<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q/A
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended September 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 0-22019
SPECIALTY CARE NETWORK, INC.
--------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 62-1623449
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
44 UNION BOULEVARD, SUITE 600, LAKEWOOD, COLORADO 80228
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (303) 716-0041
-----------------------------
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 registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
On October 31, 1999, 12,432,297 shares of the Registrant's common stock,
$.001 par value, were outstanding.
This amendment to the Company's Form 10-Q for the quarterly period ended
September 30, 1999 amends and modifies the Form 10-Q to amend and restate in its
entirety Items 1 and 2 of Part I. The purpose of the restatement is solely to
correct a date referenced in Note 2 to the Consolidated Condensed Financial
Statements and referenced in Management's Discussion and Analysis of Financial
Condition and Results of Operations, Liquidity and Capital Resources.
<PAGE> 2
PART I. FINANCIAL INFORMATION
Specialty Care Network, Inc. and Subsidiaries
Consolidated Condensed Balance Sheets
<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
1999 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 797,504 $ 1,418,201
Accounts receivable, net 1,607,351 22,281,471
Due from affiliated practices in litigation, net 2,967,280 4,747,940
Receivables from sales of affiliated practices assets
and execution of new service agreements 1,083,407 7,953,068
Loans to physician stockholders 306,499 521,355
Prepaid expenses and other 519,461 1,500,382
Current portion note receivable 1,176,686 --
Deferred tax asset
202,217 --
Prepaid and recoverable income taxes 1,069,399 4,258,102
------------ ------------
Total current assets 9,729,804 42,680,519
Property and equipment, net 3,663,802 11,050,365
Intangible assets, net 17,692 134,319
Management service agreements, net 2,155,346 13,153,048
Advances to affiliates and other 827,590 944,520
Other assets 1,013,989 2,216,507
------------ ------------
Total assets $ 17,408,223 $ 70,179,278
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current portion of capital lease obligations $ -- $ 244,446
Accounts payable 126,688 785,649
Accrued payroll, incentive compensation and related
expenses 549,065 2,453,653
Accrued expenses 1,455,649 2,730,069
Line-of-credit -- 52,925,000
Current portion note payable 800,000 --
Due to affiliated physician practices -- 3,326,014
Deferred income 1,080,109 --
Deferred income taxes -- 1,083,178
Convertible debentures -- 589,615
------------ ------------
Total current liabilities 4,011,511 64,137,624
Note payable, less current portion 11,700,000 --
Capital lease obligations, less current portion -- 680,152
Deferred income 865,900 --
------------ ------------
Total liabilities 16,577,411 64,817,776
Stockholders' equity:
Preferred stock, $0.001 par value, 2,000,000
shares authorized, no shares issued or outstanding -- --
Common stock, $0.001 par value, 50,000,000
shares authorized, 18,621,055 and 18,618,955
shares issued and outstanding in 1999 and
1998, respectively 18,621 18,619
Additional paid-in capital 67,426,955 66,993,627
Accumulated deficit (56,094,467) (57,687,071)
Treasury stock (10,520,297) (3,963,673)
------------ ------------
Total stockholders' equity 830,812 5,361,502
============ ============
Total liabilities and stockholders' equity $ 17,408,223 $ 70,179,278
============ ============
</TABLE>
See accompanying notes to consolidated condensed financial statements.
2
<PAGE> 3
Specialty Care Network, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------------- -------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Service fees $ 5,240,287 $ 19,479,388 $ 27,126,783 $ 55,963,990
Marketing, advertising and other Internet revenue 142,986 -- 279,778 --
Other 39,898 633,023 362,472 1,907,422
------------ ------------ ------------ ------------
5,423,171 20,112,411 27,769,033 57,871,412
Costs and expenses:
Clinic expenses 424,236 14,134,169 14,866,690 39,857,918
General and administrative expenses 2,653,631 3,955,398 8,483,618 9,977,359
Production, content and
product development 817,771 -- 1,374,556 --
Litigation and other costs 906,035 -- 4,269,295 --
------------ ------------ ------------ ------------
Income (loss) from operations 621,498 2,022,844 (1,225,126) 8,036,135
Other:
Gain on sale of assets, amendment
and restatement of service
agreements, and litigation
settlement 117,485 -- 3,649,243 --
Gain on sale of equity investment 127,974 -- 127,974 1,240,078
Gain on sale of majority interest
in subsidiary -- -- 221,258 --
Interest income 88,749 23,179 249,245 141,355
Interest expense (318,566) (1,054,965) (2,205,552) (2,698,668)
------------ ------------ ------------ ------------
Income before income taxes 637,140 991,058 817,042 6,718,900
Income tax (expense) benefit (920,786) (423,348) 775,561 (2,650,585)
------------ ------------ ------------ ------------
Net (loss) income $ (283,646) $ 567,710 $ 1,592,603 $ 4,068,315
============ ============ ============ ============
Net (loss) income per common share
(basic) $ (0.02) $ 0.03 $ 0.11 $ 0.22
============ ============ ============ ============
Weighted average common shares
outstanding (basic) 12,429,197 18,415,301 14,817,837 18,117,349
============ ============ ============ ============
Net (loss) income per common share (diluted) $ (0.02) $ 0.03 $ 0.10 $ 0.22
============ ============ ============ ============
Weighted average number of common shares
and common share
equivalents used in computation
(diluted) 14,186,836 18,607,745 15,637,817 18,489,022
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated condensed financial statements.
