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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-K/A NO.2
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NO. 1-12759
PHYSICIANS' SPECIALTY CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 58-2251438
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1150 LAKE HEARN DRIVE SUITE 640, ATLANTA, GA 30342
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (404) 256-7535
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve (12) months (or for such shorter period that
the registrant was required to file such report(s)), and (2) has been subject to
the filing requirements for the past ninety (90) days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
The aggregate market value of the voting and non-voting common equity
held by non-affiliates of the registrant was approximately $47,440,234 based on
the last sales price of the Common Stock as of March 29, 1999.
As of March 29, 1999, 9,172,025 shares of Common Stock, $.001 par
value, of the registrant were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
See Part III hereof with respect to incorporation by reference from the
registrant's definitive proxy statement for the fiscal year ended December 31,
1998 to be filed pursuant to Regulation 14A under the Securities and Exchange
Act of 1934 and the Exhibit Index hereto.
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PART I
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-K contains forward-looking statements within the meaning
of the "safe harbor" provisions under Section 21E of the Securities and Exchange
Act of 1934 and the Private Securities Litigation Reform Act of 1995. We use
forward-looking statements in our description of our plans and objectives for
future operations and assumptions underlying these plans and objectives.
Forward-looking terminology includes the words "may," "expects," "believes,"
"anticipates," "intends," "forecasts," "projects," or similar terms, variations
of such terms or the negative of such terms. These forward-looking statements
are based on management's current expectations and are subject to factors and
uncertainties which could cause actual results to differ materially from those
described in such forward-looking statements. We expressly disclaim any
obligation or undertaking to release publicly any updates or revisions to any
forward-looking statements contained in this Form 10-K to reflect any change in
our expectations or any changes in events, conditions or circumstances on which
any forward-looking statement is based. Factors which could cause such results
to differ materially from those described in the forward-looking statements
include those set forth under "Risk Factors" and elsewhere in, or incorporated
by reference into, this Form 10-K. These factors include the following: we have
a limited operating history and a limited history of combined operations; our
results may be adversely affected by our acquisition strategy; we depend on
affiliated physicians; our substantial debt reduces cash available for our
business, may adversely affect our ability to obtain additional funds and
increases our vulnerability to economic or business downturns; our operating
results may be adversely affected by reductions in reimbursement by third party
payors; we face intense competition in the physician practice management
industry; we are subject to various government regulation; and other risks.
ITEM 1. BUSINESS
(a) General Development of Business
We provide comprehensive 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 and head and neck, known as
ENT, including specialists practicing in the fields of allergy, audiology, oral
surgery, plastic surgery and sleep medicine:
Since January 1, 1998, we acquired substantially all of the assets and
assumed certain liabilities of:
- four ENT physician practices in the metropolitan New York area
with 33 physicians and 16 allied health care professionals
with 11 clinical offices;
- two ENT physician practices in the metropolitan Cleveland,
Ohio area with 10 physicians and eight allied health care
professionals with eight clinical offices;
- four ENT physician practices in South Florida with five
physicians and four allied health care professionals with five
clinical offices;
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- one solo ENT physician practice in the metropolitan Atlanta
area with one clinical office; and
- Preferred Diagnostic Services Inc., which operates 12 sleep
diagnostic laboratories in the metropolitan Atlanta area.
We also acquired a minority limited partnership interest in Atlanta Surgery
Center Ltd., a limited partnership operating three multi-specialty ambulatory
surgery centers.
We are currently affiliated with 91 physicians, one dentist and 85 allied health
care professionals operating 60 clinical locations in Alabama, Florida, Georgia,
Illinois, New Jersey, New York and Ohio.
We currently hold, manage and administer capitated ENT managed care
contracts covering an aggregate of approximately 400,000 enrollees of health
maintenance organization plans of United HealthCare of Georgia, Inc., United
HealthCare of Alabama, Inc., Cigna HealthCare of Georgia, Inc. and enrollees of
HMOs which have contracted with The Morgan Health Group. We believe we are the
leading physician practice management company focusing solely or substantially
on affiliating with and managing ENT physician practices.
We were incorporated in Delaware in July 1996. Our executive offices
are located at 1150 Lake Hearn Drive, Suite 640, Atlanta, Georgia 30342. Our
telephone number is (404) 256-7535 and our fax number is (404) 256-1078. Unless
the context indicates otherwise, "we" and "Physicians' Specialty" refers to
Physicians' Specialty Corp., a Delaware corporation, and its wholly-owned
subsidiaries.
(b) Financial Information about Industry Segments
We operate in only one business segment.
(c) Narrative Description of Business
GENERAL
We provide comprehensive practice management services to physician
practices and health care providers specializing in the treatment and management
of ENT diseases, including specialists practicing in the fields of allergy,
audiology, oral surgery, plastic surgery and sleep medicine. We seek to
affiliate with physician practices and health care professionals who provide
high quality, cost effective medical and surgical services to fee-for-service
patients and capitated managed care enrollees. We provide:
- - financial and administrative management;
- - enhancement of clinical operations;
- - access to ancillary services;
- - network development and payor contracting services, including the
negotiation and administration of capitated arrangements.
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We are currently affiliated with 91 physicians, one dentist and 85
allied health care professionals operating 60 clinical locations in Alabama,
Florida, Georgia, Illinois, New Jersey, New York and Ohio. We currently hold,
manage and administer capitated ENT managed care contracts covering an aggregate
of approximately 400,000 enrollees of HMO plans of United HealthCare and Cigna
and enrollees of HMOs which have contracted with the Morgan Health Group.
HEALTH CARE INDUSTRY OVERVIEW
General
The health care delivery system in the United States has been
undergoing substantial change, largely in response to concerns over the quality
and escalating cost of health care. The growth in health care expenditures has
increased the demand by government and third party payors to control health care
costs.
Significant changes in the way physicians organize themselves have been
precipitated and accelerated by:
- - the emphasis on cost containment;
- - the consolidation of the health care market in general;
- - the increased market share of managed care companies;
- - the transfer of risk from payors to providers; and
- - the focus on improving the quality of patient care.
Health care in the United States historically has been delivered by a
fragmented system of health care providers, including hospitals, individual
physicians and physician group practices. Compared to physician practice
management companies and larger group practices, individual physicians and small
group practices tend to have limited capacity for any of the following:
- - ties to other health care providers, restricting their ability to
coordinate care across a variety of specialties;
- - access to patients;
- - capital to invest in new clinical equipment and technologies; and
- - purchasing power with vendors of medical supplies.
Individual physicians and small group practices also typically lack the
negotiating leverage with payors and information systems necessary to manage
risk-sharing contracts.
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In response to the foregoing factors, physicians are increasingly
forming larger group practices and affiliating with physician networks and
physician hospital organizations. Physicians are also affiliating with physician
practice management companies in order to gain greater access to:
- - third party payor contracts;
- - patient information and management systems;
- - leverage with vendors and payors;
- - capital resources; and
- - ancillary services frequently unavailable to independent practitioners.
In addition, many payors and their intermediaries, including governmental
entities and managed care companies, are increasingly looking to outside
providers of physician services to develop and maintain quality outcomes,
management programs and patient care data.
Several multi-specialty companies in the physician practice management
industry have discontinued physician practice management activities or divested
assets related to physician practice management or announced plans to do so.
Other physician practice management companies have completed or announced
transactions, including mergers, recapitalizations or other corporate
transactions, as a result of which they are no longer public companies. As a
result of these trends and the depressed stock prices of physician practice
management companies, we believe that physician practice management companies
may generally experience a decrease in practice acquisition activity and an
associated slow down in revenue growth attributable to practice acquisitions.
Consistent with our market driven strategy, we focus primarily on practice and
ancillary services acquisitions in markets in which we already manage ENT
practices and to a lesser extent, in new markets.
Otolaryngology
Otolaryngology is the management of diseases and disorders of the ear,
nose, nasal passages, sinuses, larynx, mouth and throat, as well as structures
of the neck and face. An otolaryngologist is commonly referred to as an ENT
physician and provides some or all of the following subspecialty services:
- - Pediatric Otolaryngology: the medical and surgical treatment of
diseases of the ear, nose and throat in children.
- - Head and Neck Surgery: the medical and surgical treatment of cancerous
and noncancerous tumors in the head and neck, including thyroid and
parathyroid surgery.
- - Rhinology: the medical and surgical treatment of disorders of the nose
and sinuses.
- - Allergy: the medical treatment of inhalant allergies affecting the
upper respiratory system.
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- - Facial Plastic and Reconstructive Surgery: the treatment of cosmetic,
functional and reconstructive abnormalities of the face and neck.
- - Otology/Neurotology: the medical and surgical treatment of diseases of
the ear, including traumatic and cancerous disorders of the external,
middle and inner ear, as well as the nerve pathways which affect
hearing and balance.
- - Laryngology: the medical and surgical treatment of disorders of the
throat, including the voice.
ENT services in the United States are delivered largely through individual and
small single specialty group practices and, to a lesser extent, multi-specialty
clinics.
According to the American Academy of Otolaryngology-Head and Neck
Surgery, Inc., there were approximately 9,000 ENT physicians in the United
States as of December 31, 1997 and, based upon membership in the Academy, we
estimate that at least 70% of all ENT practices consist of individual
practitioners or small group practices (less than four physicians). According to
industry sources, ENT physicians and related specialists are increasingly
seeking to form larger group practices and affiliate with physician practice
management companies which understand the needs of ENT physicians and can
enhance practice performance.
AFFILIATED PRACTICES
We are affiliated with 91 physicians, one dentist and 85 allied health
care professionals operating 60 clinical offices in Alabama, Florida, Georgia,
Illinois, New Jersey, New York and Ohio . The following table sets forth certain
information concerning our affiliated practices as of March 29, 1999:
<TABLE>
<CAPTION>
ALLIED
AREAS HEALTH CARE OFFICE
MEDICAL GROUP LOCATION SERVED PHYSICIANS PROFESSIONALS LOCATIONS
------------- -------- ------ ---------- ------------- ---------
<S> <C> <C> <C> <C> <C>
Atlanta Ear, Nose & Atlanta, Georgia Metropolitan Atlanta 32* 42 29
Throat Associates,
P.C.
ENT & Allergy Birmingham, Alabama Birmingham 2 1 1
Associates, Inc.
Allatoona E.N.T & Cartersville, Georgia Cartersville 2 1 1
Facial Plastic
Surgery, P.C.
Otolaryngology Chicago, Illinois Barington, Crystal 4 3 3
Medical & Surgical Lake and McHenry
Associates, Ltd.
Ear, Nose & Throat Boca Raton, Florida Boca Raton, Pompano 13 11 9
Associates of South Beach, West Palm
Florida P.A. Beach & Delray Beach
ENT Associates, LLP New York and New Jersey Metropolitan New York 33 16 10
Cleveland Ear, Nose & Cleveland, Ohio Metropolitan Cleveland 9 11 7
--- --- ---
Throat Center, Inc.
92* 85 60
=== === ===
</TABLE>
- ----------
* Includes one dentist.
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Atlanta Ear, Nose & Throat Associates, P.C.
We believe Atlanta ENT is the largest independent (non-academic)
otolaryngology group practice in the United States. Atlanta ENT consists of 31
ENT physicians, one dentist, 29 audiologists, eleven physician assistants, one
nurse practitioner and one clinical esthetician with 29 clinical offices.
Atlanta ENT offers a wide range of ENT subspecialty services, including
pediatric otolaryngology, head and neck surgery, rhinology, facial plastic and
reconstructive surgery, otology and laryngology, to children and adults in the
metropolitan Atlanta area. The practice also provides audiology services,
hearing aid sales, temporo-mandibular joint diagnostics and snoring and sleep
apnea laser surgical services. The affiliated physicians at Atlanta ENT maintain
privileges at 34 hospitals and eight ambulatory surgical centers throughout
metropolitan Atlanta. Ramie A. Tritt, M.D., our Chairman of the Board and
President and a principal stockholder of Physicians' Specialty, is the President
and founder of Atlanta ENT.
ENT & Allergy Associates, Inc.
ENT & Allergy Associates, Inc. is one of our wholly-owned subsidiaries
and consists of two ENT physicians and one audiologist with one clinical office.
ENT & Allergy Associates provides a wide range of ENT subspecialty services,
including allergy testing and treatment, head and neck surgery, rhinology,
facial plastic and reconstructive surgery, otology, neurotology and laryngology,
to children and adults in the metropolitan Birmingham area.
Allatoona E.N.T. & Facial Plastic Surgery, P.C.
Allatoona ENT consists of two ENT physicians and one audiologist with
one clinical office. Allatoona ENT provides a wide range of ENT subspecialty
services, including allergy testing and treatment, head and neck surgery,
rhinology, facial plastic and reconstructive surgery, otology and laryngology,
to children and adults in the North Georgia area. The physicians at Allatoona
ENT have also instituted a hearing screening program for infants and newborns.
Otolaryngology Medical & Surgical Associates, Ltd.
Otolaryngology Medical & Surgical Associates, Ltd. consists of four ENT
physicians and three clinical audiologists with three clinical offices in the
Barington, Crystal Lake and McHenry suburbs of Chicago. Otolaryngology Medical &
Surgical Associates provides a wide range of ENT subspecialty services,
including head and neck surgery, rhinology, facial plastic and reconstructive
surgery, otology and laryngology, to children and adults in the metropolitan
Chicago area. The practice also provides audiology services, hearing aid sales
and snoring and sleep apnea surgical services. The affiliated physicians at
Otolaryngology Medical & Surgical Associates maintain privileges at three
hospitals and one ambulatory surgical center in metropolitan Chicago.
Ear, Nose & Throat Associates of South Florida, P.A.
Ear, Nose & Throat Associates of South Florida, P.A. consists of 13 ENT
physicians and 11 clinical audiologists with nine clinical offices in Boca
Raton, Pompano Beach, West Palm Beach, Delray Beach, Hollywood, Fort Lauderdale
and Lacahatchee, Florida. Ear, Nose & Throat Associates of South Florida
provides a wide range of ENT subspecialty services, including allergy testing
and treatment, head and neck
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surgery, rhinology, facial plastic, otology and neurotology, to children and
adults in the South Florida area. The practice also provides audiology services,
hearing aid sales and snoring and sleep apnea surgical services. The affiliated
physicians at Ear, Nose & Throat Associates of South Florida maintain privileges
at six hospitals and two ambulatory surgical centers in South Florida.
ENT Associates, LLP
ENT Associates LLP consists of 33 ENT physicians and 16 clinical
audiologists with 10 clinical offices. ENT Associates provides a wide range of
ENT subspecialty services, including pediatric otolaryngology, head and neck
surgery, rhinology, facial plastic and reconstructive surgery, otology and
laryngology, to children and adults in the metropolitan New York area. The
practice also provides audiology services, hearing aid sales and snoring and
sleep apnea laser surgical services. The affiliated physicians at ENT Associates
maintain privileges at 15 hospitals throughout metropolitan New York.
Cleveland Ear, Nose & Throat Center, Inc.
Cleveland Ear, Nose & Throat Center consists of nine ENT physicians and
eleven clinical audiologists with seven clinical offices. Cleveland Ear, Nose &
Throat Center provides a wide range of ENT subspecialty services, including
pediatric otolaryngology, head and neck surgery, rhinology, facial plastic and
reconstructive surgery, otology and laryngology, to children and adults in the
metropolitan Cleveland area. The practice also provides audiology services,
hearing aid sales and snoring and sleep apnea laser surgical services. The
affiliated physicians at Cleveland Ear, Nose & Throat Center maintain privileges
at nine hospitals and four ambulatory surgical centers throughout metropolitan
Cleveland.
AMBULATORY SURGERY CENTERS AND SLEEP DIAGNOSTIC LABORATORIES
PSC Ambulatory Surgery, Ltd.
PSC Ambulatory Surgery, Ltd. is a limited partnership of which we are
the sole general partner and one of our affiliated practices is the sole limited
partner. PSC Ambulatory Surgery owns a 17.5 % limited partnership interest in
Atlanta Surgery Center, Ltd., the general partner of which is not affiliated
with us. Atlanta Surgery Center operates three multi-specialty ambulatory
surgery centers, consisting of 14 operating rooms, in the metropolitan Atlanta
area. Our affiliated physicians, as well as other surgeons in the Atlanta area,
utilize these surgery centers for a variety of outpatient surgical procedures.
In 1998, in excess of 20,000 cases were performed at these surgery centers.
Preferred Diagnostic Services, Inc.
Preferred Diagnostic Services, Inc. operates 12 sleep diagnostic
laboratories in the metropolitan Atlanta area. Preferred Diagnostic Services
provides testing for a variety of sleep disorders, including severe snoring,
sleep apnea and restless leg syndrome.
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COMPANY OPERATIONS
We have a long term management services agreement with each of our
affiliated physician practices. Under the terms of a management services
agreement, we employ the practice's non-medical personnel, provide offices for
the practice and provide services in the areas of practice management,
information systems and negotiation and management of payor contracts. The
non-medical personnel, together with additional personnel at our headquarters,
manage the day-to-day non-medical operations of each affiliated practice,
including providing administrative, bookkeeping, scheduling and other routine
services. This operating structure established by us facilitates close
cooperation between us and the affiliated practice, while ensuring that the
affiliated practice maintains clinical autonomy.
Under the terms of the management services agreements, we:
- - assist the affiliated practices in strategic planning, preparation of
operating budgets and capital project analysis;
- - coordinate group purchasing of supplies, inventory and insurance for
the practices;
- - assist the affiliated practices in physician recruitment by introducing
physician candidates to the affiliated practices and advising the
affiliated practices in structuring employment arrangements
- - provide or arrange for a variety of additional services relating to the
day-to-day non-medical operations of the affiliated practices,
including:
- - managing and monitoring each practice's billing levels, invoicing and
accounts receivable collection by payor type;
- - accounting and payroll services and records; and
- - cash management and centralized disbursements.
These services are designed to reduce the amount of time physicians spend on
administrative matters, thereby enabling the physicians to dedicate more of
their efforts toward the delivery of health care.
We establish an advisory board at each affiliated practice consisting
of physicians of the affiliated practice and our management personnel whose
responsibilities are advisory in nature. The advisory board reviews, evaluates
and makes recommendations to the officers of the affiliated practice and our
officers with respect to strategic and operational planning, physician
employment and recruitment, patient fees and collection policies, quality review
and the establishment and maintenance of relationships with managed care and
other payors. Notwithstanding recommendations of the advisory board, we have
ultimate control over all decisions relating to the non-medical operations of
the affiliated practice, and the affiliated practice has ultimate control over
all decisions relating to the practice of medicine. See "-- Affiliation
Agreements."
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INFORMATION SYSTEMS
We support free-standing practice management systems utilized by our
affiliated practices to facilitate patient scheduling, billing and collection,
accounts receivable management, provider productivity analysis and certain cash
disbursement functions. Rather than replacing systems utilized by affiliated
practices, we generally integrate an affiliated practice's systems in order to
streamline consolidated financial reporting, accounts receivable management and
productivity analysis functions. We are also evaluating patient electronic
medical record systems for possible implementation at affiliated practices. We
believe that the use of an electronic medical record system may enhance
operating efficiency through automation of many routine functions, as well as
the capacity to link "procedure specific" treatment protocols, thereby enhancing
the physician's ability to provide quality cost-effective patient care.
We believe that effective and efficient access to key patient data is
critical in controlling costs and improving quality outcomes in connection with
managing risk contracts. Our proprietary comprehensive network administration
and utilization management system designed specifically for ENT practices
provides effective and efficient access to key patient data and performs the
complex processing and analytical tasks required to manage risk contracts
effectively. Our system facilitates the automation of many routine functions and
provides affiliated physicians with Internet access to the clinical and
financial data necessary to issue and manage authorization for surgeries, to
track diagnosis, procedures and admissions and to perform outcome studies, cost
analysis, quality and utilization management and reviews.
Our system integrates the following functions:
- - tracking referrals from primary care and other physicians;
- - issuing and managing authorization for surgeries and tracking
diagnoses, procedures and admissions;
- - processing claims for physician payment;
- - providing extensive customized management reports, including diagnosis
and procedure utilization data; and
- - maintaining support files.
We believe that this system provides us with a competitive advantage in
procuring, managing and administering risk contracts.
COMPETITION
The physician practice management industry is highly competitive. The
restructuring of the health care system is leading to rapid consolidation of the
existing highly fragmented health care delivery system into larger and more
organized groups and networks of health care providers. We expect competition to
increase as a result of consolidation and ongoing cost containment pressures,
among other factors. We compete with:
- - physician practice management companies;
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- - hospitals;
- - managed care companies;
- - physician practices; and
- - other competitors seeking to affiliate with physicians or provide
management services to physicians.
As compared to us, many of these competitors are:
- - significantly larger;
- - provide a wider variety of services;
- - have greater experience in providing practice management services;
- - have longer established relationships with customers for these
services; and
- - have access to substantially greater financial resources.
