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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q/A
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 1999
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 Number: 001-12759
Physicians' Specialty Corp.
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(Exact Name of Registrant as Specified in its charter)
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Delaware 58-2251438
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
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1150 Lake Hearn Drive, Suite 640 Atlanta, Georgia 30342
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(Address of principal executive offices)
404-256-7535
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(Registrant's telephone number, including area code)
N/A
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(Former name or former address, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
There were 9,172,025 shares of the Registrants' common stock, par value
$.001 per share, outstanding as of August 13, 1999.
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Physicians' Specialty Corp.
Index
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Part 1 - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at June 30, 1999
and December 31, 1998.............................................. 3
Consolidated Statements of Operations
For the Three Months and Six Months
Ended June 30, 1999 and 1998....................................... 4
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1999 and 1998....................................... 5
Notes to Consolidated Financial Statements......................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...................... 12
Part II - Other Information
Item 1. Legal Proceedings.................................................. 18
Item 5. Other Information.................................................. 18
Item 6. Exhibits and Reports on Form 8-K................................... 19
Signatures......................................................... 21
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Part 1: Financial Information
Item 1: Financial Statements
PHYSICIANS' SPECIALTY CORP.
Condensed Consolidated Balance Sheets
(Unaudited)
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<CAPTION>
June 30, December 31,
1999 1998
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ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,407,338 $ 4,925,501
Accounts receivable, net of allowance for doubtful
Accounts of $1,206,863 and $1,700,016 in
1999 and 1998, respectively 20,080,599 16,166,944
Notes receivable 1,647,662 80,000
Prepayments and other 1,263,960 1,779,070
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Total current assets 24,399,559 22,951,515
PROPERTY AND EQUIPMENT, net 11,300,104 8,861,850
INTANGIBLE ASSETS, net 31,211,198 26,267,950
PROMISSORY NOTE RECEIVABLE - RELATED PARTY 2,152,000 --
INVESTMENT IN UNCONSOLIDATED SUBSIDIARIES 4,803,864 5,396,609
OTHER ASSETS 491,749 207,231
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Total Assets $ 74,358,474 $63,685,155
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable $ 522,000 $ --
Due to physicians 702,539 --
Accounts payable and accrued expenses 6,127,647 4,563,773
Borrowing under credit agreement 861,058 --
Deferred income taxes 385,184 --
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Total current liabilities 8,598,428 4,563,773
SUBORDINATED SELLER NOTES AND
OTHER LONG TERM PAYABLES 8,860,034 7,563,701
BORROWING UNDER CREDIT AGREEMENT 5,750,000 3,750,000
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Total liabilities 23,208,462 15,877,474
SHAREHOLDERS' EQUITY:
Common stock, $.001 par value; 50,000,000 shares authorized
issued: 9,172,025 in 1999 and 9,152,160 in 1998 9,172 9,152
Additional paid-in capital 41,147,398 41,083,033
Treasury stock (184,272) --
Retained earnings 10,177,714 6,715,496
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Total shareholders' equity 51,150,012 47,807,681
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Total liabilities and shareholders' equity $ 74,358,474 $63,685,155
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</TABLE>
See accompanying notes to consolidated financial statements
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PHYSICIANS' SPECIALTY CORP.
Consolidated Statement of Operations
(Unaudited)
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Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
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REVENUES
Net patient service revenues $ 20,785,144 $12,780,051 $ 40,295,853 $23,580,191
Capitation revenues 1,311,944 1,145,368 2,674,114 2,310,674
Management fees 560,754 288,071 904,054 326,690
Earnings in unconsolidated subsidiaries 473,305 -- 768,305 --
------------ ----------- ------------ -----------
Net revenue 23,131,147 14,213,490 44,642,326 26,217,555
EXPENSES
Provider claims, wages, benefits 15,270,463 9,530,051 29,352,940 17,454,512
General and administrative 4,042,772 2,562,405 8,007,521 4,819,759
Depreciation and amortization 686,104 403,331 1,372,536 686,120
------------ ----------- ------------ -----------
Operating expenses 19,999,339 12,495,787 38,732,997 22,960,391
Operating income 3,131,808 1,717,703 5,909,329 3,257,164
Other income (expense) (219,197) 124,659 (233,964) 153,559
------------ ----------- ------------ -----------
Pretax income 2,912,611 1,842,362 5,675,365 3,410,723
Provision for income taxes 1,135,678 718,411 2,213,155 1,330,031
------------ ----------- ------------ -----------
Net income $ 1,776,933 1,123,951 $ 3,462,210 $ 2,080,692
============ =========== ============ ===========
Earnings per share:
Basic earnings per share $ 0.19 $ 0.15 $ 0.38 $ 0.29
Diluted earnings per share $ 0.19 $ 0.14 $ 0.37 $ 0.27
Weighted average shares
outstanding
Basic 9,172,025 7,695,730 9,168,388 7,106,869
Diluted 9,431,594 8,240,675 9,391,427 7,640,821
</TABLE>
See accompanying notes to consolidated financial statements
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PHYSICIAN'S SPECIALTY CORP.