3
<PAGE> 4
Specialty Care Network, Inc. and Subsidiaries
Consolidated Condensed Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30
1999 1998
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 1,592,603 $ 4,068,315
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation 1,491,225 1,528,287
Amortization 1,425,645 3,092,599
Gain on sale of subsidiary (221,258) --
Gain on sale of equity investment -- (1,228,701)
Gain on sale of assets, amendment and restatement
of service agreements and litigation settlement (3,649,243) --
Impact of termination agreements (1,073,777) --
Equity in loss of investee 23,852 --
Gain on disposal of assets (5,891) --
Deferred income tax (1,285,395) (738,735)
Non-cash compensation expense-stock options 394,277 82,503
Changes in operating assets and liabilities, net of
the non-cash effects of the acquisitions of the
net assets of physician groups:
Accounts receivable, net 3,294,746 (5,056,114)
Due from affiliated practices in litigation (1,423,324) --
Prepaid expenses and other assets 168,192 (1,178,895)
Accounts payable and accrued expenses (1,926,666) 651,892
Accrued payroll, incentive compensation and
related expenses 7,782 350,584
Income taxes payable and prepaid and
recoverable income taxes, net 3,188,703 (854,847)
Due to affiliated physician practices (3,121,548) 1,849,703
Deferred income 1,946,009 --
------------ ------------
Net cash provided by operating activities 697,958 2,566,591
INVESTING ACTIVITIES
Purchases of property and equipment (954,220) (6,897,225)
Proceeds from sale of medical equipment 1,001,856 --
Proceeds from sale of majority interest in a subsidiary
and equity investments, net of cash 3,208,397 1,075,000
Increase in other assets (39,403) 74,363
Increase in intangible assets -- (92,998)
Repayments from (advances to) affiliates 108,815 (1,404,916)
Advances to investee (899,342) --
Acquisition of physician groups -- (12,558,005)
------------ ------------
Net cash provided by (used in) investing activities 2,426,103 (19,803,781)
FINANCING ACTIVITIES
Proceeds from sales of affiliated practices
assets and execution of new service agreements 36,693,110 --
Proceeds from line-of-credit agreement -- 15,225,000
Principal repayments on line of credit agreement (40,425,000) --
Principal repayments on capital lease obligations (47,686) (172,881)
Loans to physician stockholders (48,178) --
Escrowed payment related to acquisition of additional
interest in majority-owned subsidiary (60,000) --
Purchases of treasury stock -- (1,307,474)
Repayments on loans to physician stockholders 135,451 185,797
Exercise of common stock options 7,545 231,350
------------ ------------
Net cash (used in) provided by financing
Activities (3,744,758) 14,161,792
Net decrease in cash and cash equivalents (620,697) (3,075,398)
Cash and cash equivalents at beginning of period 1,418,201 3,444,517
------------ ------------
Cash and cash equivalents at end of period $ 797,504 $ 369,119
============ ============
</TABLE>
4
<PAGE> 5
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30
1999 1998
------------ ------------
<S> <C> <C>
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 2,227,470 $ 2,508,404
============ ============
(Refund received) income taxes paid $ (2,678,869) $ 4,156,242
============ ============
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
EFFECTS OF THE ACQUISITIONS OF THE NET ASSETS OF PHYSICIAN GROUPS:
Assets acquired $ -- $ 21,992,643
Liabilities assumed -- (280,482)
Convertible note payable issued -- (5,454,439)
Cash outlay -- (11,799,305)
------------ ------------
Common stock issued to effect acquisitions $ -- $ 4,458,417
============ ============
SALE OF ASSETS AND RESTRUCTURE OF SERVICE AGREEMENTS:
Assets disposed of $(36,274,465) $ --
Liabilities transferred 2,954,021 --
Convertible debenture forgiven 589,615 --
Treasury stock acquired 6,556,623 --
Receivable from affiliated practices 1,083,407 --
Cash received 28,740,042 --
------------ ------------
Gain on sale of assets, amendment and restatement
of service agreements, and litigation settlement $ 3,649,243 $ --
============ ============
SALE OF SUBSIDIARY:
Liabilities assumed $ (343,832) $ --
Assets disposed of (9,619) --
Note receivable 172,200 --
------------ ------------
Loss on sale $ (181,251) $ --
============ ============
</TABLE>
See accompanying notes to consolidated condensed financial statements.
5
<PAGE> 6
Specialty Care Network, Inc. and Subsidiaries
Notes to Consolidated Condensed Financial Statements (Unaudited)
September 30, 1999
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements of
Specialty Care Network, Inc. and subsidiaries (collectively the "Company") have
been prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, these statements include all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation of the results of the interim periods reported herein.
Operating results for the three and nine months ended September 30, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 1998.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Production, Content and Product Development Costs
Beginning with the second quarter of 1999, the Company began incurring
production, content and product development costs related to the development and
support of its HealthGrades.com and ProviderWeb.net web sites. These costs
(which consist primarily of salaries and benefits, consulting fees and other
costs related to software development, application development and operations
expense) are expensed as incurred. Total costs for the three and nine months
ended September 30, 1999 were approximately $818,000 and $1,375,000,
respectively.
Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," requires
the capitalization of certain software development costs subsequent to the
establishment of technological feasibility. Based upon the Company's product
development process, technological feasibility is established upon the
completion of a working model. Costs incurred by the Company between completion
of a working model and the launch of its web sites have not been
significant.
DESCRIPTION OF BUSINESS
Specialty Care Network, Inc. operates two healthcare Internet sites and provides
practice management services to physicians in practices that focus on
musculoskeletal care. Healthcare Report Cards, Inc. ("HRCI") was formed in
September 1998 as a wholly-owned subsidiary of the Company. In November 1998,
HRCI launched an Internet web site, HealthCareReportCards.com(TM), that rated
the quality of outcomes at various hospitals for several medical procedures. In
June 1999, the Company formed HealthGrades.com, Inc. ("HGI") as a majority-owned
subsidiary of the Company, which succeeded to and expanded on the operations of
HRCI. HGI completed the expansion and redesign of the HRCI Internet web site
with the launch of its new web site, HealthGrades.com(TM) on August 4, 1999.
HealthGrades.com rates the performance of hospitals, physicians and health plans
across the United States. In October 1999, HGI launched ProviderWeb.net ("PWN"),
a subscription service for physician practice administrators and managers that
provides various online resources. The Company's wholly-owned subsidiary,
Provider Partnerships, Inc. ("PPI"), which provided consulting services to
hospitals, was sold to the former stockholders of PPI in June 1999 as part of an
agreement reached between the Company and the former PPI stockholders to resolve
a dispute between the Company and the former PPI stockholders. In addition, as
part of this agreement, the former PPI stockholders were given a minority
interest in HGI. (See Note 2- AGREEMENT WITH THE FORMER PPI STOCKHOLDERS). In
September 1999, Ambulatory Services, Inc., ("ASI"), a wholly-owned subsidiary of
the Company, sold its interest in an ambulatory surgery center. (See Note 4 -
SALE OF INTEREST IN AMBULATORY SURGERY CENTER.)
6
<PAGE> 7
NOTE 2 - AGREEMENT WITH THE FORMER PPI STOCKHOLDERS
In June 1999, the Company entered into an agreement (the "stockholders
agreement") with the former PPI stockholders to resolve certain issues raised by
the former stockholders of PPI relating to the transaction in which the Company
acquired PPI. The following is a summary of the significant terms of the
stockholders agreement:
o The Company formed HGI and transferred to HGI the HealthCareReportCards.com
web site and other related internet products. With respect to HGI, the
agreement provides, among other things, for the following:
o Venture5 LLC, whose members consist of the former PPI stockholders, and
Peter A. Fatianow, an employee of Specialty Care Network, Inc. who
developed a new product included in the healthcare rating web site, own
a minority interest in HGI. The Company owns a majority interest.
o The Company will facilitate financing to fund the operations of HGI. If
the Company is unable to facilitate a financing of at least $4 million
by December 31, 1999, the Company will transfer sufficient shares of HGI
stock that the Company owns so that the former PPI stockholders will
become the majority stockholders of HGI.
o Venture5's ownership position will not be diluted below 25 percent
unless certain events occur, including the reduction of the Company's
stock ownership interest below 50.1 percent after completion of an
initial round of financing or below 55 percent following a subsequent
round of financing.
o Until their ownership interest in HGI is reduced below five percent,
Venture5 is entitled to representation on HGI's Board of Directors
generally proportionate to the amount of stock that they own. Certain
corporate matters require a supermajority vote of the Board of
Directors.
o The former PPI stockholders have specified preemptive rights, tag-along
rights and registration rights with respect to their HGI shares.
o The Company sold most of the assets of PPI to the former PPI stockholders
for notes receivable totaling $172,200. The notes receivable are payable on
June 22, 2002 including all accrued and unpaid interest. The notes bear
interest at the greater of 4.8% per annum or the "Applicable Federal Rate"
as defined in Section 1274(d) of the Internal Revenue Code of 1986. The
Company will fund up to a maximum of $344,000 of expenses of HGI for the
period July 1, 1999 through December 31, 1999.
o The former PPI stockholders waived their rights under options to purchase
760,000 shares of the Company's common stock that they previously held.
o The parties to the agreement mutually released each other from claims
relating to the Company's acquisition of PPI.
In September 1999, the Company entered into an agreement with Venture5 under
which the Company has agreed to purchase a number of shares of HGI from the
former PPI stockholders that will increase its ownership in HGI to 90%. The
agreement required that the Company pay Venture5 $4,000,000 by November 1, 1999.
In November 1999, the purchase date was extended until December 31, 1999. Upon
completion of the Company's purchase, the stockholders agreement relating to HGI
will terminate. If the Company is unable to make the payment by that date, the
Company will release from escrow to Venture5 $60,000 that was deposited pursuant
to this agreement and the stockholders agreement will remain in effect.
NOTE 3 - RESTRUCTURE AND OTHER TRANSACTIONS
RESTRUCTURING TRANSACTION
Effective June 15, 1999, the Company closed its previously announced
restructuring transaction through nine separate restructure agreements involving
the following nine practices: Floyd R. Jaggears, Jr., M.D., P.C., II; Riyaz H.
