<PAGE> 1
Filed Pursuant to Rule 424(b)(3)
Registration No. 333-50425
PHYSICIANS' SPECIALTY CORP.
SUPPLEMENT NO. 1 DATED NOVEMBER 17, 1998
TO PROSPECTUS DATED MAY 12, 1998
The information contained in the Prospectus dated May 12, 1998 is
hereby updated and supplemented generally to give effect to the transactions
summarized below. All references in the Prospectus to the Probable Practice
Acquisitions are hereby updated for the consummation of the Probable Practice
Acquisitions which consisted of the PDI, Bequer and Maliner (as defined below)
transactions.
NEW PRACTICE ACQUISITIONS AND AMBULATORY SURGERY CENTER INVESTMENT
On May 27, 1998, pursuant to a stock purchase agreement, Physicians'
Specialty Corp. (the "Company") completed the acquisition of (i) substantially
all of the tangible assets and assumed certain contractual liabilities of
Physicians' Domain, Inc., a White Plains, New York based ear, nose and throat
("ENT") physician practice management company ("Physicians' Domain") and (ii)
the stock of three corporations that are successors to three ENT physician
practices affiliated with Physicians' Domain employing an aggregate of 20
physicians and 16 allied health care professionals with 11 clinical offices in
Southern New York and Northern New Jersey (collectively, "PDI"). In connection
with the PDI transaction, the Company (i) paid approximately $5.0 million in
cash, (ii) discharged approximately $4.2 million of liabilities of PDI and
(iii) issued a subordinated long-term promissory note in the principal amount
of approximately $6.4 million, which note matures in May 2003, accrues interest
at a rate of 6.0% per annum, payable quarterly, is secured by the fixed assets
acquired by the Company in the transaction and is subordinate to senior
indebtedness, including borrowings under the Company's credit facility. In
addition, the Company agreed to pay an additional $500,000, in cash or shares
of Common Stock at the Company's option, if the PDI practices achieve
stipulated performance targets. Pursuant to the stock purchase agreement, the
physicians at PDI have the right to nominate one member to the Board of
Directors of the Company. Steven H. Sacks, M.D., a nominee of the physicians
at PDI, was appointed to the Board of Directors of the Company on August 12,
1998.
In connection with the PDI transaction, the Company entered into
management services agreements with two newly organized ENT practices employing
the 20 ENT physicians. The management services agreements provide for an
aggregate fixed annual management fee of approximately $2.1 million, plus
reimbursement of practice operating expenses. Pursuant to the management
services agreements, the fixed management fee is subject to annual increases
after May 27, 2003 consistent with the annual percentage increase in the
consumer price index for the
<PAGE> 2
prior year. The management services agreements also provide for mutually agreed
increases in the fixed management fee upon (i) the management by the Company of
ancillary business developed or acquired or (ii) the acquisition of additional
physician practices which are merged into the existing PDI practices.
On June 23, 1998, pursuant to an asset acquisition agreement, the
Company completed the acquisition of substantially all of the assets of
Napoleon G. Bequer, M.D., P.A. ("Bequer"), a solo ENT physician practice with
one allied health care professional and one clinical office in South Florida.
On August 19, 1998, pursuant to an asset acquisition agreement, the
Company completed the acquisition of the assets of Robert H. Maliner, M.D.,
P.A. ("Maliner"), a two physician ENT physician practice with two allied health
care professionals and two clinical offices in South Florida.
On August 31, 1998, PSC Ambulatory Surgery, Ltd., a Georgia limited
partnership (the "PSC Partnership"), of which the Company is the sole general
partner and Atlanta Ear, Nose & Throat Associates, P.C. ("Atlanta ENT"), one of
the Company's affiliated practices, is the sole limited partner, acquired in
the aggregate a 17.5% limited partnership interest in Atlanta Surgery Center,
Ltd., a Georgia limited partnership ("Atlanta Surgery Center"). The aggregate
purchase price was paid by the Company (the "Purchase Price"). Pursuant to the
terms of the transaction, the Company and Atlanta ENT own 99% and 1%,
respectively, of the partnership interest in the PSC Partnership; provided that
Atlanta ENT has an option to purchase up to 40% of the partnership interest
from the Company for an amount equal to the percentage of the PSC Partnership
acquired by Atlanta ENT multiplied by the Purchase Price. Atlanta Surgery
Center operates three multi-specialty ambulatory surgery centers, consisting of
14 operating rooms, in the metropolitan Atlanta area. As a result of the
transaction, effective July 1, 1998, the PSC Partnership will receive 17.5% of
the distributions made by Atlanta Surgery Center and the Company and Atlanta
ENT will receive their pro rata share of such distributions based on their
ownership interest in the PSC Partnership.
On October 12, 1998, pursuant to an asset acquisition agreement, the
Company completed the acquisition of the assets of Cleveland Ear, Nose and
Throat Center, Inc. ("Cleveland ENT"), a ten physician ENT physician practice
with eight allied health care professionals and eight clinical offices in
metropolitan Cleveland, Ohio. Cleveland ENT had previously been affiliated with
MedPartners, Inc. ("MedPartners"). In connection with the transaction, the
Company entered into an amended and restated Clinic Services Agreement with
Cleveland ENT maintaining the percentage of net income management fee structure
which existed in the MedPartners/Cleveland ENT Clinic Services Agreement. The
Company is contemplating modifying the percentage of net income arrangement
consistent with the Company's historical practices. In connection therewith,
the Company has granted Cleveland ENT a one time option, which expires on
December 15, 1998, to unwind the transaction with the Company as of December
31, 1998 and repurchase all Cleveland ENT non-medical assets
-2-
<PAGE> 3
acquired by the Company for a total cash purchase price equal to the price paid
by the Company to MedPartners for such assets, plus amounts invested by the
Company in Cleveland ENT.
In connection with the Bequer, Maliner, Atlanta Surgery Center and
Cleveland ENT transactions, the Company paid an aggregate of $9,880,000
(consisting of cash and borrowings under the Company's credit facility), issued
an aggregate of 35,232 shares of Common Stock, agreed to issue an aggregate of
35,232 shares of Common Stock commencing in June 1999 and issued a $150,000
non-interest bearing contingent promissory note to one of the practices which
is payable, at the Company's option, in cash or the Company's Common Stock,
upon the holder achieving certain performance targets.
The Company used a portion of the net proceeds received from the
Company's public offering in May 1998 to pay the cash component of the PDI,
Bequer, Maliner, Atlanta Surgery Center and Cleveland ENT transactions and to
discharge the indebtedness of PDI assumed by the Company in connection with the
PDI transaction. In connection with the PDI, Bequer, Maliner, Atlanta Surgery
Center and Cleveland transactions, the Company paid or accrued approximately
$387,374 to Premier HealthCare, an affiliate of the Company's Vice Chairman and
Secretary, for advisory services rendered.
MANAGED CARE AGREEMENTS
In June 1998, the Company entered into an exclusive provider contract
with The Morgan Health Group, Inc. ("Morgan") covering approximately 60,000
enrollees of health maintenance organizations throughout metropolitan Atlanta
which have contracted with Morgan for health care services. Pursuant to the
agreement with Morgan, the Company's affiliated physicians will provide ENT
medical and surgical services to such enrollees. The agreement, effective as of
August 1, 1998, has a term of two years and provides for one year renewals
thereafter upon the mutual agreement of the parties.
In September 1998, the Company entered into an exclusive managed care
contract with United HealthCare of Alabama ("United HealthCare") covering
approximately 80,000 enrollees of United HealthCare in metropolitan Birmingham,
Alabama. The agreement, effective as of October 1, 1998, has an initial term of
two years and provides for one year renewals thereafter upon the mutual
agreement of the parties.
CREDIT FACILITY
In August 1998, the Company closed on a four year $45 million senior
credit facility syndicated by Nationsbanc Montgomery Securities LLC. Syndicate
lenders include NationsBank, N.A., PNC Bank and Rabobank Nederland (the "Credit
Facility"). The Credit Facility replaced the Company's $20 million senior
credit facility. Borrowings under the Credit Facility (i) are secured by the
assignment to the banks of the Company's stock in all of its subsidiaries and
the Company's accounts receivable, including the accounts receivable assigned
to the Company by affiliated practices pursuant to management services
agreements, (ii) are
-3-
<PAGE> 4
guaranteed by all subsidiaries (including future subsidiaries) and (iii)
restrict the Company from pledging its assets to any other party. Advances
under the Credit Facility will be used to fund acquisitions and working
capital, will be governed by a borrowing base related primarily to the
Company's earnings before interest, taxes, depreciation and amortization
("EBITDA") and will bear interest, at the Company's option, based upon either a
prime-based or LIBOR-based rate. EBITDA is used by the Company as an indicator
of a company's ability to incur and service debt. EBITDA should not be
considered an alternative to operating income, net income, cash flows or any
other measure of performance as determined in accordance with generally
accepted accounting principles, as an indicator of operating performance, or as
a measure of liquidity. The Credit Facility contains affirmative and negative
covenants which, among other things, require the Company to maintain certain
financial ratios (including maximum indebtedness to pro forma EBITDA, maximum
indebtedness to capital, minimum net worth, minimum current ratio and minimum
fixed charges coverage), limit the amounts of additional indebtedness,
dividends, advances to officers, shareholders and physicians, acquisitions,
investments and advances to subsidiaries, and restrict changes in management
and the Company's business. As of November 16, 1998, the Company had
approximately $3.7 million of borrowings under the Credit Facility.
