the Company has authorized an initial share
repurchase plan. The implementation of the share repurchase plan is subject to
the consent of the Company's line of credit banks. Under the approved share
buyback, the Company may repurchase up to $15 million of its Common Stock from
time to time on the open market at prevailing market prices.
-12-
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction
The Company is an integrated medical management company that provides
management services to the medical community. The Company also provides real
estate development and consulting services to related and unrelated third
parties for the development of medical malls, medical office buildings, and
health parks. The Company has previously affiliated with physicians by acquiring
their practices and entering into long-term management agreements with the
acquired practices. The Company also affiliates with physicians by managing
independent physician associations ("IPAs") and specialty care physician
networks through management service organizations ("MSOs") in which the Company
has ownership interests. The Company also provides ancillary services including
radiation therapy, diagnostic imaging, infusion therapy, home healthcare,
lithotripsy services, ambulatory surgery and clinical research studies. As of
July 31, 1998, the Company has acquired the practices of and entered into
long-term agreements to affiliate with approximately 345 physicians; has
obtained interests in MSOs in Connecticut, Georgia, New Jersey, New York and
Florida that provide management services to IPAs composed of over approximately
8,000 multispecialty physicians; purchased a company that provides contract
management services to approximately 4,000 physicians in specialty care
networks; purchased Clinical Studies Ltd. ("CSL"), a site management
organization conducting clinical research for pharmaceutical companies and
clinical research organizations at 32 centers located in 17 states; and acquired
several ancillary services companies and a company that provides real estate
services.
In January 1996, the Company changed its fiscal year end from December 31
to January 31.
Recent Events
During May 1998, the Company announced that the Board of Directors had
instructed management to explore various strategic alternatives for the Company
that could maximize shareholder value, including possible mergers, asset sales,
management buy back, other business combinations or strategic transactions.
During July 1998, the Company hired an investment banker in conjunction with its
decision to pursue strategic alternatives. During August 1998, the Company's
Board of Directors approved several strategic alternatives to enhance
stockholder value. The Board authorized a series of initiatives designed to
establish the Company as a preeminent market share leader in pharmaceutical
contract research, specifically clinical trials site management and outcomes
research. The Company will link its nationally focused expanding hospital
affiliations and its 92 physician networks with the clinical trials site
management and healthcare outcomes research operations.
During August 1998, the Board also approved, consistent with achieving its
stated restructuring goal, its plan to divest and exit its Physician Practice
Management (PPM) and ancillary services businesses, which include diagnostic
imaging, home health, lithotripsy, and radiation therapy. The revenue and pretax
income (prior to corporate overhead) of these businesses, which have been
identified to be divested for the six months ended July 31, 1998 were $93.5
million and $10.2 million, respectively. The net book value of these businesses
was approximately $178 million at July 31, 1998. The Company is currently
working with its investment banker in order to complete the divestiture of these
businesses. In addition, the Company expects to terminate several employed
physician agreements during the third quarter ended October 31, 1998 and expects
to record a nonrecurring pretax charge related to these expected terminations of
approximately $15 million to $17 million (which includes approximately $10
million in cash which is expected to be required to be funded by the Company).
During August 1998, the Company also announced that as part of its
restructuring, it plans to establish an integrated development company. The
Company will expand into non-healthcare development as well as continue
medical-related projects through its wholly-owned subsidiary, DASCO Companies.
The Board of Directors of the Company and its investment banker are currently
exploring the option of a spin off of this integrated development company to the
stockholders to operate as a separate company.
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<PAGE>
Acquisitions and CSL Merger
Six Months Ended July 31, 1998 Acquisitions
During February 1998, the Company purchased New England Research Center.
Located in Massachusetts, New England Research Center is a clinical research
site with over 50 ongoing studies, primarily in allergy and asthma. In
conjunction with the acquisition, the Company entered into a 40-year agreement
with the physicians and employees to manage the clinical trials at New England
Research Center. The purchase price was approximately $5,700,000. Of such
purchase price, approximately $1,450,000 was paid in cash and 333,006 shares of
Common Stock were issued having a value of $4,250,000. The purchase price was
allocated primarily to management services agreements and is currently being
amortized over 25 years.
During February 1998, the Company completed the formation of an MSO with
Beth Israel Medical Center and the physician organizations that represent more
than 1,700 physicians of Beth Israel and its parent corporation. The Company
owns one-third of the MSO. The Company will provide management services for the
MSO which will provide the physicians and hospitals with medical management and
contract negotiation support for risk agreements with managed care payors. In
connection with the formation of the MSO, PhyMatrix Management Company, Inc.
