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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended MARCH 31, 1999
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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
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SPECIALTY CARE NETWORK, INC.
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(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 Identification No.)
Incorporation or Organization)
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
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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 April 30, 1999, 18,618,955 shares of the Registrant's common stock,
$.001 par value, were outstanding.
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Specialty Care Network, Inc. and Subsidiaries
INDEX
<TABLE>
<S> <C> <C>
PART I. FINANCIAL INFORMATION:
Item 1. Consolidated Condensed Balance Sheets -
March 31, 1999 and December 31, 1998.......................................................1
Consolidated Statements of Operations -
Three Months Ended March 31, 1999 and 1998.................................................2
Consolidated Condensed Statements of Cash Flows -
Three Months Ended March 31, 1999 and 1998.................................................3
Notes to Consolidated Condensed Financial Statements.......................................5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................................8
Item 3. Quantitative and Qualitative Disclosure About Market Risk ................................12
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings.........................................................................13
Item 3. Defaults Upon Senior Securities ..........................................................13
Item 6. Exhibits and Reports on Form 8-K..........................................................13
</TABLE>
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PART I. FINANCIAL INFORMATION
Specialty Care Network, Inc. and Subsidiaries
Consolidated Condensed Balance Sheets
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 3,771,282 $ 1,418,201
Accounts receivable, net 22,641,662 22,281,471
Due from affiliated practices in litigation, net 4,749,662 4,747,940
Receivables from sales of affiliated practices' assets
and execution of new service agreements -- 7,953,068
Loans to physician stockholders 569,533 521,355
Prepaid expenses and other 1,391,597 1,500,382
Prepaid and recoverable income taxes 1,431,584 4,258,102
------------ ------------
Total current assets 34,555,320 42,680,519
Property and equipment, net 9,626,563 11,050,365
Intangible assets, net 130,824 134,319
Management service agreements, net 12,264,000 13,153,048
Advances to affiliates and other 867,009 944,520
Equity investment in and advances to investee 2,056,755 --
Other assets 1,714,598 2,216,507
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Total assets $ 61,215,069 $ 70,179,278
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current portion of capital lease obligations $ 229,712 $ 244,446
Accounts payable 375,356 785,649
Accrued payroll, incentive compensation and related
expenses 3,078,299 2,453,653
Accrued expenses 1,786,164 2,730,069
Line-of-credit 44,377,377 52,925,000
Due to affiliated physician practices 2,743,576 3,326,014
Deferred income 514,466 --
Deferred income taxes 749,059 1,083,178
Convertible debentures 589,615 589,615
------------ ------------
Total current liabilities 54,443,624 64,137,624
Capital lease obligations, less current portion 648,597 680,152
Deferred income 1,035,991 --
------------ ------------
Total liabilities 56,128,212 75,189,755
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, 18,618,955 shares issued
and outstanding in 1999 and 1998 18,619 18,619
Additional paid-in capital 67,011,806 66,993,627
Accumulated deficit (57,979,895) (57,687,071)
Treasury stock (3,963,673) (3,963,673)
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Total stockholders' equity 5,086,857 5,361,502
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Total liabilities and stockholders' equity $ 61,215,069 $ 70,179,278
============ ============
</TABLE>
See accompanying notes to consolidated condensed financial statements
1
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Specialty Care Network, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
--------------------------------
1999 1998
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<S> <C> <C>
Revenue:
Service fees $ 14,161,166 $ 17,213,803
Other 311,712 806,566
------------ ------------
14,472,878 18,020,369
Costs and expenses:
Clinic expenses 9,575,632 12,234,547
General and administrative
expenses 3,553,977 2,642,150
Litigation and other costs 1,107,700 --
------------ ------------
Income from operations 235,569 4,383,750
Other:
Gain on sale of majority interest
in a subsidiary 221,258 --
Gain on sale of equity investment -- 1,240,078
Interest income 63,338 61,320
Interest expense (1,007,243) (666,024)
------------ ------------
(Loss) income before income taxes (487,078) 3,779,046
Income tax benefit (expense) 194,254 (1,492,723)
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Net (loss) income $ (292,824) $ 2,286,323
============ ============
Net (loss) income per share (basic) $ (0.02) $ 0.13
============ ============
Weighted average shares
outstanding (basic) 16,494,704 17,731,273
============ ============
Net (loss) income per share (diluted) $ (0.02) $ 0.13
============ ============
Weighted average shares
outstanding (diluted) 16,494,704 18,272,034
============ ============
</TABLE>
See accompanying notes to consolidated condensed financial statements.