There can be no assurance that we will be able to affiliate with a sufficient
number of competent physicians and other health care professionals to expand our
business. We believe that the quality of our management services, experience in
procuring, managing and administering capitated managed care contracts, the
breadth of ENT medical and surgical professional services provided by affiliated
physicians and the utility of our network management system positions us to
compete favorably for affiliation with additional ENT and related specialty
practices.
Physicians are facing the challenge of providing quality patient care
while experiencing rising costs, strong competition for patients and a general
reduction of reimbursement rates by both private and government payors. We
believe that competition for patients is dependent upon:
- - the geographic coverage of affiliated practices;
- - the reputation and referral patterns of affiliated physicians; and
- - the breadth of ENT and related specialty medical and surgical
professional services provided by physicians practicing at our
affiliated practices.
As a result, our success is dependent upon our or our affiliated practices'
ability to recruit, train and retain qualified health care professionals in new
and existing markets. We face competition for these personnel from other health
care providers, research and academic institutions, government entities and
other organizations. There can be no assurance that sufficient numbers of
qualified health care professionals can be hired and retained. The inability to
hire and retain such health care professionals could have a material adverse
effect on our operations and financial condition.
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Concern over the rising cost of health care has led to the emergence
and increased prominence of managed care and a resulting increase in competition
for managed care contracts. Our ability to compete successfully for managed care
contracts may depend upon our ability to manage utilization under such contracts
and to increase the number of associated physicians and other health care
professionals included in our provider networks.
MEDICAL ADVISORY BOARD
We have a medical advisory board whose responsibilities include:
- - reviewing the medical appropriateness of our policies and procedures
with respect to disease management and utilization management protocols
and practice and surgery guidelines;
- - consulting with us on acquisitions;
- - reviewing the medical appropriateness of information systems utilized
or developed by us;
- - evaluating new medical technologies to be utilized by affiliated
practices; and
- - developing and coordinating our sponsored managed care and practice
management seminars for ENT physicians.
Our medical advisory board consists of three affiliated ENT physicians,
including Ramie A. Tritt, M.D., our Chairman of the Board and President, and
three non-affiliated ENT physicians.
AFFILIATION AGREEMENTS
The relationship between us and our affiliated practices and physicians
is set forth in asset or stock acquisition agreements, management services
agreements and employment agreements.
Acquisition Agreements
Pursuant to acquisition agreements, we acquire either:
- - substantially all of the assets utilized in a practice, other than
certain excluded assets such as employment agreements and patient
charts, records and files, and assume certain liabilities of the
practice group; or
- - the equity of the practice.
The practice remains liable for the payment of liabilities not assumed by us
under the acquisition agreement. Under the acquisition agreements the medical
practice and the stockholders of the practice agree for a period of time
following the closing of the acquisition, not to compete with us within a
specified geographic area, solicit patients of the practice within such
geographic area or solicit our employees. The acquisition agreements also
contain representations and warranties and indemnification provisions by each of
the parties to the agreement.
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Simultaneously with the closing of an acquisition, employment agreements are
entered into between the practice and each of its physicians and we enter into a
management services agreement with the practice.
Management Services Agreements
Our management services agreements provide for the affiliated practice
to:
- - assign to us all of its non-governmental accounts receivable and all of
its rights and interest in the proceeds of its governmental accounts
receivable, or the revenue it receives, to the extent permitted by
applicable law; and
- - grant to us the right to collect and retain the proceeds of the
accounts receivable, or revenue, for our account to be applied in
accordance with the management services agreements.
- - grant to us the right to grant a security interest and factor the
accounts receivable to secure our borrowings under our credit facility.
We generally retain a management fee equal to:
- - a stipulated percentage of all revenue generated by or on behalf of
physicians at the affiliated practice, after adjustment for contractual
allowances, as payment for the services provided by us and
non-allocable costs incurred by us as a result of providing management
services; and
- - an amount equal to all operating and capital expenses of the practice,
including depreciation, amortization and interest.
In New York, in order to comply with state law, the affiliated practice
reimburses us for the practice's operating and non-operating expenses and pays
us a fixed management fee.
Under our management services agreement, we are responsible for the
payment for and incur:
- - operating expenses of the affiliated practice, 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 practice.
We pay for all these expenses, including our fees, directly out of the proceeds
of the accounts receivable, or revenue, assigned to us by the affiliated
practice. The remaining net practice revenue is remitted to the affiliated
practice.
The affiliated practice retains the responsibility for:
- - compensating physician employees and physician assistants;
- - paying insurance premiums and deductibles for professional liability
insurance policies;
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- - ensuring that affiliated physicians have the required licenses,
credentials, approvals and other certifications needed to perform their
duties; and
- - complying with federal and state laws and regulations applicable to the
practice of medicine.
The affiliated practice also retains exclusive control over all aspects of the
practice of medicine and the delivery of medical services.
Under the management services agreements, we:
- - act as the exclusive manager and administrator relating to all
non-medical operations of the affiliated practice;
- - bill patients, insurance companies and other third party payors and
collect, on behalf of the affiliated practice, the fees for
professional medical services and other services and products rendered
or sold by the affiliated practice;
- - provide clerical, accounting, purchasing, payroll, bookkeeping and
computer services and personnel and information management services to
the affiliated practice;
- - supervise and maintain custody of all files and records of the
affiliated practice;
- - provide facilities, furniture and equipment for the affiliated
practice;
- - prepare all annual and capital operating budgets of the affiliated
practice;
- - order and purchase inventory and supplies as reasonably required by the
affiliated practice;
- - provide financial and business assistance to the affiliated practice in
the negotiation, establishment, evaluation and administration of
contracts and relationships with managed care and other similar
providers and payors; and
- - perform administrative services relating to the recruitment of
physicians for the affiliated practice.
The management services agreements have an initial term of 40 years,
which may be extended for separate and successive five year terms. The
management services agreements may be terminated by either party if the other
party files a petition in bankruptcy or other similar events occur or defaults
on the performance of a material duty or obligation, which default continues
without cure for a specified term after notice.
During the term of a management services agreement, the affiliated
practice agrees, with respect to management services, not to compete with us
within a specified geographic area. During the term of a management services
agreement and for a period following the termination of such agreement, the
affiliated practice also agrees not to solicit any of our employees or persons
affiliated with us or to contract with any entity for the provision of
management services substantially of the
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<PAGE> 15
kind contemplated by the management services agreement. The affiliated practice
also agrees not to disclose certain confidential and proprietary information
relating to us and the affiliated practice.
Physician Employment Agreements
Physicians at our affiliated practices have employment agreements with
their respective practice. Affiliated physicians are compensated based upon
either productivity or other negotiated formulas agreed upon between the
affiliated physician and the affiliated practice. The affiliated practice may
provide the affiliated physicians with health, death and disability insurance
and other benefits. Affiliated physicians are obligated to obtain and maintain
professional liability insurance coverage which we may procure on behalf of the
affiliated physicians.
Generally, under the employment agreements, affiliated physicians agree
not to compete with the affiliated practice, not to solicit patients of the
affiliated practice and not to interfere with employees of the affiliated
practice for a certain period following the termination of such employment
agreement unless the agreement is terminated by the affiliated physician for
cause. However, in certain states, such as Alabama, certain types of restrictive
covenants, including non-competition covenants, are deemed to be unenforceable
as against professionals, including physicians. In other states, these
provisions may be deemed to be unenforceable if a court determines that the
duration of the restriction, the territory covered by such restriction or the
activities restricted were unreasonable or otherwise violated public policy.
In addition, affiliated physicians agree:
- - not to disclose any confidential and proprietary information of the
affiliated practice during the term of the agreement and for a certain
period following the termination of the agreement;
- - to assign to the affiliated practice all revenue related to contracts
with managed care companies and grant the affiliated practice the right
to enter into such contracts on behalf of the physicians; and
- - to exercise independent professional and ethical judgment in all
patient care responsibilities.
The employment agreements with the affiliated physicians generally
provide for an initial term of five years. The agreements are automatically
renewed for successive one or two year terms unless an affiliated physician or
the medical practice elects not to renew the term by providing at least 90 days
written notice of such election or such agreement is otherwise terminated for
cause or the death or disability of an affiliated physician. The employment
agreements with the physicians of ENT & Allergy Associates, one of our
wholly-owned subsidiaries, provide for an initial term of six years and six
months, which will be automatically renewed for successive one or two year terms
unless the physician or ENT & Allergy Associates elects not to renew the
agreement.
ACQUISITION OF ENT PRACTICES SINCE JANUARY 1, 1998
In May 1998, we acquired the stock of three corporations that had been
affiliated with Physicians' Domain, Inc., a White Plains, New York based ENT
physician practice management company, employing an aggregate of 20 physicians
and 16 allied health care professionals with 11 clinical offices in the
metropolitan New York area.
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<PAGE> 16
In connection with this transaction, we:
- - paid approximately $5.4 million in cash;
- - discharged approximately $3.8 million of liabilities; and
- - issued a note in the principal amount of approximately $6.4 million,
payable in May 2003.
The note accrues interest at a rate of 6.0% per annum, payable
quarterly, is secured by the fixed assets acquired by us in the transaction and
is subordinate to senior indebtedness, including borrowings under our credit
facility. We also agreed to pay an additional $500,000, in cash or shares of our
common stock at our option, if these practices achieve certain performance
targets. Under the stock purchase agreement, the New York physicians have the
right to nominate one member to our Board of Directors. In August 1998, the
physicians nominated Steven H. Sacks, M.D. to our Board of Directors.
We entered into a management services agreement with a newly organized
ENT practice employing the 20 ENT physicians that had been affiliated with
Physicians' Domain. The management services agreement provided for a fixed
annual management fee of approximately $2.1 million, plus reimbursement of
practice operating expenses. In March 1999, in connection with an additional
acquisition in the Metropolitan New York area, the management services agreement
was amended and the fixed annual management fee was increased to approximately
$2.6 million. Under 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 our management of ancillary business developed or
acquired or the acquisition of additional physician practices which become part
of the existing practice.
In October 1998, we acquired the assets of Cleveland Ear, Nose and
Throat Center, Inc., a ten physician ENT practice with eight allied health care
professionals and eight clinical offices in metropolitan Cleveland, Ohio.
Cleveland ENT had previously been affiliated with MedPartners, Inc. We also
entered into a management services agreement with Cleveland ENT maintaining as a
management fee the percentage of net income structure which existed in the
agreement between MedPartners and Cleveland ENT. Under the terms of the
transaction, we granted Cleveland ENT the option to unwind the transaction by
December 15, 1998 and repurchase all Cleveland ENT non-medical assets acquired
by us for a total cash purchase price equal to the price paid by us to
MedPartners for such assets, plus amounts invested by us in Cleveland ENT. We
paid approximately $4.2 million consisting of cash and borrowings under our
credit facility, and we issued a $150,000 non-interest bearing contingent
promissory note which is payable at our option in cash or our common stock upon
Cleveland ENT achieving certain performance targets. Cleveland ENT did not
exercise their option to unwind the transaction. We amended the management
services agreement with Cleveland ENT to provide that, effective January 1,
1999, we would receive a management fee equal to 12.5% of all net clinic
revenue, after adjustment for contractual allowances, generated by Cleveland
ENT.
In January 1999, we entered into a financing arrangement with the
physicians at Cleveland ENT. Under the financing arrangement, we loaned
$1,475,000 to the Cleveland physicians. The loan bears interest at a rate of 6%
per annum and matures on the earlier of January 14, 2000, the termination of the
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<PAGE> 17
management services agreement or the termination of the employment of three or
more of the Cleveland physicians. We also granted the physicians the option to
require us to purchase from the physicians all of the common stock of a newly
organized corporate entity owned by the physicians, which holds two corporate
domain names. The option may be exercised by the physicians between January 10,
2000 and March 1, 2000. If the physicians exercise the option, we would be
required to purchase the common stock for approximately $2.0 million in cash and
issue a subordinated promissory note in the principal amount of $520,000. The
cash portion of the purchase price would be reduced by any amounts owed by the
physicians to us pursuant to the loan or any other obligations. The subordinated
promissory note would bear interest at a rate of 6% per annum and would be
payable in four equal annual installments commencing on the first anniversary of
the date of issuance of the note. We have also agreed to indemnify the
physicians for certain matters in connection with or arising out of this
transaction.
Since January 1, 1998, we also acquired:
- - substantially all of the assets and assumed certain contractual
liabilities of one ENT physician practice in the metropolitan New York
area, four ENT physician practices in South Florida, one ENT physician
practice in the metropolitan Atlanta area and one ENT physician
practice in the metropolitan Cleveland area;
- - a minority limited partnership interest in Atlanta Surgery Center, a
limited partnership operating three multi-speciality ambulatory surgery
centers; and
- - substantially all of the assets of Preferred Diagnostic Services, which
operates 12 sleep centers in the metropolitan Atlanta area.
In connection with these acquisitions, we:
- - paid an aggregate of approximately $8.1 million in cash;
- - issued an aggregate of 69,873 shares of common stock, valued at the
time of issuance at an aggregate of approximately $532,000:
- - agreed to issue to four of the affiliated practices beginning in
February 1999, an aggregate of 79,675 additional shares of common
stock, valued at the time of issuance at an aggregate of approximately
$628,000;
- - issued a subordinated convertible promissory note in the principal
amount of $250,000, payable in April 2000, accruing interest at a rate
of 6% per annum and is payable in cash or our common stock, at our
option;
- - issued subordinated promissory notes in the aggregate principal amounts
of approximately $1.4 million which notes accrue interest at 6% per
annum payable quarterly beginning in May 1999 with five annual equal
payments of principal beginning on February 1, 2000; and
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<PAGE> 18
- - issued a non-interest bearing contingent subordinated promissory note
in the principal amount of $150,000. The payment of this note is
contingent upon the physicians or practice holding such note reaching
certain performance targets. This contingent note is payable by us, at
our option, in cash or shares of our common stock, valued at the
average closing price of our common stock for the ten trading days
preceding the date of delivery of such shares.
In connection with the acquisitions since January 1, 1998, we paid an
aggregate of approximately $1.0 million to Premier HealthCare, an affiliate of
Gerald R. Benjamin, our Vice Chairman and Secretary, for advisory services
rendered in connection with these acquisitions under an agreement with Premier
HealthCare.
CAPITATED MANAGED CARE CONTRACTS; NETWORK DEVELOPMENT AND MANAGEMENT
At December 31, 1998, our Atlanta affiliated practices served as the
primary ENT provider network for three capitated managed care contracts for
United HealthCare of Georgia, Cigna HealthCare of Georgia and The Morgan Health
Group covering an aggregate of approximately 351,400 enrollees in the
metropolitan Atlanta area. At December 31, 1998, our Birmingham, Alabama
affiliated ENT practice participated in an exclusive panel of ENT physicians
providing services for a capitated managed care contract for United HealthCare
of Alabama covering approximately 80,000 enrollees in the metropolitan
Birmingham area. The following table sets forth the covered lives for each
managed care contract as of December 31, 1998:
<TABLE>
<CAPTION>
Capitated
Covered
Lives
-----
<S> <C>
United HealthCare of Georgia, Inc. ....... 169,200
United HealthCare of Alabama, Inc. ....... 79,694
Cigna HealthCare of Georgia, Inc. ........ 114,571
The Morgan Health Group, Inc. ............ 67,629
-------
431,094
=======
</TABLE>
These managed care contracts are held, managed and administered by
three of our wholly-owned subsidiaries. Through these subsidiaries, we manage
the existing provider networks, and perform quality and utilization management
under each contract. We receive a pre-determined capitation fee per enrollee per
month from the payors of the managed care contracts in exchange for agreeing to
arrange for the provision of ENT medical and surgical professional services
required by enrollees. We have contracted with physicians at certain of our
affiliated practices and with non-affiliated physicians to provide these
services to enrollees. The physicians providing services are compensated by us
on a discounted fee-for-service or contact capitation basis. For the year ended
December 31, 1998, approximately 8.0% of our net revenue was attributable to ENT
medical and surgical professional services rendered pursuant to our managed care
contracts.
We intend to develop or acquire additional ENT provider networks in
order to enter into exclusive managed care contracts with payors. We expect that
the networks will consist of affiliated physicians and related specialists as
well as non-affiliated physicians and other health care providers engaged in ENT
and related specialties who will enter into network administration agreements
with us. These agreements will provide for us to manage the provider network,
negotiate managed care contracts and perform quality and utilization management
functions. We anticipate working with specialty group practices in:
- - developing capitated contract proposals;
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<PAGE> 19
- - evaluating and assembling provider networks;
- - negotiating contract rate schedules and exclusions;
- - utilization and quality management; and
- - developing provider compensation methodologies.
We also anticipate eventually tracking outcomes to demonstrate the cost
effectiveness of care being delivered in connection with our managed care
contracts. We believe the principal benefit from including affiliated as well as
non-affiliated physicians in our provider networks will be the expansion and
diversification of provider networks available to managed care enrollees, as
increasingly required by managed care companies.
CAPITATED AGREEMENTS WITH THIRD PARTY PAYORS
Under participation agreements between us and the physicians providing
services to managed care enrollees, the physicians must follow administrative
procedures established by us and the managed care companies, such as:
- - referring enrollees to participating providers;
- - obtaining prior authorization for certain procedures; and
- - participating in quality and utilization management programs.
Quality management includes the process established by us and the payor to
improve the quality of covered services. Utilization management includes the
process established to review whether certain health care services provided to
enrollees are in accordance with the requirements established by us and the
payor. Under the participation agreements, the physicians are also required to
obtain and maintain malpractice and general liability insurance. The
participation agreements may generally be terminated by us without cause upon 60
to 90 days notice or with cause upon 30 to 60 days notice and by a physician,
with or without cause, upon 60 days notice. The participation agreements also
automatically terminate upon the termination of the relevant capitated managed
care contract.
Our subsidiaries hold capitated managed care contracts with United
HealthCare of Georgia, Cigna HealthCare of Georgia, United HealthCare of Alabama
and The Morgan Health Group which were entered into in 1991, 1992, 1997 and
1998, respectively. The contract with United HealthCare of Georgia expires in
November 1999. The contract with Cigna HealthCare of Georgia provides for
automatic annual renewals. The contracts with United HealthCare of Alabama and
The Morgan Health Group expire in October 2000 and June 1999, respectively, and
provide for automatic annual renewals. The managed care contracts with Cigna,
United HealthCare and The Morgan Health Group may be terminated by either party
for cause, including a material breach of the contract, generally upon 30 to 60
days notice by the terminating party or without cause upon 90 to 120 days notice
by the terminating party generally following the initial term of the agreement.
In March 1999, we received notification from Cigna that Cigna was terminating
its relationship
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<PAGE> 20
with The Morgan Health Group and was assuming The Morgan Health Group's
responsibility under the agreement for enrollees covered by Cigna effective May
1, 1999 and that future payments for such members to be received by us under the
contract would be paid by Cigna.
GOVERNMENT REGULATION
The health care industry is highly regulated and we cannot predict
whether the regulatory environment in which we operate will change significantly
or adversely in the future. The regulation of the health care industry,
including scrutiny of the methods and levels of payment to health care providers
is increasing on both the federal and state levels. We believe that health care
legislation, regulations and interpretations will continue to change. We expect
to modify our agreements and operations from time to time as the business and
regulatory environments change. While we believe we will be able to structure
our agreements and operations in accordance with applicable law, the lack of
definitive interpretations of many statutory and regulatory provisions means
that there can be no assurance that our arrangements are in compliance with such
provisions or will not be successfully challenged.
Government Reimbursement Programs
Under the federal Medicare program, payment for physician services,
other than under Medicare risk contracts and Medicare+Choice plans, is based on
an annually adjusted fixed fee schedule known as the Resource-Based Relative
Value Scale ("RBRVS"). The Balanced Budget Act of 1997 modified the RBRVS system
to adjust the per patient payments from the Medicare program for certain
physician services, and we anticipate further modifications in the RBRVS system
in the future. Additionally, the Balanced Budget Act creates the Medicare+Choice
plan which provides Medicare beneficiaries with the option to receive services
through managed care entities including HMOs and preferred provider
organizations, and payment for physician services under the Medicare+Choice plan
may be on a capitated basis as opposed to the RBRVS system.
This change of payment method may result in an overall decrease in
compensation for physician services under the Medicare program. Because we
anticipate that approximately 10% of our revenues will be derived from
government-funded health care programs, principally, Medicare and Medicaid, we
do not believe that such reductions will result in a material adverse change in
our results of operations. The Medicaid program is a partially federal-funded
state administered program for the indigent. Payment to physicians under state
Medicaid programs is generally based upon fee schedules. However, some states
have authorized Medicaid HMOs, and payments for physician services under these
programs may be on a capitated basis.
Stark Legislation, Fraud and Abuse Laws and Similar Laws
We and our affiliated physicians are subject to a variety of laws and
regulations governing the referral of patients for certain health services to
entities with which the referring physician has a financial relationship.