("Management"), a subsidiary of the Company, agreed with Beth Israel Medical
Center ("Beth Israel") that Management and its affiliates (including the
Company) would not, directly or indirectly, (i) operate, manage or provide risk
contract management services to any physicians, IPAs or group practices located
in New York County, Kings County or Westchester County, New York (the
"Restricted Zone") which are affiliated with a hospital or hospital system or
any affiliate (with certain exceptions) or (ii) participate with a hospital or
hospital system or any affiliate (other than Beth Israel) in an MSO or other
person that operates, manages or provides risk contract management services
within the Restricted Zone (with certain exceptions). In addition, the owners of
two-thirds of the MSO have the right to require the Company to purchase their
interests at the option price, which is based upon earnings, during years six
and seven.
During February 1998, the Company purchased a diagnostic imaging center
located in Delray Beach, Florida. The base purchase price was approximately
$6,570,000. The base purchase price was paid in 495,237 shares of Common Stock
of the Company. There is also a contingent payment up to a maximum of $2,000,000
based on the center's earnings before taxes during 1998, which is payable in
cash and/or Common Stock of the Company. The purchase price was allocated to the
assets at fair market value including goodwill of $6,570,000. The resulting
intangible is currently being amortized over 25 years.
During March 1998, the Company entered into an administrative services
agreement with HIA Bensonhurst Imaging Associates, LLP, a diagnostic imaging
center in Brooklyn, New York. The consideration paid was approximately
$5,100,000 of Common Stock. There is also a contingent payment up to a maximum
of $1,900,000 based on the center's earnings before taxes, which is payable in
cash and/or Common Stock of the Company. The purchase price was allocated to the
assets at fair market value including management services agreements of
$4,720,000. The resulting intangible is currently being amortized over 25 years.
During April 1998, the Company completed the formation of an MSO, which is
51% owned by the Company, with LIPH, LLC. The Company will manage for the MSO
the medical risk contracting for the more than 2,600 physicians in IPAs in New
York. The base purchase price was $2,970,000. Of such purchase price, $1,470,000
was paid in cash and 143,026 shares of Common Stock were issued having a value
of $1,500,000. There are also contingent payments up to a maximum of $5,000,000
payable in cash and Common Stock, with $4,000,000 of such amount based upon
earnings during the three years after the closing date and the remaining
$1,000,000 based upon the achievement of certain conditions during any twelve
month period during the three years after the closing date. The base purchase
price was allocated primarily to goodwill and is being amortized over 25 years.
During April 1998, the Company acquired the business and certain assets of
a clinical research company in Massachusetts. The base purchase price was
$2,640,000 plus the assumption of liabilities of approximately $425,000. Of such
purchase price, $1,500,000 was paid in 144,405 shares of Common Stock of the
Company, $70,000 is payable in shares of Common Stock on the first anniversary
of the closing date and $1,070,000 is
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<PAGE>
payable in shares of Common Stock of the Company on the second anniversary of
the closing date. In addition, there is a contingent payment up to a maximum of
$2,350,000 payable in Common Stock based on earnings before taxes during the
next four years. The purchase price was allocated to the assets at fair market
value including goodwill of $2,655,000. The resulting intangible is being
amortized over 20 years.
Year Ended January 31, 1998 Acquisitions (all information related to the number
of physicians is as of the acquisition date)
Physician Practices
During February 1997, the Company purchased the stock of a six physician
practice pursuant to a merger and entered into a 40-year management agreement
with the practice in exchange for 159,312 shares of Common Stock of the Company
having a value of approximately $2,440,000. The transaction has been accounted
for using the pooling-of-interests method of accounting.
During February 1997, the Company purchased the assets of and entered into
a 40-year management agreement with five physicians in Utah. The purchase price
was $2,498,148. Of such purchase price, $1,378,148 was paid in cash and 75,293
shares of Common Stock of the Company were issued having a value of $1,120,000.
The purchase price was allocated to the assets at their fair market value,
including management services agreements of $1,364,482. The resulting intangible
is currently being amortized over 25 years.
During May 1997, the Company entered into a 40-year management agreement
with a radiation therapy center in Westchester, New York. The consideration paid
in this transaction was $2,550,000. The amount paid has been allocated to
management services agreements and is currently being amortized over 25 years.
During July 1997, the Company entered into a 40-year management services
agreement with Beth Israel Hospital to manage its DOCS Division which consists
of more than 100 physicians located throughout the greater Metropolitan New York
area. Pursuant to this management services agreement, the Company is reimbursed
for all operating expenses incurred by the Company for the provision of services
to the practices plus its applicable management fee. The Company has committed
up to $40 million in conjunction with the transaction to be utilized for the
expansion of the Beth Israel delivery system throughout the New York region. In
connection with the agreement, the Company paid $13,660,000 in cash, which was
allocated to management services agreements and is currently being amortized
over 25 years.