Jinnah, M.D., II, P.A.; The Orthopaedic and Sports Medicine Center, II, P.A.;
Orthopaedic Associates of West Florida, P.A.; Orthopaedic Institute of Ohio,
Inc.; Orthopaedic Surgery Centers, P.C. II; Princeton Orthopaedic Associates,
II, P.A.; Reconstructive Orthopaedic Associates, II, P.C.; and Steven P.
Surgnier, M.D., P.A., II.
7
<PAGE> 8
Under the restructure agreements, the Company transferred, with respect to each
practice, all of the accounts receivable relating to the practice; tangible and
intangible assets purchased or acquired by the Company in respect of the
practice, other than those disposed of in the ordinary course of business since
the date the Company affiliated with the practice; all prepaid expenses relating
to the practice; all inventory relating to the practice; and all other assets
relating to the practice. The amount payable to the Company from each practice
and its physician owners for the assets sold to the practice generally equals
the sum of (1) the book value of the accounts receivable relating to the
practice on the effective date of closing; (2) the book value of all fixed
assets and other capital assets relating to the practice on the effective date
of closing; (3) the book value of all prepaid expenses relating to the practice
on the effective date of closing; (4) the book value of all notes and other
receivables the physician owners of the practice owed to the Company on the
effective date of closing; and (5) the cash balance of the practice's deposit
account on the effective date of closing, reduced by the book value of the
liabilities and obligations relating to the practice on the effective date of
closing.
In addition, the Company and each of the practices and their physician owners
entered into a management services agreement to replace the existing service
arrangement. As consideration for the Company's entry into the management
services agreement, the practices and their physician owners either paid the
Company an additional amount of cash, or paid cash and returned to the Company
shares of the Company's common stock.
Under the management services agreements, the Company provides only limited
services to the practices. In addition, the terms of the management services
arrangements have been reduced, generally from forty year terms to five year
terms beginning from the initial affiliation date of the affected practice; the
management services agreements expire at various times between one year after
closing of the restructuring transaction and September 10, 2002. The practices
pay reduced service fees to the Company. Six of the practices pay monthly
service fees, while three paid a lump sum fee in connection with the closing of
the restructuring transaction, in lieu of the monthly fee obligation.
The Company received approximately $17.8 million in payment for the
restructuring transaction. Of this amount, approximately $17.1 million was used
to reduce outstanding indebtedness.
TERMINATION OF MANAGEMENT SERVICES AGREEMENTS
During the third quarter of 1999, the Company terminated its management services
agreements with four of its affiliated practices. As a result of these
terminations, the Company is no longer required to provide management services
to these practices. Included in service fee revenue in the Company's statement
of operations for the three months ended September 30, 1999 is approximately
$2.7 million related to revenue recognized as a result of these terminations.
OTHER TRANSACTIONS
Effective June 14, 1999, the Company entered into a termination agreement with
Ortho-Associates, P.A. d/b/a Park Place Therapeutic Center ("PPTC"), which
terminated the affiliation of PPTC with the Company. The consideration paid to
the Company consisted of payment for the tangible book value of assets relating
to PPTC and payment for the termination of the service agreement. In connection
with the termination agreement, the Company received a cash payment of
$8,800,000. Additionally, warrants to purchase approximately 545,000 shares of
Company common stock held by PPTC were canceled.
Also effective June 16, 1999, the Company entered into a settlement agreement
with TOC Specialists, PL ("TOC") that resolves all legal disputes and litigation
between the Company and TOC. In connection with the settlement agreement, the
Company received a cash payment of $3,500,000 and 760,000 shares of the
Company's common stock in consideration for the tangible book value of the TOC
assets and the termination of the service agreement.
The Company used the entire $12,300,000 of cash consideration received in these
transactions to reduce outstanding indebtedness.
As of June 30, 1999, approximately $3.7 million of the cash received from the
restructure transaction was restricted for the reduction of the Company's
outstanding bank indebtedness. The cash was used to reduce the Company's bank
indebtedness in July 1999.
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NOTE 4 - SALE OF INTEREST IN AMBULATORY SURGERY CENTER
During 1998, the Company funded, through its wholly-owned subsidiary, ASI, the
purchase of a lease for, and improvements to, a surgery center in Lutherville,
Maryland. The surgery center was the only asset of SCN of Maryland, LLC, (the
"LLC"), which was owned by ASI. In March 1999, a promissory note in the amount
of $2,120,619 was issued to ASI by the LLC with respect to advances made by ASI
to cover development of the surgery center. This promissory note bore interest
at 8% and was payable in sixty monthly installments beginning July 1, 1999. In
March 1999, the Company sold 68% of its interest in the LLC to certain physician
owners of a practice affiliated with the Company for $360,505. The sale resulted
in a pre-tax gain of $221,258. In September 1999, the Company sold its remaining
interest in the LLC to the affiliated practice for $169,650. In addition, the
Company received $2,212,445, in full payment of the obligation (including
accrued interest) of the LLC to the Company and $502,633 to repay working
capital advances made by ASI to the LLC. This sale resulted in a pre-tax gain of
$127,974. The Company used approximately $1.6 million of the proceeds from this
sale to pay down its line-of-credit.