Significant prohibitions against physician referrals were enacted by Congress in
the Omnibus Budget Reconciliation Act of 1993. These prohibitions, commonly
known as "Stark II," amended prior physician self-referral legislation known as
"Stark I" by dramatically enlarging the field of physician-owned or
physician-interested entities to which the referral prohibitions apply. The
Stark Law prohibits, subject to certain exceptions, a physician, or a member of
the physician's immediate family, from referring Medicare or Medicaid patients
or patients in federally funded health care programs for "designated health
services" to an entity with which the physician has a financial relationship.
The designated
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<PAGE> 21
health services include clinical laboratory services, radiology services,
radiation therapy services, physical and occupational therapy services, durable
medical equipment, parenteral and enteral nutrients, equipment and supplies,
prosthetics, orthotics, outpatient prescription drugs, home health services and
inpatient and outpatient hospital services. The Stark Law further imposes
reporting requirements on any entity providing covered items or services for
which payment may be made under Medicare or Medicaid. An entity is required to
report information concerning the entity's ownership, investment and
compensation arrangements. The penalties for violating the Stark Law include:
- - substantial civil or criminal penalties;
- - denial of payment; and
- - exclusion from participation in the Medicare, Medicaid and federally
funded health care programs.
The Stark Law is broad and ambiguous; however, we believe that our activities
are not in violation of the Stark Law.
In addition, a number of states, including certain states in which we
operate or may operate in the future, have enacted similar laws which apply to
referrals made for services reimbursed by all payors, and not simply Medicare,
Medicaid or federally funded health care programs. We believe that our
activities are not in violation of these laws. However, we cannot predict
whether future interpretations of these laws will require structural and
organizational modification of our affiliation structure in those states. Future
legislation or regulations could require us to modify the form of our
relationships with physician organizations. Moreover, the violation of the Stark
Law or similar state laws by our affiliated physician organizations could result
in significant fines and loss of reimbursement which could materially adversely
affect our operations and financial condition.
We and our affiliated physicians are also subject to federal and state
fraud and abuse laws. These laws include the federal anti-kickback statute,
which prohibits, among other things, the offer, payment, solicitation or receipt
of any remuneration, directly or indirectly in return for:
- - the referral of patients for items or services that are paid for in
whole or in part; or
- - arranging for the furnishing of items and services that are paid for in
whole or in part by Medicare, Medicaid or federally-funded programs.
The courts and the Office of Inspector General of The Department of Health and
Human Services have stated that the anti-kickback statute is violated if one
purpose, as opposed to a primary or sole purpose, of the arrangement is to
induce referrals. In April 1998, the Office of Inspector General of the
Department of Health and Human Services issued an advisory opinion which states
that a percentage based management arrangement between a physician practice
management company and a physician group could violate the federal anti-kickback
statute if one of the purposes of the arrangement is to compensate the
management company for its efforts to arrange for referrals for the group
through its services provided to the group, including marketing and advertising.
Violations of the anti-kickback statute are punishable by criminal or civil
penalties and/or
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<PAGE> 22
exclusion of the provider from future participation in the Medicare, Medicaid
and federally-funded programs. The federal government has published exemptions,
or "safe harbors," for business transactions that will be deemed not to violate
the anti-kickback statute. Although satisfaction of the requirements of these
safe harbors provides protection from enforcement action under the anti-kickback
legislation, failure to meet the safe harbors does not necessarily mean that the
activity violates the statutory prohibitions. Rather, the legality of a
particular business arrangement will be assessed by comparing the particular
facts of the transaction to the proscriptions of the statute. In addition, a
number of states have enacted similar laws, which vary from state to state,
prohibiting remuneration or fee-splitting arrangements between health care
providers for the referral of patients to a particular provider, regardless of
the payor source. Also, under separate statutes, including the Federal False
Claims Act, submission of claims for payment that are "not provided as claimed"
may lead to:
- - civil monetary penalties;
- - criminal fines and imprisonment; and/or
- - exclusion from participation in the Medicare, Medicaid and
federally-funded health care programs.
Under the Federal False Claims Act, any person may bring suit alleging false or
fraudulent Medicare or Medicaid claims or other violations of the statute and
share in any amounts paid by the entity to the government in fines or
settlement. Such qui tam actions have increased significantly in recent years
and have increased the risk that a health care company will have to defend a
false claims action, pay fines or be excluded from participation in the Medicare
and/or Medicaid programs as a result of an investigation arising out of such an
action. Congress also enacted the Health Insurance Portability and
Accountability Act of 1996, which includes an expansion of certain fraud and
abuse provisions to health care programs. Due to the breadth of the statutory
provisions of the fraud and abuse laws and the absence of definitive regulations
or court decisions addressing the type of arrangements by which we and our
affiliated entities conduct and will conduct our business, from time to time
certain of our practices may be subject to challenge under these laws.
We have attempted to structure our business relations to comply with
the Stark Law, the fraud and abuse laws and all other applicable federal and
state health care laws and regulations. However, there can be no assurance that
such laws and regulations will be interpreted in a manner consistent with our
practices. There can be no assurance that challenges under such laws or
regulations or new laws or regulations will not require us or our affiliated
entities to change our or their practices or will not have a material adverse
effect on our operations and financial condition. Furthermore, the addition of
ancillary services may require us or our affiliated practices to alter our or
their operations to comply with applicable federal or state health care laws and
regulations.
Health Care Reform
Political, economic and regulatory influences are continuously
subjecting the health care industry in the United States to fundamental change.
On August 5, 1997, President Clinton signed the Balanced Budget Act which
contemplates savings of $115 billion in Medicare spending and $13 billion in
Medicaid spending over the five-year period from 1998 to 2002. The savings will
result primarily from reductions in reimbursements to providers due to several
factors, including but not limited to, alterations in the methodology for
calculating physician fee schedule payments, application of a budget neutrality
adjustment to prevent physician fees from increasing above a certain aggregate
amount, and expansion of options for Medicare delivery including
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<PAGE> 23
provider-sponsored organizations, HMOs, preferred provider organizations and
private fee-for-service plans. The Balanced Budget Act also establishes more
stringent sanctions for convictions of health care related crimes including
permanent exclusion from participation in the Medicare Program after conviction
of three health care related crimes and imposition of civil monetary penalties
for violations of the federal anti-kickback statute. Due to the recent enactment
of this health care reform and uncertain interpretation of these reform measures
by regulatory authorities, it is difficult to determine the impact that this
reform will have upon us and our affiliated physicians, and there can be no
assurances that these reform measures will not have a material adverse effect on
our operations and financial condition. In addition to federal health care
reform, some states in which we operate or may operate in the future are also
considering various health care reform proposals. We anticipate that both
federal and state governments will continue to review and assess alternative
health care delivery systems and payment methodologies, and that additional
reforms will likely occur in the future. Due to uncertainties regarding the
additional reforms and their enactment and implementation, we cannot predict
which, if any, reform proposals will be adopted, when they may be adopted or
what impact they may have on us, and there can be no assurance that the adoption
of reform proposals will not have a material adverse effect on our operations
and financial condition. In addition, the actual announcement by competitors and
third party payors of their strategies to respond to such initiatives or
reforms, could produce volatility in the trading and market price of our common
stock.
Other Licensing Requirements
Every state imposes licensing requirements on individual physicians,
and some regulate facilities operated and services provided by physicians. In
addition, many states require physicians to obtain regulatory approval,
including certificates of need, before establishing certain types of health care
facilities, offering certain services, or making certain capital expenditures in
excess of statutory thresholds for health care equipment, facilities or
services. To date, we and our affiliated practices have not been required to
obtain certificates of need or similar approvals for our or their activities.
However, the addition of ancillary services by one of the affiliated practices
or changes in law or regulations could require licensure, a certificate of need,
or both. There is no assurance that such required state regulatory approvals
could be obtained, or even if initially obtained, would not thereafter be
withdrawn or restricted. In connection with the expansion of our operations into
new markets and contracting with managed care companies, we and our affiliated
practices may become subject to compliance with additional regulations. In
addition, we and our affiliated practices are subject to federal, state and
local laws dealing with issues such as occupational safety, employment, medical
leave, insurance regulation, civil rights and discrimination, medical waste and
other environmental issues. Increasingly, federal, state and local governments
are expanding the regulatory requirements for businesses, including medical
practices. The imposition of these regulatory requirements may have the effect
of increasing operating costs and reducing the profitability of our operations.
Restrictions on Corporate Practice of Medicine and Unlawful Fee Splitting
The laws of certain states in which we operate or may operate in the
future prohibit non-physician entities from practicing medicine or from
exercising control over the professional judgments or decisions of physicians
concerning the treatment and diagnosis of patients. Although we have structured
our affiliations with physician groups so that the associated physicians
maintain exclusive authority regarding the delivery of medical care and exercise
their independent professional judgment in rendering medical decisions, there
can be
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no assurance that these laws will be interpreted in a manner consistent with our
practices or that other laws or regulations will not be enacted in the future
that could have a material adverse effect on our business.
In addition, the laws of certain states in which we operate or may
operate in the future prohibit certain practices such as splitting fees with
physicians or receiving fees for the referral of patients. In Florida, the Board
of Medicine recently issued a declaratory statement (the "Declaratory
Statement") interpreting Florida fee splitting statutes. The Declaratory
Statement, which has been stayed pending its appeal to the Florida courts, is
broadly drafted and could be construed as prohibiting physician management
companies from being compensated based on a percentage of the managed practice's
revenues or profits. In addition, the Declaratory Statement could be construed
as restricting the manner in which the management company provides marketing
services to a managed practice. If Florida courts uphold the Declaratory
Statement, we could be required to revise our contracts with our affiliated
practices in a manner that could have adverse effects on us. Although we have
endeavored to structure our affiliations with physician groups to comply with
applicable state fee splitting laws and anti-referral laws, there can be no
assurance that these laws will be interpreted in a manner consistent with our
practices or that other laws or regulations will not be enacted in the future
which could have a material adverse effect on our business. If a corporate
practice of medicine law or fee splitting statute is interpreted in a manner
that is inconsistent with our practices, we would be required to restructure or
terminate our relationship with the applicable physician group in order to bring
our activities into compliance with such law. The termination of, or failure by
us to successfully restructure, any such relationship could result in fines or a
loss of revenue that could have a material adverse effect on our operations and
financial condition.
LIABILITY AND INSURANCE
The provision of health care services entails the risk of potential
claims of medical malpractice and similar claims. We do not engage in the
practice of medicine or have responsibility for compliance with regulatory
requirements directly applicable to physicians and require affiliated physicians
performing medical services at our facilities to maintain medical malpractice
insurance. Nevertheless, we cannot predict whether malpractice claims will be
asserted against us directly in the event that services or procedures performed
at one of our facilities are alleged to have resulted in injury or other adverse
effects. In addition, in connection with the acquisition of assets of affiliated
practices, we have assumed certain of the stated liabilities of such practices.
Claims may be asserted against us for events related to affiliated practices
that occurred prior to our affiliation. Although we maintain liability insurance
that we believe will be adequate as to both risk and amounts, successful
malpractice claims could exceed the limits of our insurance and could have a
material adverse effect on our operations and financial condition. Moreover, a
malpractice claim asserted against us could be costly to defend, could consume
management resources and could adversely affect our reputation and business,
regardless of the merit or eventual outcome of such claim. In addition, we
cannot predict whether we will be able to obtain such insurance on commercially
reasonable terms in the future or that any such insurance will provide adequate
coverage against potential claims.
In addition to the liability insurance maintained by us, we are named
as an additional insured on the professional liability insurance policies held
by our affiliated physicians. Such insurance would provide coverage, subject to
policy limits in the event we were held liable as a co-defendant in a lawsuit
for professional malpractice against an affiliated physician. In addition, we
are indemnified under the management services agreements by the affiliated
physician groups for liabilities resulting from the performance of medical
services.
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EMPLOYEES
As of December 31, 1998, we had approximately 516 full-time employees,
including two physicians and 79 allied health care professionals. None of our
employees are represented by a labor union and we believe our relations with our
employees are good.
ITEM 2. PROPERTIES
We lease approximately 5,000 square feet of office space for our
executive offices in Atlanta, Georgia. The lease provides for annual rent of
approximately $90,000, subject to specified annual increases, and expires in
July 2002. We also lease the 60 facilities currently used by the physicians at
our affiliated practices. These leases have varying remaining terms ranging from
approximately one month to 13 years and aggregate annual rent of approximately
$3.0 million. We believe that these facilities are suitable for our current and
anticipated needs.
ITEM 3. LEGAL PROCEEDINGS
No legal proceedings are currently pending against us, and we are not
aware of any outstanding claims against any of our affiliated practices that
would have a material adverse effect on our operations and financial condition.
We and our affiliated practices may be involved from time to time in litigation
incidental to our and their respective businesses.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS
The following table sets forth the names, ages and positions of our
executive officers:
<TABLE>
<CAPTION>
Name Age Position
<S> <C> <C>
Ramie A. Tritt, M.D............................... 49 Chairman of the Board and President
Gerald R. Benjamin................................ 41 Vice Chairman of the Board, Secretary and Director
Richard D. Ballard................................ 50 Chief Executive Officer and Director
Robert A. DiProva................................. 51 Executive Vice President and Chief Financial Officer
Lawrence P. Kraska................................ 34 Executive Vice President - Operations
</TABLE>
- ----------
Ramie A. Tritt, M.D. has served as our Chairman of the Board and
President since our inception in July 1996. Dr. Tritt serves as President of
Atlanta ENT, a multi-site otolaryngology group practice which is a successor to
a practice founded by Dr. Tritt in 1979. Dr. Tritt also serves as President and
Medical Director of the ENT Center of Atlanta, Inc., Atlanta ENT Center for
Physicians, Inc., and Atlanta AHP, Inc., three otolaryngology provider networks
established to contract with HMOs in greater Atlanta, each of which is a
wholly-owned subsidiary of Physicians' Specialty. Dr. Tritt was a founding
Member and currently serves as
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<PAGE> 26
President of Georgia Multi-Specialty Group, L.L.C., a consortium of 15 specialty
group practices, encompassing approximately 650 physicians, which contracts with
payors for specialty medical services throughout the metropolitan Atlanta area.
Dr. Tritt has served on the Medical Advisory Board of Healthsource of Georgia
since June 1996 and the ENT Physician Advisory Board of the Ambulatory Surgery
Division of Columbia HCA since January 1997. Dr. Tritt also serves on our
Medical Advisory Board. Dr. Tritt received his M.D. degree from McGill
University.
Gerald R. Benjamin has served as our Vice Chairman and Secretary since
our inception in July 1996. Mr. Benjamin serves as Chief Executive Officer of
Premier HealthCare, a division of Bock, Benjamin & Co., a boutique health care
investment banking concern which Mr. Benjamin co-founded in 1993. Prior to
founding Bock, Benjamin & Co., Mr. Benjamin served as Chief Executive Officer of
Premier HealthCare, Inc., a health care venture development and management firm
which Mr. Benjamin co-founded in 1991. Prior to co-founding Premier HealthCare,
Inc., Mr. Benjamin served for ten years as Managing Partner and Director of
Corporate Finance Services for Williams, Benjamin, Benator & Libby, an Atlanta,
Georgia-based Certified Public Accounting firm. Prior to forming Williams,
Benjamin, Benator & Libby in 1982, Mr. Benjamin was a member of the Atlanta
office of Ernst & Young. Mr. Benjamin received his B.S. degree in accounting
from the University of Kentucky, where he was named a Coopers & Lybrand scholar.
Richard D. Ballard has served as our Chief Executive Officer and a
director of Physicians' Specialty since November 1996. Prior to joining
Physicians' Specialty, Mr. Ballard served as Vice President of Recruiting for
Physicians' Online, Inc., founding an intranet physician recruiting service.
Prior to joining Physicians' Online in September 1995, Mr. Ballard served as
Executive Vice President, President and Chief Executive Officer of Allegiant
Physician Services, Inc. (formerly Premier Anesthesia, Inc.), an anesthesia
contracting and physician practice management company. Prior to joining Premier
Anesthesia in 1988, Mr. Ballard served for six years as Executive Vice President
of Jackson & Coker Inc., a national physician recruiting firm and for seven
years as director of national recruiting for Spectrum Emergency Care, Inc.
Robert A. DiProva has served as an Executive Vice President and our
Chief Financial Officer since March 1997. Mr. DiProva served as Vice
President-Administration, Chief Financial Officer, Secretary and Treasurer of
A.D.A.M. Software, Inc., a publicly traded medical software company, from
September 1995 to February 1997. Prior to joining A.D.A.M. Software in 1995, Mr.
DiProva served for six years as Vice President, Chief Financial Officer and
Treasurer of DATEQ Information Network, Inc., a publicly traded data management
company. Mr. DiProva is a Certified Public Accountant and received his M.B.A.
from Emory University.
Lawrence P. Kraska has served as our Executive Vice
President-Operations since March 1998, following a one year term as our Vice
President - Operations. Prior to joining Physicians' Specialty, Mr. Kraska
served as Administrator of Atlanta ENT. Prior to joining Atlanta ENT in June
1994, Mr. Kraska provided hospital administration, physician recruiting and
practice management services as the Regional Director of Professional Relations
for the Atlanta division of National Medical Enterprises from July 1993 to May
1994, for Charter Medical Corporation - Charter Peachford Hospital from
September 1992 to June 1993 and as the Administrator for The Center For
Psychiatry, a large multi-specialty mental health group practice, from March
1990 to August 1992. Mr. Kraska received his M.B.A. from Kennesaw State
University.
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<PAGE> 27
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF SECURITIES
Our common stock began trading on March 21, 1997 on the Nasdaq National
Market under the symbol "ENTS." The table below sets forth the high and low
sales prices of our common stock as reported by the Nasdaq National Market for
the periods indicated. These prices are based on quotations between dealers, do
not reflect retail mark-up, mark-down or commissions, and do not necessarily
represent actual transactions.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
Fiscal Year Ended December 31, 1998:
January 1 through March 31, 1998 .............. $ 12.00 $ 8.4375
April 1 through June 30, 1998 .................. 11.50 8.125
July 1 through September 30, 1998 .............. 8.75 5.375
October 1 through December 31, 1998............. 8.375 5.75
Fiscal Year Ended December 31, 1997:
March 21 through March 31, 1997 ................ $ 8.25 $ 7.25
April 1 through June 30, 1997 .................. 7.625 5.00
July 1 through September 1997 .................. 11.00 5.50
October 1 through December 31, 1997 ............ 8.25 13.75
</TABLE>
APPROXIMATE NUMBER OF EQUITY SECURITY HOLDERS
The number of record holders of our common stock as of March 29, 1999
was approximately 60. We believe that the number of beneficial owners exceeds
800.
DIVIDENDS
We have never paid cash dividends on our common stock. We expect that
we will retain all earnings, if any, for the development and growth of our
business and do not anticipate paying any cash dividends to our stockholders in
the foreseeable future. Any future determination as to dividend policy will be
made by our Board of Directors in its discretion, and will depend on a number of
factors, including our future earnings, if any, capital requirements, financial
condition and business prospectus and such other factors as the Board of
Directors may deem relevant. In addition, our $45 million credit facility
restricts the payment of cash dividends. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
RECENT SALES OF UNREGISTERED SECURITIES
We did not issue any equity securities during the quarter ended
December 31, 1998 which were not registered under the Securities Act of 1933, as
amended, except as follows:
- - we granted options to purchase an aggregate of 21,000 shares of our
common stock under our 1996 HealthCare Professionals Stock Option Plan;
and
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<PAGE> 28
- - we issued an aggregate of 276,249 shares of our common stock under the
terms of acquisitions which were completed during 1997.
The above transactions were private transactions not involving a public
offering and were exempt from the registration provisions of the Securities Act
of 1933 under Section 4(2) or Regulation D of the Securities Act. The sale of
such securities was without the use of an underwriter, and the certificates for
the shares contain a restrictive legend permitting the transfer of such
securities only upon registration of the shares or an exemption under the
Securities Act.
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<PAGE> 29
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below summarizes certain
financial data which has been derived from and should be read together with the
more detailed financial statements of Physicians' Speciality Corp. and the notes
thereto which have been audited by Arthur Andersen LLP, independent public
accountants, whose report is included elsewhere in this Annual Report on Form
10-K along with said financial statements. In March 1998, the Emerging Issues
Task Force of the FASB issued its Consensus on Issue 97-2. EITF 97-2 addresses
certain specific matters pertaining to the physician practice management
industry. EITF 97-2 is effective for us for our year ended December 31, 1998.
EITF 97-2 addresses the ability of physician practice management companies to
consolidate the results of operations of physician practices with which it has
an existing contractual relationship. We have determined that our contracts met
the criteria of EITF 97-2 for consolidating the results of operations of the
related physician practices, and we have adopted EITF 97-2 in our consolidated
statement of operations for our year ended December 31, 1998. In addition, we
have adjusted our consolidated statement of operations for our year ended
December 31, 1997 to conform the presentation. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and note 2 to our
consolidated financial statements.