Ancillary Service Companies and CSL Merger
During April 1997, the Company acquired the business and certain assets of
a clinical research company in the Washington, DC area for $725,000 in the form
of a promissory note plus contingent consideration based on revenue and
profitability measures over the next five years. The contingent payments will
equal 10% of the excess gross revenue, as defined, provided the gross operating
margins of the acquired business exceed 30%. The purchase price was allocated to
intangibles, including goodwill, and is being amortized over 20 years. The note
and contingent payments are, in certain circumstances, convertible into shares
of Common Stock.
During June 1997, the Company purchased the assets of two diagnostic
imaging centers in Dade County, Florida. The purchase price was approximately
$12,600,000 plus the assumption of debt and capital leases totaling $1,570,078.
Of such purchase price, $600,000 was paid in cash and the remaining $12,000,000
was paid by the issuance of 773,026 shares of Common Stock of the Company,
562,500 of which were issued in June 1997 and 210,526 of which were issued in
September 1997. There is also a contingent payment with a maximum of $2,675,000
based on the centers' earnings before taxes over the two years subsequent to the
closing, which is payable in cash. Such maximum amount has been included in
current liabilities at July 31, 1998. The purchase price was allocated to the
assets at their fair market value, including goodwill of $12,955,273. The
resulting intangible is being amortized over 30 years.
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<PAGE>
During June 1997, the Company acquired the remaining 20% interest in a
lithotripsy company that it purchased during 1994. The interest was acquired in
exchange for cash and 54,500 shares of Common Stock of the Company having a
total value of $2,005,000. The purchase price was allocated to goodwill and is
being amortized over 20 years.
During August 1997, the Company purchased certain assets and assumed
certain liabilities of, and entered into an administrative services agreement
with BAB Nuclear Radiology, P.C., to provide administrative services to five
diagnostic imaging centers on Long Island, New York. The consideration paid in
this transaction was approximately $10,450,000 in cash, $15,000,000 in
convertible notes and the assumption of $1,621,000 in debt. The convertible
notes bear interest at 5% and are payable in three equal installments in
November 1997 and February and May 1998. At the option of the Company, the notes
are payable in either cash or shares of Common Stock of the Company. The first
two installments were paid in shares of Common Stock of the Company and the
final installment was paid in cash during May 1998. The amount paid was
allocated to the assets at their fair market value, including management
services agreements of $23,023,256 and is currently being amortized over 25
years.
During November 1997, the Company purchased certain assets of, and entered
into an administrative services agreement with Highway Imaging Associates, LLP,
to provide administrative services to a diagnostic imaging center in Brooklyn,
New York. The consideration paid in this transaction was approximately
$1,700,000. Of such amount, approximately $200,000 was paid in cash and
$1,500,000 was paid by the issuance of 108,108 shares of Common Stock of the
Company. The amount paid was allocated to the assets at their fair market value,
including management services agreements of $1,598,421, and is currently being
amortized over 25 years.
During December 1997, the Company purchased certain assets, assumed certain
liabilities of, and entered into an administrative services agreement with Ray-X
Management Services, Inc., to provide administrative services to a diagnostic
imaging center in Queens, New York. The consideration paid in this transaction
was approximately $9,500,000. Of such amount, approximately $175,000 was paid in
cash, $775,000 was assumed debt and $8,550,000 was paid by the issuance of
616,215 shares of Common Stock of the Company. The amount paid was allocated to
the assets at their fair market value, including management services agreements
of $8,133,680, and is currently being amortized over 25 years.
CSL Merger
Effective October 15, 1997, a subsidiary of the Company merged with CSL in
a transaction that was accounted for as a pooling of interests. The Company
exchanged 5,204,305 shares of its Common Stock for all of the outstanding common
stock of CSL. The Company's historical financial statements for all periods have
been restated to include the results of CSL. As a result of the merger certain
costs incurred by CSL will be noncontinuing. During the three and six months
ended July 31, 1997, the noncontinuing costs represented management fees paid to
the principal shareholders of CSL.
The following table reflects in the As Reported column the restated
consolidated net revenues, merger and other noncontinuing costs, net income, net
income per share and weighted average number of shares outstanding for the
indicated periods. The Pro Forma column adjusts the historical net income for
CSL to reflect the results of operations as if CSL had been a C corporation
rather than an S corporation for income tax purposes. The Adjusted Pro Forma
column adjusts the Pro Forma column by eliminating merger costs and certain
noncontinuing charges incurred by CSL.