NOTE 5 - AMENDMENT OF CREDIT FACILITY
Effective September 1999, the Company entered into an amendment to its credit
facility, which converted the existing credit facility to a term loan. The term
loan provides for monthly principal and interest payments through November 2000,
with interest payable at a floating rate based on the bank syndicate's prime
lending rate plus .75%. The monthly principal payments under the term loan are
as follows: $167,000 for the months of October 1999 through December 1999,
$200,000 for the months of January 2000 through March 2000, $233,000 for the
months of April 2000 through June 2000, $266,667 for the months of July 2000
through October 2000 and a final payment of $9,633,332 in November 2000. The
term loan does not contain any financial covenants other than timely principal
and interest payments. The term loan is secured by substantially all of the
assets of the Company. In addition, the Company's wholly-owned subsidiary,
HealthCareReportCards, Inc. is a guarantor of the term loan.
At September 30, 1999, the Company had $12.5 million outstanding under the term
loan at an effective interest rate of approximately 9.0% per annum.
NOTE 6 - SEGMENT DISCLOSURES
Management regularly evaluates the operating performance of the Company by
reviewing results on a product or service provided basis. The Company's
reportable segments are Physician Practice Management ("PPM") and Internet
Services. PPM derives its revenue primarily from management services provided to
physician practices. Internet Service's revenue is derived primarily from
advertising related to an Internet web site that rates the performance of
hospitals, physicians and health plans across the United States. The Company's
other segment represents ambulatory surgery center services and health care
consulting for the three and nine months ended September 30, 1999.
The Company uses net (loss) income before income taxes for purposes of
performance measurement. The measurement basis for segment assets includes
intangible assets.
9
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<TABLE>
<CAPTION>
AS OF AND FOR THE THREE MONTHS ENDED AS OF AND FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
-------------- -------------- -------------- -------------
PPM
<S> <C> <C> <C> <C>
Revenue from external customers $ 5,306,998 $ 20,112,411 $ 27,544,417 $ 57,871,412
Interest income 39,619 23,179 157,419 141,355
Interest expense 318,566 1,054,965 2,205,552 2,698,668
Segment net income before income taxes 2,970,613 991,058 4,828,522 6,718,900
Segment assets 21,282,908 170,989,765 21,282,908 170,989,765
Segment asset expenditures 29,042 2,089,907 775,797 6,897,225
INTERNET SERVICES
Revenue from external customers $ 143,047 $ -- $ 279,839 $ --
Segment net loss before income taxes (1,946,611) -- (2,877,376) --
Segment assets 340,539 -- 340,539 --
Segment asset expenditures 78,765 -- 178,423 --
OTHER
Revenue from external customers $ -- $ -- $ 132,831 $ --
Interest income 49,130 -- 91,826 --
Equity in net loss of investee (4,874) -- (23,852) --
Segment net loss before income taxes (385,008) -- (1,023,633) --
Segment assets -- -- -- --
Segment asset expenditures -- -- -- --
</TABLE>
10
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<TABLE>
<CAPTION>
AS OF AND FOR THE THREE MONTHS ENDED AS OF AND FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
-------------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
REVENUE
Total for reportable segments $ 5,450,045 $ 20,112,411 $ 27,824,256 $ 57,871,412
Other revenue (26,874) -- (55,223) --
------------ ------------ ------------ ------------
Total consolidated revenue $ 5,423,171 $ 20,112,411 $ 27,769,033 $ 57,871,412
============ ============ ============ ============
INCOME BEFORE INCOME TAXES
Total net income before tax for
reportable segments $ 1,024,002 $ 991,058 $ 1,951,146 $ 6,718,900
Other net loss (385,008) -- (1,023,633) --
Adjustment (1,854) -- (110,471) --
------------ ------------ ------------ ------------
Income before income taxes $ 637,140 $ 991,058 $ 817,042 $ 6,718,900
============ ============ ============ ============
ASSETS
Total assets for reportable segments $ 21,623,447 $170,989,765 $ 21,623,447 $170,989,765
Elimination of investment in
subsidiaries (4,215,224) -- (4,215,224) --
------------ ------------ ------------ ------------
Consolidated total assets $ 17,408,223 $170,989,765 $ 17,408,223 $170,989,765
============ ============ ============ ============
</TABLE>
For each of the years presented, the Company's primary operations and assets
were within the United States.
NOTE 7 - SUBSEQUENT EVENT
Effective November 15, 1999, the Company settled its lawsuit with the
Specialists Orthopedic Medical Corporation, (one of the Company's affiliated
practices), and the Specialists Surgery Center, a partnership that operates a
surgery center (collectively, "the Specialists"). In consideration for the
settlement of the lawsuit, the Specialists will make a current cash payment to
the Company, return a substantial amount of the Company's common stock owned by
the physicians, and enter into a note payable to the Company payable in monthly
installments through December 2003.
