<PAGE> 1
FILED PURSUANT TO RULE 424(b)(3)
REGISTRATION NO. 333-50425
PHYSICIANS' SPECIALTY CORP.
SUPPLEMENT NO. 2 DATED DECEMBER 17, 1998
TO PROSPECTUS DATED MAY 12, 1998
On November 16, 1998, the Company filed its quarterly report on Form
10-Q for the fiscal quarter ended September 30, 1998. Accordingly, the
information contained in the Prospectus under the headings "Summary 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, as previously supplemented by Supplement No. 1 dated November 17,
1998, 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 - Six Months Ended June 30, 1998," "Operating Data -
June 30, 1998," "Balance Sheet - June 30, 1998" and the notes thereto with the
following:
<PAGE> 2
SUMMARY COMBINED FINANCIAL DATA
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1998 (1)
----------------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C>
STATEMENT OF OPERATIONS DATA:
Revenue
Management Fees ................................ $ 22,345
Capitation Revenue ............................. 3,519
Net patient service revenue .................... 984
Earnings in unconsolidated subsidiary .......... 267
----------
Net revenue ...................................... 27,116
Expenses
Provider claims, wages, benefits ............... 12,149
General and administrative ..................... 8,196
Depreciation and amortization .................. 1,206
----------
Operating expenses ............................... 21,552
----------
Operating income ................................. 5,564
Net income ....................................... $ 3,437
==========
Diluted earnings per share ....................... $ 0.42
Weighted average shares outstanding .............. 8,199,259
Supplemental system-wide revenue (5) ............. $ 42,830
</TABLE>
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<PAGE> 3
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------
<S> <C>
OPERATING DATA:
Number of affiliated physicians (including
physicians employed by the Company) .................................. 72*
Number of allied health care professionals ............................... 71
Number of other employees ................................................ 455
Number of clinical location .............................................. 57
Number of capitated covered lives ........................................ 347,390
</TABLE>
- ----------
* Includes one TMJ specialist
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998(1)
---------------------
(in thousands)
<S> <C>
BALANCE SHEET DATA:
Working capital .......................................................... $16,486
Total assets ............................................................. 58,596
Total debt ............................................................... 7,564
Stockholders' equity ..................................................... 46,214
</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 nine months ended September 30, 1998
have been derived from the unaudited interim financial statements of
the Company.
The "Selected Financial Data" beginning on page 24 of the Prospectus is
hereby supplemented by (i) replacing "June 30, 1997 and 1998" in the first
paragraph with "September 30, 1997 and 1998,"
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<PAGE> 4
and (ii) replacing the information under the heading "Statement of Operations -
Six Months Ended June 30, 1998" and "Balance Sheet - June 30, 1998" with the
following:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1997 1998
---- ----
(in thousands, except share data)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenue ......................... $ 9,441 $ 27,116
Expenses
Provider claims, wages and benefits 4,981 12,149
General and administrative ........ 2,532 8,196
Depreciation and amortization ..... 227 1,206
---------- ----------
Operating expenses .................. 7,739 21,552
Operating income (loss) ............. 1,702 5,564
Net income (loss) ................... $ 1,196 $ 3,437
========== ==========
Earnings (loss) per share
Basic earnings (loss) per share ... $ 0.27 $ 0.45
Diluted earnings (loss) per share . $ 0.27 $ 0.42
Weighted average shares outstanding
Basic ............................. 4,389,746 7,699,863
Diluted ........................... 4,457,756 8,199,259
</TABLE>
<TABLE>
<CAPTION>
September 30, 1998
------------------
(in thousands)
<S> <C>
BALANCE SHEET DATA:
Cash and cash equivalents ............................... $ 4,798
Working capital ......................................... 16,486
Total assets ............................................ 58,596
Total debt .............................................. 7,564
Stockholders' equity .................................... 46,214
</TABLE>
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<PAGE> 5
"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 nine month period ended September 30, 1998 with data
for the nine month period ended September 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.