<TABLE>
<CAPTION>
For the Period
from Inception
(July 31, 1996) Fiscal Years Ended December 31,
to December 31, -------------------------------
1996 1997 1998
---- ---- ----
STATEMENT OF OPERATIONS DATA: (amounts in thousands, except share and per share data)
<S> <C> <C> <C>
Net revenue .................................... $ 51 $ 24,488 $ 61,601
Expenses:
Provider claims, salaries, wages and benefits 47 16,747 38,339
Depreciation and amortization ............... 2 377 1,850
General and administration .................. 357 4,371 13,141
--------- ---------- ----------
Total expenses ................................. 406 21,495 53,330
--------- ---------- ----------
Operating income (loss) ........................ (355) 2,993 8,271
--------- ---------- ----------
Net income (loss) .............................. (355) 2,060 5,010
========= ========== ==========
Earnings per share (loss)
Basic ....................................... $ (0.64) $ 0.42 $ 0.62
Diluted ..................................... $ (0.64) $ 0.42 $ 0.60
Weighted average shares outstanding
Basic .................................. 522,894 4,868,035 8,021,914
Diluted ................................ 522,894 4,966,778 8,434,583
</TABLE>
<TABLE>
<CAPTION>
BALANCE SHEET DATA: At December 31,
1996 1997 1998
---- ---- ----
(amounts in thousands)
<S> <C> <C> <C>
Cash and cash equivalents $ 123 $ 5,352 $ 4,926
Working capital (deficit)....................... (473) 10,469 18,388
Total assets ................................... 613 30,598 63,685
Total debt ..................................... 623 912 11,314
Stockholders equity (deficit)................... (10) 25,114 47,808
</TABLE>
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<PAGE> 30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our results of operations and financial
position should be read together with our financial statements and the notes,
appearing elsewhere in this Annual Report on Form 10-K. In these discussions,
most percentages and dollar amounts have been rounded to aid in presentation. As
a result, all such figures are approximations.
OVERVIEW
We are a physician practice management company which provides
comprehensive management services to physician practices specializing in the
treatment and management of ENT diseases and disorders, including specialists
practicing in the related fields of allergy, audiology, oral surgery, plastic
surgery and sleep medicine. We are currently affiliated with 91 physicians, one
dentist and 85 allied health care professionals operating 60 clinical locations
in Alabama, Florida, Georgia, Illinois, New Jersey, New York and Ohio. We also
own a sleep diagnostic laboratory company operating 12 sleep diagnostic
laboratories and a minority equity interest in Atlanta Surgery Center, which
owns three ambulatory surgery centers containing 14 operating rooms.
Our revenue is derived:
- - under management services agreements with affiliated practices;
- - from our capitated managed care contracts;
- - from patient service revenue generated by physicians employed by us;
and
- - from earnings related to ambulatory surgery centers in which we own a
minority interest.
Management fees consist of a stipulated percentage of revenue generated
by or on behalf of physicians practicing at our affiliated practices or a fixed
fee, along with reimbursement of expenses of our affiliated practices.
Capitation revenue consists of fixed monthly payments received by us directly
from HMOs or payors subcontracting with HMOs. Patient service revenue consists
of gross charges, less allowances for bad debts and contractual adjustments,
generated by or on behalf of physicians practicing at our wholly-owned
subsidiary, ENT & Allergy Associates. Additionally, we record our allocable
share of earnings for our minority interest in Atlanta Surgery Center on the
equity basis of accounting.
MANAGEMENT SERVICES AGREEMENTS
The management services agreements delineate the responsibilities and
obligations of us and our affiliated practices. Under the management services
agreements, the affiliated practice assigns to us all of its non-governmental
accounts receivable and all of its right and interest in the proceeds of its
governmental accounts receivable and grants to us the right to collect and
retain the proceeds of the accounts receivable for our account to be applied
under the terms of the agreement. We are responsible for the payment for and
incur practice expenses which include:
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<PAGE> 31
- operating expenses of the affiliated practice, including
salaries and benefits of non-medical employees of the
practice, lease obligations of office space and equipment,
medical and office supplies; and
- the non-operating expenses of the affiliated practice.
We pay for all such expenses directly out of the proceeds of the accounts
receivable assigned to us by the affiliated practice. In addition, under our
management services agreements, we retain, as a part of our management fee, a
stipulated percentage (generally between 12.5% and 15%) of all revenue (after
adjustment for contractual allowances) generated by or on behalf of physicians
practicing at such practice. Contractual allowances are the differences between
the amounts customarily charged by physicians practicing at such practice and
the amounts received pursuant to negotiated fee schedules from payors under
managed care, governmental and indemnity arrangements. We believe that such
contractual allowances are not currently expected to materially adversely affect
our revenue. In New York, in order to comply with state law, we are reimbursed
for practice expenses and are paid a fixed management fee of approximately $2.5
million per year subject to annual increases after the fifth anniversary of the
date of the management services agreement, consistent with the annual percentage
increase in the consumer price index. Our management fees under future
management services agreements will be determined based upon negotiations
between us and future affiliating practices and may vary significantly in the
future.
CAPITATED MANAGED CARE CONTRACTS
Our managed care contracts require us to contract for the provision of
substantially all of the ENT medical and surgical professional services required
by the enrollees under the managed care contracts. We have contracted with
physicians, including those at our affiliated practices in Atlanta, North
Georgia and Birmingham, Alabama, to provide a substantial portion of the medical
professional services in exchange for compensation on a discounted
fee-for-service or contact capitation basis. Affiliated physicians provided
approximately 84% of 1998 services, based upon claims paid or incurred, in
connection with our capitated managed care contracts.
We incur direct costs or provider claims based on medical services
provided by the participating physicians to the managed care company's
enrollees. As a result, if capitation amounts received by us are reduced by the
managed care companies or if enrollees covered by capitated contracts require
more frequent or more extensive care than is anticipated, operating margins may
be reduced or the revenue derived from such contracts may be insufficient to
cover the direct costs of the professional services provided by associated
physicians to enrollees under the contracts. Because of this we may be required
to adjust our rates paid to participating physicians. As a result, our business,
financial condition and results of operations may be adversely affected,
particularly if we are unable to renegotiate compensation levels paid to
participating physicians under the participation agreements on a timely or
favorable basis or negotiate capitated managed care contracts on terms favorable
to us.
Prior to entering into a capitated managed care contract, we analyze
the costs of managing such contracts including a study of the number of lives to
be covered, the geographic region to be covered and the historical utilization
patterns and the associated costs of enrollees. We then determine the capitation
fee necessary to generate acceptable returns under the contract and will
negotiate the capitation rate with the managed care
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<PAGE> 32
company. Capitalization fees are generally a fixed amount per enrollee per
month. Capitated managed care contracts frequently provide for periodic
renegotiation of capitation fees and adjustments based upon changes in the
number of enrollees under the contracts, changes in the types of professional
services to be provided under the contracts, and changes in the geographic areas
to be covered under the contracts.
To assist in monitoring and controlling direct costs or provider claims
under capitated managed care contracts held by us, we utilize our management
information system, a comprehensive capitation administration and utilization
management system. We believe the system enables us to effectively analyze
clinical and cost data necessary to monitor and control expenses and manage
profitability under capitated arrangements and to accurately anticipate the
costs participating physicians will incur in providing services under such
contracts so that we undertake contracts which we can expect to realize adequate
profit margins or otherwise meet our objectives.
During the years ended December 31, 1997 and 1998, approximately 14.8%
and 8.0% of our net revenue, respectively, was derived from capitated
arrangements.
RESULTS OF OPERATIONS
We were incorporated in July 1996 and did not conduct any significant
operations prior to the closing of our initial public offering and initial
acquisitions in March 1997. Accordingly, only nominal revenues were recognized
and general and administrative expenses were incurred during the period from
inception to March 1997. However, we did incur various legal, accounting and
auditing costs in connection with our initial public offering and acquisitions
during the period from inception through December 31, 1996. In addition, our
results of operations for our year ended December 31, 1997 represent less than a
full year of business operations.
In March 1998, the Emerging Issues Task Force of the FASB issued its
Consensus on Issue 97-2. EITF 97-2 addresses certain specific matters pertaining
to the physician practice management industry. EITF 97-2 is effective for us for
our year ended December 31, 1998. EITF 97-2 addresses the ability of physician
practice management companies to consolidate the results of operations of
physician practices with which it has an existing contractual relationship. We
have determined that our contracts met the criteria of EITF 97-2 for
consolidating the results of operations of the related physician practices, and
we have adopted EITF 97-2 in our consolidated statement of operations for our
year ended December 31, 1998. In addition, we have adjusted our consolidated
statement of operations for our year ended December 31, 1997 to conform with
such consolidation.
The following table shows the percentage of net revenue represented by
various expense categories reflected in our consolidated statement of
operations:
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1998
----- -----
<S> <C> <C>
Net Revenues 100.0 % 100.0 %
Operating expenses:
Provider claims, wages and benefits 68.4 62.2
General and administrative 17.9 21.4
Depreciation and amortization 1.5 3.0
----- -----
Total operating expenses 87.8 86.6
----- -----
Operating Income: 12.2 13.4
Other income (expense) - net 1.8 (0.1)
----- -----
Income before income taxes 14.0 13.3
Provision for income taxes 5.6 5.2
----- -----
Net Income 8.4 % 8.1 %
===== =====
</TABLE>
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<PAGE> 33
In the following discussions, most percentages and dollar amounts have
been rounded to aid presentation. As a result, all such figures are
approximations.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUE. Net patient service revenue increased from $20.7 million in 1997 to
$54.9 million in 1998, an increase of $34.2 million, or 165%. The increase in
patient service revenue was primarily attributable to an increase in the number
of physicians affiliated with us to 82 physicians at December 31, 1998 as
compared with 46 physicians at December 31, 1997. Patient service revenue
generated by physicians who were affiliated with us for both 1997 and 1998
increased on average 12% per physician. Capitation revenues increased from
$3.6 million in 1997 to $4.9 million in 1998, an increase of $1.3 million, or
36%. The increase in capitation revenues was primarily attributable to an
increase in the aggregate number of enrollees to approximately 431,000 at
December 31, 1998 as compared to approximately 315,000 at December 31, 1997, an
increase of approximately 116,000 enrollees, or 37%. Management fees increased
from $169,000 in 1997 to $1.2 million in 1998 primarily as a result of
transitional management fees earned in conjunction with integration of our
acquired affiliated practices. For 1998, we recorded as revenue earnings from
our 17.5% equity interest in Atlanta Surgery Center, which we acquired in
September 1998, in the amount of $630,000.
As a result of the foregoing factors, our net revenue increased to
$61.6 million in 1998 as compared with $24.5 million in 1997, an increase of
$37.1 million or 152%.
PROVIDER CLAIMS, WAGES AND BENEFITS. Provider claims, wages and benefits, which
includes physician compensation, increased to $38.3 million in 1998 from $16.7
million in 1997, an increase of $21.6 million or 129%. The dollar increase in
provider claims, wages, and benefits was primarily attributable to the addition
of non-medical personnel at our affiliated practices required to support the
increase in the number of affiliated physician groups managed by us. As a
percent of net revenue, provider claims, wages and benefits decreased to 62% in
1998 from 68% in 1997.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased to
$13.1 million in 1998 from $4.4 million in 1997, an increase of $8.7 million or
198%. This increase was primarily attributable to the addition of personnel and
greater support costs associated with our rapid expansion since March 1997. As a
percent of net revenue, general and administrative expenses increased to 21% in
1998 as compared to 18% in 1997.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses increased
to $1.8 million in 1998 from $377,000 in 1997, an increase of $1.4 million or
377%. The increase was primarily the result of the increases in intangible
assets, or goodwill, resulting from additional acquisitions and resulting
increases in amortization of intangible assets associated with these
acquisitions, as well as investments in equipment, leasehold improvements and
management information systems and resulting increases in depreciation of these
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<PAGE> 34
assets. As a percent of net revenue, depreciation and amortization expense
increased to 3% in 1998 from 1.5% in 1997.
OTHER INCOME (EXPENSE). Other expense for 1998 was $54,000 representing interest
expense related primarily to the subordinated seller notes and borrowings and
the commitment fee in conjunction with our $45 million senior credit facility
which was offset by interest income earned on the short term investment of
excess cash and cash equivalents. Other income for 1997 was $429,000 and was
derived from interest income earned on the short term investment of cash and
cash equivalents of our initial public offering proceeds, net of amounts of
immaterial interest.
INCOME TAXES. Income taxes were provided for at 39% and 40% effective tax rates
for 1998 and 1997, respectively.
NET INCOME. As a result of the foregoing factors, net income increased to $5.0
million in 1998 as compared to $2.1 million in 1997, an increase of $2.9 million
or 143%.
QUARTERLY RESULTS
The following table presents certain unaudited quarterly financial data
for each of the quarters during the years ended December 31, 1997 and 1998. This
information has been prepared on the same basis as our consolidated financial
statements appearing elsewhere in this Form 10-K and include, in our opinion,
all adjustments (consisting of only normal recurring adjustments) necessary to
present fairly the quarterly results when read in conjunction with our
consolidated financial statements and the notes thereto. We have historically
experienced and expect to continue to experience quarterly fluctuations in net
revenue and net income primarily relating to the timing of acquisitions and
seasonable variations. As a result, the operating results for any quarter are
not necessary indicative of results for any future period or for the full year.
<TABLE>
<CAPTION>
1997 1998
--------------------------------------- -------------------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
----- ------ ----- ------ ------ ------ ----- ------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NET REVENUE $ 634 $6,263 $7,785 $9,806 $12,004 $14,213 $16,613 $18,771
OPERATING INCOME 20 720 962 1,291 1,539 1,718 2,306 2,708
NET INCOME 20 512 664 864 957 1,124 1,357 1,572
BASIC NET INCOME PER SHARE $0.02 $ 0.09 $ 0.11 $ 0.14 $ 0.15 $ 0.15 $ 0.15 $ 0.18
DILUTED NET INCOME PER SHARE $0.02 $ 0.09 $ 0.11 $ 0.13 $ 0.14 $ 0.14 $ 0.15 $ 0.17
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
We utilize capital primarily:
- to acquire assets or equity of physician practices;
- to acquire equipment utilized by our affiliated practices;
- to fund corporate capital expenditures including management
information systems; and
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<PAGE> 35
- to fund ongoing corporate working capital requirements.
At December 31, 1998, we had working capital of $18.4 million compared
to $10.5 million at December 31, 1997, an increase of $7.9 million. The increase
in working capital was due primarily to an increase in net accounts receivable
of $6.9 million relating to the increase in the number of affiliated physician
groups managed by us.
For the year ended December 31, 1998, net cash provided by operating
activities was $1.4 million compared to net cash used in operating activities of
$1.3 million for the year ended December 31, 1997. Net cash provided by
operating activities for the year ended December 31, 1998 consists of our net
income, increased by non-cash expenses such as depreciation and amortization,
and decreased by the non-cash earnings from our 17.5% interest in Atlanta
Surgery Center, and adjusted by changes in the components of working capital,
primarily accounts receivable and income taxes. For the year ended December 31,
1998, we remitted estimated income tax payments of $3.7 million related to our
pre-tax earnings and the realization of accounts receivable acquired in
connection with physician practice acquisitions having zero basis for income tax
purposes.
Net cash used in investing activities was $21.8 million for the year
ended December 31, 1998 compared to $5.7 million for the year ended December 31,
1997. Our uses of cash in investing activities related exclusively to physician
practice acquisitions and capital expenditures in both the 1998 and 1997
periods. In 1998 we received a distribution from our 17.5% interest in Atlanta
Surgery Center of approximately $320,000.
Net cash provided by financing activity was $20.0 million for the year
ended December 31, 1998 compared to $12.2 million for the year ended December
31, 1997. We realized net proceeds of $16.5 million in connection with a public
offering of 2,307,540 shares of our common stock on May 15, 1998. In addition in
1998 we borrowed $3.7 million under our $45 million credit facility. In 1997 we
realized proceeds of $14.3 million in connection with our initial public
offering of which $2.3 million was utilized to extinguish debt assumed in
connection with physician practice asset acquisitions.
On July 31, 1998, we 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. Our $45 million credit facility replaced our $20 million senior
credit facility. Borrowings under our credit facility:
- are secured by the assignment to the banks of our stock in all
of our subsidiaries and our accounts receivable, including the
accounts receivable assigned to us by affiliated practices
pursuant to our management services agreements;
- are guaranteed by all our subsidiaries, including future
subsidiaries; and
- restrict us from pledging our assets to any other party.
Advances under our credit facility will be used to fund acquisitions and working
capital, will be governed by a borrowing base related primarily to our earnings
before interest, taxes, depreciation and amortization and will bear interest, at
our option, based upon either a prime-based or LIBOR-based rate. EBITDA is used
by us as an indicator of our ability to incur and service debt. EBITDA should
not be considered an alternative to operating
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<PAGE> 36
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. Our credit facility
contains affirmative and negative covenants which, among other things, require
us 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 our business. We were in compliance with the debt
covenants at December 31, 1998. At March 29, 1999, we had borrowings of $3.75
million under our credit facility.
Several multi-specialty companies in the physician practice management
industry have discontinued physician practice management activities or divested
assets related to physician practice management or announced plans to do so.
Other physician practice management companies have completed or announced
transactions, including mergers, recapitalizations or other corporate
transactions, as a result of which they are no longer public companies. As a
result of these trends and the depressed stock prices of physician practice
management companies, we believe that physician practice management companies
may generally experience a decrease in practice acquisition activity and an
associated slow down in revenue growth attributable to practice acquisitions.
Consistent with our market driven strategy, we focus primarily on practice and
ancilliary services acquisitions in markets in which we already manage ENT
practices and to a lesser extent, in new markets.
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," which establishes standards for the reporting of
comprehensive income in a company's financial statements. Comprehensive income
includes all changes in a company's equity during the period that results from
transactions and other economic events other than transactions with its
stockholders. SFAS No. 130 was effective for the year beginning January 1, 1998.
For us, comprehensive income equals net income.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information," which requires that an enterprise
disclose certain information about operating segments. SFAS No. 131 was
effective for our financial statements for the year ended December 31, 1998. We
consider our entire business as one reporting segment: providing 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 and related specialties.
In February 1998, the FASB issued SFAS No. 132, "Employer's Disclosure
About Pensions and Other Postretirement Benefits," which require disclosure of
additional information about the cost and financial status of pension and
postretirement plans. SFAS No. 132 was effective for financial statements for
the year ended December 31, 1997. SFAS No. 132 did not require any significant
disclosures or revision of prior disclosures.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes standards for reporting
and disclosing information about for derivative instruments. SFAS No. 133 is
effective for financial statements for our fiscal quarter beginning July 1,
1999. We do not expect SFAS No. 133 will have a significant effect on our
current financial reporting.
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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 our operations and adversely affect our cash flows and results of
operations.
We recognize the importance of the Year 2000 issue and have given it
high priority. Our 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. The scope of our compliance efforts include (i) identification
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.
There are three major IT system applications that we rely upon to
process transactions and provide information for managing our operations. These
applications have been identified as follows:
- accounting and financial reporting system;
- practice management billing and accounts receivable systems;
and
- capitated claims processing and reporting system.
Accounting and financial reporting system. During 1998 we fully
implemented the Great Plains accounting and financial reporting software
applications at all of our affiliated practices, our subsidiaries and our
corporate locations. The Great Plains accounting package has been modified and
tested and we believe it is Year 2000 compliant.
Practice management billing and accounts receivable systems. Our
affiliated practices currently utilize software packages which were developed by
large third party software development companies such as Medic, Medical Manager,
Verysis and Reynolds & Reynolds. We have been in contact with all of these
companies and believe that all Year 2000 compliant modified programs will be
fully tested and implemented by us and our affiliates during the second quarter
of 1999.
Capitated claims processing and reporting system. We have internally
developed a proprietary capitated claims processing and reporting system which
we believe is Year 2000 compliant.
We are also highly dependent on receiving payments from third party
payors for capitated fees and for insurance reimbursement for claims submitted
by our 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 our cash flow and could materially adversely affect our
operations. We and our affiliated practices have been or will be in
communication with these payors to ensure 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.
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Like virtually every company, we are at risk for the failure of major
infrastructure providers to adequately address potential Year 2000 problems. We
are highly dependent on a variety of public and private infrastructure
providers to conduct our 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 our ability and our
affiliated practices' ability to conduct business. While we are aware of these
risks, a complete assessment of all such risks is beyond the scope of our Year
2000 project.
Through December 31, 1998, we have incurred costs of approximately
$125,000 related to the Year 2000 issue. We do not anticipate that we will incur
any additional material costs associated with addressing Year 2000 issues.
Our current estimates of the amount of time and costs necessary to
remediate and test our 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 our estimates of the
amount of time and costs needed to modify and test our IT and non-IT systems for
Year 2000 compliance. These developments include, but are not limited to:
- the availability and cost of personnel trained in this area;
- the ability to locate and correct all relevant date-sensitive
codes in both IT and non-IT systems;
- unanticipated failures in our IT and non-IT systems; and
- the planning and Year 2000 compliance success that
third-parties attain.