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ITEM 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Statements in this section regarding, the sufficiency of cash flows from
operations, possible issuance of equity or debt securities, adequacy of our
efforts to address Year 2000 issues, cost of Year 2000 initiatives, effects of
failure of us or other companies to be Y2K compliant are "forward looking
statements." Actual events or results may differ materially from those discussed
in forward looking statements as a result of various factors, including the
unavailability of bank or other debt or equity financings on acceptable terms,
unanticipated expenditures, inadequacy of efforts to remediate Year 2000 issues,
unanticipated costs related to Year 2000 initiatives and other factors discussed
below and in the Company's Annual Report on Form 10-K for the year ended
December 31, 1998, particularly under, "Risk Factors" in Item 1 and in our
proxy statement dated May 12, 1999 for our special meeting of stockholders on
June 11, 1999, particularly under "Information About Specialty Care Network,
Inc."
GENERAL
We operate two healthcare Internet sites and provide practice management
services to physicians. Through our Internet web site, HealthGrades.com, we
provide ratings or "report cards" on hospitals and health plans, designate
"leading physicians" in 60 specialties and offer directories of specialty
healthcare providers across the country. HealthGrades.com profiles more than
600,000 physicians, 5,000 hospitals, 400 health plans, 10,000 mammography
clinics and 300 fertility clinics nationwide. ProviderWeb.net is a subscription
service for physician practice administrators and managers that provides online
resources.
Prior to the restructuring transaction described below under "RESTRUCTURING
TRANSACTION", we entered into long-term service agreements with practices
affiliated with us pursuant to which we, among other things, provided facilities
and management, administrative and development services, and employed most
non-physician personnel, in return for specified service fees. The operating
expenses incurred by us included the salaries, wages and benefits of personnel
(other than physician owners and certain technical medical personnel), supplies,
expenses involved in administering the clinical aspects of the affiliated
practices and depreciation and amortization of assets. In addition to the
operating expenses discussed above, we incurred personnel and administrative
expenses in connection with our corporate offices, which provided management,
administrative and development services to the affiliated practices.
RESTRUCTURING TRANSACTION
Effective June 15, 1999, we closed our previously announced restructuring
transaction through nine separate restructure agreements involving the following
nine practices: Floyd R. Jaggears, Jr., M.D., P.C., II; Riyaz H. Jinnah, M.D.,
II, P.A.; The Orthopaedic and Sports Medicine Center, II, P.A.; Orthopaedic
Associates of West Florida, P.A.; Orthopaedic Institute of Ohio, Inc.;
Orthopaedic Surgery Centers, P.C. II; Princeton Orthopaedic Associates, II,
P.A.; Reconstructive Orthopaedic Associates, II, P.C.; and Steven P. Surgnier,
M.D., P.A., II. (See Note 3 to the Consolidated Condensed Financial Statements
for information regarding this transaction.)
We have received to date approximately $17.8 million in payment for the
restructuring transaction. Of this amount, approximately $17.1 million was used
to reduce outstanding indebtedness.
OTHER TRANSACTIONS
Effective June 14, 1999, we entered into a termination agreement with
Ortho-Associates, P.A. d/b/a Park Place Therapeutic Center ("PPTC"), which
terminated the affiliation of PPTC with us. Also effective June 16, 1999, we
entered into a settlement agreement with TOC Specialists, PL ("TOC") that
resolves all legal disputes and litigation between us and TOC. (See Note 3 to
the Consolidated Condensed Financial Statements for further information
regarding these transactions.)
We used the entire amount of the cash consideration received in these
transactions of $12,300,000 to reduce outstanding indebtedness.
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ACCOUNTING TREATMENT
Commencing January 1, 1999, costs of obtaining long-term service agreements for
practices affiliated with us which are not party to the restructuring
transaction are amortized using the straight-line method over estimated lives of
five years from January 1, 1999.
RESULTS OF OPERATIONS
REVENUES:
Service fees
For the three months ended September 30, 1999, service fees revenue, including
reimbursement of clinic expenses, was $5.2 million compared with $19.5 million
for the same period of 1998. Our service fees revenue was $27.1 million for the
nine months ended September 30, 1999, compared to $55.9 million for the same
period in 1998. These decreases were primarily the result of the reduced service
fees received by us due to the modification of arrangements with four practices
beginning January 1, 1999 and as a result of the restructuring transaction. (See
Note 3 to the Consolidated Condensed Financial Statements for information
regarding the restructuring transaction). In connection with the restructuring
transaction, the Company and the practices agreed to reduce Company management
services obligations and reduced service fees commencing on April 1, 1999.
During the third quarter of 1999, the Company terminated its management services
agreements with four of its affiliated practices. As a result of these
terminations, the Company is no longer required to provide management services
to these practices. Included in service fee revenue for the three months ended
September 30, 1999 is approximately $2.7 million related to revenue recognized
as a result of these terminations.
Marketing, advertising and other Internet revenue
Marketing, advertising and other Internet revenue was $142,986 and $279,778 for
the three and nine month periods ended September 30, 1999. There was no
corresponding revenue during 1998.
COSTS AND EXPENSES:
Clinic expenses and general and administrative expenses
For the three months ended September 30, 1999, total clinic expenses were
approximately $424,000 compared to $14.1 million for the same period of 1998.