2
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Specialty Care Network, Inc. and Subsidiaries
Consolidated Condensed Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31
1999 1998
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<S> <C> <C>
OPERATING ACTIVITIES
Net (loss) income $ (292,824) $ 2,286,323
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 721,205 402,276
Amortization 892,543 776,551
Gain on sale of subsidiary (221,258) --
Gain on sale of equity investment -- (1,240,078)
Equity in earnings of investee (14,884) --
Loss on disposal of assets 29,604 --
Deferred income taxes (334,119) 115,263
Non-cash compensation expense-stock options -- 27,501
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 (360,191) (1,863,867)
Due from affiliated practices in litigation (1,722) --
Prepaid expenses and other assets (34,366) (962,893)
Accounts payable and accrued expenses (1,211,600) 914,665
Accrued payroll, incentive compensation and
related expenses 644,761 (34,223)
Income taxes payable and prepaid and
recoverable income taxes, net 2,826,518 (849,724)
Due to physicians groups (582,438) 1,352,445
Deferred income 1,550,457 --
------------ ------------
Net cash provided by operating activities 3,611,686 924,239
INVESTING ACTIVITIES
Purchases of property and equipment (701,625) (2,799,729)
Proceeds from sales of majority interest in a subsidiary
and equity investments, net of cash 322,812 1,075,000
Increase in other assets (15,847) (15,263)
Increase in intangible assets -- (90,138)
Repayments from (advances to) affiliates 77,511 (1,061,339)
Advances to investee (252,434) --
------------ ------------
Net cash used in investing activities (569,583) (2,891,469)
FINANCING ACTIVITIES
Proceeds from sales of affiliated practices
assets and execution of new service agreements 7,953,068 --
Proceeds from line-of-credit agreement -- 13,225,000
Principal repayments on line of credit agreement (8,547,623) --
Principal repayments on capital lease obligations (46,289) (55,808)
Loans to physician stockholders (48,178) --
Repayments on loans to physician stockholders -- 4,004
Exercise of common stock options -- 205,600
------------ ------------
Net cash (used in) provided by financing activities (689,022) 13,378,796
Net increase in cash and cash equivalents 2,353,081 11,411,566
Cash and cash equivalents at beginning of period 1,418,201 3,444,517
------------ ------------
Cash and cash equivalents at end of period $ 3,771,282 $ 14,856,083
============ ============
</TABLE>
3
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Specialty Care Network, Inc. and Subsidiaries
Consolidated Condensed Statements of Cash Flows (Unaudited)
(continued)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1999 1998
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<S> <C> <C>
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 825,133 $ 684,131
============ ============
(Refund received) income taxes paid $ (2,686,653) $ 2,143,102
============ ============
Supplemental schedule of noncash investing and
financing activities
Effects of the acquisitions of the net assets of physician groups:
Assets acquired $ -- $ 21,654,833
Liabilities assumed -- (252,977)
Convertible note payable issued -- (5,579,439)
Due to physician group -- (11,239,000)
------------ ------------
Common Stock issued to effect acquisitions $ -- $ 4,583,417
============ ============
</TABLE>
See accompanying notes to consolidated condensed financial statements.
4
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Specialty Care Network, Inc. and Subsidiaries
Notes to Consolidated Condensed Financial Statements (Unaudited)
March 31, 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 months ended March 31, 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.