Consolidated Statements of Cash Flows
(Unaudited)
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<CAPTION>
Six Months Ended
June 30,
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1999 1998
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,462,210 $ 2,080,692
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization 1,372,536 686,120
Compensation expense -- 32,987
Earnings in unconsolidated subsidiaries (775,697) --
Increase in accounts receivable (3,188,709) (3,197,606)
Change in prepayments and other 282,597 (686,091)
Change in accounts payable and accrued liabilities 179,070 972,442
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Total adjustments (2,130,203) (2,192,148)
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Net cash provided by (used in) operating activities 1,332,007 (111,456)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Payment for acquisitions, net of cash acquired (6,431,100) (10,310,258)
Distributions from unconsolidated subsidiaries 574,171 --
Purchase of property and equipment (1,684,412) (917,354)
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Net cash used in investing activities (7,541,341) (11,227,612)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock, net of offering costs 14,385 16,520,043
Common stock repurchased (184,272) --
Borrowing under credit agreement 2,861,058 75,185
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Net cash provided by financing activities 2,691,171 16,595,228
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NET CHANGE IN CASH AND CASH EQUIVALENTS (3,518,163) 5,256,159
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 4,925,501 5,351,639
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,407,338 $ 10,607,798
=========== ============
</TABLE>
See accompanying notes to consolidated financial statements
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Physicians' Specialty Corp.
Notes to the Consolidated Financial Statements (Unaudited)
June 30, 1999
NOTE 1. ORGANIZATION
Physicians' Specialty Corp. (the "Company") was organized in July 1996
to provide comprehensive physician practice management services to physician
practices and health care providers specializing in the treatment and management
of diseases and disorders of the ear, nose, throat, head and neck ("ENT") and
related specialties. The Company commenced its business activities upon
consummation of the reorganization, as described in Note 3, and its initial
public offering ("IPO") on March 26, 1997. The Company provides financial and
administrative management, enhancement of clinical operations, network
development and payor contracting services, including the negotiation and
administration of capitated arrangements. The Company has operations in greater
Atlanta, Georgia; Chicago, Illinois; Birmingham, Alabama; the South Florida
area; Southern New York and Northern New Jersey and in metropolitan Cleveland,
Ohio.
NOTE 2. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries and its investment in an
unconsolidated subsidiary and have been prepared in accordance with generally
accepted accounting principles for interim financial reporting and in accordance
with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, the accompanying
unaudited consolidated financial statements contain all adjustments (consisting
of normal recurring items) necessary for a fair presentation of the results for
the interim periods presented. These financial statements and footnote
disclosures should be read in conjunction with the audited financial statements
and the notes thereto included in the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1998.
NOTE 3. REORGANIZATION
The Company acquired substantially all of the assets (other than
certain excluded assets such as employment agreements and patient charts,
records, and files) and certain liabilities of (i) Atlanta Ear, Nose & Throat
Associates, P.C. ("Atlanta ENT"), (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.
NOTE 4. ACQUISITIONS
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
approximately $615,000) to four of the affiliated practices beginning in
February 1999, of which 12,765 shares of common stock have been issued, (iv)
issued a subordinated convertible promissory note in the principal amount of
$250,000 that is convertible into shares of common stock, at the Company's
option, 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.
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In addition, 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 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 $2.1 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 a subsidiary of 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"). The aggregate purchase price of
approximately $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 had an option to purchase up to 40% of the partnership interest from
the Company based upon the Company's cost. Atlanta Surgery Center operates three
multispecialty ambulatory surgery centers in the metropolitan Atlanta area. In
January 1999, Atlanta ENT issued a secured promissory note in the amount of
$2,152,000 as consideration for an additional 39% equity interest in the PSC
Partnership. In January 1999 the Company sold 39% of its equity investment in
the PSC partnership to New Atlanta ENT.
Also during 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
Cleveland ENT achieving certain performance targets.
In January 1999, the Company amended the Clinic Services Agreement with
Cleveland ENT. Under the Agreement, as amended, the Company receives a
management fee equal to 12.5% of all net clinic revenue (after adjustment for
contractual allowances) generated by Cleveland ENT. Cleveland ENT also agreed to
pay the Company an additional $300,000 for management services provided during
the period from October 1, 1998 through December 31, 1998.
In connection with these acquisitions, the Company paid approximately
$1.0 million to Premier HealthCare, an affiliate of the Company's Vice Chairman
and Secretary for advisory services rendered.
ACQUISITIONS FROM JANUARY 1, 1999 THROUGH JUNE 30, 1999
During the three month period ended March 31, 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 (i) E.N.T. Medical Associates, Inc., P.C.