-16-
<PAGE>
<TABLE>
<CAPTION>
(B)
(A) Adjusted
As Reported Pro Forma Pro Forma
----------- ------------- --------------
(In thousands, except per share data)
<S> <C> <C> <C>
FOR THE THREE MONTHS ENDED JULY 31, 1997
Net revenue $ 82,909 $ 82,909 $ 82,909
Merger and other noncontinuing costs 600 600 --
Net income 4,588 4,462 4,822
Net income per share - basic $ 0.16 $ 0.15 $ 0.16
Net income per share - diluted $ 0.16 $ 0.15 $ 0.16
Weighted average number of shares outstanding - basic 29,471 29,471 29,471
Weighted average number of shares outstanding - diluted 29,613 29,613 29,613
FOR THE SIX MONTHS ENDED JULY 31, 1997
Net revenue $158,776 $158,776 $158,776
Merger and other noncontinuing costs 907 907 --
Net income 8,826 8,574 9,118
Net income per share - basic $ 0.30 $ 0.29 $ 0.31
Net income per share - diluted $ 0.30 $ 0.29 $ 0.31
Weighted average number of shares outstanding - basic 29,068 29,068 29,068
Weighted average number of shares outstanding - diluted 29,204 29,204 29,204
</TABLE>
(A) Adjusts the As Reported results for CSL to reflect the operations of CSL as
if CSL had been a C corporation rather than an S corporation for income tax
purposes.
(B) Adjusts the As Reported results by eliminating CSL merger expenses and
certain noncontinuing costs of CSL and providing for income tax expense as
if CSL had been a C corporation rather than an S corporation for income tax
purposes.
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<PAGE>
Contract Management Acquisitions
During April 1997, the Company acquired a pulmonary physician network
company for a base purchase price of $3,049,811. Of such purchase price,
$756,964 was paid in cash and 180,717 shares of Common Stock of the Company were
issued during May 1997 having a value of $2,292,847. There is also a contingent
payment up to a maximum of $2,000,000 based on the acquired entities' earnings
before taxes during the three years subsequent to the closing, which will be
paid in cash and/or Common Stock of the Company. During May 1998, the Company
issued 88,149 shares of Common Stock of the Company having a value of $1,055,592
representing a portion of the aforementioned contingent payment. The purchase
price was allocated to goodwill and is being amortized over 30 years.
During December 1997 the Company purchased the stock of Urology Consultants
of South Florida. The base purchase price was approximately $3,555,000, paid in
244,510 shares of Common Stock of the Company. There is also a contingent
payment up to a maximum of $2,000,000 based on the acquired entities' earnings
before taxes during the three years subsequent to the closing, which will be
paid in cash and/or Common Stock of the Company. The purchase price has been
allocated to the assets at their fair market value including goodwill of
$3,555,000. The resulting goodwill is being amortized over 30 years.
Accounting Treatment
The terms of the Company's relationships with its affiliated physicians are
set forth in various asset and stock purchase agreements, management services
agreements, and employment and consulting agreements. Through the asset and/or
stock purchase agreement, the Company acquires the equipment, furniture,
fixtures, supplies and, in certain instances, service agreements, of a physician
practice at the fair market value of the assets. The accounts receivable are
typically purchased at the net realizable value. The purchase price of the
practice generally consists of cash, notes and/or Common Stock of the Company
and the assumption of certain debt, leases and other contracts necessary for the
operation of the practice. The management services or employment agreements
delineate the responsibilities and obligations of each party.
Net revenue from services is reported at the estimated realizable amounts
from patients, third-party payors and others for services rendered. Revenue
under certain third-party payor agreements is subject to audit and retroactive
adjustments. Provisions for estimated third-party payor settlements and
adjustments are estimated in the period the related services are rendered and
adjusted in future periods as final settlements are determined. The provision
and related allowance are adjusted periodically, based upon an evaluation of
historical collection experience with specific payors for particular services,
anticipated reimbursement levels with specific payors for new services, industry
reimbursement trends, and other relevant factors. Included in net revenues from
services are revenues from the diagnostic imaging centers in New York which the
Company operates pursuant to Administrative Service Agreements.