NINE MONTHS ENDED SEPTEMBER 30, 1998
Revenue. Management fees increased to $9,185,413 for the three months
ended September 30, 1998 as compared with $3,462,249 for the same period in
1997, an increase of $5,723,164 or 165%. The increase in management fees is
primarily attributable to an increase in the number of physicians affiliated
with the Company at September 30, 1998 to 82 as compared with 33 for the same
period in 1997 as a result of the Company's acquisitions since the
Reorganization. Capitation revenues increased to $1,208,506 for the three months
ended September 30, 1998 as compared with $1,135,825 for the same period in
1997, an increase of $72,681 or 6%. The increase in capitation revenues is
primarily attributable to an increase in the aggregate number of enrollees to
approximately 347,000 at September 30, 1998, an increase of approximately 6%.
Patient service revenues increased to $410,743 for the three months ended
September 30, 1998 as compared with $339,886 for the same period in 1997, an
increase of $70,907 or 20.1%. The increase in patient service revenues is
primarily attributable to an increase in the aggregate number of patient office
visits and surgeries performed during the three months period ended September
30, 1998 as compared with the same period in 1997.
For the three month period ended September 30, 1998, the Company
recorded as revenue earnings from its 17.5% equity interest in Atlanta Surgery
Center in the amount of $267,440.
On a supplemental basis, patient service revenue generated by
physicians who were affiliated with the Company for both periods ended September
30, 1997 and 1998 increased on average approximately 2% per physician.
As a result of the foregoing factors, the Company's net revenue
increased to $11,072,152 for the three months ended September 30, 1998 as
compared with $4,937,960 for the same period in 1997, an increase of $6,134,192
or 124%.
Provider claims, wages, and benefits. Provider claims, wages and
benefits, increased to $4,868,739 for the three months ended September 30, 1998
as compared with $2,436,570 for the same period in 1997, an increase of
$2,432,169 or 99%. 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 44% for the three months ended
September 30, 1998 as compared to 49% for the same period in
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<PAGE> 6
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 $3,376,666 for the three months ended September 30, 1998 as
compared with $1,409,034 for the same period in 1997, an increase of $1,967,632
or 140%. This increase was primarily attributable to the addition of personnel
and greater support costs associated with the Company's rapid expansion since
September 30, 1997. As a percent of net revenue, general and administrative
expenses increased to 30% for the three months ended September 30, 1998 as
compared to 29% for the same period in 1997, as a result of the foregoing
factors.
Depreciation and Amortization. Depreciation and amortization expenses
increased to $519,987 for the three months ended September 30, 1998 as compared
with $130,166 for the same period in 1997, an increase of $389,821 or 300%. This
increase was primarily the result of the increases in intangible assets
resulting from additional acquisitions and resulting increases in 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 5% for the three months ended September 30,
1998 as compared with 3% for the same period in 1997, as a result of the
foregoing factors.
Other Income (expense). Other expense for the three months ended
September 30, 1998 was $83,773 and is derived from interest income earned on the
short term investment of excess cash and cash equivalents which was offset by
(i) interest charges to affiliated practices for additions to clinical
equipment, leasehold improvements and other fixed assets and (ii) interest
expense related primarily to the subordinated seller notes and the commitment
fee in conjunction with the $45 million senior credit facility. Other income for
the three months ended September 30, 1997 was $126,877 and is derived from
interest income earned on the short term investment in cash and cash equivalents
of the IPO proceeds, net of amounts of immaterial interest expense.
Income Taxes. Income taxes for the quarters ended September 30, 1998
and 1997 were provided for at 39% effective tax rate.
"Liquidity and Capital Resources" beginning on page 30 of the
Prospectus is hereby supplemented by replacing the information under "Liquidity
and Capital Resources" with the following:
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.
- 6 -
<PAGE> 7
At September 30, 1998, the Company had working capital of $16,486,043,
compared to $10,469,429 at December 31, 1997, an increase of $6,016,614. The
increase in working capital was due primarily to an increase in net accounts
receivable of $6,003,601.
For the nine month period ended September 30, 1998 net cash provided by
operating activities was $1,012,004 compared to net cash used in operating
activities of $718,690 for the same period in 1997. Net cash used in investing
activities for the nine months ended September 30, 1998 was $18,216,013 with
$16,577,826 expended as cash consideration for acquisitions. Net cash provided
by financing activities for the nine months ended September 30, 1998 was
$16,650,511 with $16,577,826 received pursuant to the Company's public offering
in May 1998, net of offering costs.