("ENT Medical"), and (ii) Advanced Surgical Arts, Inc. ("ASA"). In addition the
Company acquired substantially all of the business assets and assumed certain
contractual liabilities of Preferred Diagnostic Services,
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Inc. ("PDS"). In connection with the ENT Medical, ASA, and PDS transactions
completed by the Company during the three month period ended March 31, 1999 the
Company, (i) paid an aggregate of $2,102,000 in cash, (ii) issued an aggregate
of 4,600 shares of common stock (valued at the time of issuance at an aggregate
of approximately $37,000, (iii) agreed to issue an aggregate of 1,637 shares of
common stock (valued at an aggregate of approximately $13,000 and (iv) issued
subordinated promissory notes in the aggregate principal amounts of $1,360,000
which accrue interest at a rate of 6% per annum payable quarterly beginning in
May 1999 with principal payments beginning in February 2000. In connection with
these acquisitions, the Company paid approximately $207,000 to Premier
HealthCare, an affiliate of the Company's Vice Chairman and Secretary for
advisory services rendered.
During the three month period ended June 30, 1999, PSC Marietta
Ambulatory Surgery, Ltd., a Georgia limited partnership ("PSC Marietta
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 12.5% limited partnership interest in Marietta
Outpatient Surgery, Ltd., a Georgia limited partnership ("Marietta Surgery
Center"). The aggregate purchase price was paid 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 PSC Marietta Partnership provided
that Atlanta ENT has an option to purchase up to 40% of the partnership interest
from the Company based upon the Company's cost. Marietta Surgery Center operates
a multi-specialty ambulatory surgery center consisting of 8 operating rooms, in
the Marietta suburb of metropolitan Atlanta. As a result of the transaction,
effective April 1, 1999, the PSC Marietta Partnership will receive 12.5% of the
distributions made by Marietta Surgery Center and the Company and Atlanta ENT
will receive their pro rata share of such distributions based on their ownership
interest in the PSC Marietta Partnership.
Also, during the three months period ended June 30, 1999, the Company
acquired the assets of Computerized Tomography Center, Inc. ("CTC"), a
diagnostic imaging center located in the northern suburbs of metropolitan
Atlanta. CTC was previously an indirect wholly-owned subsidiary of PhyMatrix
Corp.
In connection with the PSC Marietta Partnership and CTC transactions
completed by the Company during the three month period ended June 30,1999, the
Company (i) paid an aggregate of $3,497,100 in cash (ii) issued a subordinated
promissory note in the principal amount of $125,000 with principal payments
beginning in June 2000, and bearing interest at a rate of 6% per annum, (iii)
agreed to pay in cash $192,900 upon the satisfactory completion of a computer
upgrade installation and (iv) entered into a Non Compete/Non Solicitation
Agreement with PhyMatrix providing for additional cash consideration in the
amount of $500,000 payable in equal monthly installments of $10,000 (without
interest) for 35 consecutive months, with a final payment of $150,000 on the
36th month. In connection with these acquisitions, the Company paid
approximately $240,000 to Premier HealthCare, an affiliate of the Company's Vice
Chairman and Secretary for advisory services rendered.
NOTE 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.
In May 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 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 which were issued in December 1998 in connection with a
practice asset acquisition completed in December 1997, may be sold from time to
time by the physician stockholders.
In May 1998, the Company completed a public offering of 2,050,263
shares of its common stock (i) of which 2,000,000 shares were sold by the
Company and (ii) 50,263 shares were sold by certain stockholders of the Company.
In May 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.
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NOTE 6. INTANGIBLE ASSETS
The Company's physician practice acquisitions involve the purchase of
tangible and intangible assets and the assumption of certain liabilities of the
acquired practices. As part of the purchase price allocation, the Company
allocates the purchase price to the tangible and identifiable intangible assets
acquired and liabilities assumed based on estimated fair market values. Costs of
acquisitions in excess of the net estimated fair value of tangible and
identifiable intangible assets acquired and liabilities assumed are amortized
using the straight line method over a period of 25 years. At June 30, 1999, the
amount of such intangible assets was approximately $31,211,000 with accumulated
amortization totaling approximately $1,454,000.
NOTE 7. NOTES RECEIVABLE
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 (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.
In January 1999, Atlanta ENT issued a secured promissory note in the
amount of $2,152,000 to PSC Georgia Corp., a wholly owned subsidiary of the
Company and the general partner of PSC Ambulatory Surgery, Ltd., as
consideration for an additional 39% equity interest in PSC Ambulatory Surgery
Ltd. This note bears a fluctuating rate of interest equal to the prime rate (as
defined in the note), and is payable on a monthly basis commencing February 1999
and continues for 119 consecutive months at which time all accrued interest and
principal is due and payable. The note is secured by Atlanta ENT's acquired
interest in PSC Ambulatory Surgery, Ltd.
NOTE 8. 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.
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 was 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
effective for the year ended December 31, 1998. The Company has adjusted the
statement of operations for the three and six months ended June 30, 1998 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.
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NOTE 9. 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 three month period ended March 31, 1999,
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.
NOTE 10. EARNINGS PER SHARE
The Company has calculated its basic and diluted earnings per share in
accordance with SFAS No. 128, "Earnings Per Share". Basic earnings per share are
calculated by dividing net income available to common stockholders by the
weighted average number of common shares outstanding for the periods presented.
Diluted earnings per share reflects the potential dilution that could occur if
securities and other contracts to issue common stock 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
$8,000 and $15,000 and $10,000 and $19,000 related to the subordinated seller
notes was added to net income in computing diluted earnings per share for the
three and six month periods ending June 30, 1999 and 1998, respectively.