QUARTERLY REPORT ON FORM 10-Q
On August 14, 1998, the Company filed its quarterly report on Form
10-Q for the fiscal quarter ended June 30, 1998. Accordingly, the information
contained in the Prospectus under the headings "Summary Combined Financial
Data," "Unaudited Pro Forma Combined Financial Data," "Selected Financial
Data," "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and "Financial Statements" beginning on pages 4, 19, 24, 25 and
F-1, respectively, of the Prospectus, is hereby supplemented and updated as
follows:
The "Summary Combined Financial Data" beginning on page 4 of the
Prospectus is hereby supplemented by replacing the information under the
heading "Statement of Operations Year Ended December 31, 1997 and Three Months
Ended March 31, 1998," "Operating Data March 31, 1998," "Balance Sheet - March
31, 1998" and the notes thereto with the following:
-4-
<PAGE> 5
SUMMARY COMBINED FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, 1997 ENDED JUNE 30, 1998
----------------- -------------------
PRO FORMA FOR PRO FORMA
COMPLETED FOR
ACTUAL (1) ACQUISITIONS ACTUAL (1) COMPLETED
---------- (2)(3)(4)(6)(7) ---------- ACQUISITIONS
--------------- (2)(3)(4)(6)(7)
---------------
(IN THOUSANDS, EXCEPT SHARE DATA)
STATEMENT OF OPERATIONS DATA:
<S> <C> <C> <C> <C>
Revenue
Management Fees..................... 10,974 42,597 $ 13,159 $ 21,480
Capitation Revenue.................. 3,619 4,876 2,311 2,311
Net patient service revenue......... 967 1,263 574 574
Earnings in unconsolidated
subsidiary........................ 0 1,070 0 646
---------- ---------- ---------- ----------
Net revenue............................ 15,560 49,806 16,044 25,011
Expenses
Provider claims, wages, benefits ...... 7,819 22,523 7,281 11,384
General and administrative............. 4,371 15,655 4,820 7,492
Depreciation and amortization.......... 377 2,251 686 1,012
---------- ---------- ---------- ----------
Operating expenses..................... 12,567 40,429 12,786 19,890
---------- ---------- ---------- ----------
Operating income......................... 2,993 9,377 3,257 5,121
Net income............................... 2,060 5,531 $ 2,081 $ 3,109
========== ========== ========== ==========
Diluted earnings per share............... $ 0.42 $ .060 $ 0.27 $ 0.34
Weighted average shares outstanding...... 4,966,778 9,217,761 7,640,821 9,217,761
Supplemental system-wide revenue(5)...... $ 25,191 $ 72,733 $ 26,218 $ 39,743
</TABLE>
-5-
<PAGE> 6
<TABLE>
<CAPTION>
June 30, 1998
-------------------
Actual Pro Forma (7)
------ -------------
<S> <C> <C>
OPERATING DATA:
Number of affiliated physicians (including
physicians employed by the Company). . . . . . . . . . . 69 * 81 *
Number of allied health care professionals . . . . . . . . . 69 79
Number of other employees . . . . . . . . . . .. . . . . . . 336 452
Number of clinical location. . . . . . . . . . . . . . . . . 55 66
Number of capitated covered lives. . . . . . . . . . . . . . 320,137 320,137
</TABLE>
- -------------------------
* Includes one TMJ specialist
<TABLE>
<CAPTION>
JUNE 30, 1998
----------------------------
Actual(1) Pro Forma(2)(7)
---------- ---------------
(in thousands)
<S> <C> <C>
BALANCE SHEET DATA:
Working capital....................................... $ 20,908 $14,643
Total assets.......................................... 58,931 59,757
Total debt............................................ 7,564 7,564
Stockholders' equity ................................. 44,433 44,858
</TABLE>
- -------------------------
(1) The historical consolidated financial information should be read in
conjunction with the consolidated financial statements of the Company
and the notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appearing elsewhere
herein. The consolidated financial statement data for the year ended
December 31, 1997 have been derived from and are qualified by
reference to the audited consolidated financial statements of the
Company included elsewhere herein, which have been audited by Arthur
Andersen LLP, the Company's independent public accountants. The
consolidated financial statement data for the six months ended June
30, 1998 have been derived from the unaudited interim financial
statements of the Company.
-6-
<PAGE> 7
(2) The summary unaudited pro forma combined financial data should be read
in conjunction with the financial statements of the Company, Atlanta
ENT, the ENT Networks, Cobb Ear, Nose & Throat Associates, P.C.
("Cobb") and Ear, Nose & Throat Associates, P.C., a medical practice
whose shareholders own 50% of the equity of Physicians' Domain ("ENT
Associates"), and the notes thereto included elsewhere herein, the
unaudited pro forma combined financial statements of the Company and
the notes thereto elsewhere herein and "Management's Discussion and
Analysis of Financial Condition and Results of Operations." The
summary unaudited pro forma combined data does not purport to
represent what the Company's financial position or results of
operations actually would have been had such transactions in fact
occurred on the dates indicated, or to project the Company's financial
position or results of operations for any future date or period. The
pro forma adjustments are based on currently available information and
certain assumptions that the Company believes are reasonable under the
circumstances.
(3) Represents the unaudited pro forma combined results of operations for
the Company's affiliated practices as if the acquisition of the assets
or equity of these practices had occurred on January 1, 1997.
(4) Represents the unaudited pro forma combined results of operations for
the Company's affiliated practices as if the acquisition of the assets
or equity of the Company's affiliated practices had occurred on
January 1, 1997.
(5) The unaudited supplemental system-wide revenue is being presented for
supplemental purposes only and should be read in conjunction with the
Company's financial statements. The Emerging Issues Task Force of the
FASB has recently issued its Consensus on Issue 97-2 ("EITF 97-2").
EITF 97-2 addresses certain specific matters pertaining to the
physician practice management industry. EITF 97-2 would be effective
for the Company for its year ending December 31, 1998. EITF 97-2
addresses the ability of physician practice management companies to
consolidate the results of physician practices with which it has an
existing contractual relationship. The Company is in the process of
analyzing the effect of all its contractual relationships but
currently believes that certain contracts would meet the criteria of
EITF 97-2 for consolidating the results of operations of the related
physician practices, which would require the Company to restate its
prior period financial statements to conform to such consideration.
EITF 97-2 also has addressed the accounting method for future
combinations with individual physician practices. The Company believes
that, based on the criteria set forth in EITF 97-2, virtually all of
its future acquisitions of individual physician practices will
continue to be accounted for under the purchase method of accounting.
See "Management's Discussion and Analysis of Financial Conditions and
Results of Operations."
(6) Giving effect to the 2,307,540 shares sold by the Company at the public
offering price of $8.50 per share, the pro-forma diluted earnings per
share for the year ended December 31, 1997 and the six month period
ended June 30, 1998 would have been $.60 and $.34, respectively,
computed as follows:
<TABLE>
<CAPTION>
Year Ended Six Months Ended
December 31, 1997 June 30, 1998
----------------- -------------
<S> <C> <C>
Pro Forma Combined Net Income $5,269 $3,015
Interest Income, Net of Taxes 262 94
------ ------
Pro Forma, as Adjusted 5,531 3,109
Weighted Average Shares 9,218 9,218
Outstanding (Diluted)
Diluted Earnings Per Share $ .60 $ .34
====== ======
</TABLE>
(7) Gives pro forma effect to the acquisition of Maliner, Bequer,
Cleveland ENT and Atlanta Surgery Center as if the acquisition of the
assets or equity of these entities had occurred on June 30, 1998.