DESCRIPTION OF BUSINESS
The Company is a health care management services company that 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 rates the quality of
outcomes at various hospitals for several medical procedures. In addition, in
December 1998, Ambulatory Services, Inc., ("ASI") was formed as a wholly-owned
subsidiary of the Company. ASI was formed to engage in the development and
management of freestanding and in-office ambulatory surgery centers. The
Company's wholly-owned subsidiary, Provider Partnerships, Inc. ("PPI"), provides
consulting services to hospitals to increase their operating performance, with a
specific focus on the cardiac area. However, the Company is currently involved
in a dispute with the former stockholders of PPI. Management of the Company is
exploring alternatives to terminate its relationship with PPI. (See Note 2 for
discussion of the dispute with the former stockholders of PPI.) All significant
intercompany balances and transactions have been eliminated in consolidation.
CHANGE IN ACCOUNTING ESTIMATE
In light of the Company's pending restructuring transaction, as well as numerous
other factors in the physician practice management industry in general, during
the fourth quarter of 1998, management undertook an evaluation of the carrying
amount of its long-term service agreements pursuant to the provisions of
Statement of Financial Accounting Standards No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. As
a result of this evaluation, the Company recorded an impairment loss on its
service agreements of approximately $94.6 million in December 1998.
Additionally, as a result of management's evaluation of its long-term service
agreements, commencing January 1, 1999, the Company reduced the amortization
lives of its service agreements associated with practices affiliated with the
Company which are not party to the pending restructuring transaction to five
years from January 1, 1999. This change in accounting estimate resulted in an
increase of approximately $252,000 over what amortization expense would have
been for the three months ended March 31, 1999 on the above-mentioned service
agreements subsequent to the impairment loss recorded in December 1998.
5
<PAGE> 8
RECLASSIFICATIONS
Certain amounts in the Consolidated Statement of Operations and the
Consolidated Condensed Statement of Cash Flows for the three months
ended March 31, 1998 have been reclassified in order to conform to the
current presentation.
NOTE 2 - AGREEMENT IN PRINCIPLE WITH THE FORMER PPI STOCKHOLDERS
The Company has entered into an agreement in principle 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 agreement
provides for the following:
o The Company will form a new company that will own the
HealthCareReportCards.com web site and other related internet products. (It
is possible that, instead of a new company, our wholly-owned Health Care
Report Cards, Inc. subsidiary will be subject to the following provisions.)
With respect to the new company, the agreement in principle provides, among
other things, for the following:
o The former PPI stockholders will have a 25 percent ownership interest in
the new company. Peter A. Fatianow, an employee of Specialty Care
Network, Inc. who developed a new product to be included in our
healthcare rating web site, will own a five percent interest in the new
company. The remainder will initially be owned by the Company.
o The former PPI stockholders' 25 percent ownership position will not be
diluted 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 the new company is reduced below five
percent, the former PPI stockholders will have representation on the new
company's Board of Directors proportionate to the amount of stock that
they own. Certain corporate matters will require a supermajority vote of
the Board of Directors.
o The Company will facilitate financing to fund the operations of the new
company. 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 the new company stock that we own so that the former PPI
stockholders will become the majority stockholders of the new company.
o The new company will provide specified compensation to the former PPI
stockholders (who will be employees of the new company).
o The Company will guarantee payment of the new company's expenses until
December 31, 1999 or, if sooner, the date the new company receives third
party financing of $1 million.
o The former PPI stockholders will have specified preemptive rights, tag-along
rights and registration rights with respect to their new company shares.
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o The Company will sell most of the assets of PPI to the former PPI
stockholders for nominal consideration. The Company will retain the revenue
from PPI contracts earned through March 31, 1999, and the Company will fund
up to a maximum of $500,000 of expenses of the new business through December
31, 1999.
o The former PPI stockholders will return the 420,000 shares of the Company's
common stock that they received in connection with the Company's acquisition
of PPI. The Company has agreed to reimburse the former PPI stockholders for
any tax liability they may incur with regard to the return of the shares.
o The former PPI stockholders will return options to purchase 760,000 shares
of the Company's common stock that they now hold. (The former PPI
stockholders waived their rights under these options in April 1999).
o The parties to the agreement will mutually release each other from claims
relating to the Company's acquisition of PPI.
The agreement in principle is subject to the preparation and execution of a
definitive agreement.