During the three month period ended September 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) Maliner, (ii) Leonard, and (iii) acquired
in the aggregate a 17.5% limited partnership interest in Atlanta Surgery Center.
In connection with the acquisition of assets of Maliner, Leonard and limited
partnership interest, the Company (i) paid an aggregate of $5,455,000 in cash,
(ii) issued an aggregate of 34,552 shares of Common Stock of the Company, (iii)
agreed to issue an aggregate of 34,552 shares of Common Stock of the Company and
(iv) issued a $150,000 non-interest bearing contingent promissory note which is
payable at the Company's option, in cash or the Company's Common Stock, upon the
holder achieving certain performance targets. In connection with these
transactions, the Company paid approximately $219,500 in fees to Premier
HealthCare, an affiliate of the Company's Vice Chairman and Secretary, for
advisory services rendered.
On October 12, 1998, pursuant to an asset acquisition agreement, the
Company completed the acquisition of the assets of 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. 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 discussing 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 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 this transaction, the Company borrowed approximately $3.7
million under the Company's Credit Facility and used a portion of the net
proceeds received from the Company's public offering in May 1998.
The Company believes that the net proceeds of the Public Offering and
borrowings under the Credit Facility, together with existing cash resources and
cash flow expected to be generated from operations, will be sufficient to fund
the Company's anticipated acquisition, expansion and working capital needs for
at least the next 12 to 18 months. No assurance can be given that such existing
cash
- 7 -
<PAGE> 8
resources or proceeds of the Public Offering will be sufficient to satisfy
the Company's cash requirements for the next 12 to 18 months or beyond. There
can be no assurance that borrowings under the Credit Facility will be available
or that alternative financing will be available for future acquisitions or
expansion of the Company's business.
Several multi-specialty companies in the physician practice management
("PPM") industry have recently announced that they will be discontinuing PPM
activities or will be divesting certain assets related to physician practice
management. The Company believes that as a result of this and other market
conditions, there has been and will continue to be a decrease in acquisition
activity in the PPM industry which will likely affect the Company. As a result,
the Company believes that it and other PPM companies may see a slow down in
revenue growth attributable to acquisitions. As previously announced, the
Company intends to focus its efforts on ancillary service development, practice
acquisitions in the Company's existing markets and enhancing the operations of
affiliated practices. The Company also intends to continue to pursue new market
acquisitions on a highly selective basis. There are additional factors, such as
health care and government regulation and general economic conditions which may
also affect the PPM industry. As a result of these and other conditions, there
can be no assurance that acquisition opportunities will be available to the
Company or that the Company will be able to consummate future acquisitions.
YEAR 2000
The Year 2000 issue is the result of using only the last two digits to
indicate the year in computer hardware and software programs and embedded
technology such as micro-controllers. As a result, these programs do not
properly recognize a year that begins with "20" instead of the familiar "19." If
uncorrected, such programs will be unable to interpret dates beyond the year
1999, which could cause computer system failure or miscalculations which could
disrupt the Company's operations and adversely affect its cash flows and results
of operations.
The Company recognizes the importance of the Year 2000 issue and has
given it high priority. The Company's objective is to ensure an uninterrupted
transition to the year 2000 by assessing, testing and modifying products and
information technology ("IT") systems and non-IT systems so that such systems
and software will perform as intended and information and dates can be processed
with expected results ("Year 2000 Compliant"). The scope of the Company's
compliance efforts include (i) identifying and assessment of risks, including
the risks of non-compliance by third parties, (ii) development of remediation
and contingency plans, (iii) implementation and (iv) testing. The Company has
not yet determined the extent of contingency planning that may be required.
There are three major IT system applications that the Company relies
upon to process transactions and provide information for managing its
operations. These applications have been identified as follows:
- Accounting and financial reporting system
- Practice management billing and accounts receivable systems
- Capitated claims processing and reporting system
- 8 -
<PAGE> 9
Accounting and financial reporting system - During 1998 the Company
fully implemented the Great Plains accounting and financial reporting software
applications at all of its affiliated practices, its subsidiaries and its
corporate locations. The Great Plains accounting package has been modified and
tested and is Year 2000 compliant.