-7-
<PAGE> 8
The "Unaudited Pro Forma Combined Financial Data" beginning on pages
19 and F-2 of the Prospectus is hereby supplemented by (i) replacing "March 31,
1998" in the first paragraph with "June 30, 1998," (ii) replacing the
information under the heading "Unaudited Pro Forma Combined Statement of
Operations - Year Ended December 31, 1997 and Three Months Ended March 31,
1998," "Unaudited Pro Forma Combined Balance Sheet - March 31, 1998" and the
notes thereto with the following:
-8-
<PAGE> 9
UNAUDITED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Acquisition Adjustments
------------------------------------------------------------------------------
(amounts in thousands, except per share data)
ENT
Head &
PSC Reorg ENT ------
Historical Parties Allatoona Specialists Neck
---------- ------- --------- ----------- ----
<S> <C> <C> <C> <C> <C>
Management fees $ 10,974 $ 0 $ 0 $ 0 $ 0
Capitation revenues 3,619 1,257 0 0 0
Patient Services revenues 967 4,862 608 860 1,173
Partnership net income 0 0 0 0 0
---------- ------ ------ ---- ------
Net revenue $ 15,560 $6,119 $ 608 $860 $1,173
Expenses
Provider claims, wages,
benefits $ 7,819 $4,848 $ 520 $657 $1,012
General & administrative 4,371 1,166 105 193 165
Depreciation &
amortization 377 98 11 12 0
---------- ------ ------ ---- ------
Operating expenses $ 12,567 $6,112 $ 636 $862 $1,177
Operating income (loss) 2,993 7 (28) (2) (4)
Other (income) expense, net (429) 7 (28) 1 (4)
---------- ------ ------ ---- ------
Pretax income (loss) 3,422 0 0 (3) 0
Provision for income taxes 1,362 (40) 0 3 0
---------- ------ ------ ---- ------
Net income (loss) $ 2,060 $ 40 $ (0) $ (0) $ 0
========== ====== ====== ==== ======
Pro forma weighted average
shares outstanding $4,966,778
Pro forma earnings per share $ 0.42
==========
<CAPTION>
Acquisition Adjustments
--------------------------------------------------------------------------
(amounts in thousands, except per share data)
Northside Cobb James J.
ENT OMSA ENTSF Ent Murata
--- ---- ----- --- ------
<S> <C> <C> <C> <C> <C>
Management fees $ 0 $ 0 $ 0 $ 0 $ 0
Capitation revenues 0 0 0 0 0
Patient Services revenues 321 2,056 4,128 4,438 585
Partnership net income 0 0 0 0 0
---- ------ ------ ------ ----
Net revenue $321 $2,056 $4,128 $4,438 $585
Expenses
Provider claims, wages,
benefits $185 $1,420 $3,000 $2,758 $375
General & administrative 134 593 1,093 1,282 230
Depreciation &
amortization 2 35 53 68 10
---- ------ ------ ------ ----
Operating expenses $321 $2,048 $4,146 $4,108 $615
Operating income (loss) 0 8 (18) 330 (30)
Other (income) expense, net 0 6 (18) 25 0
---- ------ ------ ------ ----
Pretax income (loss) 0 2 0 305 (30)
Provision for income taxes 0 2 0 121 0
---- ------ ------ ------ ----
Net income (loss) $ 0 $ 0 $ 0 $ 184 $(30)
==== ====== ====== ====== ====
Pro forma weighted average
shares outstanding
Pro forma earnings per share
</TABLE>
<TABLE>
<CAPTION>
John Physicians Napoleon Robert Cleveland PSC
Westerkamm Domain Bequer Maliner ENT Ambulatory
---------- ------ ------- ------- --- ----------
<S> <C> <C> <C> <C> <C> <C>
Management fees $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
Capitation revenues 0 0 0 0 0 0
Patient services revenues 795 15,621 925 1,935 6,908 0
Partnership net income 0 0 0 0 0 1,070
---- ------- ---- ------ ------ ------
Net revenue $795 $15,621 $925 $1,935 $6,908 $1,070
Expenses
Provider claims,
wages, benefits $499 $10,991 $602 $1,308 $4,858 $0
General &
administrative 257 $ 3,711 280 603 1,472 0
Depreciation &
amortization 24 414 4 22 127 0
---- ------- ---- ------ ------ ------
Operating expenses $780 $15,116 $886 $1,933 $6,457 $ 0
Operating income (loss) 15 505 39 2 451 1,070
Other (income) expense, net 11 252 39 2 0 0
---- ------- ---- ------ ------ ------
Pretax income (loss) 4 253 0 0 451 1,070
Provision for income taxes 2 172 0 0 0 0
---- ------- ---- ------ ------ ------
Net income (loss) $ 2 $ 81 $ 0 $ 0 $ 451 $1,070
==== ======= ==== ====== ====== ======
Pro forma weighted average
shares outstanding
Pro forma earnings per share
<CAPTION>
Unaudited Pro-Forma Pro-Forma (8) Pro-Forma
Combined Adjustments Combined As Adjusted
-------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Management fees $10,974 $31,623 (1) $ 42,597 $ 42,597
Capitation revenues 4,876 4,876 4,876
Patient services revenues 46,182 (44,919) (1) 1,263 1,263
Partnership net income 1,070 1,070 1,070
------- -------- ---------- ----------
Net revenue $63,102 ($13,296) $ 49,806 $ 49,806
Expenses
Provider claims,
wages, benefits $40,852 ($18,532) (2) $ 22,523 $ 22,523
General &
administrative 15,655 203 (3) 15,655 15,655
Depreciation &
amortization 1,257 994 (4) 2,251 2,251
------- -------- ---------- ----------
Operating expenses $57,764 ($17,335) $ 40,429 $ 40,429
Operating income (loss) 5,338 4,039 9,377 9,377
Other (income) expense, net (136) 824 (5) 688 310
------- -------- ---------- ----------
Pretax income (loss) 5,474 3,215 8,689 9,067
Provision for income taxes 1,616 1,772 (6) 3,338 3,536
------- -------- ---------- ----------
Net income (loss) $ 3,858 $ 1,443 $ 5,301 $ 5,531
======= ======== ========== ==========
Pro forma weighted average $6,910,221 9,217,761
shares outstanding (7) (8)
Pro forma earnings per share $ 0.77 $ 0.60
</TABLE>
-9-
<PAGE> 10
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1998
<TABLE>
<CAPTION>
Adjustments (1)
---------------------------------------------------------------
(amounts in thousands, except per share data)
PSC James J. John Physicians' Napoleon Robert
Historical Murata Westerkamm Domain Bequer Maliner
---------- ------ ---------- ------ ------ -------
<S> <C> <C> <C> <C> <C> <C>
Management fees $ 13,159 $ 0 $ 0 $ 0 $ 0 $ 0
Capitation revenues 2,311 0 0 0 0 0
Patient service revenues 574 78 269 7,410 428 696
Partnership net Income 0 0 0 0 0 0
---------- --- ---- ------ ---- ----
Net revenue $ 16,044 $78 $269 $7,410 $428 $696
Expenses
Provider claims, wages, $ 7,281 $52 $171 $5,693 $280 503
benefits
General & administrative 4,820 29 85 1,585 134 199
Depreciation &
amortization 686 1 8 120 0 0
---------- --- ---- ------ ---- ----
Operating expenses $ 12,787 $82 $264 $7,398 $414 $702
Operating income (loss) 3,257 (4) 5 12 14 (6)
Other (income) expense,
net (154) 0 4 0 14 (6)
---------- --- ---- ------ ---- ----
Pretax income (loss) 3,411 (4) 1 12 0 0
Provision for income
taxes $ 1,330 0 1 12 0 0
---------- --- ---- ------ ---- ----
Net income (loss) $ 2,081 ($4) $ 0 $ 0 $ 0 $ 0
========== === ==== ====== ==== ====
Pro forma weighted
average shares
outstanding 7,640,821
Pro forma earnings per
share $ 0.27
==========
<CAPTION>
Adjustments(1)
-------------------------------------------------------------------------------
(amounts in thousands, except per share data)
Cleveland PSC Ambulatory Unaudited Pro-Forma Pro-Forma
ENT Surgery Combined Adjustments Combined
-------- --------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
Management fees $ 0 $ 0 $13,159 $8,321 (2) $ 21,480
Capitation revenues 0 0 2,311 2,311
Patient service revenues 3,998 0 13,453 (12,879)(3) 574
Partnership net Income 0 646 646 646
------ ---- ------- ------- ----------
Net revenue $3,998 $646 $29,569 ($4,558) $ 25,011
Expenses
Provider claims, wages, $2,976 $0 $16,956 ($5,572)(4) $ 11,384
benefits
General & administrative 640 0 7,492 7,492
Depreciation & amortization 77 0 892 122 (5) 1,014
------ ---- ------- ------- ----------
Operating expenses $3,693 $ 0 $25,340 ($5,450) $ 19,890
Operating income (loss) 305 646 4,229 892 5,121
Other (income) expense, net 0 0 142 166 (6) 24
------ ---- ------- ------- ----------
Pretax income (loss) 305 646 4,371 726 5,097
Provision for income
taxes 0 0 1,343 645 (7) 1,988
------ ---- ------- ------ ----------
Net income (loss) $ 305 $646 $ 3,028 $ 81 $ 3,109
====== ==== ======= ====== ==========
Pro forma weighted
average shares
outstanding 9,217,761
(8)
Pro forma earnings per
share $ 0.34
==========
</TABLE>
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
At June 30, 1998
(amounts in thousands, except per share data)
<TABLE>
<CAPTION>
Physicians' (9)
Specialty Cleveland Acquisition Pro-Forma
Corp Maliner ENT Adjustments Combined
--------- ------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Assets
Current Assets
Cash and cash equivalents $10,608 $ 0 $ 0 $(6,894) $ 3,714
Accounts receivable, net 16,403 150 880 17,433
Other current assets 831 0 0 831
------- ---- ------ ------- --------
Current assets 27,842 150 880 (6,894) 21,978
Property & Equipment (net) 7,009 225 900 565 8,134
Intangible assets (net) 23,478 0 0 24,043
Investment in Unconsolidated 0 0 0 5,000 5,000
subsidiary
Other assets 602 0 0 602
------- ---- ------ ------- --------
Total assets $58,931 $375 $1,780 $(1,329) $ 59,757
======= ==== ====== ======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Notes payable $ 0 $ 0 $ 0 $ 0
Accounts payable & accured 6,044 0 0 401 6,445
expenses 890 0 0 0 890
------- ---- ------ ------- --------
Deferred taxes 6,934 0 0 401 7,335
Current liabilities
Subordinated Seller Notes 7,564 0 0 0 7,564
Stockholders' Equity 44,433 375 1,780 (1,730) 44,858
------- ---- ------ ------- --------
Total liabilities and
stockholders' equity $58,931 $375 $1,780 $(1,329) $ 59,757
======= ==== ====== ======= ========
</TABLE>
-10-
<PAGE> 11
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL DATA
The following is a summary of the adjustments reflected in the
Unaudited Pro Forma Combined Financial Statements assuming the acquisition of
assets or equity of the Practices and the consummation of the Physicians'
Domain acquisition had occurred on January 1, 1997 with respect to the
unaudited pro forma combined statements of operations and as of June 30, 1998
with respect to the unaudited pro forma combined balance sheet.