NOTE 3 - SALE OF MAJORITY INTEREST IN A SUBSIDIARY
During 1998, the Company formed SCN of Maryland, LLC, a limited liability
corporation established to develop and operate an ambulatory surgery center in
Baltimore, Maryland. In March 1999, the Company sold 68% of its interest in SCN
of Maryland, LLC to certain physician owners of a practice affiliated with the
Company for total consideration of $360,505. The sale resulted in a pre-tax gain
of $221,258.
NOTE 4 - 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 is the Company's base business which derives its revenue
primarily from the management of physician practices. Internet Service's
revenue is derived primarily from advertising related to an Internet web site
that rates U.S. hospitals with respect to several medical specialties. The
Company's other segment represents ambulatory surgery center services and
health care consulting for the three months ended March 31, 1999.
The Company uses net (loss) income before income taxes for purposes of
performance measurement. The measurement basis for segment assets includes
intangible assets.
Summary information by segment is as follows:
<TABLE>
<CAPTION>
As of and for the Three Months Ended
March 31
1999 1998
--------------- ---------------
<S> <C> <C>
PPM
Revenue from external customers $ 14,415,325 $ 18,020,369
Interest income 63,338 61,320
Interest expense 1,007,243 666,024
Segment net (loss) income before income taxes (291,095) 3,779,046
Segment assets 62,173,448 179,131,964
Segment asset expenditures 678,075 2,811,106
INTERNET SERVICES
Revenue from external customers $ 74,040 $ --
Segment net (loss) income before income taxes (135,814) --
Segment assets 140,919 --
Segment asset expenditures 21,137 --
OTHER
Revenue from external customers $ 132,831 $ --
Equity in net income of unconsolidated affiliate 14,884 --
Segment net (loss) income before income taxes (58,317) --
Segment assets 111,138 --
Segment asset expenditures 2,413 --
</TABLE>
A reconciliation of the Company's segment revenue, segment net (loss)
income before income taxes, segment assets and other significant items to the
corresponding amounts in the Consolidated Condensed Financial Statements is as
follows:
<TABLE>
<CAPTION>
As of and for the Three Months Ended
March 31,
1999 1998
--------------- ---------------
<S> <C> <C>
REVENUE
Total for reportable segments $ 14,489,365 $ 18,020,369
Other revenue (16,487) --
--------------- ---------------
Total consolidated revenue $ 14,472,878 $ 18,020,369
=============== ===============
(LOSS) INCOME BEFORE INCOME TAXES
Total net (loss) profit before tax for
reportable segments $ (426,909) $ 3,779,046
Other net loss (58,317) --
Adjustment (1,852) --
--------------- ---------------
(Loss) income before income taxes $ (487,078) $ 3,779,046
=============== ===============
ASSETS
Total assets for reportable segments $ 62,314,367 $ 179,131,964
Other assets 111,138 --
Elimination of investment in subsidiary (1,210,436) --
--------------- ---------------
Consolidated total assets $ 61,215,069 $ 179,131,964
=============== ===============
</TABLE>
For each of the years presented, the Company's primary operations and
assets were within the United States.
7
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ITEM 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Statements in this section, including statements concerning the proposed
restructuring,, the sufficiency of cash flows from operations, possible
additional bank borrowings and issuance of equity or debt securities,
anticipated capital expenditures, adequacy of Company efforts to address Year
2000 issues and cost of Year 2000 initiatives 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 changes in the
proposed restructuring, abandonment of the proposed restructuring, failure of
the stockholders to approve the proposed restructuring, unwillingness of the
Company's lending bankers to restructure our credit arrangement, 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.
GENERAL
Specialty Care Network, Inc. is a health care management services company that
provides practice management services to physicians. We also provide a health
care rating internet site, HealthCareReportCards.com, that rates the quality of
outcomes at various hospitals for several medical procedures. In addition,
through our subsidiary, Ambulatory Services, Inc., we are establishing a
business to be engaged in the development and management of freestanding and
in-office ambulatory surgery centers.