A reconciliation of the number of weighted average shares used in
calculating basic and diluted earnings per share is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Weighted average number of common
shares outstanding - basic 9,172,025 7,695,730 9,168,388 7,106,869
Effect of potentially dilutive shares outstanding 142,247 431,490 105,717 431,577
Effect of convertible debt 117,322 113,455 117,322 102,375
--------- --------- --------- ---------
Weighted average number of common shares
outstanding - diluted 9,431,594 8,240,675 9,391,427 7,640,821
========= ========= ========= =========
</TABLE>
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<PAGE> 11
NOTE 11. CREDIT AGREEMENT
Effective July 31, 1998, the Company closed on a four year $45 million
amended and restated senior credit facility syndicated by Nationsbanc Montgomery
Securities LLC. Syndicate lenders include NationsBank, N.A., PNC Bank and
Rabobank Nederland (the "Credit Facility"). The Credit Facility replaced the
Company's $20 million senior credit facility. Borrowings under the Credit
Facility (i) are secured by the assignment to the banks of the Company's stock
in all of its material 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
material subsidiaries (including future subsidiaries) and (iii) restrict the
Company from pledging its assets to any other party. Advances under the Credit
Facility are used to fund acquisitions and working capital, are governed by a
borrowing base related primarily to the Company's earnings before interest,
taxes, depreciation and amortization ("EBITDA") and bears interest, at the
Company's option, based upon either a prime-based or LIBOR-based rate. EBITDA is
used by the Company as an indicator of a company's ability to incur and service
debt. EBITDA should not be considered an alternative to operating income, net
income, cash flows or any other measure of performance as determined in
accordance with generally accepted accounting principles, as an indicator of
operating performance, or as a measure of liquidity. The Credit Facility
contains affirmative and negative covenants which, among other things, require
the company to maintain certain financial ratios (including maximum indebtedness
to pro forma EBITDA, maximum indebtedness to capital, minimum net worth, minimum
current ratio and minimum fixed charges coverage), limit the amounts of
additional indebtedness, dividends, advances to officers, shareholders and
physicians, acquisitions, investments and advances to subsidiaries, and restrict
changes in management and the Company's business. As of August 13, 1999, the
Company had approximately $5.8 million of borrowings outstanding under the
Credit Facility with approximately $34.6 million available under the Credit
Facility.
NOTE 12: DEFINITIVE MERGER AGREEMENT
On June 14, 1999, the Company announced the signing of a definitive
merger agreement between the Company and a new company organized at the
direction of TA Associates ("MergerCo"). Under the terms of the merger
agreement, each outstanding share of Physicians' Specialty Corp. common stock,
other than shares as to which appraisal rights are properly perfected and not
withdrawn, shares held by the Company or any of its subsidiaries or by MergerCo,
certain shares held by management and their affiliates, certain affiliated
physicians and certain shares held by employee option holders, will be converted
into the right to receive $10.50 per share and certain indebtedness of the
Company will be refinanced. In addition, certain shares held by the Company's
Chairman and President, other member of Company management and their affiliates,
and certain affiliated physicians will be converted into shares of the surviving
corporation and management will retain an equity interest in the surviving
corporation. Company management and affiliated physicians holding approximately
3.6 million shares of Company common stock (representing 40% of the outstanding
shares) have entered into a Voting Agreement, under which they agreed to vote
their shares in favor of the proposed merger. TA Associates, Inc. and a
syndicate of five commercial banks including and led by First Union National
Bank have agreed, subject to the satisfaction of certain terms and conditions,
to provide financing in connection with the merger.
On June 29, 1999, the Company announced that the Company, certain of
its directors and TA Associates have been named as defendants in a lawsuit filed
as a purported class action in the Chancery Court for New Castle County,
Delaware. This suit alleges, that members of the Board of Directors suffer from
conflicts of interest that made in impracticable for the Board to conduct a
"bona fide" market check or auction of the Company prior to approval of the
Merger. The lawsuit also alleges that the announcement of the Merger was timed
to place an artificial lid on the market price of Physicians' Specialty Common
Stock. The suit seeks, among other things, injunctive relief prohibiting
consummation of the merger or, in the event that the transaction is consummated,
rescission, compensatory damages and costs and disbursements.
The Company believes the suit has no merit and intends to vigorously
defend the lawsuit.
NOTE 13: SUBSEQUENT EVENT
On July 1, 1999, the Company acquired substantially all of the assets
and assumed certain contractual obligations of Robert A. Mayers M.D., P.C., a
solo allergy practice located in Rye Brook, New York. In connection with the
acquisition of the assets of this practice, the Company paid $175,000 in cash.
In addition the Company paid approximately $5,000 to Premier HealthCare an
affiliate of the Company's Vice Chairman and Secretary for advisory services
rendered.