(1) Reflects operations of acquired practices from January 1, 1997
through their respective date of acquisition by the Company.
(2) Management fees have been calculated based upon the management
services agreements. For providing services pursuant to the management services
agreements, the Company retains a fixed amount, varying percentage of all
revenue generated by or on behalf of physicians practicing at the practice
(after adjusting for, among other things, uncollectible accounts and
contractual allowances) or a percentage of practice income before physician
compensation. The Company is responsible for the payment of operating expenses
of the affiliated practices, including salaries and benefits of non-medical
employees of the practice, lease obligations for office space and equipment and
medical and office supplies and the non-operating expenses of the affiliated
physician practice, including depreciation, amortization and interest.
Management fee adjustments under the management services agreements
are calculated as follows:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1997 JUNE 30, 1998
----------------- -------------
(IN THOUSANDS)
<S> <C> <C>
ATLANTA MARKET
- --------------
Atlanta ENT.............................................. $ 3,671 $ ---
Additional Atlanta Practices............................. 895 ---
ENT Specialists.......................................... 860 ---
ENT Head & Neck.......................................... 1,173 ---
Northside................................................ 321 ---
Cobb ENT................................................. 4,438 ---
CHICAGO MARKET
- --------------
OMSA..................................................... 2,056 ---
</TABLE>
-11-
<PAGE> 12
<TABLE>
<S> <C> <C>
SOUTH FLORIDA MARKET
- --------------------
ENTSF.................................................... 4,128 --
Murata................................................... 585 78
Bequer.................................................. 925 428
Maliner.................................................. 1,935 696
Westerkamm............................................... 795 269
-- --
Pro Forma Patient Service Revenue.................... $21,782 $1,471
Management Fee %..................................... 12.5% 12.5%
------- ------
$ 2,723(A) $ 184(A)
NORTH GEORGIA MARKET
- --------------------
Allatoona................................................ $ 608 $ --
Pro Forma Patient Service Revenue.................... $ 608 $ --
Management Fee % 15.0% --%
------- --
$ 91(B) $ --(B)
PDI GROUP ACQUISITION......................................... $ 2,048(C) $ 853(C)
- ---------------------
CLEVELAND ENT
- -------------
Pro Forma Net Income Before Physician
Compensation............................................. $ 3,696 $2,514
Management Fee %......................................... 12.0% 12.0%
------- ------
$ 444(D) $ 302(D)
------- ------
Pro Forma Management Fees (A)+(B)+(C)+(D)..................... $ 5,306 $1,339
Pro Forma Practice Operating Expenses......................... $26,317 $6,982
------- ------
Pro Forma Management Fee Adjustment........................... $31,623 $8,321
======= ======
</TABLE>
Under the current management services agreements, the Company retains
on an annual basis 12.5% to 15.0% of affiliated physician practice revenue.
Under certain management services agreements, in the event the affiliated
practice's annual revenues exceeds 150% of such practice's annual revenue in
the year prior to its affiliation with the Company (the "Threshold Amount"),
the Company will be entitled to receive incentive compensation (in lieu of the
12.5% amount) for the remainder of such fiscal year in amounts ranging from 20%
to 25% of the affiliated practice's income (net practice revenue less practice
expenses), prior to the payment of physician compensation and benefits. In
connection with the PDI transaction, the management services agreements contain
a fixed monthly management fee, subject to annual escalation based on increases
in the consumer price index after the fifth anniversary of the date of the
agreement. The Cleveland ENT management services agreement calls for management
fees to be calculated as a percentage of practice income before physician
compensation.
-12-
<PAGE> 13
There is no management fee adjustment for ENT & Allergy Associates
because physicians at ENT & Allergy Associates are directly employed by the
Company. See Note 3 below.
(3) Reflects the elimination of net patient service revenue for all
physician practices with which the Company has management services agreements
but does not directly employ the physicians of such practices, except for the
physicians of ENT & Allergy Associates.
(4) Reflects the elimination of physician compensation at the
practices in which the Company does not have an equity ownership. After the
Company collects its management fees pursuant to the management services
agreements and pays the operating and non-operating expenses, the remaining
revenue is remitted to the affiliated practice to pay physician compensation
and benefits pursuant to employment agreements between the practice and each
individual physician and to pay physician assistant compensation and benefits.
The reduction of physician compensation at ENT & Allergy Associates is a result
of a contractual agreement with the Company. Also the adjustment reflects the
net cost of additional employment contracts entered into by the Company for
certain management positions. The adjustments do not include bonuses due to
their subjective nature and requisite board approval for the granting of
bonuses based upon meeting certain profitability and non-financial goals.
(5) Reflects amortization of intangibles and deferred organization
costs of the Company.
(6) Reflects interest expense in connection with the subordinated
promissory notes incurred in connection with certain of the Company's
acquisitions computed at the rate of approximately 6% per annum.
(7) Reflects the establishment of a provision for income taxes at an
estimated 39% effective tax rate, which consists of a 34% statutory federal tax
rate and an average state statutory tax rate of 5%.
(8) Reflects weighted average shares outstanding for common stock and
stock equivalents (which have been calculated using the treasury stock method)
giving effect to the acquisition of Murata and Maliner.
Giving effect to the 2,307,540 shares sold by the Company at the
public offering price of $8.50 per share, the pro-forma diluted earnings per
share for the year ended December 31, 1997 and the six month period ended June
30, 1998 would have been $.60 and $.34, respectively, computed as follows:
-13-
<PAGE> 14
<TABLE>
<CAPTION>
Year Ended Six Months Ended
December 31, 1997 June 30, 1998
----------------- -------------
<S> <C> <C>
Pro Forma Combined Net Income $5,269 $3,015
Interest Income, Net of Taxes 262 94
------ ------
Pro Forma, as Adjusted 5,531 3,109
Weighted Average Shares 9,218 9,218
Outstanding (Diluted)
Diluted Earnings Per Share $ .60 $ .34
====== ======
</TABLE>
(9) Reflects the acquisition of the tangible and identifiable
intangible assets of Maliner and Cleveland ENT. Also reflects the acquisition
of a 17.5% interest in Atlanta Surgery Center accounted for using the equity
method of accounting.