We have entered into long-term service agreements with practices affiliated with
us pursuant to which we, among other things, provide facilities and management,
administrative and development services, and employ most non-physician
personnel, in return for specified service fees. The operating expenses incurred
by us include the salaries, wages and benefits of personnel (other than
physician owners and certain technical medical personnel), supplies, expenses
involved in administering the clinical practices of the affiliated practices and
depreciation and amortization of assets. We seek to reduce certain operating
expenses, as a percentage of net revenue, of the affiliates practices. The
negotiated amounts of our service fee also affect operating expenses, measured
as a percentage of net revenue. In addition to the operating expenses discussed
above, we incur personnel and administrative expenses in connection with our
corporate offices, which provide management, administrative and development
services to the affiliated practices.
RESTRUCTURING TRANSACTION
In March 1999, we entered into restructuring agreements with ten of our
affiliated practices. The agreements:
o Provide for the repurchase by affiliated physicians or affiliated
practices of practice assets and for new management service arrangements
in exchange for cash and/or common stock;
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<PAGE> 11
o Limit management services provided to the affiliated practices by us
under our service agreements;
o Reduce the term of our service agreements with the affiliated practices;
and
o Lower service fees paid to us by the affiliated practices.
The purchase price paid to us will consist of payments for the book value of the
assets to be purchased by the practices, less the practice liabilities as of the
closing date of the transaction and payments for the execution of a management
services agreement to replace the existing management services arrangement. The
restructure transaction is subject to several conditions, including shareholder
approval. On May 13, 1999 we received consent from our bank syndicate for the
restructuring transaction, subject to the following conditions:
o The transaction with the ten affiliated practices closes on or before
June 15, 1999;
o No change occurring in the terms and conditions of the restructuring
transaction;
o The outstanding balance under the credit facility being paid down to
$22,000,000 simultaneously with the closing of the transaction;
o The payment of a consent fee to the bank syndicate of 2% of the
outstanding principal balance of the credit facility on June 16, 1999.
(However, if the outstanding balance under the credit facility is less
than $12,500,000 on June 16, 1999, no consent fee will be due); and
o The pledge of all additional collateral in any subsidiaries owned by us
and not previously pledged.
If the restructuring transaction is completed, the Company expects to reacquire
3,786,957 shares of its common stock and have the ability to reduce its
indebtedness by approximately $17.6 million (subject to adjustment), including
$0.6 million through cancellation of an outstanding convertible debenture. In
addition, we anticipate that at least a portion of the approximately $6 million
in prepaid service fees will also be applied to the payment of our bank
indebtedness.
MODIFICATION OF ARRANGEMENTS WITH FOUR PRACTICES
Near the end of 1998, we entered into transactions with four of our affiliated
practices. In these transactions, we sold to each of the practices accounts
receivable, fixed assets and certain other assets relating to the respective
practices and replaced the original management service arrangements with new
arrangements. Under the management services agreements, which terminate at
certain dates between November 2001 and March 2003, we provide substantially
reduced services to the practices, and the practices pay significantly reduced
service fees. These transactions were closed effective December 31, 1998. As a
result of the completion of these four transactions, we reacquired 2,124,959
shares of our common stock and reduced our outstanding indebtedness at December
31, 1998 by approximately $5.5 million through the cancellation of a convertible
note with one of the affiliated practices. Additionally, during the first
quarter of 1999, we used the proceeds from the completion of these four
transactions to reduce the amount outstanding under our credit facility by
approximately $8.5 million.
ACCOUNTING TREATMENT
Commencing January 1, 1999, costs of obtaining long-term service agreements for
practices affiliated with U.S. 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. This change in accounting estimate resulted
in an increase of approximately $252,000 over what amortization expense would
have been on the above-mentioned service agreements for the three months ended
March 31, 1999 subsequent to the impairment loss recorded in December 1998. (See
Note 1 to the Consolidated Condensed Financial Statements for discussion of the
change in accounting estimate related to our long-term management service
agreements). Under the service agreements between us and each of the affiliated
practices, we have the exclusive right to provide management, administrative and
development services during the term of the agreement.