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<PAGE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
All references to "we" or "us" refers to Physicians' Specialty Corp., a
Delaware corporation, and its wholly-owned subsidiaries. This Form 10-Q 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-Q 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 from time to time into, our filings with the Securities and Exchange
Commission. These factors include the following: we are unable to predict the
outcome of pending litigation or its impact on our proposed merger, 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.
GENERAL
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, sleep medicine and ancillary services. We are currently affiliated with
92 physicians, one dentist and 84 allied health care professionals operating 67
clinical locations in Alabama, Florida, Georgia, Illinois, New Jersey, New York
and Ohio. We are also affiliated with a sleep diagnostic laboratory company
operating 12 sleep diagnostic laboratories and we own minority equity interests
in Atlanta Surgery Center and Marietta Surgery Center, which in the aggregate
own four ambulatory surgery centers containing 22 operating rooms.
Our revenue is derived:
- - from patient service revenue generated by physicians who are affiliated
or employed by us;
- - from our capitated managed care contracts;
- - from earnings related to ambulatory surgery centers in which we own
minority interests; and
- - from transitional management fees earned in conjunction with
integration of our acquired affiliated practices.
Patient service revenue consists of gross charges, less allowances for
bad debts and contractual adjustments, generated by or on behalf of physicians
affiliated with us or practicing at our wholly-owned subsidiary, ENT & Allergy
Associates. Capitation revenue consists of fixed monthly payments received by us
directly from HMOs or payors subcontracting with HMOs. Additionally, we record
our allocable share of earnings for our minority interests in Atlanta Surgery
Center and Marietta Surgery Center on the equity basis of accounting.
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<PAGE> 13
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:
- - 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 contract capitation basis.
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 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.
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<PAGE> 14
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 anticipate accurately 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.
RESULTS OF OPERATIONS
Revenue. Net patient service revenue increased to $20,785,000 and
$40,296,000 for the three and six months ended June 30, 1999 as compared with
$12,780,000 and $23,580,000 for the same periods in 1998, representing increases
of $8,005,000 and $16,716,000 or 63% and 71%, respectively. The increase in
patient service revenue is primarily attributable to an increase in the number
of physicians affiliated with us to 92 physicians at June 30, 1999 as compared
with 68 physicians at June 30, 1998, an increase of 24 physicians or 35%.
Patient service revenue generated by physicians who were affiliated with us for
both six month periods ended June 30, 1998 and 1999 increased on average
approximately 10% per physician. Capitation revenues increased to $1,312,000 and
$2,674,000 for the three and six months ended June 30, 1999 as compared with
$1,145,000 and $2,311,000 for the same periods in 1998 representing increases of
$167,000 and $363,000 or 15% and 16%, respectively. The increase in capitation
revenues was primarily attributable to an increase in the aggregate number of
enrollees to approximately 358,000 at June 30, 1999 as compared to approximately
320,000 at June 30, 1998, an increase of approximately 38,000 enrollees or 12%.
Management fees increased to $561,000 and $904,000 for the three and six months
ended June 30, 1999 as compared with $288,000 and $327,000 for the same periods
in 1998 primarily as a result of transitional management fees earned in
conjunction with integration of our acquired affiliated practices. For the three
and six months ended June 30, 1999, we recorded as revenue earnings from our
equity interests in Atlanta Surgery Center and Marietta Surgery Center in the
amount of $473,000 and $768,000. This revenue is not included in the three and
six months ended June 30, 1998. As a result of the foregoing factors, our net
revenue increased to $23,131,000 and $44,642,000 for the three and six months
ended June 30, 1999 as compared with $14,213,000 and $26,218,000 for the same
periods in 1998, representing increases of $8,918,000 and $18,424,000 or 63% and
70% respectively.
Provider Claims, Wages and Benefits. Provider claims, wages and
benefits, which includes physician compensation, increased to $15,270,000 and
$29,353,000 for the three and six months ended June 30, 1999, as compared with
$9,530,000 and $17,455,000 for the same periods in 1998 representing increases
of $5,740,000 and $11,898,000 or 60% and 68%, respectively. The dollar increase
in provider claims, wages and benefits is primarily attributable to the increase
in the number of affiliated physicians managed by us and the addition of
non-medical personnel at our affiliated practices required to support the
increase in the number of affiliated physicians. As a percent of net revenue,
provider claims, wages and benefits decreased slightly to 66% for both the three
and six month periods ended June 30, 1999 as compared to 67% for the same
periods in 1998.
General and Administrative. General and administrative expenses
increased to $4,043,000 and $8,008,000 for the three and six months ended June
30, 1999 as compared with $2,562,000 and $4,820,000 for the same periods in
1998, representing increases of $1,481,000 and $3,188,000 or 58% and 66%,
respectively. These increases are primarily attributable to the addition of
personnel and greater support costs associated with our expansion during 1998.
As a percent of net revenue, general and administrative expenses were 18% for
both the three and six months ended June 30, 1999 as compared to 18% for the
same periods in 1998.
Depreciation and Amortization. Depreciation and amortization expenses
increased to $686,000 and $1,373,000 for the three and six months ended June 30,
1999 as compared with $403,000 and $686,000 for the same periods in 1998,
representing increases of $283,000 and $687,000 or 70% and 100%, respectively.