We cannot determine the impact of these potential developments on the
current estimate of probable costs of making our IT and non-IT systems Year 2000
compliant. Accordingly, we are not able to estimate our possible future costs
beyond the current estimate of costs. As new developments occur, these cost
estimates may be revised to reflect the impact of these developments on the
costs to us of making our IT and non-IT systems Year 2000 compliant. Such
revisions in costs could have a material adverse impact on our results of
operations in the quarterly period in which they are recorded. Although we
consider it unlikely, such revisions could also have a material adverse effect
on the business, financial condition or results of our operations. If Year 2000
compliance is not achieved, we have developed a contingency plan which includes:
- increasing normal inventories of critical supplies for our
affiliated practices prior to December 31, 1999;
- ensuring an adequate line of bank credit if third party payor
payments are disrupted; and
- ensuring that all critical staff are available or scheduled to
work prior to, during and immediately after December 31, 1999.
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SEASONALITY
Our business is subject to seasonal patient visits to affiliated
physicians. Fee-for-service revenue is typically lower during the third quarter
of our fiscal year. This lower level of patient visits is attributable to
physician vacations, patients returning to school and seasonal illness patterns.
Capitated revenue, however, is not susceptible to seasonal influences. Quarterly
results also may be materially affected by the timing of acquisitions and the
timing and magnitude of costs related to acquisitions. Results for any quarter,
therefore, may not necessarily be indicative of the results that we may achieve
for any subsequent fiscal quarter or for a full fiscal year.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA
The response to this item is included in a separate section of this
Report. See Index to Consolidated Financial Statements on Page F-1.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not applicable.
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PART III
The information called by Item 10: Directors and Executive Officers of
the Registrant; Item 11: Executive Compensation; Item 12: Security Ownership of
Certain Beneficial Owners and Management; and Item 13: Certain Relationships and
Related Transactions will be included in and is incorporated by reference from
our definitive proxy statement to be filed pursuant to Regulation 14A within 120
days after the close of our fiscal year.
RISK FACTORS
You should review the following factors carefully, in conjunction with
the other information in this Report and our consolidated financial statements.
These factors could cause our actual results to differ materially from those we
currently anticipate and contained in forward-looking statements made in this
Report and presented elsewhere by our management from time to time. See "Note
Regarding Forward Looking Statements."
COMPANY RISKS
We have a limited operating history and may not be able to manage and integrate
affiliating practices.
We were formed in July 1996 and prior to our affiliation with physician
practices in March 1997, we had no history of operations. Since that time, we
have acquired several ENT physician practices. If we do not successfully
integrate our affiliated practices or any future affiliating practices our
operations and financial condition would be materially adversely affected.
Before we acquired these practices, each physician practice operated as
a separate independent entity. As a result, we have limited experience in
integrating and managing multiple or multi-state physician practices and we have
a relatively small number of management personnel conducing these activities. We
also have limited experience in integrating and managing physician practices
outside the Atlanta area. We cannot predict whether we will be able to:
- successfully manage physician practices outside of the
metropolitan Atlanta area;
- successfully integrate the operations of our affiliated
physician practices or future affiliating practices; and
- implement our company-wide systems and procedures necessary to
successfully manage the combined business on a profitable
basis.
Our operating results may be adversely affected by our acquisition strategy.
Our strategy of growth through acquisitions presents risks that could
materially adversely affect our business, results of operations or financial
condition, including:
- the diversion of management's attention;
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- - the assimilation of the operations and personnel of affiliated
practices;
- - the contingent and latent risks associated with the past operations of
and other unanticipated problems arising in affiliated practices;
- - increased competition for acquisition opportunities;
- - the need to hire and retain additional management and administrative
personnel and expand operational systems;
- - charges to operations for depreciation and amortization and, to the
extent debt financing is used, interest expense; and
- - if we issue equity securities in connection with future acquisitions or
seek additional equity financings, our existing stockholders will
experience dilution.
We cannot predict whether:
- - we can effectively implement our acquisition strategy or that such
strategy will be successful;
- - we will be able to affiliate with physician practices on terms
favorable to us;
- - the operations of any practices we acquire can be successfully
integrated into our business;
- - we will realize any benefits of the affiliations;
- - there will be substantial unanticipated costs associated with new
acquisitions; or
- - we can profitably provide management services to any specialty
physician practices that may be acquired in the future.
The failure to manage growth effectively could materially adversely
affect our operations and financial condition. Our ability to consummate future
acquisitions depends to a significant extent on the efforts of Gerald R.
Benjamin, our Vice Chairman and Secretary. We are evaluating and are in various
stages of discussions in connection with the potential acquisition of assets or
equity of several ENT physician practices and related specialty practices and
ancillary service providers. However, we have no agreements or arrangements with
respect to the terms of any particular acquisitions and we may not be able to
complete any additional acquisitions. Several multi-specialty companies in the
physician practice management industry have discontinued physician practice
management activities or divested assets related to physician practice
management or announced plans to do so. Other physician practice management
companies have completed or announced transactions, including mergers,
recapitalizations or other corporate transactions, as a result of which they are
no longer public companies. As a result of these trends and the depressed stock
prices of physician practice management companies, we believe that physician
practice management companies may generally experience a decrease in practice
acquisition activity and an associated slow down in revenue growth attributable
to practice acquisitions. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
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We depend on our affiliated physicians.
If we are unable to retain our affiliated physicians our operations
will be adversely affected. Our revenues depend primarily on:
- - the fees and revenues generated by affiliated physicians;
- - the continued participation of affiliated physicians providing medical
services to enrollees of managed care companies that we have capitated
contracts with; and
- - to a lesser extent, independent physicians contracting with us to
participate in provider networks which we have developed.
In particular, 65 of 92 of our affiliated physicians are employed by
two of our affiliated practices and generate a substantial portion of our
revenue. We cannot predict the continued services of any particular physician.
Physicians providing medical services under our managed care contracts can
typically terminate their agreements to provide these services by providing
notice of such termination to the payor. Termination of these agreements by such
physicians may result in termination by the payor of a managed care contract
between us and the payor. Any material loss of revenue by affiliated physicians
or the termination of managed care contracts resulting from the loss of network
physicians or otherwise, could materially adversely affect our operations and
financial condition.
Our operating results may be adversely affected by over-utilization by managed
care enrollees and reduction of capitated rates.
Under our capitated contracts, we typically accept a pre-determined
amount for professional services per patient per month from the payor in
exchange for arranging for the provision of all covered professional services to
the enrollees under the agreement. To the extent that the enrollees covered by
such managed care contracts require more frequent or extensive care than is
anticipated:
- - our operating margins could be reduced; and
- - the revenues derived from such contracts could be insufficient to cover
the costs of the services provided.
In either event, our operations and financial condition could be materially
adversely affected.
Capitated contracts pass much of the financial risk of providing care,
such as over-utilization, from the payor to the provider. We compensate
physicians on a discounted fee-for-service or contact capitation basis for
providing ENT medical and surgical professional services to enrollees of a
managed care company. We incur costs based on the frequency and extent of
professional services provided by such physicians, but only receive a fixed fee
for agreeing to provide such services.
As an increasing percentage of patients enroll in managed care
arrangements, our future success and ability to expand will depend in part upon
our ability to:
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- - negotiate and renew on behalf of physicians, contracts with managed
care payors on terms favorable to us;
- - increase the number of managed care enrollees served by physicians
providing services under our managed care contracts;
- - contract on a favorable basis with additional physicians to provide
medical professional services to such enrollees; and
- - effectively manage health care costs through various methods, including
competitive pricing and utilization management and review for purchased
services.
The proliferation of capitated contracts in markets served by us could result in
decreased predictability of operating margins. We cannot predict whether:
- - we will be able to negotiate or renew, on behalf of physicians,
satisfactory arrangements on a capitated basis;
- - we will be able to contract with sufficient numbers of physicians to
meet the requirements of managed care organizations; or
- - that such arrangements will be profitable to us in the future.
Our capitated managed care contracts together accounted for
approximately 8.0% of our net revenue for the year ended December 31, 1998. Our
capitated managed care agreements are generally subject to 90 to 120 day
cancellation by either party, and certain contracts are subject to periodic
renegotiation of rates, covered benefits and other terms and conditions. We
cannot predict whether we will be able to renew any of these managed care
agreements or, if renewed, that they will contain terms favorable to us and the
physicians providing medical services. The loss of any of these contracts or
significant reductions in capitated reimbursement rates under these contracts
could materially adversely affect our operations and financial condition.
In addition, in certain jurisdictions, capitated agreements in which
the provider bears the risk are regulated under insurance laws. The degree to
which these capitated arrangements are regulated by insurance laws varies on a
state by state basis. As a result, we may be limited in the states in which we
have capitated arrangements and other states in which we may seek to enter into
or arrange capitated agreements for physicians when those capitated contracts
involve the assumption of risk.
Our substantial debt reduces cash available for our business, may adversely
affect our ability to obtain additional funds and increases our vulnerability to
economic or business downturns.
As of December 31, 1998, our indebtedness was approximately $11.3
million, representing approximately 19.5% of our total capitalization.
Accordingly, we are subject to all of the risks associated with substantial
indebtedness, including:
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- - a substantial portion of our cash flow from operations will be used to
service our indebtedness;
- - charges for interest expense adversely affect our results of
operations;
- - reduced funds are available for operations, business opportunities
and other purposes;
- - our ability to obtain additional financing for acquisitions, working
capital, capital expenditures, general corporate or other purposes may
be impaired;
- - we are more vulnerable to economic downturns, less able to withstand
competitive pressures and less flexible in reacting to changes in our
industry and general economic conditions; and
- - if we default under any of our debt instruments or if our creditors
demand payment of a portion or all of our indebtedness, we may not have
sufficient funds to make such payments.
Any of these risks may materially adversely affect our operations and financial
condition and adversely affect our stock price.
Our indebtedness as of December 31, 1998 consisted of:
- - borrowings under our credit facility in the aggregate amount of
approximately $3.8 million;
- - long-term subordinated promissory notes in the aggregate principal
amount of approximately $7.6 million, which promissory notes have
varying maturity dates and interest rates ranging from 5.6% to 6.0%;
and
- - contingent promissory notes in the aggregate principal amount of
approximately $3.8 million, payable only if the holders of the notes
achieve certain performance thresholds.
We will incur additional indebtedness, including additional borrowings under our
credit facility, for future acquisitions and integration and management of
acquired practices. We may also issue our securities in connection with future
transactions or seek additional equity financings, which could result in the
dilution of existing equity positions.
Our credit facility restricts borrowings and certain activities and requires us
to comply with financial requirements.
Borrowings under our credit facility are governed by, among other
factors, our earnings before interest, taxes, depreciation and amortization. We
cannot predict whether:
- - amounts available under our credit facility will be sufficient to fund
future acquisitions; or
- - if such amounts are not sufficient, that we will be able to obtain
additional financing on terms acceptable to us or at all.
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An inability to obtain such financing on favorable terms could limit our growth.
Future borrowings under our credit facility will bear interest at variable
rates. Accordingly, increases in interest rates would increase our interest
expense and would adversely affect our cash flow and results of operations. In
connection with our credit facility we:
- - are required to maintain certain financial ratios;
- - are restricted from engaging in certain activities; and
- - have granted to the lenders a security interest in the capital stock of
our subsidiaries and all of our accounts receivable, including the
accounts receivable of affiliated practices assigned to us under our
management services agreements.
In the event of a default under our credit facility or a bankruptcy, liquidation
or our reorganization, such stock and assets would be available to the lenders
to satisfy our obligations to such lenders before any payment could be made to
our stockholders. As a result, our stockholders could lose all or a substantial
portion of their investment in our common stock.
Our operating results may be adversely affected by reductions in reimbursement
by third party payors.
Both government and private payors have instituted cost containment
measures designed to limit payments made to health care providers by:
- - reducing reimbursement rates;
- - limiting services covered;
- - increasing utilization review of services;
- - negotiating prospective or discounted contract pricing;
- - adopting capitation strategies; and
- - seeking competitive bids.
We believe that these trends will continue to result in a reduction of per
patient revenue at our affiliated practices.
In addition, government reimbursement programs are subject to:
- - statutory and regulatory changes;
- - retroactive rate adjustments;
- - administrative rulings; and
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- - government restrictions,
These reductions and trends materially decrease the range of services covered by
such programs or the reimbursement rates paid for the medical services provided
by our affiliated physicians which would have a material adverse effect on our
operations and financial condition. Changes in the composition of third party
payors from higher reimbursement rate payors to lower reimbursement rate payors
could have an adverse effect on our operating results. These measures may
adversely affect:
- - the amounts or types of services that may be reimbursable in the
future; or
- - the future reimbursement (including reductions in capitated rates) for
any service offered by physicians.
Substantially all of our revenue and the revenue of our affiliated
practices has been, and are expected to continue to be, derived from:
- - managed care companies;
- - commercial insurers;
- - Medicare; and
- - other third party payors.
We depend on key personnel.
Because we have a limited number of management personnel, we depend to
a significant extent on our executive officers and key personnel, including:
- - Ramie A. Tritt, M.D., our Chairman of the Board and President and a
principal stockholder of Physicians' Specialty (and a principal
stockholder of an affiliated practice);
- - Richard D. Ballard, our Chief Executive Officer; and
- - Lawrence P. Kraska, our Executive Vice President -- Operations.
In addition, our ability to consummate future acquisitions depends to a
significant extent on the efforts of Gerald R. Benjamin, our Vice Chairman and
Secretary. The loss of Dr. Tritt, Mr. Ballard, Mr. Benjamin or Mr. Kraska could
materially adversely affect our business. We believe that our future success
will depend in part upon our ability to attract and retain additional management
personnel. Competition for these personnel is intense and we will compete for
qualified personnel with numerous other employers, some of whom have greater
financial and other resources. We cannot predict whether we will be successful
in attracting or retaining these personnel.
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We are subject to conflicts of interest with some of our affiliates.
There have been and are currently agreements by and among us, certain
affiliated practices, each of their respective officers, directors and
affiliates, and entities controlled by such officers, directors and affiliates.
In addition, Dr. Tritt is a physician at one of our affiliated practices and
will be subject to competing demands on his time. In addition, we have
agreements with Premier Health Care, of which Mr. Benjamin is a principal,
relating to acquisitions and corporate transactions entitling Premier Health
Care to fees in connection with these transactions. Any future transactions and
agreements between us and such individuals and entities are subject to approval
by a majority of the board of directors, including a majority of the independent
directors.
Industry Risks
We face intense competition in the physician practice management industry.
The physician practice management industry is highly competitive. We
expect competition to increase as a result of the consolidation of the existing
highly-fragmented health care delivery system into larger and more organized
groups and networks of health care providers and ongoing cost containment
pressures among other factors. We compete with:
- - physician practice management companies;
- - for-profit and nonprofit hospitals;
- - managed care companies;
- - physician practices; and
- - other competitors seeking to affiliate with physicians or provide
management services to physicians.
As compared to us, many of our competitors:
- - are significantly larger;
- - provide a wider variety of services;
- - have greater experience in providing health care management services;
- - have longer established relationships with customers for these
services; and
- - have access to substantially greater financial resources.
Physicians are facing the challenge of providing quality patient care
while experiencing:
- - rising costs;
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- - strong competition for patients; and
- - a general reduction of reimbursement rates by both private and
government payors.
We believe that competition for patients is dependent upon, among other things:
- - the geographic coverage of affiliated practices;
- - the reputation and referral patterns of affiliated physicians; and
- - the breadth of ENT and related specialty medical and surgical services
provided by physicians practicing at affiliated practices.
Therefore, our success is dependent upon our ability or our affiliated
practices' ability to recruit, train and retain qualified health care
professionals in new and existing markets. We face competition for these
personnel from:
- - other health care providers;
- - research and academic institutions;
- - government entities; and
- - other organizations.
We cannot predict whether we will be able to hire and retain a sufficient number
of competent physicians and other health care professionals to operate and
expand our business. Our inability to hire and retain such health care
professionals could materially adversely affect our operations and financial
condition.
Concern over the rising cost of health care has led to the emergence
and increased prominence of managed care and a resulting increase in competition
for managed care contracts. Our ability to compete successfully for exclusive
managed care contracts may depend upon our ability:
- - to manage utilization under such contracts; and
- - to increase the number of physicians and other health care
professionals included in our provider networks.
We compete for exclusive managed care contracts with
- - physician practice management companies;
- - multi-specialty physician practices; and
- - certain other entities.
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We cannot predict whether managed care companies will seek to contract with an
entity, such as us, that is affiliated with physicians providing services in a
single specialty rather than an entity that is affiliated with physicians
providing multi-specialty services. Our inability to enter into such
arrangements in the future on behalf of our affiliated practices could
materially adversely affect our operations and financial condition.
We are subject to antitrust laws.
We and our affiliated practices are subject to federal and state
antitrust statutes that prohibit anti-competitive activities by groups of
competitors, including:
- - price fixing; and
- - market allocation.
The federal and state antitrust enforcement agencies have brought civil and
criminal enforcement actions against the joint activities of physician
organizations that violate antitrust laws. Anti-competitive activity may also be
subject to private lawsuits by those injured by the activity. Collaboration
regarding the pricing of services; market allocation; and certain other types of
joint action, however, may be permissible in the context of an integrated joint
venture if those activities are ancillary to otherwise legitimate purposes of
the joint venture. The federal antitrust agencies, the Federal Trade Commission
and the United States Department of Justice, have established "antitrust safety
zones" for physician networks that meet certain criteria. The antitrust safety
zones are for networks in which the providers:
- - share substantial financial risk (e.g., capitation or substantial
withholding); and
- - constitute less than specified percentages (20% for exclusive networks
and 30% for non-exclusive networks) of total providers in a specialty
or subspecialty in the market.
Conduct outside the safety zones is not necessarily unlawful, but antitrust
regulatory authorities will give greater scrutiny to the potential impact on
overall competition. State antitrust agencies may or may not rely on antitrust
analysis similar to that of the federal agencies. A determination that our
operations violate federal or state antitrust laws could materially adversely
affect our operations and financial condition. Regardless of the merit or
eventual outcome of such a claim, an antitrust claim asserted by Federal or
state antitrust agencies or a private party against us could:
- - be costly to defend;
- - consume management resources; and
- - adversely affect our operations and financial condition.
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We are subject to various government regulations.
The health care industry is highly regulated. We cannot predict whether
the regulatory environment in which we operate will change significantly in the
future. In general, regulation of health care companies is increasing. Every
state imposes licensing requirements on individual physicians and on facilities
and services operated by physicians. Many states require regulatory approval,
including certificates of need, before:
- - establishing certain types of health care facilities;
- - offering certain services; or
- - making expenditures in excess of statutory thresholds for health care
equipment, facilities or programs.
We cannot predict whether we will be required to obtain certificates of need for
our activities. Federal and state laws also regulate HMOs and other managed care
organizations. In connection with the expansion of existing operations and the
entry into new markets and managed care arrangements, we and our affiliated
practices may become subject to compliance with additional regulations.
We and our affiliated practices are also subject to federal, state and
local laws addressing issues such as:
- - occupational health and safety;
- - employment;
- - medical leave;
- - insurance regulations;
- - civil rights and discrimination; and
- - medical waste and other environmental issues.
Federal, state and local governments are expanding, at an increasing rate, the
regulatory requirements on businesses, including medical practices. The
imposition of these regulatory requirements may have the effect of increasing
our operating costs and reducing our profitability.
Various state and federal laws regulate the relationships between
providers of health care services, physicians and other clinicians. These laws,
among others, include:
- - the federal anti-kickback statute; and
- - the Stark Law.
The anti-kickback statute prohibits the offer, payment, solicitation or receipt
of any direct or indirect remuneration in return for:
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- - the referral of patients for items or services for which payment may be
made under Medicare, Medicaid or federally funded healthcare programs;
or
- - the ordering or arranging for the furnishing of items or services for
which payment may be made under Medicare, Medicaid or federally-funded
health care programs.
In April 1998, the Office of Inspector General of the Department of Health and
Human Services issued an advisory opinion which states that a percentage based
management arrangement between a physician practice management company and a
physician group could violate the federal anti-kickback statute if one of the
purposes of the arrangement is to compensate the management company for its
efforts to arrange for referrals for the group through its services provided to
the group, including marketing and advertising.
The Stark Law prohibits physicians' referrals for certain designated health
services to entities with which they have financial relationships. Violations of
these laws may result in:
- - substantial civil or criminal penalties;
- - denial of payment; and/or
- - exclusion from participation in the Medicare, Medicaid and
federally-funded health care programs.
To the extent that we are deemed to be a separate provider of medical services
under our management services agreements and to receive referrals from
physicians, the financial arrangements could be subject to scrutiny under the
Stark Law or anti-kickback statute. One of our wholly owned subsidiaries does
employ physicians, and as such, it does maintain a provider number. In addition,
under separate statutes, submission of claims for payment that are not provided
as claimed or are false, fictitious or fraudulent or misrepresent a material
fact may lead to substantial civil or criminal penalties to us or one or more of
our affiliated practices. It may also result in the exclusion from participation
in the Medicare, Medicaid and federally-funded programs which could result in a
significant loss of reimbursement. Our arrangements have not been the subject of
Federal judicial or regulatory interpretation. A determination of liability
under any such laws could result in substantial costs and penalties to us.