RESULTS OF OPERATIONS
Revenue. Our service fees revenue, including reimbursement of clinic expenses,
decreased by $3.0 million to $14.2 million for the three months ended March 31,
1999, compared to $17.2 million for the same period in 1998. This decrease was
primarily the result of the reduced service fees received by us due to the
modification of arrangements with four practices as described above. We no
longer pay clinic expenses with respect to the four practices; as a result, we
are not reimbursed for such expenses. Other revenue for the three months ended
March 31, 1999 was approximately $312,000 compared to $807,000 for the same
period in 1998. This decrease is primarily the result of revenue from business
consulting fees and other miscellaneous revenue received in 1998.
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<PAGE> 12
Clinic expenses and general and administrative expenses. For the three months
ended March 31, 1999, total clinic expenses were $9.6 million compared to $12.2
million for the same period of 1998. This decrease was primarily the result of
the elimination of our payment of clinic expenses due to the modification of
arrangements with four practices as further described above. General and
administrative expenses increased by $1.0 million to $3.6 million for the three
months ended March 31, 1999, compared to $2.6 million for the same period in
1998. The increase in general and administrative expenses is primarily the
result of the increased amortization expense related to the change in accounting
estimate described above as well as expenses incurred by us related to
subsidiaries formed and/or acquired during 1998.
Litigation and other costs. We are currently involved in disputes with TOC
Specialists, P.L., The Specialists Orthopaedic Medical Corporation and 3B
Orthopaedics, P.C., which are practices affiliated with us. As a result of
these disputes, we incurred approximately $830,000 in expenses directly related
to these disputes for the three months ended March 31, 1999. In addition, we
incurred approximately $280,000 in legal and other consulting fees associated
with the negotiation of a restructuring transaction with ten of our affiliated
practices.
Gains on sales. In March 1998, we sold our entire interest in West Central
Ohio Group Ltd., an Ohio limited liability company, for a pre-tax gain of
approximately $1.2 million. In March 1999, we sold 68% of our interest in SCN
of Maryland, LLC to certain physician owners of a practice affiliated with us
for total consideration of approximately $360,000. The sale resulted in a
pre-tax gain of approximately $220,000.
Interest expense. During the three months ended March 31, 1999, we incurred
interest expense of $1.0 million compared to $0.7 million for the same period of
1998. The increase is primarily the result of additional borrowings of
approximately $13.2 million under our bank credit facility, which were used to
fund our affiliation transaction with Orlin & Cohen Associates LLP, which was
effective March 31, 1998, as well as other borrowings made to fund the purchase
of ancillary equipment for installation at affiliated practices. At March 31,
1999, $44.4 million was outstanding under the credit facility.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999, we had a working capital deficit of approximately $19.9
million, a decrease of $1.6 million from $21.5 million as of December 31, 1998.
For the first three months of 1999, cash flow provided by operations was $3.6
million compared to cash flow provided by operations of $.9 million for the same
period of 1998.
During the three months ended March 31, 1999, we received an income tax refund
of approximately $2.7 million related to the overpayment of 1998 estimated
taxes. Additionally, we received approximately $8.0 million from the sales of
affiliated practices, assets and execution of new service agreements and $1.6
million in prepayment of service fees for the new service agreements related to
the modification arrangements with four practices described above. We used the
proceeds from the modification arrangements to pay down our credit facility by
approximately $8.5 million during the first quarter of 1999.
As of March 31, 1999 and December 31, 1998, we were not in compliance with
certain of the financial ratio covenants required by our credit facility. As a
result of the non-compliance with certain financial ratio covenants, we are in
default under the terms of the credit facility. In the event of default, the
terms of the credit facility provide that the bank syndicate can immediately
terminate its obligation to make further advances under the respective
commitments and/or declare our outstanding debt under the credit facility to be
immediately due and payable. Accordingly, the total amount outstanding under the
credit facility of approximately $44.4 million has been included in our
Consolidated Condensed Balance Sheet as a current liability at March 31, 1999.
The bank syndicate notified us in December 1998 that it was suspending any
further advances under the credit facility. We are currently negotiating with
the bank syndicate to restructure our credit arrangement.