Practice management billing and accounts receivable systems - The
Company's affiliated practices currently utilize software packages which were
developed by large third party software development companies. The Company has
been in contact with all of these companies and believes that all Year 2000
compliant modified programs will be fully tested and implemented by the Company
and its affiliates during the first quarter of 1999.
Capitated claims processing and reporting system - The Company has
developed internally a capitated claims processing and reporting system which is
Year 2000 compliant.
The Company is also highly dependent on receiving payments from third
party payors for capitated fees and for insurance reimbursement for claims
submitted by its affiliated practices, and as such, the ability of such payors
to process claims submitted by affiliated practices accurately and timely,
constitutes a significant risk to the Company's cash flow and could materially
adversely affect the Company's operations. The Company and its affiliated
practices have been or will be in communication with these payors to insure that
these payors will be Year 2000 Compliant and will be able to process claims
uninterrupted. However, there can be no assurance that such third party payors
will be Year 2000 Compliant.
Like virtually every company, the Company is at risk for the failure of
major infrastructure providers to adequately address potential Year 2000
problems. The Company is highly dependent on a variety of public and private
infrastructure providers to conduct its business. Failures of banking systems,
basic utility providers, telecommunication providers and other services to
achieve Year 2000 compliance, could have a material adverse effect on the
ability of the Company and its affiliated practices to conduct business. While
the Company is aware of these risks, a complete assessment of all such risks is
beyond the scope of the Company's Year 2000 project or ability to address.
Through September 30, 1998, the Company had incurred costs of
approximately $125,000 related to the Year 2000 issue. The Company does not
anticipate that it will incur any additional material costs associated with
addressing Year 2000 issues.
The Company's current estimates of the amount of time and costs
necessary to remediate and test its computer systems are based on the facts and
circumstances existing at this time. The estimates were made using assumptions
of future events including the continued availability of certain resources, Year
2000 modification plans, implementation success by key third-parties, and other
factors. New developments may occur that could affect the Company's estimates of
the amount of time and costs needed to modify and test its IT and non-IT systems
for Year 2000 compliance. These developments include, but are not limited to:
(i) the availability and cost of personnel trained in this area; (ii) the
ability to locate and correct all relevant date-sensitive codes in both IT and
non-IT
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<PAGE> 10
systems; (iii) unanticipated failures in its IT and non-IT systems; and (iv) the
planning and Year 2000 compliance success that third-parties attain.
The Company cannot determine the impact of these potential developments
on the current estimate of probable costs of making its products and IT and
non-IT systems Year 2000 Compliant. Accordingly, the Company is not able to
estimate its possible future costs beyond the current estimates of costs. As new
developments occur, these cost estimates may be revised to reflect the impact of
these developments on the costs to the Company of making its products and IT and
non-IT systems Year 2000 Compliant. Such revisions in costs could have a
material adverse impact on the Company's results of operations in the quarterly
period in which they are recorded. Although the Company considers it unlikely,
such revisions could also have a material adverse effect on the business,
financial condition or results of operations of the Company.
The "Financial Statements" beginning on page F-9 are hereby
supplemented as follows:
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<PAGE> 11
PHYSICIANS' SPECIALTY CORP.
Condensed Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,798,144 $ 5,351,639
Accounts receivable, net of allowance for doubtful accounts 15,277,166 9,273,565
of $683,733 and $261,714 in 1998 and 1997, respectively
Notes receivable 80,000 81,682
Prepayments and other 1,149,280 335,650
----------- -----------
Total current assets 21,304,590 15,042,536
PROPERTY AND EQUIPMENT, net 7,532,013 3,431,707
INTANGIBLE ASSETS, net 24,136,929 11,793,777
INVESTMENT IN UNCONSOLIDATED SUBSIDIARY 5,308,584 --
OTHER ASSETS 314,035 330,338
----------- -----------
Total Assets $58,596,151 $30,598,358
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Due to physicians $ 1,062,123 $ 1,177,009
Accounts payable and accrued expenses 2,904,723 3,057,880
Deferred income taxes 851,701 338,218
----------- -----------
Total current liabilities 4,818,547 4,573,107
SUBORDINATED SELLER NOTES 7,563,701 911,715
----------- -----------
Total liabilities 12,382,248 5,484,822
SHAREHOLDERS' EQUITY:
Common stock, $.001 par value; 50,000,000 shares 8,975 6,503
authorized issued: 8,975,646 in 1998 and 6,503,098 in 1997
Additional paid-in capital 41,062,216 23,401,657
Retained earnings 5,142,712 1,705,376
----------- -----------
Total shareholders' equity 46,213,903 25,113,536
----------- -----------
Total liabilities and shareholders' equity $58,596,151 $30,598,358
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE> 12
PHYSICIANS' SPECIALTY CORP.