Net revenue from management services agreements include the revenues
generated by the physician practices. The Company, in most cases, is responsible
and at risk for the operating costs of the physician practices. Expenses include
the reimbursement of all medical practice operating costs and all payments to
physicians (which are reflected as cost of affiliated physician management
services) as required under the various management agreements. For providing
services under management services agreements entered into prior to April 30,
1996, physicians generally received a fixed percentage of net revenue of the
practice. "Net revenues" is defined as all revenue computed on an accrual basis
generated by or on behalf of the practice after taking into account certain
contractual adjustments or allowances. The revenue is generated from
professional medical services furnished to patients by physicians or other
clinicians under physician supervision. In several of the practices, the Company
has guaranteed that the net revenues of the practice will not decrease below the
net revenues that existed immediately prior to the agreement with the Company.
Under most management services agreements entered into after April 30, 1996, the
physicians receive a portion of the operating income of the practice which
amounts vary depending on the profitability of the practice. In 1997, the
Emerging Issues Task Force of the Financial Accounting Standards Board issued
EITF 97-2 concerning the consolidation of physician practice revenues. Physician
practice management companies ("PPMs") will be required to consolidate financial
information of a physician where the
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<PAGE>
PPM acquires a "controlling financial interest" in the practice through the
execution of a contractual management agreement even though the PPM does not own
a controlling equity interest in the physician practice. EITF 97-2 outlines six
requirements for establishing a controlling financial interest. The Company will
adopt EITF 97-2 in the fourth quarter of this fiscal year. The Company does not
believe that the implementation of EITF 97-2 will have a material impact on its
financial condition or its earnings. However, the impact of this statement would
have resulted in a reduction of reported revenues and expenses for the three and
six months ended July 31, 1998, by a maximum of $17.6 million and $34.8 million,
respectively. The Company has implemented EITF 97-2 for all transactions
occurring after November 20, 1997. Net revenues under management services
agreements for the three and six months ended July 31, 1998, were $45.0 million
and $87.5 million, respectively.
Results of Operations
Three and Six Months Ended July 31, 1998 Compared to Three and Six Months Ended
July 31, 1997
The following discussion reviews the results of operations for the three
and six months ended July 31, 1998 (the "1999 Quarter" and "1999 Period"),
respectively, compared to the three and six months ended July 31, 1997 (the
"1998 Quarter" and "1998 Period"), respectively.
Revenues
The Company derives revenues from health care services and real estate
services. Within the health care segment, the Company distinguishes between
revenues from cancer services, noncancer physician services and other ancillary
services. Cancer services include physician practice management services to
oncology practices and certain ancillary services, including radiation therapy
and infusion therapy. Noncancer physician services include physician practice
management services to all practices managed by the Company other than oncology
practices; management services to MSOs and hospitals and administrative services
to health plans which include reviewing, processing, and paying claims and
subcontracting with specialty care physicians to provide covered services. Other
ancillary services include home health care services, lithotripsy, various
health care management services, diagnostic imaging, ambulatory surgery, and
clinical research studies.
Net revenues were $95.0 million and $196.3 million for the 1999 Quarter and
1999 Period, respectively. Of this amount, $30.1 million and $59.2 million or
31.7% and 30.2% of such revenues was attributable to cancer services; $42.6
million and $84.9 million or 44.8% and 43.2% was related to noncancer physician
services; $21.2 million and $44.2 million or 22.4% and 22.5% of such revenues
was attributable to other ancillary services; and $1.1 million and $8.0 million
or 1.1% and 4.1% related to real estate services.
Net revenues were $82.9 million and $158.8 million for the 1998 Quarter and
1998 Period, respectively. Such revenues consisted of $26.7 million and $52.3
million or 32.3% and 32.9% related to cancer services; $36.0 million and $67.9
million or 43.3% and 42.8% related to noncancer physician services; $15.0
million and $27.9 million or 18.1% and 17.6% related to other ancillary
services; and $5.2 million and $10.7 million or 6.3% and 6.7% related to real
estate services.
Expenses
The Company's cost of affiliated physician management services was $17.6
million and $34.8 million or 39.1% and 39.7% of net revenue from management
services agreements during the 1999 Quarter and 1999 Period, respectively. The
cost of affiliated physician management services was $16.6 million and $33.5
million or 41.4% and 44.3% of net revenue from management services agreements
during the 1998 Quarter and 1998 Period, respectively. Net revenue for the
physician practices managed by the Company was $45.0 million and $87.5 million
during the 1999 Quarter and 1999 Period and $40.0 million and $75.7 million
during the 1998 Quarter and 1998 Period, respectively. The cost of affiliated
physician management services as a percentage of net revenue from management
services varies based upon the type of physician practices.