The issues described above raise substantial doubt about our ability to continue
as a going concern. Management intends to address these issues through a
restructuring transaction involving ten of our affiliated practices, which is
intended to substantially reduce our outstanding debt and allow management to
pursue the development of a health care rating internet site and our ambulatory
surgery center business. The proposed restructuring transaction, which is
subject to several conditions, including approval by our stockholders, is more
fully described above under "Restructuring Transaction." Additionally,
management believes that the cash flow from operations will be sufficient
10
<PAGE> 13
to fund our operations at the current level for the next twelve months. However,
we are incurring significant legal fees and other costs related to pending
litigation with three of our affiliated practices and the proposed
restructuring. We anticipate that we will require additional funds to finance
capital expenditures relating to expansion of our business. We expect that
capital expenditures during 1999 will relate primarily to (i) the development of
our surgery center business, (ii) expansion and replacement of medical and
office equipment for the affiliated practices not restructuring, and (iii) the
purchase of equipment to expand our computer capabilities. 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.
Pursuant to the service agreements with the affiliated practices, we purchase,
subject to adjustment, the accounts receivable of the affiliated practices
monthly. The purchase price for such accounts receivable generally equals the
gross amounts of the accounts receivable recorded each month, less adjustments
for contractual allowances, allowances for doubtful accounts and other
potentially uncollectible amounts based on the practice's historical collection
experience, as determined by us. However, we and certain affiliated practices
are currently making periodic adjustments so that amounts paid by us for the
accounts receivable are adjusted upwards or downwards based on our actual
collection experience. We expect to use working capital to fund our obligation
to purchase, subject to adjustment, the accounts receivable on an ongoing basis.
No adjustments are made to reflect financing costs related to the carrying of
such receivables by us.
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, which have embedded computer chips that may be date sensitive.
We are coordinating our efforts to address the Y2K issue with our affiliated
practices, third-party payors, 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.
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 Third-party
Payors.
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. In the prior six-month period, all significant internal
applications have been reviewed and updated. We currently anticipate that all
remaining internal applications will be Y2K compliant by the end of the second
quarter of 1999. Total costs incurred by us to modify the software used at the
corporate office were not material.
11
<PAGE> 14
Affiliated Practices: We have assessed the status of the computer systems at our
affiliated practices. Based on the results of this assessment, we have
determined that the majority of our affiliated practices' systems are Y2K
compliant. The remaining practices are currently upgrading their systems or are
in the testing phase. Based upon our review, and discussion with our affiliated
practices, we expect all remaining affiliated practices to be compliant by the
end of the second quarter of 1999. All costs to modify systems to become Y2K
compliant have been and will be borne by the affiliated practices.
Third-Party Payors: Although our affiliated practices' internal systems are
expected to be compliant by the end of the second quarter of 1999, our
affiliated practices also have important relationships with third party payors
and managed care organizations. We have been reviewing with these major payors
and managed care organizations the status of their Y2K readiness. Most of our
major payors are large insurance carriers and government agencies. Based on
discussions with some of our affiliated practices, many of the major third-party
payors are either compliant or are in the testing phase at this time. However,
we also understand there are some government payors, such as Medicare, that are
not yet Y2K compliant. Any failure by one of our significant third-party payors
to fully address all Y2K issues could have a material adverse effect on us.
Although we believe we are addressing all significant Y2K issues which 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, our
practices or third-party payors, 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Because we are in default under our credit facility, amounts outstanding under
the credit facility bear interest at the prime lending rate plus .5%. As a
result, this debt is subject to fluctuations in the market which affect the
prime rate.
There were no significant changes to market risk from what was reported in
Item 7A in our Annual Report on Form 10-K for the year ended December 31, 1998.
12
<PAGE> 15
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
On January 4, 1999, Mid-Atlantic Orthopaedic Specialists, P.C., ("MAOS") one of
our affiliated practices, gave us notice that they intended to terminate the
service agreement between us and the practice based on our material default in
the performance of our duties and obligations imposed upon us by the service
agreement. Under the terms of our service agreements, in the event that an
affiliated practice asserts a material default under the service agreement, we
have sixty days in which to cure any such default. In our response letter to the
practice, we informed the practice that we did not believe that we were in
material default under the service agreement and that in any event the practice
had failed to give us adequate notice of a material default in order to give us
a reasonable opportunity to cure any specific default within the sixty-day
period provided for in the service agreement. After reviewing this matter in
detail, we continue to believe that we are not in material default under the
terms of our service agreement with MAOS.