-14-
<PAGE> 15
The "Selected Financial Data" beginning on page 24 of the Prospectus
is hereby supplemented by (i) replacing "March 31, 1997 and 1998" in the first
paragraph with "June 30, 1997 and 1998," and (ii) replacing the information
under the heading "Statement of Operations Three Months Ended March 31, 1998"
and "Balance Sheet - March 31, 1998" with the following:
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1997 1998
---- ----
(in thousands, except share data)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenue....................................... $ 4,503 $ 16,044
Expenses
Provider claims, wages and benefits............. 2,544 7,281
General and administrative...................... 1,123 4,820
Depreciation and amortization................... 97 686
---------- ----------
Operating expenses................................ 3,764 12,786
Operating income (loss)........................... 740 3,257
Net income (loss)................................. $ 532 $ 2,081
========== ==========
Earnings (loss) per share
Basic earnings (loss) per share................. $ 0.15 $ 0.29
Diluted earnings (loss) per share............... $ 0.15 $ 0.27
Weighted average shares outstanding
Basic........................................... 3,519,742 7,106,869
Diluted......................................... 3,519,742 7,640,821
</TABLE>
<TABLE>
<CAPTION>
June 30, 1998
-------------
(in thousands)
<S> <C>
BALANCE SHEET DATA:
Cash and cash equivalents......................... $10,608
Working capital................................... 20,908
Total assets...................................... 58,931
Total debt........................................ 7,564
Stockholders' equity.............................. 44,433
</TABLE>
-15-
<PAGE> 16
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" beginning on page 25 is hereby supplemented as follows:
RESULTS OF OPERATIONS - HISTORICAL
Comparisons of the six month period ended June 30, 1998 with data for
the six month period ended June 30, 1997 are not meaningful since the Company
did not commence business operations until the closing of the reorganization
and its IPO on March 26, 1997.
SIX MONTHS ENDED JUNE 30, 1998
Revenue. Management fees increased to $7,235,132 for the three months
ended June 30, 1998 as compared with $2,668,918 for the same period in 1997, an
increase of $4,566,214 or 171%. The increase in management fees is primarily
attributable to an increase in the number of physicians affiliated with the
Company at June 30, 1998 to 68 as compared with 22 for the same period in 1997
as a result of the Company's acquisitions since the Reorganization. Capitation
revenues decreased to $1,145,368 for the three months ended June 30, 1998 as
compared with $1,301,703 for the same period in 1997, a decrease of $156,335 or
12%. The decrease in capitation revenues is primarily attributable to a
modification by Aetna Health Plans of Georgia ("Aetna") of its delivery system
of physician specialty services in the Atlanta market which resulted in the
termination of its capitated managed care contracts with each physician
specialty group including the Company, effective June 30, 1997. Patient service
revenues decreased to $264,569 for the three months ended June 30, 1998 as
compared with $293,814 for the same period in 1997, a decrease of $29,245 or
10%. The decrease in patient service revenues is mainly attributable to an
increase in contractual adjustments from third party payors in the Birmingham,
Alabama market. Such adjustments represent the difference between charges at
established rates compared with actual recoverable amounts.
On a supplemental basis, patient service revenue generated by
physicians who were affiliated with the Company for both periods ended June 30,
1997 and 1998 increased on average approximately 15% per physician.
As a result of the foregoing factors, the Company's net revenue
increased to $8,645,069 for the three months ended June 30, 1998 as compared
with $4,264,435 for the same period in 1997, an increase of $4,380,634 or 103%.
Provider claims, wages, and benefits. Provider claims, wages and
benefits, increased to $3,961,630 for the three months ended June 30, 1998 as
compared with $2,360,886 for the same period in 1997, an increase of $1,600,744
or 68%. The dollar increase in provider claims, wages and benefits was
primarily attributable to the addition of non-medical personnel at the
company's affiliated practices required to support the increase in the number
of affiliated physician groups managed by the Company. As a percent of net
revenue, provider claims, wages and benefits decreased to 45% for the three
months ended June 30, 1998 as compared to 55% for the same
-16-
<PAGE> 17
period in 1997. This decrease was primarily attributable to the increase in net
revenue that was greater than the incremental increase in wages and benefits.
General and administrative. General and administrative expenses
increased to $2,562,405 for the three months ended June 30, 1998 as compared
with $1,089,953 for the same period in 1997, an increase of $1,472,452 or 135%.
This increase was primarily attributable to the to the addition of personnel
and greater support costs associated with the Company's rapid expansion since
June 30, 1997. As a percent of net revenue, general and administrative expenses
increased to 30% for the three months ended June 30, 1998 as compared to 26%
for the same period in 1997, as a result of the foregoing factors.
Depreciation and Amortization. Depreciation and amortization expenses
increased to $403,331 for the three months ended June 30, 1998 as compared with
$93,771 for the same period in 1997, an increase of $309,560 or 330%. This
increase was primarily the result of the amortization of intangible assets
associated with the Company's affiliation with physician groups, as well as
investments in equipment, leasehold improvements and management information
systems. As a percent of net revenue, depreciation and amortization expense
increased to 4% for the three months ended June 30, 1998 as compared with 2%
for the same period in 1997, as a result of the foregoing factors. The Company
believes amortization expense will increase substantially in future periods as
a result of the PDI transaction.
Other Income - net. Other income-net increased to $124,659 for the
three months ended June 30, 1998 as compared with $119,306 for the same period
in 1997, an increase of $5,353 or 4%. Other income is derived from interest
income earned on the short term investment of excess cash and cash equivalents
as well as interest charges to affiliated practices for additions to clinical
equipment, leasehold improvements and other fixed assets, net of amounts of
interest expense related primarily to the subordinated seller notes and
debenture. The Company believes interest expense will increase substantially in
future periods as a result of the PDI transaction.
Income Taxes. Income taxes for the quarters ended June 30, 1998 and
1997 were provided for at 39% effective tax rate.
RESULTS OF OPERATIONS - UNAUDITED PRO FORMA COMBINED
The unaudited pro forma combined results of operations reflect the
operations of the Company as if the acquisition of assets of the Practices had
occurred on January 1, 1997.
SIX MONTHS ENDED JUNE 30, 1998
Revenue. Pro forma combined net revenue for the six months ended June
30, 1998 was $25.0 million, consisting of $21.4 million of pro forma combined
management fees, $2.3 million of pro forma combined capitated revenue, $646,000
of pro forma combined earnings from an ambulatory surgery center investment,
and $574,000 of pro forma combined net patient service revenue.
-17-
<PAGE> 18
Operating Expenses. Pro forma combined operating expenses for the six
months ended June 30, 1998 were $19.8 million, or 79.2% of pro forma combined
net revenue, consisting of provider claims, wages and benefits ($11.4 million
or 45.5% of pro forma combined net revenue); general and administrative
expenses ($7.5 million or 30.0% of pro forma combined net revenue); and
depreciation and amortization expense ($1.0 million or 4.1% of pro forma
combined net revenue).
Other Income (Expense). Pro forma combined other income (expense) for
the three months ended March 31, 1998 consisted of net interest expense of
$24,000 or .1% of pro forma combined net revenue. Interest expense related to
promissory notes and advances under the Credit Facility incurred in connection
with certain of the Company's acquisitions has been computed at rates of 6% and
9% per annum, respectively.
Income Taxes. Pro forma combined income tax expense for the six months
ended June 30, 1998 was $1.9 million or 39.0% of pre-tax income.
YEAR ENDED DECEMBER 31, 1997
Revenue. Pro forma combined net revenue for the year ended December
31, 1997 was $49.8 million, consisting of $42.5 million of pro forma combined
management fees, $4.9 million of pro forma combined capitated revenue, $1.3
million of pro forma combined net patient service revenue, and $1.0 million of
pro forma combined earnings from an ambulatory surgery center investment.
Operating Expenses. Pro forma combined operating expenses for the year
ended December 31, 1997 were $40.4 million, or 81.2% of pro forma combined net
revenue, consisting of provider claims, wages and benefits ($22.5 million or
45.2% of pro forma combined net revenue); general and administrative expenses
($15.6 million or 31.4% of pro forma combined net revenue); and depreciation
and amortization expense ($2.2 million or 4.5% of pro forma combined net
revenue).
Other Income (Expense). Pro forma combined other income (expense) for
the year ended December 31, 1997 consisted of net interest expense of $360,000
or .6% of pro forma combined net revenue. Interest expense related to
promissory notes and advanced under the Company's Credit Facility incurred in
connection with certain of the Company's acquisitions has been computed at
rates of 6% and 9% per annum, respectively.
Income Taxes. Pro forma combined income tax expense for the year ended
December 31, 1998 was $3.5 million, or 39.0% of pre-tax income.
The first eight paragraphs under "Liquidity and Capital Resources" are
hereby deleted and replaced by the following:
-18-
<PAGE> 19
The Company utilizes capital primarily (i) to acquire assets or equity
of physician practices, (ii) to acquire equipment utilized by affiliated
practices, (iii) to fund corporate capital expenditures including management
information systems and (iv) to fund ongoing corporate working capital
requirements.
At June 30, 1998, the Company had working capital of $20,907,810,
compared to $10,469,429 at December 31, 1997, an increase of $10,438,381. The
increase in working capital was due primarily to an increase in net accounts
receivable of $7,128,975, an increase in cash of $5,256,159 primarily as a
result of the Company's public offering of Common Stock in May 1998, offset by
an increase in accounts payable, accrued expenses and payments to physicians of
$1,809,097.