Several states, including certain states in which we operate or may
operate in the future, have adopted laws similar to the Stark Law and federal
anti-kickback law that cover patients in private programs as well as government
programs. In addition, the laws of many states, including certain states in
which we operate or may operate in the future, also prohibit physicians from
splitting fees with non-physicians. In Florida, the Florida Board of Medicine
recently issued a declaratory statement, which has been stayed pending its
appeal, indicating that certain types of arrangements between physicians and
physician practice management companies may violate fee splitting and patient
referral laws. If upheld such declaratory statement could be construed as
prohibiting physician management companies from being compensated based on a
percentage of the managed practice's revenues or profits. In addition, the
declaratory statement could be construed as restricting the manner in which the
management company provides marketing services to a managed practice.
The laws of some states, including certain states in which we operate
or may operate, prohibit non-physician entities from:
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- - practicing medicine; or
- - exercising control over the professional judgments or decisions of
physicians concerning the treatment and diagnosis of patients.
These laws and their interpretation vary from state to state and are enforced by
the courts and by regulatory authorities with material discretion. A
determination of liability under any such laws could materially adversely affect
our operations and financial condition.
Our business operations have not been the subject of judicial or
regulatory interpretation. We cannot predict whether:
- - our business and our contractual arrangements with affiliated practices
and any practices with which we have arrangements in the future will
not be successfully challenged as constituting the unlicensed practice
of medicine or unlawful splitting of fees by physicians with
non-physicians;
- - review of our business and our arrangements with affiliated practices
by courts or regulatory authorities will not result in determinations
that could adversely affect our operations; or
- - the health care regulatory environment will change so as to restrict
our operations or their expansion.
Additionally, any claim or proceeding asserted by state or federal agencies or a
private person against us or our affiliated practices could:
- - be costly to defend;
- - consume management resources; and
- - adversely affect our reputation and business regardless of the merit or
eventual outcome of such claim.
The regulatory requirements of certain jurisdictions may limit our expansion
into, or ability to continue operations within, such jurisdictions if we are
unable to modify our operational structure to conform with such regulatory
requirements. Any limitation on our ability to expand could materially adversely
affect our operations and financial condition.
Our operations could be affected by health care reform.
Political, economic and regulatory influences are continuously
subjecting the health care industry in the United States to fundamental change.
On August 5, 1997, President Clinton signed the Balanced Budget Act which
contemplates savings of $115 billion in Medicare spending and $13 billion in
Medicaid spending over the five-year period from 1998 to 2002. The savings will
result primarily from reductions in reimbursements to providers due to several
factors, including but not limited to:
- - alterations in the methodology for calculating physician fee schedule
payments;
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<PAGE> 53
- - application of a budget neutrality adjustment to prevent physician fees
from increasing above a certain aggregate amount; and
- - expansion of options for Medicare delivery including provider-sponsored
organizations, HMOs, preferred provider organizations and private
fee-for-service plans.
The Balanced Budget Act also establishes more stringent sanctions for
convictions of health care related crimes including:
- - permanent exclusion from participation in the Medicare program after
conviction of three health care related crimes; and
- - imposition of civil monetary penalties for violations of the federal
anti-kickback statute.
Due to the enactment of this health care reform and uncertain interpretation of
these reform measures by regulatory authorities, it is difficult to determine
the impact that this reform will have upon us and our affiliated physicians. We
cannot predict whether these reform measures will materially adversely affect
our operations and financial condition. In addition to federal health care
reform, some states in which we operate or may operate in the future are also
considering various health care reform proposals. We anticipate that both
federal and state governments will continue to review and assess alternative
health care delivery systems and payment methodologies and that additional
reforms will likely occur in the future. Due to uncertainties regarding the
additional reforms and their enactment and implementation, we cannot predict:
- - which, if any, reform proposals will be adopted;
- - when they may be adopted; or
- - what impact they may have on us.
The actual announcement by competitors and third party payors of their
strategies to respond to such initiatives or reforms, could produce volatility
in the trading and market price of our common stock.
We may become a party to legal proceedings which may adversely affect our
results of operations and financial condition.
The provision of health care services entails the substantial risk of
potential claims of medical malpractice and similar claims. We do not engage in
the practice of medicine or assume responsibility for compliance with regulatory
requirements directly applicable to our affiliated physicians. We cannot predict
whether claims will be asserted against us in the event that services provided
by our affiliated physicians are alleged to have resulted in injury or other
adverse effects. Medical malpractice claims have been asserted and are pending
against a number of managed care companies. In addition, legislation has been
proposed in various states expressly providing for medical malpractice liability
for managed care companies. In the event that regulatory authorities determine
that we are a managed care company, the enactment of any such laws could
materially adversely affect our operations and financial condition. Successful
malpractice claims could exceed the limits of our insurance. We cannot predict
whether:
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<PAGE> 54
- - we will be able to renew our insurance on commercially reasonable
terms; or
- - our insurance will provide adequate coverage against potential claims.
Regardless of the merit or eventual outcome of a malpractice claim asserted
against us, such claim could:
- - be costly to defend;
- - consume management resources; and
- - could adversely affect our reputation and business.
In connection with our acquisition of affiliated practices, we may assume or
acquire certain of the stated liabilities of such practices. Therefore, claims
may be asserted against us for events related to an affiliated practice that
occurred prior to its affiliation with us. We cannot predict whether any
successful claims will exceed applicable policy limits of the insurance coverage
maintained by us or such affiliated practices.
We are subject to rapid technological change in the health care information
industry.
The health care information industry is relatively new and is
experiencing:
- - rapid technological change;
- - changes in physician and payor needs;
- - frequent new product introductions; and
- - evolving industry standards.
As the computer and software industries continue to experience rapid
technological change, we must be able to adapt quickly and successfully update
our clinical information systems so that they continue to integrate well with
the computer platforms and other software employed by affiliated physicians. We
may experience difficulties that could delay or prevent the successful
development and introduction of system enhancements or new systems in response
to technological changes. Our inability to respond to technological changes in a
timely and cost-effective manner could materially adversely affect our
operations and financial condition by reducing our ability to:
- - facilitate receipt of accounts receivable of affiliated practices; and
- - efficiently and accurately analyze and anticipate the costs incurred by
associated physicians providing medical services pursuant to capitated
managed care contracts.
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<PAGE> 55
We may incur significant costs if our systems are not Year 2000 compliant.
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of our
programs that have time-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a major system
failure or miscalculations. If our information technology and non-information
technology systems fail to achieve Year 2000 compliance we would have to:
- - purchase additional hardware and software components to update and
enhance such systems; or
- - purchase new systems which are Year 2000 compliant.
We cannot predict whether these costs would be material to our operations and
financial condition. The failure of such systems to achieve Year 2000 compliance
could result in:
- - a slow down of our operations;
- - adverse publicity;
- - delays in collecting our accounts receivable; and
- - delays in processing accounts payable.
We have commenced review of our computer systems to identify the
systems that could be affected by the "Year 2000" issue and have developed an
implementation plan to resolve the issue. We have established a project team to
assess, test and modify our information technology and non-information
technology systems. Our project team is also responsible for contacting and
determining the readiness of our affiliated practices and third parties,
including our payors.
Achieving Year 2000 compliance is dependent on many factors, some of
which are not completely within our control. We cannot predict whether we, our
affiliated practices, third parties or our payors will achieve Year 2000
compliance. If such compliance is not achieved, we have developed a contingency
plan which includes:
- - increasing normal inventories of critical supplies for our affiliated
practices prior to December 31, 1999;
- - ensuring an adequate line of bank credit if third party payor payments
are disrupted; and
- - ensuring that all critical staff are available or scheduled to work
prior to, during and immediately after December 31, 1999.
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<PAGE> 56
Control by Stockholders
Our existing officers, directors and principal stockholders control Physicians'
Specialty reducing the influence of our other stockholders.
As of March 29, 1999,
- - Ramie A. Tritt, our Chairman of the Board and President, beneficially
owned approximately 19% of our outstanding common stock;
- - the other physicians at Atlanta ENT, an affiliated practice (excluding
Dr. Tritt, the President of Atlanta ENT) in the aggregate beneficially
owned approximately 17% of our outstanding common stock; and
- - our other officers and directors (excluding Dr. Tritt) in the aggregate
beneficially owned approximately 8% of our outstanding common stock.
As a result, these stockholders may be able to influence significantly:
- - the election of our directors; and
- - the outcome of mergers, sales of assets or other corporate transactions
or matters submitted for stockholder approval.
As a result, our other stockholders may have little influence over matters
submitted for stockholder approval. The influence by these stockholders could
preclude any unsolicited acquisition of us and consequently adversely affect the
market price of our common stock.
Anti-takeover provisions may adversely affect our stockholders.
Our board of directors may issue, without stockholder approval, shares of
preferred stock with such terms and conditions as our board of directors may
determine in its sole discretion. The preferred stock could have voting,
liquidation, dividend or other rights superior to the common stock. Therefore,
if we issue preferred stock, our common stockholders' rights may be adversely
affected. We are also subject to a Delaware statute regulating business
combinations. Upon the occurrence of certain events, including a merger and a
sale of all or substantially all of our assets, all outstanding options under
our stock option plans will become immediately exercisable. The employment
agreements with our executive officers allow for termination by the executives
and the payment of severance compensation to the executives upon a change of
control of Physicians' Specialty.
Any of these provisions could:
- - discourage, hinder or preclude an unsolicited acquisition of
Physicians' Specialty;
- - make it less likely that our stockholders receive a premium for their
shares as a result of any such attempt; and
- - adversely affect the market price of our common stock.
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<PAGE> 57
Stock and Market Risks
Our stock price may be volatile.
The stock prices of companies in the physician practice management
industry have experienced significant price and volume fluctuations that are
unrelated to operating performance. These market fluctuations may adversely
affect our stock price. Factors which may affect our stock price also include:
- - perceptions about conditions in the physician practice management and
health care industries;
- - variations in our quarterly operating results;
- - changes in estimates of our earnings;
- - the impact of various health care reform proposals; and
- - general economic conditions.
These market fluctuations could have an adverse effect on the market price or
liquidity of our common stock.
Future sales of our common stock in the public market could adversely affect our
stock price and our ability to raise new funds.
Sales of shares of stock by current stockholders could have an adverse
effect on our stock price. As of March 29, 1999, we had 9,172,025 shares of
common stock outstanding. Substantially all of these shares are eligible for
sale without restriction under Rule 144.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including persons who may be deemed to be
"affiliates" of Physicians' Specialty as that term is defined under the Act, is
entitled to sell within any three-month period a number of restricted shares
beneficially owned for at least one year that does not exceed the greater of:
- - one percent of the then outstanding shares of our common stock; or
- - the average weekly trading volume in our common stock during the four
calendar weeks preceding such sale.
Sales under Rule 144 are also subject to certain requirements as to the manner
of sale, notice and the availability of current public information about us.
However, a person who is not an affiliate and has beneficially owned such shares
for at least two years is entitled to sell such shares without regard to the
volume or other requirements.
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<PAGE> 58
In addition, an aggregate of 2,250,000 shares of our common stock
issued or issuable pursuant to our stock purchase plan or upon exercise of
options granted or to be granted under our 1996 Stock Option Plan are eligible,
upon exercise, for sale to the public pursuant to our registration statements on
Form S-8. The holders of an aggregate of approximately 4,600,000 shares of
common stock and warrants to purchase shares of our common stock have certain
registration rights with respect to their shares of common stock, which rights
are currently exercisable.
The sale of a substantial number of shares of our common stock in the
public market, or the perception that such sales could occur, could adversely
affect the market price of our common stock and impair our ability to raise
additional capital in the future.
Additional shares of our common stock may be issued if options or warrants are
exercised, causing dilution to our stockholders.
We have outstanding at March 29, 1999:
- - options to purchase 1,400,940 shares of common stock under our 1996
Stock Option Plan; and
- - options to purchase 103,500 shares of common stock under our 1996
HealthCare Professionals Stock Option Plan; and
- - warrants to purchase 220,000 shares of common stock.
The existence of these securities may adversely affect us or our
stockholders for many reasons, including:
- - the market price of our stock may be adversely affected;
- - if any of these securities are exercised, the value of the stock held
by our stockholders will be diluted if the value of such stock
immediately prior to the exercise of such securities exceeds the
exercise price;
- - these securities give the holders the opportunity, at nominal cost, to
profit from a rise in the market price of our stock;
- - the terms upon which we could issue additional common stock or obtain
additional financing may be adversely affected.
Holders of warrants and options are also likely to exercise them when,
in all likelihood, we could obtain additional capital on terms more favorable
than those provided by the warrants and options.
We do not intend to pay dividends to our stockholders.
We have never paid any cash dividends on our common stock and do not
intend to pay cash dividends in the foreseeable future. We currently intend to
retain all earnings, if any, for the development of our business.
Our credit facility contains restrictions on the payment of dividends.
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<PAGE> 59
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
An index to Consolidated Financial Statements appears on page F-1.
2. Schedules
All financial statement schedules are omitted because they are not
applicable, not required under the instructions or all the information required
is set forth in the financial statements or notes thereto.
(b) Reports on Form 8-K
We filed a report on Form 8-K on October 28, 1998 reporting information
under Item 5 and a report on Form 8-K on January 13, 1999 reporting information
under Item 2.
(c) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C> <C>
3.1 -- Certificate of Incorporation of the Registrant. (1)
3.2 -- Amended and Restated By-laws of the Registrant. (1)
4.1 -- Promissory Notes issued by the Registrant in connection with certain
acquisitions. (6)
10.1 -- Asset Acquisition Agreement dated November 26, 1996 between the
Registrant, PSC Management Corp. ("PSC Management") and Atlanta Ear,
Nose & Throat Associates, P.C.("Atlanta ENT"). (1)
10.2 -- Acquisition Agreement dated November 26, 1996 between the Registrant,
PSC Acquisition Corp. and Ramie A. Tritt, M.D. (1)
10.3 -- Amended and Restated Employment Agreement between the Registrant and
Ramie A. Tritt, M.D. dated as of February 10, 1997.(1)
10.4 -- Employment Agreement between the Registrant and Richard D. Ballard dated
as of November 26, 1996. (1)
10.5 -- Employment Agreement between the Registrant and Gerald R. Benjamin
dated as of M.D. dated as of November 26, 1996. (1)
10.6 -- Management Services Agreement to be entered into between the Registrant,
PSC Management Corp. and Atlanta ENT. (1)
10.8 -- Form of Registration Rights Agreement. (1)
10.10 -- Lease Agreement for office space located at The Medical Quarters, 5555
Peachtree Dunwoody Road, Suite 235, Atlanta, Georgia dated October 1, 1988
between Atlanta ENT and Ramie Tritt, M.D., as amended. (1)
</TABLE>
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<PAGE> 60
<TABLE>
<S> <C> <C>
10.11 -- Lease Agreement for office space located at the Gwinnett Medical Building,
3540, Duluth Park Lane, Duluth Georgia dated December 29, 1989 between
Duluth Professional Center, L.P., Gwinnett Pulmonology, P.C. and Atlanta
ENT, as amended. (1)
10.12 -- Lease Agreement for office space located at Eastside Physicians Center, 1700
Tree Lane, Snellville, Georgia dated July 11, 1994 and effective June 1, 1995
between Atlanta ENT and Eastside Physicians Center, L.P. (1)
10.13(b) -- 1996 Stock Option Plan, as amended.*
10.14 -- 1996 Health Care Professionals Stock Option Plan. (1)
10.15 -- Form of Indemnification Agreement. (1)
10.16 -- Group Practice Managed Care Agreement dated September 1, 1992 by and
between CIGNA HealthCare of Georgia, Inc. and The ENT Center of Atlanta,
Inc. +(1)
10.18 -- Agreement dated June 1, 1995 by and between United HealthCare of Georgia,
Inc. and Atlanta ENT Center for Physicians, Inc. +(1)
10.23 -- Employment Agreement between the Registrant and Robert A. DiProva dated
as of January 6, 1997. (1)
10.24 -- Employment Agreement between the Registrant and Lawrence P. Kraska
dated as of February 11, 1997. (1)
10.25 -- Acquisition Agreement dated as of February 13, 1997 by and among the
Registrant, PSC Acquisition Corp. and Metropolitan Ear, Nose & Throat, P.C.(1)
10.26 -- Acquisition Agreement dated as of February 13, 1997 by and among the
Registrant, PSC Acquisition Corp. and Atlanta Head and Neck Surgery, P.C.(1)
10.27 -- Acquisition Agreement dated as of February 13, 1997 by and among the
Registrant, PSC Acquisition Corp. and Ear, Nose & Throat, Associates P.C.(1)
10.28 -- Acquisition Agreement dated as of February 20, 1997 by and among the
Registrant, PSC Acquisition Corp. and W.J. Cornay, III, M.D., P.C. (1)
10.34 -- Agreement dated May 19, 1997 by and between the Registrant and Premier
HealthCare. (3)
10.35 -- Management Services Agreement dated July 1, 1997 by and among New
Allatoona E.N.T. & Facial Plastic Surgery, P.C., Thomas U. Muller, M.D.,
PSC Management Corp. and the Registrant. (4)
10.36 -- Management Services Agreement dated September 22, 1997 by and among
New Otolaryngology Medical and Surgical Associates, Ltd., PSC
Management Corp. and the Registrant. +(4)
10.37 Specialist Group Physician Agreement dated August 1, 1997 by and between
AHI Medical Group Atlanta, P.C. and ENT Center of Atlanta, Inc. +(4)
10.38 -- Lease dated July 31, 1997 by and between the Registrant and Pavilion
Partners, L.P.(4)
10.39 -- Stock Purchase Agreement dated as of October 31, 1997 by and among the
Registrant, PSC Management Corp., South Florida Otolaryngology, Inc. and
the other parties named therein. (5)
</TABLE>
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<PAGE> 61
<TABLE>
<S> <C> <C>
10.41 -- Management Services Agreement dated October 31, 1997 by and among New
Ear, Nose & Throat Associates of South Florida, P.A., PSC Management
Corp. and the Registrant. (6)
10.42(a) -- 1997 Employee Stock Purchase Plan, as amended. (7)
10.43 -- Amendment No. 1 to Restated and Amended Lease Agreement dated January
1, 1998 between Ramie A. Tritt, M.D. and the Registrant as successor in
interest to Atlanta ENT. (6)
10.44 -- Amendment dated March 19, 1998 to Agreement dated May 19, 1997 by and
between the Registrant and Premium HealthCare. (6)
10.45 -- Amendment No. 1 to Employment Agreement dated as of March 25, 1998
between the Registrant and Gerald R. Benjamin. (8)
10.46 -- Stock Purchase Agreement dated as of May 1, 1998 by and among the
Registrant, PSC Acquisition and the other parties named therein. (7)
10.47 -- Management Services Agreement dated May 27, 1998 among the Registrant,
PSC Management Corp. and ENT Associates LLP. (9)
10.48 -- Management Services Agreement dated May 27, 1998 among the Registrant,
PSC Management Corp. and ENT Associates of New Jersey, P.C. (9)
10.49 -- Termination Letter terminating the Stock Purchase Agreement dated May 22,
1998 by and among the Registrant, PSC Acquisition Corp. and the other
parties named therein. (9)
10.50 -- Stock Purchase Agreement dated as of May 27, 1998 by and among the
Registrant, PSC Acquisition Corp. and the other parties named therein
(superseding the Stock Purchase Agreement dated as of May 1, 1998 by and
among the Registrant, PSC Acquisition Corp. and the other parties named
therein and filed as Exhibit 10.40 to the Registrant's Quarterly Report on
Form 10-Q for the three months ended March 31, 1998). (9)
10.51 -- Promissory Note in the Principal Amount of $6,401,986 issued by PSC
Acquisition Corp and PSC Management Corp. and guarantied by the
Registrant to Kurzman & Kisenberg, LLP as agent for the parties named
therein. (9)
10.52 -- Provider Agreement dated June 12, 1998 by and between the Morgan Health
Group, and ENT Center of Atlanta, Inc. a wholly-owned subsidiary of the
Registrant. +(10)
10.53 -- Amended and Restated Credit Agreement dated as of July 31,
1998 by and among the Registrant, as borrower, and the
financial institutions party thereto.(11)
10.54 -- Network Agreement dated October 1, 1998 between United HealthCare of
Alabama, Inc. and Alabama ENT Center, Inc. +(11)
10.55 -- Amended and Restated Clinic Services Agreement dated October 1, 1998 by
and among Cleveland Ear, Nose and Throat Center, Inc., PSC Management
Corp. and the Registrant. (11)
10.56 -- First Amendment to Amended and Restated Clinic Services Agreement
effective as of January 1, 1999 by and among Cleveland Ear, Nose and Throat
Center, Inc., PSC Management Corp. and the Registrant. (12)
</TABLE>
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<PAGE> 62
<TABLE>
<S> <C> <C>
10.57 -- Amended and Restated Management Services Agreement dated March 1,
1999 among the Registrant, PSC Management Corp. and ENT Associates,
LLP.*
21.1 -- Subsidiaries of the Registrant.*
23.1 -- Consent of Arthur Andersen LLP.