On May 7, 1999, we filed a declaratory judgment action in the U.S. District
Court for the District of Colorado against MOAS, seeking a determination and
adjudication of the rights and liabilities of the parties under the merger
agreement and service agreement. We have also sought a declaration confirming
that we have not materially breached the service agreement and that MAOS is not
entitled to terminate that agreement. The complaint may be amended to assert
additional causes of action against MAOS.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company is currently not in compliance with certain of the financial ratio
covenants required by its credit facility. As a result of this non-compliance
with certain financial ratio covenants, it is in default under the terms of the
credit facility. (See further discussion in Part I - Financial Information, Item
2. Management's Discussion and Analysis of Financial Condition and Results of
Operations).
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -- The following is a list of exhibits filed as part of this
quarterly report on Form 10-Q.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
11 Statement re: computation of per share earnings
27 Summary financial data schedule
</TABLE>
(b) Reports on Form 8-K. During the period covered by this report, the
Company filed a Form 8-K with the Commission on January 15, 1999
reporting information under Items 2 and 7. This report, dated December
31, 1998, included unaudited pro forma consolidated financial statements
of the Company and subsidiaries for the year ended December 31, 1997 and
for the nine months ended September 30, 1998.
13
<PAGE> 16
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: May 18, 1999 By: /s/ D. Paul Davis
------------------------------ -----------------------------
D. Paul Davis
Senior Vice President, Finance
(Chief Financial Officer)
<PAGE> 17
Specialty Care Network, Inc. and Subsidiaries
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
11 Computation of Per Share Earnings
27 Summary Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 11
Specialty Care Network, Inc. and Subsidiaries
Computation of Per Share Earnings
<TABLE>
<CAPTION>
FOR THE FOR THE
THREE THREE
MONTHS MONTHS
ENDED ENDED
MARCH 31, 1999 MARCH 31, 1998
-------------- --------------
<S> <C> <C>
Weighted average
shares outstanding 16,494,704 17,731,273
Effect of dilutive securities:
Employee stock options -- 540,761
-------------- --------------
Weighted average number of
common shares and common
share equivalents used in
computation 16,494,704 18,272,034
============== ==============
Net (loss) income $ (292,824) $ 2,286,323
============== ==============
Net (loss) income per common
share (basic) $ (0.02) $ 0.13
============== ==============
Net (loss) income per common
share (diluted) $ (0.02) $ 0.13
============== ==============
</TABLE>
<PAGE> 1
[ARTICLE] 5
[MULTIPLIER] 1,000
<TABLE>
<S> <C>
[PERIOD-TYPE] 3-MOS
[FISCAL-YEAR-END] DEC-31-1999
[PERIOD-START] JAN-01-1999
[PERIOD-END] MAR-31-1999
[CASH] 3,771
[SECURITIES] 0
[RECEIVABLES] 56,214
[ALLOWANCES] (28,822)
[INVENTORY] 0
[CURRENT-ASSETS] 34,555
[PP&E] 15,103
[DEPRECIATION] (5,476)
[TOTAL-ASSETS] 61,215
[CURRENT-LIABILITIES] 54,444
[BONDS] 0
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[COMMON] 19
[OTHER-SE] 5,068
[TOTAL-LIABILITY-AND-EQUITY] 61,215
[SALES] 14,473
[TOTAL-REVENUES] 14,473
[CGS] 0
[TOTAL-COSTS] 13,129
[OTHER-EXPENSES] 1,108
[LOSS-PROVISION] 0
[INTEREST-EXPENSE] 944
[INCOME-PRETAX] (487)
[INCOME-TAX] 194
[INCOME-CONTINUING] (293)
[DISCONTINUED] 0
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] (293)
[EPS-PRIMARY] (0.02)
[EPS-DILUTED] (0.02)
</TABLE>