Consolidated Statement of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES
Patient service revenues $ 410,793 $ 339,886 $ 984,317 $ 660,061
Capitation revenues 1,208,506 1,135,825 3,519,180 2,493,376
Management fees 9,185,413 3,462,249 22,344,815 6,287,909
Earnings in unconsolidated subsidiary 267,440 267,440 267,440 --
----------- ---------- ----------- ----------
Net revenue 11,072,152 4,937,960 27,115,752 9,441,346
EXPENSES
Provider claims, wages, benefits 4,868,739 2,436,570 12,149,296 4,980,961
General and administrative 3,376,666 1,409,034 8,196,425 2,531,771
Depreciation and amortization 519,987 130,166 1,206,107 226,721
----------- ---------- ----------- ----------
Operating expenses 8,765,392 3,975,770 21,551,828 7,739,893
Operating income (loss) 2,306,760 962,190 5,563,924 1,701,893
Other income (expense) (83,773) 126,877 69,786 259,376
----------- ---------- ----------- ----------
Pretax income (loss) 2,222,987 1,089,067 5,633,710 1,961,269
Provision for income taxes 866,343 424,736 2,196,374 764,895
----------- ---------- ----------- ----------
Net income (loss) $ 1,356,644 $ 664,331 $ 3,437,336 $1,196,374
=========== ========== =========== ==========
Earnings per share:
Basic earnings per share $ 0.15 $ 0.11 $ 0.45 $ 0.27
Diluted earnings per share $ 0.15 $ 0.11 $ 0.42 $ 0.27
Weighted average shares
Outstanding
Basic 8,866,514 6,211,618 7,699,863 4,389,746
Diluted 9,298,644 6,279,665 4,457,756 4,457,756
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE> 13
PHYSICIAN'S SPECIALTY CORP.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income 3,437,336 1,196,374
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,206,107 226,721
Compensation expense 32,987 48,000
Increase in accounts receivable (2,262,251) (901,134)
(Increase) decrease in prepayments and other (796,903) 89,482
Increase (decrease) in accounts payable and accrued liabilities (605,272) (1,378,133)
------------ ------------
Total Adjustments (2,425,332) (1,915,064)
------------ ------------
Net cash (used in) provided by operating activities 1,012,004 (718,690)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payment for acquisitions, net of cash acquired (16,721,158) (1,498,000)
Purchase of property and equipment (1,494,855) (284,824)
------------ ------------
Net cash used in investing activities (18,216,013) (1,782,824)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock, net of offering costs 16,577,826 15,408,094
Borrowing under short-term debt 72,685 170,000
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 16,650,511 13,319,532
------------ ------------
NET CHANGE IN CASH AND CASH EQUIVALENTS (553,498) 10,818,018
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 5,351,639 123,540
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,798,141 $ 10,941,558
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE> 14
Physicians' Specialty Corp.
Notes to the Consolidated Financial Statements (Unaudited)
September 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; Southern New York and Northern New Jersey and in metropolitan Cleveland,
Ohio.
NOTE 2. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the
Company and its wholly owned and unconsolidated 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 aggregate of 3,104,755
shares of its Common Stock (valued at the time of issuance at approximately
$24.8 million).
POST REORGANIZATION ACQUISITIONS THROUGH JUNE 30, 1998
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<PAGE> 15
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., (viii) John C. Westerkamm, M.D., P.A.,
(ix) Napoleon G. Bequer, 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 $5.5 million in
cash, (ii) discharged approximately $260,000 of liabilities, (iii) issued an
aggregate of 629,171 shares of Common Stock (valued at an aggregate of
approximately $4.8 million), (iv) agreed to issue an aggregate of 319,735
additional shares of Common Stock (valued at an aggregate of approximately $2.9
million) to four of the affiliated practices beginning in September 1998, (v)
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 (vi) 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% per annum, (vii) 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 $492,000 to Premier HealthCare, an affiliate of
the Company's Vice Chairman and Secretary, for advisory services rendered.