For the nine months ended September 30, 1999, total clinic expenses were $14.9
million compared to $39.9 million for the same period of 1998. These decreases
were primarily the result of the elimination of our obligation to pay clinic
expenses with respect to practices that were party to the transactions described
above under "Revenues - Service fees". For the three months ended September 30,
1999, general and administrative expenses were $2.7 million compared with $4.0
million for the same period of 1998. General and administrative expenses were
$8.5 million for the nine months ended September 30, 1999, compared to $10
million for the same period in 1998. The decreases in general and administrative
expenses are primarily the result of the reduction in corporate overhead due to
the transactions described above.
Production, content and product development costs
In the second quarter of 1999, we began incurring production, content and
product development costs related to the development and support of our
HealthGrades.com and ProviderWeb.net Internet sites. These costs (which consist
primarily of salaries and benefits, consulting fees and other costs related to
content acquisition and licensing, software development, application development
and operations expense) are expensed as incurred. Total costs for the three and
nine months ended September 30, 1999 were $817,771 and $1,374,556, respectively.
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Litigation and other costs
We continue to be involved in litigation with certain of its affiliated
practices. As a result of the disputes, we recorded a charge of approximately
$0.6 million and $2.7 million for the three and nine months ended September 30,
1999, respectively, to reserve for service fee revenues for these practices that
have not been paid. For the three and nine months ended September 30, 1999, we
incurred approximately $160,000 and $850,000, respectively, in expenses directly
related to these disputes. In addition, we incurred legal and other consulting
fees associated with the negotiation of a restructuring transaction with nine of
our affiliated practices of approximately $200,000 and $710,000 for the three
and nine months ended September 30, 1999, respectively.
Gain on sale of assets, amendment and restatement of service agreements, and
litigation settlement
Effective June 15, 1999, we closed the restructuring transaction with nine
practices. Additionally, we entered into a termination agreement with Park Place
Therapeutic Center and entered into a settlement agreement with TOC Specialists,
PL, during the second quarter of 1999. We recorded a pre-tax gain on these
transactions of $3.6 million for the nine months ended September 30, 1999.
Gain on sale
During 1998, we funded, through our wholly-owned subsidiary, Ambulatory
Services, Inc. ("ASI"), the purchase of a lease for, and improvements to, a
surgery center in Lutherville, Maryland. The surgery center was the only asset
of SCN of Maryland, LLC (the "LLC"), which was owned by ASI. In March 1999, a
promissory note in the amount of $2,120,619 was issued to ASI by the LLC with
respect to advances made by ASI to cover development of the surgery center. This
promissory note bore interest at 8% and was payable in sixty monthly
installments beginning July 1, 1999. In March 1999, we sold 68% of our interest
in the LLC to certain physician owners of a practice affiliated with us for
$360,505. The sale resulted in a pre-tax gain of $221,258. In September 1999, we
sold our remaining interest in the LLC to the affiliated practice for $169,650.
In addition, we received $2,212,445, in full payment of the obligation
(including accrued interest) of the LLC to us and $502,633 to repay working
capital advances made by ASI to the LLC. This sale resulted in a pre-tax gain of
$127,974. We used approximately $1.6 million of the proceeds from this sale to
pay down its line-of-credit.
Income taxes
For the three and nine months ended September 30, 1999, our effective income tax
expense (benefit) rate was 145% and (95%), respectively. For the three months
ended September 30, 1999, the effective tax rate differs from an expected 35%
federal rate principally due to operating losses incurred by HealthGrades.com,
Inc ("HGI"). This majority-owned subsidiary is not eligible for consolidation
with us for federal income tax purposes and, as a result, no current or future
income tax benefit has been recorded for its losses. The effective income tax
rate for the nine months ended September 30, 1999 is less than the expected
federal tax rate principally due to reductions in the valuation allowance for
deferred tax assets recorded resulting from our restructuring transaction. The
reduction in the valuation allowance for the nine months ended September 30,
1999, was partially offset by our inability to record a future income tax
benefit for the operating losses of HGI, as discussed above.
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<PAGE> 15
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, we had a working capital surplus of approximately $5.7
million, an increase of $27.2 million from a working capital deficit of $21.5
million as of December 31, 1998. The increase was principally the result of an
amendment to our credit facility during September 1999, which converted our
existing credit facility to a term loan. At December 31, 1998, we were in
default under our credit facility because we were not in compliance with certain
financial covenants. As a result, the bank syndicate could declare the
outstanding balance immediately due and payable. Accordingly, the total amount
outstanding under the credit facility of approximately $52.9 million at December
31, 1998 was included as a current liability in our Consolidated Balance Sheet.
The term loan now provides for monthly principal and interest payments through
November 2000, with interest payable at a floating rate based on the bank
syndicate's prime lending rate plus .75%. The monthly principal payments are as
follows: $167,000 for the months of October 1999 through December 1999, $200,000
for the months of January 2000 through March 2000, $233,000 for the months of
April 2000 through June 2000, $266,667 for the months of July 2000 through
October 2000 and a final payment of $9,633,332 in November 2000. The term loan
does not contain any financial covenants other than timely principal and
interest payments. The term loan is secured by substantially all of the assets
of the Company. In addition, the Company's wholly-owned subsidiary,
HealthCareReportCards, Inc. is a guarantor of the term loan. At September 30,
1999, the Company had $12.5 million outstanding under the term loan at an
effective interest rate of approximately 9.0% per annum.