These increases were 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 assets. As a percent of
net revenue, depreciation and amortization expense remained at 3% for both the
three and six month periods ended June 30, 1999 as compared to 3% for the same
periods in 1998.
Other Income (Expense). Other expense for the three and six months
ended June 30, 1999 was $219,000 and $234,000, respectively representing
interest expense related primarily to the subordinated seller notes and
borrowings in conjunction with our $45,000,000 senior credit facility which was
offset by interest income earned on interest bearing promissory notes and the
short term investment of excess cash and cash equivalents. Other income for the
three and six months ended June 30, 1998 was $125,000 and
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<PAGE> 15
$154,000, respectively and was derived from interest income earned on the short
term investment of cash and cash equivalents net of amounts of interest paid
primarily on the subordinated seller notes.
Income Taxes. Income taxes were provided for at 39% effective tax rates
for the three and six month periods ended June 30, 1999 and 1998 respectively.
Net Income. As a result of the foregoing factors, net income increased
to $1,777,000 and $3,462,000 for the three and six months ended June 30, 1999 as
compared to $1,124,000 and $2,081,000 for the same periods in 1998, representing
increases of $653,000 and $1,381,000 or 58% and 66%, respectively.
LIQUIDITY AND CAPITAL RESOURCES
We utilize capital primarily:
- - to acquire assets or equity of physician practices and related
ancillary businesses;
- - to acquire equipment utilized by our affiliated practices;
- - to fund corporate capital expenditures including management information
systems; and
- - to fund ongoing corporate working capital requirements.
At June 30, 1999, we had working capital of $15,801,000 compared to
$18,388,000 at December 31, 1998, a decrease of $2,587,000. The decrease in
working capital was due primarily to the decrease in cash and cash equivalents
at June 30, 1999 relating to the cash consideration paid for acquisitions
completed by us during the six month period ended June 30, 1999.
For the six month period ended June 30, 1999 net cash provided by
operating activities was $1,332,000 compared to net cash used in operating
activities of $111,000 for the same period in 1998. Net cash provided by
operating activities for the period ended June 30, 1999 consists of our net
income, increased by non-cash expenses such as depreciation and amortization and
decreased by non-cash earnings from our equity interests in Atlanta Surgery
Center and Marietta Surgery Center, and adjusted by changes in the components of
working capital primarily accounts receivable, prepayments and accounts payable.
Net cash used in investing activities was $7,541,000 for the six month
period ended June 30, 1999 compared to $11,228,000 for the same period in 1998.
Our uses of cash in investing activities related primarily to acquisitions and
capital expenditures in both the 1999 and 1998 periods. For the six month period
ended June 30, 1999 we received a distribution from our equity interest in
Atlanta Surgery Center of approximately $574,000.
Net cash provided by financing activities was $2.7 million for the six
month period ended June 30, 1999 primarily due to borrowings of approximately
$2.9 million under our $45 million credit facility. For the same period in 1998
we realized net proceeds of $16.5 million in connection with a public offering
of approximately 2.3 million shares of our common stock.
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 (the "Credit Facility"). The Credit Facility replaced our $20 million
senior credit facility. Borrowings under the Credit Facility (i) are secured by
the assignment to the banks of our stock in all of our material subsidiaries and
our accounts receivable, including the accounts receivable assigned to us by
affiliated practices pursuant to management services agreements, (ii) are
guaranteed by all material subsidiaries (including future subsidiaries) and
(iii) restrict us from pledging our assets to any other party. Advances under
the Credit Facility will be used to fund acquisitions and working capital, will
be governed by a borrowing base related primarily to our earnings before
interest, taxes, depreciation and amortization ("EBITDA") 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 income, net income,
cash flows or any other measure of performance as determined in accordance with
generally accepted accounting principles, as an indicator of operating
performance, or as a measure of liquidity. The Credit Facility contains
affirmative and negative covenants which, among other things, require us to
maintain certain financial ratios
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<PAGE> 16
(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
our officers, shareholders and physicians, acquisitions, investments and
advances to subsidiaries, and restrict changes in management and our business.
As of August 13, 1999, we had approximately $5.8 million of borrowings
outstanding under the Credit Facility with approximately $34.6 million available
under the Credit Facility.
During the three month period ended June 30, 1999, PSC Marietta
Ambulatory Surgery, Ltd., a Georgia limited partnership ("PSC Marietta
Partnership"), of which our subsidiary PSC Georgia Corp. is the sole general
partner, and Atlanta ENT is the sole limited partner, acquired in the aggregate
a 12.5% limited partnership interest in Marietta Outpatient Surgery, Ltd., a
Georgia limited partnership ("Marietta Surgery Center"). The aggregate purchase
price was paid by us. Pursuant to the terms of the transaction, we and Atlanta
ENT own 99% and 1% respectively, of the partnership interest in PSC Marietta
Partnership provided that Atlanta ENT has an option to purchase up to 40% of the
partnership interest from us based upon our cost of such interest. Marietta
Surgery Center operates a multi-specialty ambulatory surgery center consisting
of 8 operating rooms, in the Marietta suburb of metropolitan Atlanta. As a
result of the transaction, effective April 1, 1999, the PSC Marietta Partnership
will receive 12.5% of the distributions made by Marietta Surgery Center, and we
and Atlanta ENT will receive our pro rata share of such distributions based on
each of our respective ownership interests in the PSC Marietta Partnership.