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
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<PAGE> 16
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.
ACQUISITIONS FROM JULY 1, 1998 THROUGH SEPTEMBER 30, 1998
During the three month period ended September 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), of (i)
Robert H. Maliner, M.D., P.A., ("Maliner"), and (ii) James R. Leonard, M.D.,
P.C. ("Leonard").
In addition, 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.
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<PAGE> 17
In connection with the Maliner, Leonard and the Atlanta Surgery Center
transactions completed by the Company during the three month period ended
September 30, 1998, the Company, (i) paid an aggregate of $5,455,000 in cash,
(ii) issued an aggregate of 34,552 shares of Common Stock of the Company, (iii)
agreed to issue an aggregate of 34,552 shares of Common Stock of the Company and
(iv) issued a $150,000 non-interest bearing contingent promissory note which is
payable, at the Company's option, in cash or the Company's Common Stock, upon
the holder achieving certain performance targets. In connection with these
transactions, the Company paid approximately $219,500 in fees to Premier
HealthCare, an affiliate of the Company's Vice Chairman and Secretary, for
advisory services rendered.
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 registered under the Securities Act of
1933, as amended (the "Act"), 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. 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
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<PAGE> 18
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:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Percentage of affiliated practice patient service $2,293,343 $ 955,953 $ 5,509,388 $1,685,626
revenue and fixed management fee
Reimbursement of practice operating expenses 6,892,070 2,506,296 16,835,427 4,602,283
---------- ---------- ----------- ----------
Total management fee revenue $9,185,413 $3,462,249 $22,344,815 $6,287,909
========== ========== =========== ==========
</TABLE>
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<PAGE> 19
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 Nine Months Ended
September 30, September 30,
--------------------------- ----------------------------
1998 1997 1998 1997
----------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Supplemental Net Patient Service
Revenue:
Owned Practice $ 410,793 $ 339,886 $ 984,317 $ 660,061
Managed Practices 14,239,478 6,266,398 37,246,145 11,397,240
----------- ---------- ----------- -----------
Total Supplemental Patient
Service Revenue 14,650,271 6,606,284 38,230,462 12,057,301
Plus:
Capitation Revenue $ 1,208,506 $1,135,825 $ 3,519,180 $ 2,493,376
Management Fees 486,349 42,486 813,039 130,804
Earnings in unconsolidated subsidiary 267,440 0 267,440 0
----------- ---------- ----------- -----------
Total Supplemental
System wide Revenue $16,612,566 $7,784,595 $42,830,121 $14,681,481
Less:
Amounts Retained by
Physicians Groups 5,540,414 2,846,635 15,714,369 5,240,135
----------- ---------- ----------- -----------
Total Net Revenue $11,072,152 $4,937,960 $27,115,752 $ 9,441,346
=========== ========== =========== ===========
</TABLE>
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 September 30, 1998,
the amount of such intangible assets was approximately $24,907,000, with
accumulated amortization totaling approximately $770,000.
NOTE 7. NEW ACCOUNTING PRONOUNCEMENTS
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<PAGE> 20
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.
In March 1998, the Emerging Issues Task Force of the FASB 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. The Company anticipates incorporating the provisions of EITF 97-2
effective for its year ending December 31, 1998. 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.
NOTE 8. EARNINGS PER SHARE
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.
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<PAGE> 21
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 Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted average number of common Shares 8,866,514 6,211,618 7,699,863 4,389,746
outstanding - basic
Effect of potentially dilutive shares outstanding 312,354 68,047 393,901 68,010
Effect of convertible debt 119,776 -- 105,495 --
--------- --------- --------- ---------
Weighted average number of common shares
Outstanding - diluted 9,298,644 6,279,665 8,199,259 4,457,756
========= ========= ========= =========
</TABLE>
NOTE 9. CREDIT AGREEMENT
On July 31, 1998, the Company closed on a four year $45 million amended
and restated 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 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 13, 1998, the
Company had approximately $3.7 million of borrowings under the Credit Facility.
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<PAGE> 22
NOTE 10. SUBSEQUENT EVENTS
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 discussing 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 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.
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