27.1 -- Financial Data Schedule (for SEC use only).*
</TABLE>
- ----------
+ Confidential treatment was granted with respect to portions of this
exhibit.
* Previously filed.
(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (File No. 333-17091) declared effective on March 20, 1997.
(2) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the three months ended March 31, 1997.
(3) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the six months ended June 30, 1997.
(4) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the nine months ended September 30, 1997.
(5) Incorporated by reference to the Registrant's Current Report on Form
8-K filed on March 24, 1998.
(6) Incorporated by reference to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1997.
(7) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the three months ended March 31, 1998.
(8) Incorporated by reference to the Registrant's Registration Statement on
Form S-1(File No. 333-50419).
(9) Incorporated by reference to the Registrant's Current Report on Form
8-K filed on June 8, 1998.
(10) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the six months ended June 30, 1998.
(11) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the nine months ended September 30, 1998.
(12) Incorporated by reference to the Registrant's Current Report on Form
8-K filed on January 13, 1999.
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<PAGE> 63
PHYSICIANS' SPECIALTY CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following Consolidated Financial Statements of the Registrant are
submitted herewith in response to Item 8 and 14(a):
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants ................................ F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 ............ F-3
Consolidated Statements of Operations for the period from inception
(July 31, 1996) to December 31, 1996 and for the years ended
December 31, 1997 and 1998 ............................................ F-4
Consolidated Statements of Stockholders' Equity for the period from
inception (July 31, 1996) to December 31, 1996 and for the years
ended December 31, 1997 and 1998 ...................................... F-5
Consolidated Statements of Cash Flows for the period from inception
(July 31, 1996) to December 31, 1996 and for the years ended
December 31, 1997 and 1998 ............................................ F-6
Notes to Consolidated Financial Statements .............................. F-7
</TABLE>
F-1
<PAGE> 64
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Physicians' Specialty Corp.:
We have audited the accompanying consolidated balance sheets of PHYSICIANS'
SPECIALTY CORP. (a Delaware corporation) AND SUBSIDIARIES as of December 31,
1997 and 1998 and the related consolidated statements of operations,
stockholders' equity, and cash flows for the period from inception (July 31,
1996) to December 31, 1996 and for each of the two years ended December 31, 1997
and 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Physicians' Specialty Corp. and
subsidiaries as of December 31, 1997 and 1998 and the results of their
operations and their cash flows for the period from inception (July 31, 1996) to
December 31, 1996 and for each of the two years ended December 31, 1997 and 1998
in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
February 10, 1999
F-2
<PAGE> 65
PHYSICIANS' SPECIALTY CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
ASSETS
1997 1998
----------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 5,351,639 $ 4,925,501
Accounts receivable, net of allowance for doubtful accounts of $261,714 and
$1,700,016 at December 31, 1997 and 1998, respectively 9,273,565 16,166,944
Notes receivable 81,682 80,000
Prepayments and other 335,650 1,730,825
Deferred income taxes 0 48,245
----------- -----------
Total current assets 15,042,536 22,951,515
EQUIPMENT, NET 3,431,707 8,861,850
INTANGIBLE ASSETS, NET 11,793,777 26,267,950
INVESTMENT IN UNCONSOLIDATED SUBSIDIARY 0 5,396,609
OTHER ASSETS 330,338 207,231
----------- -----------
Total assets $30,598,358 $63,685,155
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 397,185 $ 2,012,658
Due to physicians 1,177,009 0
Accrued expenses 1,701,667 1,978,868
Accrued income taxes 321,302 0
Provider claims payable 637,726 572,247
Deferred income taxes 338,218 0
----------- -----------
Total current liabilities 4,573,107 4,563,773
----------- -----------
SUBORDINATED SELLER NOTES AND DEBENTURE 911,715 7,563,701
BORROWING UNDER CREDIT AGREEMENT 0 3,750,000
----------- -----------
Total long-term debt 911,715 11,313,701
----------- -----------
Total liabilities 5,484,822 15,877,474
----------- -----------
COMMITMENTS AND CONTINGENCIES (NOTE 11)
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value; 10,000 shares authorized, no shares issued
and outstanding at December 31, 1997 and 1998, respectively 0 0
Common stock, $0.001 par value; 50,000,000 shares authorized, 6,503,098 and
9,152,160 shares issued and outstanding at December 31, 1997 and 1998, 6,503 9,152
respectively
Additional paid-in capital 23,401,657 41,083,033
Retained earnings 1,705,376 6,715,496
----------- -----------
Total stockholders' equity 25,113,536 47,807,681
----------- -----------
Total liabilities and stockholders' equity $30,598,358 $63,685,155
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
balance sheets.
F-3
<PAGE> 66
PHYSICIANS' SPECIALTY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Period
From Inception FOR THE YEARS ENDED
(July 31, 1996) DECEMBER 31,
to December 31, ------------------------------
1996 1997 1998
-------------- ----------- -----------
<S> <C> <C> <C>
REVENUE:
Net patient service revenue $ 0 $20,699,486 $54,889,930
Management fees 51,240 169,128 1,164,418
Capitation revenue 0 3,619,408 4,916,424
Earnings in unconsolidated subsidiary 0 0 630,415
-------------- ----------- -----------
Net revenue 51,240 24,488,022 61,601,187
-------------- ----------- -----------
OPERATING EXPENSES:
Provider claims, wages, and benefits 46,582 16,747,582 38,339,351
General and administrative 357,340 4,370,611 13,140,889
Depreciation and amortization 1,919 377,286 1,849,864
-------------- ----------- -----------
Total operating expenses 405,841 21,495,479 53,330,104
-------------- ----------- -----------
OPERATING INCOME (LOSS) (354,601) 2,992,543 8,271,083
OTHER INCOME (EXPENSE), NET 0 429,254 (54,169)
-------------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES (354,601) 3,421,797 8,216,914
PROVISION FOR INCOME TAXES 0 1,361,820 3,206,794
-------------- ----------- -----------
NET INCOME (LOSS) $ (354,601) $ 2,059,977 $ 5,010,120
============== =========== ===========
EARNINGS (LOSS) PER SHARE:
Basic $ (0.64) $ 0.42 $ 0.62
============== =========== ===========
Diluted $ (0.64) $ 0.42 $ 0.60
============== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 552,894 4,868,035 8,021,914
============== =========== ===========
Diluted 552,894 4,966,778 8,434,583
============== =========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated statements.
F-4
<PAGE> 67
PHYSICIANS' SPECIALTY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
---------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
--------- ------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE, INCEPTION (JULY 31, 1996) 0 $ 0 $ 0 $ 0 $ 0
Issuance of common stock 599,893 600 711 0 1,311
Compensation expense 0 0 343,000 0 343,000
Net loss 0 0 0 (354,601) (354,601)
--------- ------ ----------- ----------- ------------
BALANCE, DECEMBER 31, 1996 599,893 600 343,711 (354,601) (10,290)
Issuance of common stock, net of offering costs 2,200,000 2,200 14,272,859 0 14,275,059
Issuance of common stock--practice acquisitions 3,703,205 3,703 8,737,087 0 8,740,790
Compensation expense 0 0 48,000 0 48,000
Net income 0 0 0 2,059,977 2,059,977
--------- ------ ----------- ----------- ------------
BALANCE, DECEMBER 31, 1997 6,503,098 6,503 23,401,657 1,705,376 25,113,536
Issuance of common stock, net of offering costs 2,307,540 2,308 16,517,458 0 16,519,766
Issuance of common stock--practice acquisitions 341,522 341 1,109,935 0 1,110,276
Compensation expense 0 0 53,983 0 53,983
Net income 0 0 0 5,010,120 5,010,120
--------- ------ ----------- ----------- ------------
BALANCE, DECEMBER 31, 1998 9,152,160 $9,152 $41,083,033 $ 6,715,496 $ 47,807,681
========= ====== =========== =========== ============
</TABLE>
The accompanying notes are an integral part of these
consolidated statements.
F-5
<PAGE> 68
PHYSICIANS' SPECIALTY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Period
From Inception For the Years Ended
(July 31, 1996) December 31,
to December 31, -------------------------------
1996 1997 1998
--------------- ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(354,601) $ 2,059,977 $ 5,010,120
--------- ------------ ------------
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 1,919 377,286 1,849,864
Provision for deferred income taxes 0 338,218 (367,468)
Compensation expense 343,000 48,000 53,983
Earnings in unconsolidated subsidiary 0 0 (630,415)
Changes in operating assets and liabilities, net of effects from
acquisitions of businesses:
Accounts receivable, net (26,976) (4,648,359) (1,882,029)
Prepayments and other (1,100) (318,721) (1,304,647)
Accounts payable and accrued liabilities 118,270 853,751 (1,357,210)
--------- ------------ ------------
Total adjustments 435,113 (3,349,825) (3,637,922)
--------- ------------ ------------
Net cash provided by (used in) operating activities 80,512 (1,289,848) 1,372,198
--------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payment for acquisitions, net of cash acquired 0 (4,933,104) (19,759,897)
Purchase of property and equipment, net of equipment sold (21,706) (870,526) (2,335,215)
Decrease in other assets 0 135,078 0
Distributions from unconsolidated subsidiary 0 0 320,117
--------- ------------ ------------
Net cash used in investing activities (21,706) (5,668,552) (21,774,995)
--------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock, net of offering costs 1,311 14,275,059 16,519,766
Borrowings under short-term debt 505,000 170,000 0
Repayment of debt 0 (2,258,560) (170,000)
Borrowing under credit facility, net of issuance costs 0 0 3,626,893
Deferred offering costs (441,577) 0 0
--------- ------------ ------------
Net cash provided by financing activities 64,734 12,186,499 19,976,659
--------- ------------ ------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 123,540 5,228,099 (426,138)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 0 123,540 5,351,639
--------- ------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 123,540 $ 5,351,639 $ 4,925,501
========= ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated
statements.
F-6
<PAGE> 69
PHYSICIANS' SPECIALTY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1998
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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All significant intercompany balances
and transactions are eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts and disclosures in the
Company's financial statements and the accompanying notes.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers cash on deposit with financial institutions and all
highly liquid investments with original maturities of three months or less
to be cash and cash equivalents.
EQUIPMENT
Equipment is recorded at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of depreciable assets
for financial statement reporting
F-7
<PAGE> 70
purposes. Maintenance and repairs are charged to expenses as incurred.
The cost of renewals and betterments is capitalized and depreciated
over the applicable estimated useful lives. The cost and accumulated
depreciation of assets sold, retired, or otherwise disposed of are
removed from the accounts, and the related gain or loss is credited or
charged to operations.
Depreciable assets at December 31, 1997 and 1998 consisted of the
following:
<TABLE>
<CAPTION>
USEFUL
1997 1998 LIVES
---------- ----------- ---------------------
<S> <C> <C> <C>
Equipment $1,132,111 $ 5,362,937 Three to seven years
Computer system and software 432,157 1,135,673 Three years
Furniture and fixtures 1,678,971 2,924,911 Seven years
Automobiles 57,548 0 Five years
Leasehold improvements 495,144 882,076 Three to five years
---------- -----------
Total cost 3,795,931 10,305,597
Less accumulated depreciation (364,224) (1,443,747)
---------- -----------
$3,431,707 $ 8,861,850
========== ===========
</TABLE>
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. The Company continually evaluates whether later events
and circumstances have occurred that indicate the remaining balance of
goodwill may not be recoverable. In evaluating possible impairment, the
Company uses the most appropriate method of evaluation given the
circumstances surrounding the particular acquisition, which has generally
been an estimate of the related practice's undiscounted operating income
before interest and taxes over the remaining life of the goodwill.
At December 31, 1997 and 1998, the amount of such intangible assets was
approximately $11,884,000 and $27,143,000, respectively, with accumulated
amortization totaling approximately $90,000 and $875,000, respectively.
Amortization expense was approximately $0, $90,000, and $785,000 during
1996, 1997, and 1998, respectively.
NET PATIENT SERVICE REVENUE
Net patient service revenue is based on established billing rates, less
estimated allowances for patients covered by Medicare and other
contractual reimbursement programs, and discounts from established billing
rates. Amounts received by the Company for treatment of patients covered
by Medicare and other contractual reimbursement programs, which may be
based on cost of services provided or predetermined rates, are generally
less than the established billing rates of the Company's practices.
F-8
<PAGE> 71
In March 1998, the Emerging Issues Task Force of the Financial Accounting
Standards Board (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 is effective for the
Company for the year ended 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 has determined that its contracts met the
criteria of EITF 97-2 for consolidating the results of operations of the
related physician practices, and the Company has adopted EITF 97-2 in its
consolidated statement of operations for the year ended December 31, 1998.
In addition, the Company has adjusted the statement of operations for the
year ended December 31, 1997 to conform with such consolidation. 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, any future acquisitions of individual
physician practices will be accounted for under the purchase method of
accounting.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company grants credit without collateral to its patients, most of whom
are insured under third-party payor arrangements. The provision for bad
debts that relates to patient service revenue is based on an evaluation of
potentially uncollectible accounts. The provision for bad debt expense was
$0, $133,794, and $805,510 during 1996, 1997, and 1998, respectively. The
allowance for doubtful accounts represents the estimate of the
uncollectible portion of accounts receivable.
CAPITATED CONTRACTS
Revenue is recognized over the applicable coverage period on a per-member
basis for covered members. Deferred revenue is recorded when premium
payments are received in advance of the applicable coverage period.
The Company establishes accruals for costs incurred in connection with its
capitated contracts based on historical trends. Any contracts that would
have a realized loss would be immediately accrued for and the loss would
be charged to operations.
F-9
<PAGE> 72
During the years ended December 31, 1997 and 1998, approximately 14.8% and
8%, respectively, of the Company's net revenues were derived from
capitated arrangements.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company estimates that the carrying amounts of financial instruments,
including cash and cash equivalents, accounts receivable, accounts
payable, subordinated seller notes and debenture, and short-term debt
approximated their fair values as of December 31, 1997 and 1998 due to the
relatively short maturity of these instruments.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, FASB issued Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income," which establishes
standards for the reporting of comprehensive income in a company's
financial statements. Comprehensive income includes all changes in a
company's equity during the period that result from transactions and other
economic events other than transactions with its stockholders. SFAS No.
130 was effective for the year beginning January 1, 1998. For the Company,
comprehensive income equals net income.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information," which requires that an enterprise
disclose certain information about operating segments. SFAS No. 131 was
effective for the Company's financial statements for the year ended
December 31, 1998. The Company considers its entire business as one
reporting segment: providing 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 and related specialties.
In February 1998, the FASB issued SFAS No. 132, "Employer's Disclosures
About Pensions and Other Postretirement Benefits," which requires
disclosure of additional information about the cost and financial status
of pension and postretirement plans. SFAS No. 132 was effective for
financial statements for the year ended December 31, 1997. SFAS No. 132
did not require any significant disclosures or revision of prior
disclosures.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes standards for
reporting and disclosing information about derivative instruments. SFAS
No. 133 is effective for financial statements for the Company's fiscal
quarter beginning July 1, 1999. The Company does not expect SFAS No. 133
will have a significant effect on its current financial reporting.
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 years presented. Diluted earnings per share reflect the potential
dilution that could occur if securities and other contracts to issue
common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the
entity. Interest expense, net of tax, of approximately $0, $8,000, and
$31,000 related to the subordinated seller notes was added to net income
in computing diluted earnings per share in 1996, 1997, and 1998,
respectively.
F-10
<PAGE> 73
A reconciliation of the number of weighted average shares used in
calculating basic and diluted earnings per share is as follows:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------------------
1996 1997 1998
--------- ---------- -------------
<S> <C> <C> <C>
Weighted average number of common shares
outstanding--basic 552,894 4,868,035 8,021,914
Effect of potentially dilutive shares outstanding 0 83,294 304,638
Effect of convertible debt 0 15,449 108,031
--------- ---------- ------------
Weighted average number of common shares
outstanding--diluted
552,894 4,966,778 8,434,583
========= ========== ============
</TABLE>
INCOME TAXES
The Company follows the practice of providing for income taxes based on
SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 requires
recognition of deferred tax liabilities and assets for the expected future
tax consequences of events that have been included in the financial
statements or tax returns.
INDUSTRY RISKS
The health care industry is subject to numerous laws and regulations at
all levels of government. These laws and regulations include, but are not
necessarily limited to, matters such as licensure, accreditation,
government health care program participation requirements, reimbursement
for patient services, and Medicare and Medicaid fraud and abuse. Recently,
government activity has increased with respect to investigations and
allegations concerning possible violations of fraud and abuse statutes and
regulations by health care providers. Violations of these laws could
result in significant fines and penalties as well as significant payments
for services previously billed. The Company is subject to similar
regulatory reviews. A determination of liability under any such laws could
have a material effect on the Company's financial position, results of
operations, stockholders' equity, and cash flows.
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------
1996 1997 1998
-------- ------------ ------------
<S> <C> <C> <C>
Cash paid during the period for interest $ 0 $ 87,474 $ 345,006
Cash paid during the period for income taxes, net of refunds 0 2,233,550 3,700,980
Liabilities issued or assumed in connection with businesses
acquired 0 (5,758,144) (6,651,986)
Common stock issued (value at time of issuance) 0 7,090,000 1,110,000
</TABLE>
F-11
<PAGE> 74
RECLASSIFICATIONS
Certain amounts in the December 31, 1996 and 1997 financial statements
have been reclassified to conform to the current year presentation.
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. ("AtlantaENT"), (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. The Reorganization was accounted for as a promoter
transaction under Staff Accounting Bulletin No. 48 at historical cost.
4. ACQUISITIONS
1997 ACQUISITIONS
During 1997, 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 six ENT physician practices 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 these acquisitions, the Company (i) paid an aggregate
of approximately $5 million in cash, (ii) issued an aggregate of 598,450
shares of common stock (valued at approximately $4.5 million), (iii)
agreed to issue an aggregate of 276,249 additional shares of common stock
(valued at the time of issuance at approximately $2.6 million) to two of
the affiliated practices beginning in September 1998 all of which have
been issued as of December 31, 1998, (iv) issued subordinated convertible
promissory notes in the aggregate principal amount of approximately
$912,000 that are convertible into shares of common stock at a conversion
price of $10 per share, and (v) issued noninterest bearing contingent
subordinated promissory notes in the aggregate principal amount of
approximately $3 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.
F-12
<PAGE> 75
1998 ACQUISITIONS
During 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
five ENT physician practices.
In connection with these acquisitions, the Company (i) paid an aggregate
of approximately $1.4 million in cash, (ii) issued an aggregate of 65,273
shares of common stock (valued at approximately $495,000), (iii) agreed to
issue an aggregate of 78,038 additional shares of common stock (valued at
the time of issuance at approximately $615,000) to four of the affiliated
practices beginning in February 1999, (iv) issued a subordinated
convertible promissory note in the principal amount of $250,000 that 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, and (v) issued a $150,000 noninterest 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. The excess of the purchase price over the fair value
of net assets acquired (goodwill) was approximately $2.2 million.
Additionally, in May 1998, 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 (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. If the PDI practices achieve
stipulated performance targets, the Company will pay an additional
$500,000, in cash or shares of common stock, at the Company's option. The
excess of the purchase price over the fair value of net assets acquired
(goodwill) was approximately $2.2 million.
The Company also entered into a management services agreement in
connection with the PDI transaction. The management services agreement
provides for a fixed annual management fee of approximately $1.9 million,
plus reimbursement of practice operating expenses. Pursuant to the
management services agreement, 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 agreement also provides for mutually agreed-on 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.
In addition, PSC Ambulatory Surgery, Ltd., a Georgia limited partnership
(the "PSC Partnership"), of which the Company is the sole general partner,
and 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") in July 1998. The aggregate purchase price of
approximately
F-13
<PAGE> 76
$4.8 million was paid in cash by the Company. 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 of $4.8 million.
Atlanta Surgery Center operates three multispecialty ambulatory surgery
centers in the metropolitan Atlanta area.
Additionally in October 1998, the Company acquired the assets of Cleveland
Ear, Nose, and Throat Center, Inc. ("Cleveland ENT") which had previously
been affiliated with MedPartners, Inc. ("MedPartners"). In connection with
the transaction, the Company entered into a clinic services agreement with
Cleveland ENT maintaining the percentage of net income management fee
structure which existed in the original agreement with MedPartners. Under
the terms of the transaction, the Company granted Cleveland ENT a one-time
option to unwind the transaction with the Company and repurchase all
Cleveland ENT nonmedical assets acquired by the Company. Cleveland ENT's
option to unwind the transaction expired on December 15, 1998. In
connection with the acquisition of the assets of this practice, the
Company (i) paid approximately $4.2 million in cash and (ii) issued a
$150,000 noninterest 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. The excess of the purchase
price over the fair value of net assets acquired (goodwill) was
approximately $2.9 million.