For the six month period ended June 30, 1998 net cash used in
operating activities was $111,456 compared to net cash provided by operating
activities of $1,448,591 for the same period in 1997. Net cash used in
investing activities for the six months ended June 30, 1998 was $11,229,612
with $10,310,258 expended as cash consideration for acquisitions, including
PDI. Net cash provided by financing activities for the six months ended June
30, 1998 was $16,595,227 with $16,520,043 received pursuant to the Company's
public offering in May 1998, net of offering costs.
During the three month period ended June 30, 1998, the Company
acquired substantially all of the assets (other than certain excluded assets
such as employment agreements and patient charts, records and files) and
assumed certain contractual liabilities of (i) Westerkamm and (ii) Bequer. In
connection with the acquisition of assets or equity of these practices, the
Company (i) paid an aggregate of approximately $415,000 in cash, (ii)
discharged approximately $260,000 of liabilities, (iii) issued a subordinated
convertible promissory note in the principal amount of $250,000 which note
matures in April 2000 and accrues interest at a rate of 6.0% per annum and is
convertible into shares of Common Stock valued at the average closing price of
such Common Stock for the ten trading days, preceding the date of delivery of
such shares, (iv) issued an aggregate of approximately 18,000 shares of Common
Stock (valued at an aggregate of approximately $163,000), and (v) agreed to
issue approximately 18,000 additional shares of Common Stock (valued at an
aggregate of approximately $163,000) to one of the affiliated practices
beginning in February, 1999. In connection with these acquisitions (other than
PDI), the Company paid an aggregate of approximately $63,300 to Premier
HealthCare, an affiliate of the Company's Vice Chairman and Secretary, for
advisory services rendered.
In addition, on May 27, 1998, pursuant to a Stock Purchase Agreement,
the Company, through PSC Acquisition Corp., a wholly-owned subsidiary of the
Company, acquired (i) substantially all of the tangible assets and assumed
certain contractual liabilities of Physicians' Domain, Inc., a White Plains,
New York based ENT physician practice management company ("Physicians' Domain")
and (ii) the stock of three corporations that are successors to three ENT
physician practices affiliated with Physicians' Domain employing an aggregate
of 20 physicians and 16 allied health care professionals with 11 clinical
offices in Southern New York and Northern New Jersey (collectively, "PDI"). In
connection with the PDI transaction, the Company (i) paid
-19-
<PAGE> 20
approximately $5.4 million in cash, (ii) discharged approximately $3.8 million
of liabilities of PDI and (iii) issued a subordinated long-term promissory note
in the principal amount of approximately $6.4 million , which note matures in
May 2003, accrues interest at a rate of 6.0% per annum, payable quarterly, is
secured by the fixed assets acquired by the Company in the transaction and is
subordinate to senior indebtedness, including borrowings under the Company's
credit facility. In addition, the Company will pay an additional $500,000, in
cash or shares of Common Stock at the Company's option, if the PDI practices
achieve stipulated performance targets. Pursuant to the stock purchase
agreement. The physicians at PDI have the right to nominate one member to the
Board of Directors of the Company. Steven H. Sacks, M.D., a nominee of the
physicians at PDI, was appointed to the Board of Directors of the Company on
August 12, 1998. In connection with the PDI transaction, the Company paid
approximately $260,000 to Premier HealthCare for advisory services rendered.
The Company also entered into management services agreements with two
newly organized ENT practices employing the 20 ENT physicians in connection
with the PDI transaction,. The management services agreements provide for an
aggregate fixed annual management fee of approximately $2.0 million, plus
reimbursement of practice operating expenses. Pursuant to the management
services agreements, the fixed management fee is subject to annual increases
after May 27, 2003 consistent with the annual percentage increase in the
consumer price index for the prior year. The management services agreements
also provide for mutually agreed increases in the fixed management fee upon (i)
the management by the Company of ancillary business developed or acquired or
(ii) the acquisition of additional physician practices which are merged into
the existing PDI practices.
The Company used a portion of the net proceeds received from the
Company's public offering in May 1998 to pay the cash component of the PDI and
to discharge the indebtedness of PDI assumed by the Company in connection with
the PDI transaction.
In August 1998, the Company closed on a four year $45 million senior
credit facility with Nationsbanc Montgomery Securities LLC, NationsBank, N.A.,
PNC Bank and Rabobank Nederland (the "Credit Facility"). The Credit Facility
replaced the Company's $20 million senior credit facility. Borrowings under the
Credit Facility (i) are secured by the assignment to the banks of the Company's
stock in all of its subsidiaries and the Company's accounts receivable,
including the accounts receivable assigned to the Company by affiliated
practices pursuant to management services agreements, (ii) are guaranteed by
all subsidiaries (including future subsidiaries) and (iii) restrict the Company
from pledging its assets to any other party. Advances under the Credit Facility
will be used to fund acquisitions and working capital, will be governed by a
borrowing base related primarily to the Company's earnings before interest,
taxes, depreciation and amortization ("EBITDA") and will bear interest, at the
Company's option, based upon either a prime-based or LIBOR-based rate. EBITDA
is used by the Company as an indicator of a company's ability to incur and
service debt. EBITDA should not be considered an alternative to operating
income, net income, cash flows or any other measure of performance as
determined in accordance with generally accepted accounting principles, as an
indicator of operating performance, or as a measure of liquidity. The Credit
Facility contains affirmative and negative
-20-
<PAGE> 21
covenants which, among other things, require the Company to maintain certain
financial ratios (including maximum indebtedness to pro forma EBITDA, maximum
indebtedness to capital, minimum net worth, minimum current ratio and minimum
fixed charges coverage), limit the amounts of additional indebtedness,
dividends, advances to officers, shareholders and physicians, acquisitions,
investments and advances to subsidiaries, and restrict changes in management
and the Company's business. As of September 30, 1988, the company had no
borrowings under the Credit facility.
The "Financial Statements" beginning on page F-9 are hereby
supplemented as follows:
PHYSICIANS' SPECIALTY CORP.
Condensed Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
June 30,1998
------------
<S> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $10,607,798
Accounts receivable, net of allowance for doubtful
accounts of $457,005 and $261,714 in
1998 and 1997, respectively 16,402,540
Notes receivable 80,000
Prepayments and other 751,551
-----------
Total current assets 27,841,889
PROPERTY AND EQUIPMENT, net 7,009,294
INTANGIBLE ASSETS, net 23,478,157
OTHER ASSETS 601,613
-----------
Total Assets $58,930,953
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Due to physicians $ 2,058,566
Accounts payable and accrued expenses 3,985,420
Deferred income taxes 890,093
-----------
Total current liabilities 6,934,079
SUBORDINATED SELLER NOTES & DEBENTURE 7,563,701
-----------
Total liabilities 14,497,780
SHAREHOLDERS' EQUITY:
Common stock, $.001 par value; 50,000,000 shares authorized
issued: 8,841,359 in 1998 and 6,503,098 in 1997 8,842
Additional paid-in capital 40,638,263
Retained earnings 3,786,068
-----------
Total shareholders' equity 44,433,173
Total liabilities and shareholders' equity $58,930,953
===========
</TABLE>
See accompanying notes to consolidated financial statements
-21-
<PAGE> 22
PHYSICIANS' SPECIALTY CORP.
Consolidated Statement of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
-------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES
Patient service revenues $ 264,569 $ 293,814 $ 573,524 $ 320,175
Capitation revenues 1,145,368 1,301,703 2,310,674 1,357,551
Management fees 7,235,132 2,668,918 13,159,402 2,825,660
----------- ------------ ------------- -----------
Net revenue 8,645,069 4,264,435 16,043,600 4,503,386
EXPENSES
Provider claims, wages, benefits 3,961,630 2,360,886 7,280,557 2,544,391
General and administrative 2,562,405 1,089,953 4,819,759 1,122,737
Depreciation and amortization 403,331 93,771 686,120 96,555
----------- ------------ ------------- -----------
Operating expenses 6,927,366 3,544,610 12,786,436 3,763,683
Operating income 1,717,703 719,825 3,257,164 739,703
Other income - net 124,659 119,306 153,559 132,499
----------- ------------ ------------- -----------
Pretax income 1,842,362 839,131 3,410,723 872,202
Provision for income taxes 718,411 327,261 1,330,031 340,159
----------- ------------ ------------- -----------
Net income $ 1,123,951 511,870 $ 2,080,692 $ 532,043
=========== ============ ============= ===========
Earnings per share:
Basic $ 0.15 $ 0.09 $ 0.29 $ 0.15
Diluted $ 0.14 $ 0.09 $ 0.27 $ 0.15
Weighted average shares outstanding
Basic 7,695,730 5,904,648 7,106,869 3,519,742
Diluted 8,240,675 5,904,648 7,640,821 3,519,742
</TABLE>
See accompanying notes to consolidated financial statement.