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<PAGE>
The Company's salaries, wages, and benefits increased by $2.5 million from
$20.5 million or 24.8% of net revenues during the 1998 Quarter to $23.0 million
or 24.2% of net revenues during the 1999 Quarter and $7.7 million from $39.1
million or 24.6% of net revenues during the 1998 Period to $46.8 million or
23.9% of net revenues during the 1999 Period. The change as a percentage of net
revenues is primarily attributable to the additional salaries, wages and
benefits from the expansion of the Company's businesses. In general, salaries,
wages, and benefits vary depending on whether the physician practice or
ancillary service company is owned or managed.
The Company's supplies expense increased by $4.0 million from $10.9 million
or 13.2% of net revenues during the 1998 Quarter to $14.9 million or 15.7% of
net revenues during the 1999 Quarter and $9.1 million from $19.9 million or
12.5% of net revenues during the 1998 Period to $29.0 million or 14.8% of net
revenues during the 1999 Period. The increase in supplies expense as a
percentage of revenue is due to acquisitions of various ancillary service
companies that are more supply intensive.
The Company's depreciation and amortization expense increased by $1.1
million from $2.5 million or 3.1% of net revenues during the 1998 Quarter to
$3.6 million or 3.8% of net revenues during the 1999 Quarter and $2.2 million
from $4.9 million or 3.1% of net revenues during the 1998 Period to $7.1 million
or 3.6% of net revenues during the 1999 Period. The increase is primarily a
result of the acquisitions completed after the 1998 Quarter and the allocation
of the purchase prices as required by purchase accounting and also the effect of
the Company's change in policy regarding certain intangibles. Effective February
1, 1998, management changed its policies regarding amortization of its
management services agreement intangible assets. The Company adopted a maximum
of 25 years (from the inception of the respective intangible asset) as the
useful life for amortization of its management services agreement intangible
assets. Using the unamortized portion of the intangible at January 31, 1998, the
Company began amortizing the intangible over the remainder of the 25 year useful
life. These costs had historically been charged to expense through amortization
using the straight line method over the periods during which the agreements are
effective, generally 30 to 40 years. This change represents a change in
accounting estimate and, accordingly, does not require the Company to restate
reported results for prior years. This change increases amortization expense
relating to existing intangible assets at January 31, 1998, by approximately
$740,000 annually.
The Company's rent expense increased by $1.1 million from $3.8 million or
4.6% of net revenues during the 1998 Quarter to $4.9 million or 5.1% of net
revenues during the 1999 Quarter and $2.5 million from $7.2 million or 4.5% of
net revenues during the 1998 Period to $9.7 million or 4.9% of net revenues
during the 1999 Period. Rent expense as a percentage of net revenue varies
depending upon the size of each of the affiliated practice's offices, the number
of satellite offices and the current market rental rate for medical office space
in a particular geographic market.
The Company's merger and other noncontinuing costs of $0.6 million, and
$0.9 million during the 1998 Quarter and 1998 Period, respectively, represented
certain noncontinuing management fee expenses incurred by CSL.
The Company's gain on sale of assets of $4.5 million and $5.4 million
during the 1999 Quarter and 1999 Period, respectively, represented gains from
the sale of real estate of approximately $4.5 million during July 1998 and from
the sale of a radiation therapy center of approximately $0.9 million during
February 1998. The gain on sale of assets of $0.7 million during the 1998 Period
resulted from the sale of a radiation therapy center.
The Company's nonrecurring charge of $5.3 million during the 1999 Period
represents the charge resulting from the termination of several physician
management and employment agreements.
Prior to the CSL merger, CSL was treated as an S corporation under the
Internal Revenue Code (the "Code") and its stockholders recognized its income
for income tax purposes. Accordingly, the Company's statements of operations do
not include provisions for income taxes for income related to CSL. Prior to the
CSL merger, dividends were paid primarily to reimburse stockholders for income
tax liabilities incurred by them.
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<PAGE>
The Company's income tax expense decreased by $1.3 million from $4.5
million or 34% of pre-tax income during the 1998 Period to $3.2 million or 33%
of pretax income during the 1999 Period. The pro forma net income and net income
per share information in the consolidated statement of operations reflect the
effect on historical results as if CSL had been a C corporation rather than an S
corporation and had paid income taxes. The Company follows the provisions of
Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for
Income Taxes."
Real Estate Services
The Company provides real estate services to related and unrelated third
parties in connection with the establishment of various healthcare related
facilities, including health parks, medical malls and medical office buildings.
The Company derives its real estate service revenues from the provision of
a variety of services. In rendering such services, the Company generates income
without bearing the costs of construction, expending significant capital or
incurring substantial indebtedness. Net revenues from real estate services are
recognized at the time services are performed. In some cases fees are earned
upon the achievement of certain milestones in the development process, including
the receipt of a building permit and a certificate of occupancy of the building.