The 1998 acquisitions described above were accounted for by the purchase
method of accounting for business combinations. Accordingly, the accompanying
statements of operations do not include revenues or expenses related to these
acquisitions prior to the respective closing dates. Following are the Company's
unaudited pro forma results for 1998 and 1997 assuming the acquisitions
occurred on January 1, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Net revenues $74,074,187 $44,837,546
Net income $ 5,898,134 $ 1,915,980
Diluted earnings per share $ 0.67 $ 0.32
Diluted weighted average shares outstanding 8,806,245 6,028,678
</TABLE>
These unaudited pro forma results have been prepared for comparative
purposes only and do not purport to be indicative of the results of operations
which would have actually resulted had the combinations been in effect on
January 1, 1997 and 1998, or for future results of operations.
The Company amended the clinic services agreement with Cleveland ENT to
provide that, effective January 1, 1999, the Company would receive a
management fee equal to 12.5% of all net clinic revenue (after adjustment
for contractual allowances) generated by Cleveland ENT.
5. 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, a portion of which was 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 12, 1998, the Company registered under the Securities Act of 1933,
as amended, 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 which were issued 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.
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
F-14
<PAGE> 77
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 this offering and
the 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.
6. LONG-TERM DEBT
As of December 31, 1997 and 1998, long-term debt, consisting of borrowings
under the credit agreement and subordinated seller notes and debenture, is
summarized as follows:
<TABLE>
<CAPTION>
1997 1998
------------- -----------
<S> <C> <C>
Credit agreement due July 2002; interest rate at LIBOR (6.84% at
December 31, 1998) $ 0 $ 3,750,000
Subordinated convertible promissory notes payable to physicians; due
October 2000; interest rate of 5.61% 911,715 911,715
Subordinated promissory note payable to physicians; due April 2000;
interest rate of 6% 0 250,000
Subordinated promissory note payable to physicians; due May 2003; 0 6,401,986
interest rate of 6% ------------- -----------
Total long-term debt $ 911,715 $11,313,701
============= ===========
</TABLE>
Principal maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
Year ended December 31:
<S> <C>
1999 $ 0
2000 1,161,715
2001 0
2002 3,750,000
2003 6,401,986
Thereafter 0
-------------
$ 11,313,701
=============
</TABLE>
On July 31, 1998, the Company closed on a four-year, $45 million amended
and restated senior credit agreement (the "Credit Agreement") syndicated
by Nationsbanc Montgomery Securities LLC. The Credit Agreement replaced
the Company's $20 million senior credit
F-15
<PAGE> 78
agreement. At December 31, 1998, the Company had $41.25 million available
for borrowing under the Credit Agreement. Borrowings under the Credit
Agreement (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.
The Credit Agreement contains certain restrictive covenants which, among
other things, require the company to maintain certain financial ratios,
limit the amounts of additional indebtedness, dividends, advances to
officers, shareholders and physicians, acquisitions, investments and
advances to subsidiaries, and restrict changes in management of the
Company's business. The Company was in compliance with all debt covenants
at December 31, 1998.
Interest expense was $0, $78,874, and $523,227 during 1996, 1997, and
1998, respectively.
7. INCOME TAXES
For all periods presented, the accompanying financial statements reflect
provisions for income taxes computed in accordance with the requirements
of SFAS No. 109.
The following summarizes the components of the income tax provision:
<TABLE>
<CAPTION>
1996 1997 1998
------- ----------- ------------
<S> <C> <C> <C>
Current:
Federal $ 0 $ 868,153 $ 3,097,528
State 0 155,449 476,734
Deferred:
Federal 0 279,108 (319,052)
State 0 59,110 (48,416)
------- ----------- -----------
Provision for income taxes $ 0 $ 1,361,820 $ 3,206,794
======= =========== ===========
</TABLE>
F-16
<PAGE> 79
The provision for income taxes differs from the amounts computed by
applying federal statutory rates due to the following:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ------------ -----------
<S> <C> <C> <C>
Provision computed at the federal statutory rate $ (120,564) $ 1,163,411 $ 2,795,676
State income taxes, net of federal income tax benefit (14,042) 142,573 282,690
Amortization of intangibles 0 18,116 108,512
Nondeductible compensation expense 130,260 0 0
Other, net (1,674) 43,740 19,916
Change in valuation allowance 6,020 (6,020) 0
---------- ------------ -----------
Provision for income taxes $ 0 $ 1,361,820 $ 3,206,794
========== ============ ===========
</TABLE>
The tax effect of significant temporary differences representing deferred
tax assets and liabilities at December 31, 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
1997 1998
--------- ----------
<S> <C> <C>
Deferred income tax assets:
Accrued shareholder compensation $ 129,433 $ 167,917
Allowance for doubtful accounts 10,745 358,605
Other 0 7,415
--------- ----------
Total deferred tax assets 140,178 533,937
--------- ----------
Deferred income tax liabilities:
Acquired accounts receivable (418,458) (122,018)
Depreciation and amortization (59,938) (363,674)
--------- ----------
Total deferred tax liabilities (478,396) (485,692)
--------- ----------
Valuation allowance 0 0
--------- ----------
Net deferred income tax
(liabilities) assets $(338,218) $ 48,245
========= ==========
</TABLE>
The Company had no income tax net operating loss carryforwards as of
December 31, 1998.
8. STOCKHOLDERS' EQUITY
The Company has authorized 10,000 shares of preferred stock with $1 par
value. No shares have been issued, and therefore, there were no shares
outstanding at December 31, 1997 and 1998. The board of directors has the
authority to issue these shares and to fix dividends, voting and
conversion rights, redemption provisions, liquidation preferences, and
other rights and restrictions. During the period ended December 31, 1996,
the Company declared a .6875-to-1 reverse stock split. All financial
information has been restated to reflect for the stock split. In
connection with certain stock issuances during
F-17
<PAGE> 80
1996, 1997, and 1998, the Company recorded a charge to compensation of
approximately $343,000, $48,000, and $54,000, respectively.
9. STOCK PLANS
STOCK OPTION PLANS
In November 1996, the Company adopted two stock option plans, the 1996
Stock Option Plan (the "1996 Plan") and the 1996 Health Care Professionals
Stock Option Plan (the "Health Care Professionals Plan").
In March and November 1998, the board of directors adopted amendments to
the 1996 Plan to increase the aggregate number of shares of common stock
authorized under the 1996 Plan to 2,000,000 shares of the Company's
authorized but unissued common stock authorized for issuance pursuant to
the grant by the Company of options to officers, directors, employees,
consultants, and independent contractors of the Company.
The Company may grant options for up to 2,275,000 shares under two plans,
the 1996 Plan and the Health Care Professionals Plan. The Company has
granted options for up to 439,940 and 993,000 shares through December 31,
1997 and 1998, respectively, under the 1996 Plan and has granted options
for up to 35,000 and 63,000 shares under the Health Care Professionals
Plan through December 31, 1997 and 1998, respectively. The 1996 Plan and
the Health Care Professional Plan options vest over periods ranging from
three to five years, and both expire after ten years. A summary of the
status of the Company's two stock option plans at December 31, 1997 and
1998 is presented in the table below:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTION PRICE EXERCISE
SHARES (PER SHARE) PRICE
----------- ------------- ----------
<S> <C> <C> <C>
Outstanding at December 31, 1996 247,460 $ 6.80 $ 6.80
Granted 227,480 $6.00-$12.875 7.42
Exercised 0 $ 0.00 0.00
Canceled (3,000) $ 8.00 8.00
----------- ------------- --------
Outstanding as of December 31, 1997 471,940 $6.00-$12.875 7.09
Granted 1,056,000 $ 5.75-$11.50 8.51
Exercised 0 $ 0.0 0.00
Canceled (4,000) $8.00-$12.875 8.70
----------- ------------- --------
Outstanding as of December 31, 1998 1,523,940 $5.75-$12.875 $ 8.08
=========== ============= ========
</TABLE>
F-18
<PAGE> 81
The following table summarizes information about the Company's outstanding
stock options at December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
WEIGHTED REMAINING
AVERAGE CONTRACTUAL
SHARES EXERCISE PRICE LIFE
----------- -------------- -----------
<S> <C> <C> <C>
Range of exercise prices:
$0.00-$8.00 1,014,440 $ 7.32 8.57
$8.01-$12.00 497,500 9.53 6.97
$12.01-$20.00 12,000 12.41 8.20
----------- --------- ------
Total 1,523,940 $ 8.08 8.04
=========== ========= ======
</TABLE>
The following table summarizes information about the Company's exercisable
stock options at December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
---------- -------
<S> <C> <C>
Range of exercise prices:
$0.00-$8.00 394,010 $ 7.16
$8.01-$12.00 110,000 9.37
$12.01-$20.00 4,750 12.64
---------- -------
Total 508,760 $ 7.68
========== =======
</TABLE>
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," but applies Accounting
Principles Board Opinion No. 25 and related interpretations in accounting
for its stock option plans. If the Company had elected to recognize
compensation cost for these plans based on the fair value at the grant
dates for awards under the plans consistent with the method prescribed by
SFAS No. 123, net income (loss) and earnings (loss) per share would have
been changed to the pro forma amounts indicated below at December 31,
1996, 1997, and 1998:
F-19
<PAGE> 82
<TABLE>
<CAPTION>
1996 1997 1998
------------ ----------- -----------
<S> <C> <C> <C>
Net (loss) income:
As reported $ (354,601) $ 2,059,977 $ 5,010,120
Pro forma (634,924) 1,464,400 2,959,650
(Loss) earnings per share:
Basic:
As reported $(0.64) $0.42 $0.62
Pro forma (1.15) 0.30 0.37
Diluted:
As reported (0.64) 0.42 0.60
Pro forma (1.15) 0.30 0.35
</TABLE>
The fair value of the Company's stock options used to compute pro forma
net income (loss) and earnings (loss) per share disclosures is the
estimated present value at grant date using the Black-Scholes option
pricing model with the following weighted average assumptions for 1996 and
1997: a dividend yield of 0%, an expected volatility of 44%, and a
risk-free interest rate range of 6% to 6.9%, and an expected holding
period of seven years; and for 1998: a dividend yield of 0%, an expected
volatility of 67.5%, and a risk-free interest rate range of 4.73%-5.72%,
and an expected holding period of seven years.
1997 EMPLOYEE STOCK PURCHASE PLAN
The Company's 1997 Employee Stock Purchase Plan (the "Stock Purchase
Plan") was approved by the board of directors in November 1997 and
approved by the Company's stockholders in June 1998. The Stock Purchase
Plan is intended to qualify as an employee stock purchase plan under
Section 423 of the Internal Revenue Code of 1986, as amended, in order to
provide employees of the Company with an opportunity to purchase common
stock through payroll deductions. An aggregate of 250,000 shares of the
Company's common stock have been reserved for issuance under the Stock
Purchase Plan and are available for purchase thereunder, and as of
December 31, 1998, no shares have been purchased.
10. RETIREMENT PLAN
On March 15, 1998, the Company established a defined contribution 401(k)
retirement plan (the "Plan") covering substantially all employees who
qualify and elect to participate. Participants may make contributions up
to a total annual limit of 15% of annual compensation not to exceed
$10,000. The Company makes a contribution equal to 1.5% of each
participant's salary. The Company contributed approximately $64,000 to the
Plan during the year ended December 31, 1998.
F-20
<PAGE> 83
11. COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company and its affiliated physician groups are insured with respect
to medical malpractice risks on a claims-made basis. In the opinion of
management, the amount of potential liability with respect to these claims
will not materially affect the Company's financial position or results of
operations.
No legal proceedings are currently pending against the Company, and the
Company is not aware of any outstanding claims against any of its
affiliated practices that would have a material adverse effect on the
Company's business, financial condition, or results of operations. The
Company and its affiliated practices may be involved from time to time in
litigation incidental to their respective businesses.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with certain executive
officers of the Company. The agreements, which are substantially similar,
provide for compensation to the officers in the form of annual base
salaries. The employment agreements also provide for severance benefits
upon the occurrence of certain events, including a change in control, as
defined.
LEASES
The Company leases equipment and certain medical office facilities under
noncancelable operating lease agreements which expire in various years
through 2010. Rental expenses under these leases amounted to approximately
$0, $1,157,000, and $2,993,000 in 1996, 1997, and 1998, respectively.
Future minimum rental commitments under all noncancelable operating lease
agreements, excluding lease agreements that expire within one year, are as
follows as of December 31, 1998:
<TABLE>
<S> <C>
1999 $ 3,546,687
2000 3,013,817
2001 2,420,826
2002 1,611,562
2003 1,250,475
Thereafter 5,565,560
------------
Total $ 17,408,927
============
</TABLE>
12. RELATED-PARTY TRANSACTIONS
In May 1997, the Company entered into an agreement with Premier
HealthCare, an affiliate of the Company's vice chairman and secretary,
that was amended in March 1998, pursuant to which Premier HealthCare will
assist the Company as a financial adviser in connection with acquisitions
and similar transactions. In the event that the Company completes any
F-21
<PAGE> 84
transaction in which Premier HealthCare performed advisory services,
Premier HealthCare will receive a fee equal to (i) its out-of-pocket
expenses and (ii) 5% of the initial $1 million of the transaction value,
as defined, 4% of the next $1 million of the transaction value, 3% of the
next $1 million of the transaction value, 2% of the next $1 million of the
transaction value, and 1% of the amount of the transaction value in excess
of $4 million. Pursuant to the agreement, the fee to be paid to Premier
HealthCare for a particular transaction will be reduced by any finder's
fee payable by the Company, which has been approved by Premier HealthCare,
and the aggregate fee to be paid to Premier HealthCare in any given year
will be reduced by the product of (i) $12,500 and (ii) the number of
months in any year in which the Company's vice chairman and secretary is
employed by the Company. Therefore, so long as the Company's vice chairman
and secretary is employed by the Company at his current salary, the
aggregate fee to be paid to Premier HealthCare in any given year will be
reduced by $150,000. The agreement may be terminated by either party upon
90 days' written notice to the other.
During the year ended December 31, 1997, the Company paid an aggregate of
$647,000 to Premier HealthCare consisting of (i) $250,000 for consulting
services in connection with the formation of the Company and the
Reorganization and (ii) $397,000 for consulting services in connection
with the acquisition of assets or equity of the additional practices which
were acquired during 1997.
During the year ended December 31, 1998, the Company paid an aggregate of
$893,000 to Premier HealthCare consisting of (i) $197,000 for consulting
services in connection with a public offering completed on May 15, 1998
and (ii) $696,000 for consulting services in connection with the
acquisition of assets or equity of the additional practices which were
acquired during 1998.
LEASES
The Company leases one clinical location from the Company's chairman and
president. The lease is for approximately 23,000 square feet and provides
for monthly rental payments of approximately $47,000, subject to annual
increases. The Company also leases one clinical location from Eastside
Physicians Center, L.P., a Georgia limited partnership, of which the
Company's chairman and president is a limited partner. The lease is for
approximately 4,800 square feet and provides for monthly rental payments
of approximately $8,000, subject to annual increases. The future minimum
rental commitments related to these two leases are included in Note 11.
13. QUARTERLY FINANCIAL DATA (UNAUDITED)
Net revenue has been adjusted for all quarters of 1997 and 1998 as the
Company has adopted EITF 97-2 in its statement of operations for its years
ending December 31, 1997 and 1998.
F-22
<PAGE> 85
<TABLE>
<CAPTION>
1998
--------------------------------------------------
FIRST SECOND THIRD FOURTH
------ ------- -------- ---------
(IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net revenue $ 12,004 $ 14,213 $16,613 $ 18,771
Operating income 1,539 1,718 2,306 2,708
Net income 957 1,124 1,357 1,572
Basic earnings per share $ 0.15 $ 0.15 $ 0.15 $ 0.18
Diluted earnings per share (a) 0.14 0.14 0.15 0.17
Weighted average shares outstanding:
Basic 6,511 7,696 8,867 8,978
Diluted 7,034 8,241 9,299 9,385
<CAPTION>
1997
--------------------------------------------------
First Second Third Fourth
---------- ------- ----- ---------
(In Thousands,
Except Per Share Amounts)
<S> <C> <C> <C> <C>
Net revenue $ 634 $6,263 $7,785 $ 9,806
Operating income 20 720 962 1,291
Net income 20 512 664 864
Basic earnings per share $ 0.02 $ 0.09 $ 0.11 $ 0.14
Diluted earnings per share (a) 0.02 0.09 0.11 0.13
Weighted average shares outstanding:
Basic 836 5,905 6,207 6,329
Diluted 865 5,905 6,275 6,597
</TABLE>
(a) The sum of the diluted earnings per share for 1997 and 1998
by quarter does not agree with the amount disclosed on the
statement of operations due to the weighted average effect
of the shares issued in the IPO and the Company's offering
in May 1998.
14. SUBSEQUENT EVENTS (UNAUDITED)
In January 1999, the Company loaned $1,475,000 to the Cleveland ENT
physicians. This loan bears interest at a rate of 6% per annum and matures
on the earlier of January 14, 2000, the termination of the management
services agreement, or the termination of the employment of three or more
of the physicians. In addition, the Company granted the physicians the
right and option (the "Put Option") to require the Company to purchase
from the physicians all of the outstanding shares of common stock of Ohio
Nasal Sinus Center, Inc. ("ONSC"), the sole asset of which is a corporate
domain name. The Put Option may be exercised by the physicians commencing
January 10, 2000 and expiring on March 1, 2000. In the event the
physicians exercise the Put Option, the Company would be required to
purchase the ONSC common stock for approximately $2 million in cash and
the issuance of a subordinated promissory note in the principal amount of
$520,000
F-23
<PAGE> 86
(collectively, the "Put Purchase Price"). The subordinated promissory note
would bear interest at a rate of 6% per annum and would be payable in four
equal annual installments commencing on the first anniversary of the date
of issuance of the note. In the event the Put Option is exercised by the
physicians, the cash portion of the Put Purchase Price would be reduced by
any amounts owed under the loan or any other monetary obligations owed by
the physicians to the Company. Pursuant to the terms of the transaction,
the Company has agreed to indemnify the physicians for certain matters
arising out of the transaction. The Company expects loan repayment from
Cleveland ENT physicians even if the Put Option is not exercised.
On January 11, 1999, 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 E.N.T. Medical Associates, Inc., P.C., a solo ENT practice
located in the Middleberg Heights suburbs of greater Cleveland, Ohio. In
addition, on February 1, 1999, the Company acquired substantially all of
the business assets and assumed certain contractual liabilities of
Preferred Diagnostic Services, Inc., an Atlanta, Georgia-based provider of
sleep diagnostic laboratory services. In connection with the acquisition
of the assets of this practice and the laboratory, the Company (i) paid an
aggregate of approximately $840,000 in cash, (ii) issued 4,600 shares of
common stock (valued at the time of issuance at approximately $37,000),
(iii) agreed to issue 1,637 additional shares of common stock (valued at
the time of issuance at approximately $13,000) in February 2000, and (iv)
issued a subordinated promissory note in the aggregate principal amount of
approximately $200,000 that accrues interest at 6% per annum paid
quarterly beginning in May 1999, with five annual equal payments of
principal beginning on February 1, 2000. In connection with these
acquisitions, the Company paid approximately $85,000 to Premier HealthCare
for advisory services rendered.
F-24
<PAGE> 87
SIGNATURE
Pursuant to the requirements of Section 13 of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: September 29, 1999 PHYSICIANS' SPECIALTY CORP.
By: /s/ Ramie A. Tritt
-----------------------------------
Ramie A. Tritt, M.D.
Chairman of the Board and President
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Ramie A. Tritt Chairman of the Board and
- ------------------------------------ President (principal executive September 29, 1999
Ramie A. Tritt, M.D. officer)
/s/ Richard D. Ballard Chief Executive Officer and September 29, 1999
- ------------------------------------- Director
Richard D. Ballard
/s/ Gerald R. Benjamin Vice Chairman of the Board and September 29, 1999
- ------------------------------------ Secretary
Gerald R. Benjamin
/s/ Robert A. DiProva Executive Vice President and September 29, 1999
- ------------------------------------ Chief Financial Officer (principal
Robert A. DiProva financial and accounting officer)
/s/ Lawrence P. Kraska Executive Vice President-Operations September 29, 1999
- ------------------------------------
Lawrence P. Kraska
/s/ Edward R. Casas Director September 29, 1999
- ------------------------------------
Edward R. Casas
/s/ Sidney Kirschner Director September 29, 1999
- ------------------------------------
Sidney Kirschner
/s/ Steven L. Posar Director September 29, 1999
- ------------------------------------
Steven L. Posar
/s/ Steven H. Sacks Director
- ------------------------------------
Steven H. Sacks September 29, 1999
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report dated February 10, 1999 included in this Form 10-K/A for the year ended
December 31, 1998, into the previously filed registration statements of
Physician's Specialty Corp. on Form S-8 (Files Nos. 333-41605 and 333-62033).
/s/ ARTHUR ANDERSEN LLP
Atlanta, Georgia
September 28, 1999