-22-
<PAGE> 23
PHYSICIAN'S SPECIALTY CORP.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1998 1997
------------------- -----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,080,692 $ 532,043
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 686,120 96,555
Compensation expense 32,987 48,000
Increase in accounts receivable (3,197,606) (35,501)
Increase in prepayments and other (686,091) 133,144
Increase in accounts payable and accrued liabilities 972,442 674,348
----------- -------------
Total Adjustments (2,192,148) 916,548
----------- -------------
Net cash (used in) provided by operating activities (111,456) 1,448,591
----------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payment for acquisitions, net of cash acquired (10,310,258) 0
Purchase of property and equipment (917,354) (164,322)
----------- -------------
Net cash used in investing activities (11,227,612) (164,322)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock, net of offering costs 16,520,043 15,408,094
Borrowing under short-term debt 75,185 170,000
Repayment of short-term debt 0 (2,258,562)
Repayment of long-term debt 0 0
Deferred offering costs 0 0
----------- -------------
Net cash provided by financing activities 16,595,228 13,319,532
----------- -------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 5,256,159 14,603,891
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 5,351,639 123,540
----------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $10,607,798 $ 14,727,341
=========== =============
</TABLE>
See accompanying notes to consolidated financial statements
-23-
<PAGE> 24
Physicians' Specialty Corp.
Notes to the Consolidated Financial Statements (Unaudited)
June 30, 1998
NOTE 1. ORGANIZATION
Physicians' Specialty Corp. (the "Company") was organized in July 1996
to provide comprehensive physician practice management services to physician
practices and health care providers specializing in the treatment and
management of diseases and disorders of the ear, nose, throat, head and neck
("ENT") and related specialties. The Company commenced its business activities
upon consummation of the reorganization, as described in Note 3, and its
initial public offering ("IPO") on March 26, 1997. The Company provides
financial and administrative management, enhancement of clinical operations,
network development and payor contracting services, including the negotiation
and administration of capitated arrangements. The Company has operations in
greater Atlanta, Georgia; Chicago, Illinois; Birmingham, Alabama; the South
Florida area and Southern New York and Northern New Jersey.
NOTE 2. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries and 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. Accordingly, they do not
include all of the information and notes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, the accompanying unaudited consolidated financial statements
contain all adjustments (consisting of normal recurring items) necessary for a
fair presentation of the results for the interim periods presented. These
financial statements and footnote disclosures should be read in conjunction
with the audited financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1997.
NOTE 3. REORGANIZATION
The Company acquired substantially all of the assets (other than
certain excluded assets such as employment agreements and patient charts,
records and files) and certain liabilities of (i) Atlanta Ear, Nose & Throat
Associates, P.C., (ii) ENT & Allergy Associates, Inc. (iii) Metropolitan Ear,
Nose & Throat, P.C., (iv) Atlanta Head and Neck Surgery, P.C. and (v) Ear, Nose
& Throat Associates, P.C. (collectively, the "Initial Practices"), and all of
the outstanding shares of common stock of three corporations holding managed
care contracts (the "ENT Networks") in March 1997 (the "Reorganization"). In
connection with the acquisition of assets of the initial practices and the
common stock of the ENT Networks, the Company issued an
-24-
<PAGE> 25
aggregate of 3,104,755 shares of Common Stock (valued at the time of issuance
at approximately $24.8 million).
POST REORGANIZATION ACQUISITIONS THROUGH MARCH 31, 1998
Since the Reorganization, the Company acquired (a) substantially all
of the assets (other than certain excluded assets such as employment agreements
and patient charts, records and files) and assumed certain contractual
liabilities of (i) Allatoona Ear, Nose & Throat Associates, P.C, (ii) Ear Nose
& Throat Specialists, P.C., (iii) Ear, Nose & Throat Specialists, Head & Neck
Surgery, P.C., (iv) Northside Ear, Nose & Throat Associates, P.C., (v)
Otolaryngology Medical & Surgical Associates, Ltd., (vi) Cobb Ear, Nose &
Throat Associates, P.C., (vii) James J. Murata. M.D., P.A. and (b) the stock of
six professional associations owned by seven ENT physicians and a partnership
owned and operated by the professional associations in Palm Beach and Broward
Counties, Florida.
In connection with the acquisition of assets or equity of these
practices, the Company (i) paid an aggregate of approximately $5.1 million in
cash, (ii) issued an aggregate of 611,215 shares of Common Stock (valued at an
aggregate of approximately $4.6 million), (iii) agreed to issue an aggregate of
301,779 additional shares of Common Stock (valued at an aggregate of
approximately $2.7 million) to three of the affiliated practices beginning in
September 1998, (iv) issued subordinated convertible promissory notes in the
aggregate principal amount of approximately $912,000, which notes mature in
October 2000 and accrue interest at a rate of 5.61% per annum and are
convertible into shares of Common Stock at a conversion price of $10.00 per
share and (v) issued non-interest bearing contingent subordinated promissory
notes in the aggregate principal amount of approximately $3.0 million. The
payment of these notes is contingent upon the physicians or practice holding
such notes reaching certain performance targets. Substantially all of these
contingent notes are payable by the Company, at the Company's option, in shares
of Common Stock, valued at the average closing price of the Common Stock for
the ten trading days preceding the date of delivery of such shares. In
connection with these acquisitions, the Company paid an aggregate of
approximately $397,000 to Premier HealthCare, an affiliate of the Company's
Vice Chairman and Secretary, for advisory services rendered.
ACQUISITIONS FROM APRIL 1, 1998 THROUGH JUNE 30, 1998
During the three month period ended June 30, 1998, the Company
acquired substantially all of the assets (other than certain excluded assets
such as employment agreements and patient charts, records and files) and
assumed certain contractual liabilities of (i) John C. Westerkamm, M.D., P.A.
("Westerkamm"), and (ii) Napoleon G. Bequer, M.D., P.A. ("Bequer"). In
connection with the acquisition of assets or equity of these practices, the
Company (i) paid an aggregate of approximately $415,000 in cash, (ii)
discharged approximately $260,000 of liabilities, (iii) issued a subordinated
promissory note in the principal amount of $250,000 which note matures in April
2000 and accrues interest at a rate of 6.0% per annum and is payable, at the
Company's option, in cash or the Company's Common
-25-
<PAGE> 26
Stock, (iv) issued an aggregate of approximately 18,000 shares of Common Stock
(valued at an aggregate of approximately $163,000), and (v) agreed to issue
approximately 18,000 additional shares of Common Stock (valued at an aggregate
of approximately $163,000) to one of the affiliated practices beginning in June
1999. In connection with these acquisitions, the Company paid an aggregate of
approximately $63,300 to Premier HealthCare, an affiliate of the Company's Vice
Chairman and Secretary, for advisory services rendered.
In addition, on May 27, 1998, pursuant to a Stock Purchase Agreement,
the Company, through PSC Acquisition Corp., a wholly-owned subsidiary of the
Company, acquired (i) substantially all of the tangible assets and assumed
certain contractual liabilities of Physicians' Domain, Inc., a White Plains,
New York based ENT physician practice management company ("Physicians' Domain")
and (ii) the stock of three corporations that are successors to three ENT
physician practices affiliated with Physicians' Domain employing an aggregate
of 20 physicians and 16 allied health care professionals with 11 clinical
offices in Southern New York and Northern New Jersey (collectively, "PDI"). In
connection with the PDI transaction, the Company (i) paid approximately $5.4
million in cash, (ii) discharged approximately $3.8 million of liabilities of
PDI and (iii) issued a subordinated long-term promissory note in the principal
amount of approximately $6.4 million , which note matures in May 2003, accrues
interest at a rate of 6.0% per annum, payable quarterly, is secured by the
fixed assets acquired by the Company in the transaction and is subordinate to
senior indebtedness, including borrowings under the Company's credit facility.
In addition, the Company will pay an additional $500,000, in cash or shares of
Common Stock at the Company's option, if the PDI practices achieve stipulated
performance targets. Pursuant to the stock purchase agreement, the physicians
at PDI have the right to nominate one member to the Board of Directors of the
Company. Steven H. Sacks, M.D., a nominee of the physicians at PDI, was
appointed to the Board of Directors of the Company on August 12, 1998. In
connection with the PDI transaction, the Company paid approximately $260,000 to
Premier HealthCare for advisory services rendered
The Company also entered into management services agreements with two
newly organized ENT practices employing the 20 ENT physicians in connection
with the PDI transaction. The management services agreements provide for an
aggregate fixed annual management fee of approximately $2.0 million, plus
reimbursement of practice operating expenses. Pursuant to the management
services agreements, the fixed management fee is subject to annual increases
after May 27, 2003 consistent with the annual percentage increase in the
consumer price index for the prior year. The management services agreements
also provide for mutually agreed increases in the fixed management fee upon (i)
the management by the Company of ancillary business developed or acquired or
(ii) the acquisition of additional physician practices which are merged into
the existing PDI practices.