Also, during the three months period ended June 30, 1999, we acquired
the assets of Computerized Tomography Center, Inc. ("CTC"), a diagnostic imaging
center located in the northern suburbs of metropolitan Atlanta. CTC was
previously an indirect wholly-owned subsidiary of PhyMatrix Corp.
In connection with the PSC Marietta Partnership and CTC transactions
completed by us during the three month period ended June 30,1999, we (i) paid an
aggregate of $3,497,100 in cash, (ii) issued a subordinated promissory note in
the principal amount of $125,000 with principal payments beginning in June 2000,
and bearing interest at a rate of 6% per annum, (iii) agreed to pay in cash
$192,900 upon the satisfactory completion of a computer upgrade installation and
(iv) entered into a Non Compete/Non Solicitation Agreement providing for
additional cash consideration in the amount of $500,000 payable in equal monthly
installments of $10,000 (without interest) for 35 consecutive months, with a
final payment of $150,000 on the 36th month. In connection with these
acquisitions, we paid approximately $240,000 to Premier HealthCare, an affiliate
of the Company's Vice Chairman and Secretary for advisory services rendered.
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.
On June 14, 1999, our Board of Directors approved the terms of a
definitive merger agreement with a new company formed by TA Associates, Inc.
which will effect a recapitalization of Physicians' Specialty. Under the Merger
Agreement, we will be recapitalized and each outstanding share of our common
stock, other than certain of our shares held by management and certain
affiliated physicians, will be converted into the right to receive $10.50 in
cash, and certain of our indebtedness will be refinanced. Certain shares of our
common stock held by Ramie A. Tritt, M.D., our Chairman of the Board and
President, our other executive officers and certain affiliated physicians will
be converted into shares of the surviving corporation and management will
maintain an equity interest in the surviving corporation. If the proposed merger
is consummated, we will become a private company.
The proposed transaction is subject to certain conditions, including
approval by our stockholders holding a majority of the outstanding shares,
financing and other customary closing conditions. Our management and affiliated
physicians holding approximately 3.6 million shares of our common stock
(representing approximately 40% of the outstanding shares) have entered into a
Voting Agreement, under which they have agreed to vote their shares in favor of
the proposed merger. TA Associates and a syndicate of five commercial banks
including and led by First Union National Bank have agreed, subject to certain
terms and conditions to provide the necessary financing for the transaction.
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<PAGE> 17
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 third 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.
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 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 June 30, 1999, 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:
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<PAGE> 18
- - 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.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 18, 1999, a lawsuit, Chill v. Physicians' Specialty Corp., et
al. (CA No. 17244NC), was filed as a purported class action in the Chancery
Court for New Castle County, Delaware on behalf of all holders of Physicians'
Specialty Common Stock excluding the defendants and their related or affiliated
entities. The lawsuit names a defendants Physicians' Specialty, six of the
Company's seven directors (including the three members of the Special Committee)
and TA Associates, Inc.
The lawsuit alleges, among other things, that the directors of
Physician's Specialty have breached their fiduciary duties to the Company's
stockholders by approving the Merger. In particular, the lawsuit alleges that
members of the Board of Directors suffer from conflicts of interest that made it
impracticable for the Board of Directors to conduct a "bona fide" market check
or auction of the Company prior to approval of the Merger. The lawsuit also
alleges that the announcement of the Merger was timed to place an artificial lid
on the market price of Physicians' Specialty Common Stock. The lawsuit seeks
among other things, preliminary and permanent injunctive relief prohibiting
consummation of the Merger, unspecified damages, attorneys' fees and other
relief. Physicians' Specialty believes the lawsuit has no merit and intends to
contest this lawsuit vigorously.
ITEM 5. OTHER INFORMATION
During the three month period ended June 30, 1999, PSC Marietta
Ambulatory Surgery, Ltd., a Georgia limited partnership ("PSC Marietta
Partnership"), of which our subsidiary is the sole general partner, and Atlanta
ENT is the sole limited partner, acquired in the aggregate a 12.5% limited
partnership interest in Marietta Outpatient Surgery, Ltd., a Georgia limited
partnership. The aggregate purchase price was paid by us. Pursuant to the terms
of the transaction, we and Atlanta ENT own 99% and 1% respectively, of the
partnership interest in PSC Marietta Partnership. Atlanta ENT has an option to
purchase up to 40% of the partnership interest from us based upon our cost of
such interest. Marietta Surgery Center operates a multi-specialty ambulatory
surgery center consisting of 8 operating rooms, in the Marietta suburb of
metropolitan Atlanta. As a result of the transaction, effective April 1, 1999,
the PSC Marietta Partnership will receive 12.5% of the distributions made by
Marietta Surgery Center and we and Atlanta ENT will receive our pro rata share
of such distributions based on our ownership interest in the PSC Marietta
Partnership.