Unearned revenue relates to all fees received in advance of services being
completed on development projects.
The Company typically receives the following compensation for its services:
development fees (including management of land acquisition, subdivision, zoning,
surveying, site planning, permitting and building design), general contracting
management fees, leasing and marketing fees, project cost savings income (based
on the difference between total budgeted project costs and actual costs) and
consulting fees.
The amount of development fees and leasing and marketing fees are stated in
the various agreements. Those agreements also provide the basis for payment of
the fees. The financing fees and consulting fees are generally not included in
specific agreements but are negotiated and disclosed in project pro formas
provided to the owners of the buildings and hospital clients. Specific
agreements usually incorporate those pro formas and provide that the projects
will be developed in conformity therewith. General contracting management fees
and project cost savings income are included in guaranteed maximum cost
contracts entered into with the general contractor. These contracts are usually
approved by the owners which in many cases include hospital clients and
prospective tenants. During August 1998, Bruce Rendina resigned as CEO and
President of DASCO. The Company has not yet determined the impact of Mr.
Rendina's resignation on the business and future results of operations of this
segment, and there can be no assurance that his resignation will not have a
material adverse impact on the business and results of operations of the Company
as a whole.
During the 1999 Quarter and the 1999 Period, the Company's real estate
services generated revenues of $1.0 million and $8.0 million and operating
(loss) income of ($1.0 million) and $3.7 million, respectively. In addition, the
real estate services segment recorded a gain on sale of real estate of $4.5
million during the 1999 Quarter.
Liquidity and Capital Resources
Cash provided by operating activities was $1.1 million for the 1999 Period.
Cash used by operating activities was $2.1 million for the 1998 Period. At July
31, 1998, the Company's principal sources of liquidity consisted of working
capital of $91.3 million which included $35.0 million in cash. The Company also
had $32.0 million of current liabilities, including approximately $4.0 million
of indebtedness maturing before July 31, 1999.
Cash used by investing activities was $8.6 million for the 1999 Period.
This primarily represents the total funds required by the Company for
acquisitions and capital expenditures of $11.6 million and advances under notes
receivable of $1.8 million offset by proceeds from the sale of assets of $4.8
million during the 1999 Period. Cash used by investing activities was $19.5
million for the 1998 Period. This primarily represents funds required
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<PAGE>
by the Company for acquisitions and capital expenditures of $25.1 million offset
by repayments under notes receivable of $4.7 million and proceeds of $1.5
million from the sale of assets during the 1998 Period.
Cash used by financing activities was $7.1 million for the 1999 Period and
primarily represented the repayment of debt of $7.1 million. Cash used by
financing activities was $0.7 million for the 1998 Period, which was primarily
comprised of the release of cash collateral of $0.5 million and borrowings under
a line of credit of $1.0 million, offset by the payment of dividends and the
repayment of other debt of $0.7 million and $1.7 million, respectively.
In conjunction with various acquisitions that were completed through July
31, 1998, the Company may be required to make various contingent payments in the
event that the acquired companies attain predetermined financial targets during
established periods of time following the acquisitions. If all of the applicable
financial targets were satisfied, for the periods covered, the Company would be
required to pay an aggregate of approximately $29.2 million over the next five
years. The payments, if required, are payable in cash and/or Common Stock of the
Company and have not been reflected on the balance sheet at July 31, 1998. In
addition, in conjunction with the acquisition of a clinical research center and
in conjunction with a joint venture entered into by the Company during the year
ended January 31, 1998, the Company may be required to make additional
contingent payments based on revenue and profitability measures over the next
five years. The contingent payments will equal 10% of the excess gross revenue,
as defined, provided the gross operating margins exceed 30%.
During July 1997, the Company entered into a management services agreement
to manage a network of over 100 physicians in New York. In connection with this
transaction, the Company has committed to expend up to $40 million (of which
none has been expended as of July 31, 1998) to be utilized for the expansion of
the network.
In conjunction with certain of its acquisitions the Company has agreed to
make payments in shares of Common Stock of the Company at a predetermined future
date. The number of shares to be issued are generally determined based upon the
average price of the Company's Common Stock during the five business days prior
to the date of issuance. As of July 31, 1998, the Company had committed to issue
$1.1 million of Common Stock of the Company using the methodology discussed
above. This amount is included in other long-term liabilities on the balance
sheet.
In conjunction with the restructuring (as described earlier in "Recent
Events"), the Board approved its plan to divest and exit its PPM and ancillary
services businesses. The revenue and pretax income (prior to corporate overhead)
of these businesses, which have been identified to be divested, for the six
months ended July 31, 1998 were $93.5 million and $10.2 million, respectively.