For the nine months ended September 30, 1999, cash flow provided by operations
was $697,958 compared to cash flow provided by operations of $2.6 million for
the same period of 1998. For the three months ended September 30, 1999, cash
flow used in operations was $1.9 million.
During the nine months ended September 30, 1999, we received an income tax
refund of approximately $2.7 million related to the overpayment of 1998
estimated taxes. We expect to receive, by December 31, 1999, an additional $1.3
million of tax refunds related to net operating loss carrybacks and overpayments
of 1998 estimated state taxes.
We continue to incur significant legal fees and other costs related to pending
litigation with affiliated practices. Additionally, we are incurring significant
costs relating to the development and marketing of our Internet sites'
HealthGrades.com and ProviderWeb.net. In September 1999, we entered into an
agreement with the former stockholders of Provider Partnerships, Inc., under
which we have agreed to purchase a number of shares of HGI that will increase
our ownership in HGI to 90%. The agreement requires that we pay $4,000,000 to
the former stockholders of Provider Partnerships, Inc. by December 31, 1999.
(See also Note 2 to the Condensed Consolidated Financial Statements.) We
anticipate that we will require additional funds to finance our ongoing
operations and to service our debt. Management is currently examining various
financing alternatives. The availability and terms of any financing will depend
on market and other conditions. We cannot assure that sufficient funds will be
available on terms acceptable to us, if at all.
YEAR 2000
The Year 2000 (Y2K) issue is a result of a global programming standard that
records dates as six digits (i.e. MM/DD/YY), using only the last two digits for
the year. Any software application or hardware product that uses two-digit
fields could interpret the year 2000 as the year 1900. Systems that do not
properly recognize the correct year could generate erroneous data or cause a
system to fail, resulting in business interruption. This situation is not
limited to computers; it has the potential to affect many systems, components,
and devices that have embedded computer chips that may be date sensitive.
We are coordinating our efforts to address the Y2K issue with our affiliated
practices and vendors. We cannot assure that the systems of other companies on
which our systems rely will be timely converted. A failure to convert by another
company or a conversion that is incompatible with our systems could have a
material adverse effect on us.
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In 1997, we established a Y2K Coordinator to oversee all corporate-wide Y2K
initiatives. These initiatives encompass all of our computer software and
embedded systems. Teams of internal and external specialists were established to
inventory and test critical computer programs and automated operational systems.
Additionally, a detailed project plan has been created that outlines all
activities related to the Y2K issue. Generally speaking, the project involves
three areas: Corporate Headquarters, Affiliated Practices, and Internet
Operations.
Corporate Headquarters: Because we began operations in 1996, most of our
corporate computer hardware is relatively new. Additionally, most of the
software applications are "off the shelf", resulting in few internal software
modifications. Since January 1998, all significant internal applications have
been reviewed and updated. We have completed identifying and have corrected all
internal applications. We have completed upgrading and modifying all computer
hardware that required Y2K conversions. As of September 30, 1999, we have
completed our Y2K activities. Total costs incurred by us to modify the software
used at the corporate office were not material.
Affiliated Practices: The restructuring and other transactions shifted
responsibility for Year 2000 compliance to most of the practices we were
formerly affiliated with. We have assessed the status of the computer systems at
the affiliated practices that continue to be affiliated with us. Based upon our
review, and discussion with our remaining practices, we believe that all
affiliated practices are compliant. All costs to modify systems to become Y2K
compliant have been, and will be borne by the affiliated practices.
Although we believe we have addressed all significant Y2K issues that could
affect us, we have few alternatives available, other than reversion to manual
methods, in order to avoid the effects of not establishing Y2K readiness. As a
result, if any significant issues arise with our corporate headquarters, we
could incur significant additional costs to correct the problem. There can be no
assurance that any remediation plan will address all the problems that may
arise. For the Y2K non-compliance issues identified to date, the cost to upgrade
or prepare for Y2K is not expected to have a material impact on our operating
results.
Internet Operations: To the extent that our assessment is finalized without
identifying any additional material non-compliant IT systems we operate, or that
are operated by third parties, the most likely worst case Y2K scenario is a
systemic failure beyond our control. This could include a prolonged
telecommunications or electrical failure. Such a failure could prevent us from
operating our business, prevent users from accessing our web site, or change the
behavior of advertising customers or persons accessing our web site. We believe
that the primary business risks, in the event of such failure, would include,
but not be limited to, lost advertising revenues, increased operating costs,
loss of customers or persons accessing our web site, or other business
interruptions of a material nature. These issues could lead to claims of
mismanagement, misrepresentation, or breach of contract, any of which could have
a material adverse effect on our business, results of operations and financial
condition. We have not made any contingency plans to address such risks.
Additionally, the computer systems necessary to maintain the viability of the
Internet or any of the Web sites that direct consumers to the Company's link to
online stores may not be Y2K compliant. Computers used by customers to access
these online stores may not be Y2K compliant, delaying customers' product
purchases.
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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.
SPECIALTY CARE NETWORK, INC.
Date: November 30, 1999 By: /s/ Paul Davis
--------------------------- ------------------------------
Paul Davis
Executive Vice President, Finance
(Chief Financial Officer)
17