The Company used a portion of the net proceeds received from the
Company's public offering in May 1998 to pay the cash component of and to
discharge the indebtedness of PDI assumed by the Company in connection with the
PDI transaction.
-26-
<PAGE> 27
NOTE 4. PUBLIC OFFERINGS
On March 26, 1997, the Company completed its IPO of 2,200,000 shares
of its common stock. The net proceeds of the IPO were approximately $14,275,000
and a portion of which were used for repayment of indebtedness of the acquired
practices, repayment of indebtedness of the Company, payment of a consulting
fee, and for general corporate purposes and working capital requirements.
On May 15, 1998, the Company completed a public offering of 2,050,263
shares of its common stock (i) 2,000,000 of which shares were sold by the
Company and (ii) 50,263 of which were sold by certain stockholders of the
Company. On May 19, 1998 the Company's underwriters exercised their option to
purchase 307,540 additional shares of common stock from the Company to cover
over-allotments. The net proceeds to the Company from the offering and exercise
of the over-allotment shares were approximately $16,520,000, with approximately
$5,400,000 and $3,800,000 respectively, used to pay the cash portion of the
purchase price of the PDI transaction and to repay outstanding indebtedness of
PDI.
On May 12, 1998 the Company also completed the registration under the
Securities Act of 1933, as amended (the "Act"), of an aggregate of 3,146,514
shares of Common Stock, of which (i) 2,750,000 shares may be issued from time
to time by the Company in connection with potential future affiliation
transactions with ENT physicians or related specialty practices or the merger
with or acquisition by the Company of other related businesses or assets, (ii)
220,000 shares of Common Stock are issuable upon exercise of warrants issued to
the representatives of the underwriters in the IPO which may be sold from time
to time by the holders of the warrants after issuance and (iii) 176,514 shares
of Common Stock are issuable in December 1998 in connection with a practice
asset acquisition completed in December 1997, which may be sold from time to
time by the physician stockholders after issuance.
NOTE 5. MANAGEMENT FEE REVENUE
The Company records revenue on a management fee basis as derived from
physician practices managed by the Company in which a controlling equity
ownership interest does not exist. Management fees are composed of (i) a
varying percentage of affiliated practice patient service revenue (typically
12.5%), (ii) a fixed management fee in connection with the PDI affiliation of
approximately $2,045,000 per year, subject to certain increases, and (iii)
reimbursement of practice operating expenses (excluding compensation to
physicians and physician assistants). Management fee revenue earned by the
Company is detailed as follows:
-27-
<PAGE> 28
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Percentage of affiliated practice patient service
revenue and fixed management fee..................... $1,856,299 $ 618,398 $ 3,216,045 $ 729,673
Reimbursement of practice operating expenses.............. 5,378,833 2,050,520 9,943,357 2,095,987
---------- ---------- ----------- ----------
Total management fee revenue $7,235,132 $2,668,918 $13,159,402 $2,825,660
========== ========== =========== ==========
</TABLE>
There currently exists wide disparity in the methods of recording
revenue in the physician practice management (PPM) industry. The Company
believes the following unaudited supplemental information, which includes
patient service revenue of both owned as well as managed practices ("system
wide" revenue) allows a reader of the Company's financial statements to
evaluate comparability with other PPM companies recording patient services
revenue on a consolidated basis for financial reporting purposes. The unaudited
supplemental "system wide" information is being presented for supplemental
purposes only and should be read in conjunction with the Company's financial
statements.
SUPPLEMENTAL SYSTEM WIDE INFORMATION
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1998 1997 1998 1997
----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Supplemental Net Patient Service Revenue:
Owned Practice ............. $ 264,569 $ 293,814 $ 573,524 $ 320,175
Managed Practices 12,515,482 4,627,267 23,006,667 5,130,842
----------- ---------- ----------- ----------
Total Supplemental Patient
Service Revenue ................ 12,780,051 4,921,081 23,580,191 5,451,017
Plus:
Capitation Revenue .................. $ 1,145,368 $1,301,703 $ 2,310,674 $1,357,551
Management Fees ..................... 288,071 39,989 326,690 88,318
----------- ---------- ----------- ----------
Total Supplemental
System wide Revenue ............ $14,213,490 $6,262,773 $26,217,555 $6,896,886
Less:
Amounts Retained by
Physicians Groups .............. 5,568,421 1,998,338 10,173,958 2,393,500
----------- ---------- ----------- ----------
Total Net Revenue ................... $ 8,645,069 $4,264,435 $16,043,600 $4,503,386
=========== ========== =========== ==========
</TABLE>
-28-
<PAGE> 29
NOTE 6. INTANGIBLE ASSETS
The Company's physician practice acquisitions involve the purchase of
tangible and intangible assets and the assumption of certain liabilities of the
acquired practices. As part of the purchase price allocation, the Company
allocates the purchase price to the tangible and identifiable intangible assets
acquired and liabilities assumed based on estimated fair market values. Costs
of acquisitions in excess of the net estimated fair value of tangible and
identifiable intangible assets acquired and liabilities assumed are amortized
using the straight line method over a period of 25 years. At June 30, 1998, the
amount of such intangible assets was approximately $23,988,000, with
accumulated amortization totaling approximately $510,000.
NOTE 7. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." SFAS No. 130 is designed to improve the reporting of
changes in equity from period to period. SFAS No. 130 is effective for fiscal
years beginning after December 15, 1997. The adoption of SFAS No. 130 for
fiscal 1998 was not material to the Company's financial statements.
NOTE 8. SUBSEQUENT EVENTS
In July 1998, the Company received notification from CIGNA Healthcare
of Georgia, Inc. ("CIGNA") that as a result of the financial issues associated
with FPA Medical Management, Inc., ("FPA"), CIGNA was terminating its
relationship with FPA and was assuming FPA's responsibility under the agreement
effective August 1, 1998 and that the future capitation payments to be received
by the Company would be paid by CIGNA beginning with the June 1998 payment.
In August, 1998 the Company received an additional notice from CIGNA
stating that FPA, in connection with its bankruptcy filing on July 20, 1998,
had obtained a court order from the U.S. Bankruptcy Court prohibiting CIGNA,
and other payors, from making any direct payment to physicians or organizations
managing capitated managed care contracts for FPA, such as the Company, for
services prior to August 1, 1998. As of July 31, 1998 the Company had recorded
a receivable due from FPA of approximately $24,000. There can be no assurance
that such amount will be paid by FPA or CIGNA.
On July 31, 1998, the Company executed a four year $45.0 million
amended and restated syndicated Credit Facility with NationsBank, N.A. as agent
and lender and PNC Bank and Rabobank Nederland as lenders, replacing the
Company's previous $20 million credit facility. Advances under the Credit
Facility will bear interest, at the Company's option, at either a prime-based
rate or a LIBOR based rate with interest only payments required until
termination of the agreement. Borrowings under the Credit Facility may be used
to finance
-29-
<PAGE> 30
permitted acquisitions and investments, to refinance existing debt,
and for working capital and general corporate purposes. Revolving loans under
the Credit Facility may be borrowed repaid and reborrowed prior to the
termination date of the facility. The Credit Facility contains various
affirmative and negative covenants, which among other things require the
Company to maintain certain financial ratios or to meet certain financial
requirements, including ratios of funded debt and senior funded debt to
earnings before interest, taxes, depreciation and amortization; a minimum net
worth; and a fixed charge coverage ratio, and sets certain restrictions on
investments, acquisitions, mergers and sale of assets. Borrowings under the
Credit Facility are secured by the capital stock of the Company's material
subsidiaries, the Company's (and such subsidiaries') accounts receivable, and
the Company's rights under its management services agreements with physician
practice groups. As of August 13, 1998, the Company had no outstanding
borrowings under the Credit Facility.
NOTE 9.
The Company has calculated its basic and diluted earnings per share in
accordance with SFAS No. 128, "Earnings Per Share". Basic earnings per share
are calculated by dividing net income available to common stockholders by the
weighted average number of common shares outstanding for the periods presented.
Diluted earnings per share reflects the potential dilution that could occur if
securities and other contracts to issue common stock where exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity.
A reconciliation of the number of weighted average shares used in
calculating basic and diluted earnings per share is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted average number of common
shares outstanding - basic.......................... 7,695,730 5,904,648 7,106,869 3,519,742
Effect of potentially dilutive shares outstanding....... 431,490 -- 431,577 --
Effect of convertible debt.............................. 113,455 -- 102,375 --
--------- --------- --------- ---------
Weighted average number of common shares
outstanding - diluted................................ 8,240,675 5,904,648 7,640,821 3,419,742
========= ========= ========= =========
</TABLE>
-30-