The net book value of these businesses was approximately $178 million at July
31, 1998. The Company is currently working with its investment banker in order
to complete the divestiture of these businesses. In addition, the Company
expects to terminate several employed physician agreements during the third
quarter ended October 31, 1998 and expects to record a nonrecurring pretax
charge related to these expected terminations of approximately $15 million to
$17 million (which includes approximately $10 million in cash which is expected
to be required to be funded by the Company).
The Board of Directors of the Company has authorized an initial share
repurchase plan. The implementation of the share repurchase plan is subject to
the consent of the Company's line of credit banks. Under the approved share
buyback, the Company may repurchase up to $15 million of its Common Stock from
time to time on the open market at prevailing market prices.
The development and implementation of the Company's management information
systems will require ongoing capital expenditures. The Company expects that the
existing working capital of $91.3 million, which includes cash of $35.0 million,
and the expected cash to be generated from the sale of the businesses identified
to be divested and the cash available under its revolving line of credit will be
adequate to satisfy the Company's cash requirements for the next 12 months. The
Company's capital needs over the next several years may exceed capital generated
from operations. To finance its capital needs, the Company may incur
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<PAGE>
indebtedness and issue, from time to time, additional debt or equity securities,
including Common Stock or convertible notes. However, there can be no assurance
that the Company will not be required to seek additional financing during this
period. The failure to raise the funds necessary to finance its future cash
requirements would adversely affect the Company's ability to pursue its strategy
and could adversely affect its results of operations for future periods.
In September 1997, the Company entered into a secured credit agreement with
a bank providing for a $100 million revolving line of credit ($16.0 million of
which was outstanding at July 31, 1998, $6.0 million of such $16.0 million was
outstanding letters of credit) for working capital and acquisition purposes. The
credit agreement (i) prohibits the payment of dividends and repurchase of shares
by the Company, (ii) limits the Company's ability to incur indebtedness and make
acquisitions except as permitted under the credit agreement and (iii) requires
the Company to comply with certain financial covenants which include minimum net
worth and interest coverage requirements and a maximum funded debt to cash flow
limitation. In contemplation of the restructuring (as described earlier in
"Recent Events"), the Company has amended the credit agreement in order to allow
for the repurchase of up to $15 million of shares of its Common Stock using the
Company's funds as well as revising certain financial covenants.
Factors to be Considered
The part of this Quarterly Report on Form 10-Q captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
contains certain forward-looking statements which involve risks and
uncertainties. Readers should refer to a discussion under "Factors to be
Considered" contained in Part I, Item 1 of the Company's Annual Report on Form
10-K for the year ended January 31, 1998 concerning certain factors that could
cause the Company's actual results to differ materially from the results
anticipated in such forward-looking statements. This discussion is hereby
incorporated by reference into this Quarterly Report.
Risks Associated With Year 2000
The Year 2000 date change issue is believed to affect virtually all
companies and organizations. If not corrected, many computer applications and
medical equipment could fail or create erroneous results by or at the year 2000.
The Company recognizes the need to ensure its operations will not be adversely
impacted by the inability of the Company's information systems to process data
having dates on or after January 1, 2000 (the "Year 2000" issues). The Company
expects to complete its full assessment of the Year 2000 issue no later than
January 31, 1999, which is prior to any anticipated impact on its operating
systems. As part of the Year 2000 assessment, the Company expects to communicate
with all of its physician practices and networks, as well as suppliers and third
parties with which the Company does business, to determine the extent to which
the Company's interface systems are vulnerable to those parties' failure to
remedy their Year 2000 issues. There is no guarantee that the systems of other
companies on which the Company relies will be corrected in a timely manner or
that the failure to correct will not have a material adverse effect on the
Company's systems. The Company does not believe that it will incur a material
financial impact from the risk, or from assessing the risk, arising from the
Year 2000 issues. However, there can be no guarantee that the Company's initial
assessment of the financial impact of this risk will be accurate; actual results
could differ materially from those anticipated. Specific factors that might
cause such material differences, include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes, and similar uncertainties.
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<PAGE>
PART II--OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on August 17, 1998 with the
Securities and Exchange Commission reporting under Item 5 the announcement by
the Company of certain plans to implement strategic alternatives.
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<PAGE>
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, on the 14th day of September, 1998.
PHYMATRIX CORP.
By: /s/ Frederick R. Leathers
------------------------------------------
Financial Officer, Treasurer
and Principal Accounting Officer
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