Also, during the three months period ended June 30, 1999, we acquired
the assets of CTC, a diagnostic imaging center located in the northern suburbs
of metropolitan Atlanta. CTC was previously an indirect wholly-owned subsidiary
of PhyMatrix Corp.
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In connection with the PSC Marietta Partnership and CTC transactions
completed by us during the three month period ended June 30,1999, we (i) paid an
aggregate of $3,047,000 in cash, (ii) issued a subordinated promissory note in
the principal amount of $125,000 with principal payments beginning in June 2000,
and bearing interest at a rate of 6% per annum, (iii) agreed to pay in cash
$192,900 upon the satisfactory completion of a computer upgrade installation and
(iv) entered into a Non Compete/Non Solicitation Agreement providing for
additional cash consideration in the amount of $500,000 payable in equal monthly
installments of $10,000 (without interest) for 35 consecutive months, with a
final payment of $150,000 on the 36th month. In connection with these
acquisitions, we paid approximately $240,000 to Premier HealthCare, an affiliate
of the Company's Vice Chairman and Secretary for advisory services rendered.
On June 14, 1999, our Board of Directors approved the terms of a
definitive merger agreement with a new company formed by TA Associates, Inc.
which will effect a recapitalization of Physicians' Specialty. Under the Merger
Agreement, we will be recapitalized and each outstanding share of our common
stock, other than certain shares held by management and certain affiliated
physicians, will be converted into the right to receive $10.50 in cash, and
certain of our indebtedness will be refinanced. Certain shares of our common
stock held by Ramie A. Tritt, M.D., our Chairman of the Board and President, our
other executive officers and certain affiliated physicians will be converted
into shares of the surviving corporation and management will maintain an equity
interest in the surviving corporation. If the proposed merger is consummated, we
will become a private company.
The proposed transaction is subject to certain conditions, including
approval by our stockholders holding a majority of the outstanding shares,
financing and other customary closing conditions. Our management and affiliated
physicians holding approximately 3.6 million shares of our common stock
(representing approximately 40% of the outstanding shares) have entered into a
Voting Agreement, under which they have agreed to vote their shares in favor of
the proposed merger. TA Associates and a syndicate of five commercial banks
including and led by First Union National Bank have agreed, subject to certain
terms and conditions, to provide the necessary financing for the transaction.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1 Agreement and Plan of Merger dated as of June 14, 1999 by and among
Physicians' Specialty Corp., TA MergerCo., Inc., TA/Advent VIII, L.P.,
TA/Atlantic and Pacific IV, L.P., TA Investors LLC and TA Executives
Fund LLC (1)
10.60 Stock Option Exercise and Termination Agreement dated as of June 14,
1999 by and among Physicians' Specialty Corp. and each of the
individuals listed on Exhibit A thereto.(2)
10.61 Voting Agreement dated as of June 14, 1999 among TA MergerCo, Inc., the
persons listed on Exhibit A thereto, and Physicians' Specialty Corp.(2)
10.62 Rollover Agreement dated as of June 14, 1999 by and among TA MergerCo.,
Inc. and each of the entities listed on the signature pages attached
thereto.(2)
10.63 Stock Purchase Agreement dated as of June 14, 1999 by and among
TA/Advent VIII, L.P., TA/Atlantic and Pacific IV, L.P., TA Executives
Fund LLC, TA Investors LLC and the holders of the capital stock of
Physicians' Specialty Corp. listed on Exhibit A thereto.(2)
10.64 Registration Rights Agreement dated as of June 14, 1999 by and among TA
MergerCo, Inc. and each of the persons listed on the signature pages
attached thereto.(2)
10.65 Stockholders Agreement dated as of June 14, 1999 by and among TA
MergerCo, Inc. and each of the persons listed on the signature pages
attached thereto.(2)
10.66 Amendment to Executive Employment Agreement dated as of June 14, 1999
between Physicians' Specialty Corp. and Richard D. Ballard.(2)
10.67 Amendment to Executive Employment Agreement dated as of June 14, 1999
between Physicians' Specialty Corp. and Gerald R. Benjamin.(2)
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<PAGE> 20
10.68 Amendment to Executive Employment Agreement dated as of June 14, 1999
between Physicians' Specialty Corp. and Lawrence P. Kraska. (2)
10.69 Amendment to Executive Employment Agreement dated as of June 14, 1999
between Physicians' Specialty Corp. and Ramie A. Tritt, M.D. (2)
27.1 Financial Data Schedule (for SEC use only) (2)
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(1) Incorporated by reference to our Current Report on Form 8-K
filed on June 18, 1999.
(2) Previously filed.
(b) Reports on Form 8-K
During the three months ended June 30, 1999, we filed a current report
on Form 8-K on June 14, 1999 reporting information under Item 5.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHYSICIANS' SPECIALTY CORP.
DATE September 29, 1999 /s/ Robert A. DiProva
-------------------- ----------------------------------------
Robert A. DiProva Executive Vice
President and Chief Financial Officer
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