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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-K/A
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
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: 0-19786
PHYCOR, INC.
(Exact Name of Registrant as Specified in Its Charter)
TENNESSEE 62-1344801
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
30 BURTON HILLS BLVD., SUITE 400
NASHVILLE, TENNESSEE 37215
(Address of Principal Executive (Zip Code)
Offices)
Registrant's telephone number, including area code: (615) 665-9066
Securities Registered pursuant to Section 12(b) of the Act:
NONE NONE
(Title of Each Class) (Name of Each Exchange on Which Registered)
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE PER SHARE
---------------------------------------------------------------------------
(Title of Class)
4.5% CONVERTIBLE SUBORDINATED DEBENTURES DUE 2003
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(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the shares of Common Stock (based upon
the closing sales price of these shares as reported on the Nasdaq Stock Market's
National Market on March 26, 1998) of the registrant held by non-affiliates on
March 26, 1998, was approximately $1.686 billion.
As of March 26, 1998, 64,354,339 shares of the registrant's Common
Stock were outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Documents incorporated by reference and the part of Form 10-K into
which the document is incorporated:
<TABLE>
<S> <C>
Portions of the Registrant's 1997 Annual Report to
Shareholders....................................................Part II
Portions of the Registrant's Definitive Proxy
Statement Relating to the Annual Meeting of
Shareholders to be held on June 2, 1998........................Part III
</TABLE>
FORWARD-LOOKING STATEMENTS
This report and other information that is provided by PhyCor, Inc.
("PhyCor" or the "Company") contain forward-looking statements including those
regarding the acquisition of additional clinics, the development of additional
IPAs, the adequacy of PhyCor's capital resources and other statements regarding
trends relating to various revenue and expense items. Many factors, including
PhyCor's ability to consolidate clinics and operate them profitably,
competition, regulatory developments and changes, the profitability of capitated
fee arrangements and other methods of payment for medical services, the fact
that the physician groups with which PhyCor affiliates are exposed to the risk
of professional liability claims, its dependence on the revenue generated by its
affiliated clinics and other uncertainties, could cause actual results to differ
materially from those projected in such forward-looking statements. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Risk Factors."
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
PhyCor is a physician practice management company ("PPM") that
acquires and operates multi-specialty medical clinics and develops and manages
independent practice associations ("IPAs"). PhyCor's objective is to organize
physicians into professionally managed networks that assist physicians in
assuming increased responsibility for delivering cost-effective medical care,
while attaining quality clinical outcomes and patient satisfaction. As of
December 31, 1997, the Company operated 55 clinics with 3,863 physicians in 28
states. The Company also manages IPAs, which are networks of independent
physicians, that, as of December 31, 1997, included over 19,000 physicians in 28
markets. As of December 31, 1997, the Company's affiliated physicians provided
capitated medical services to approximately 1,132,000 members, including
approximately 174,000 Medicare members.
The Company's strategy is to position its affiliated multi-specialty
medical clinics and IPAs to be the physician component of organized health care
systems. PhyCor targets
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for acquisition primary care-oriented multi-specialty medical clinics with
significant market shares and established reputations for providing quality
medical care. The Company is also assisting independent physicians in particular
markets in developing new physician groups that enter into long-term agreements
with the Company. The Company focuses its IPA development and management efforts
in markets that have characteristics indicating opportunities for rapid
enrollment growth and attractive capitation rates. The Company generates
increased demand for the services and capabilities of its affiliated physician
organizations and achieves growth through the addition of physicians, the
expansion of managed care relationships and the addition and expansion of
ancillary services.
PhyCor believes that primary care-oriented multi-specialty physician
organizations are a critical element of organized health care systems, because
physician decisions determine the cost and quality of care. PhyCor believes that
physician-driven organizations, including multi-specialty medical clinics, IPAs
and the combination of such organizations, present more attractive alternatives
for physician consolidation than hospital or insurer/health maintenance
organization ("HMO")-controlled organizations. The combination of PhyCor's
multi-specialty medical clinic, IPA management capabilities and new
group-formation efforts enables the Company to offer physician practice
management services to substantially all types of physician organizations.
PhyCor implements a number of programs and services at each clinic in
order to promote growth and efficiency, including strategic planning and
budgeting, which focus on cost containment and expense reduction. PhyCor
negotiates managed care contracts, enters into national purchasing agreements,
conducts productivity and procedure coding and charge capturing studies and
assists the clinics in physician recruitment efforts. The Company maintains
information processing systems for each of its clinics, which have expanded the
Company's accounting, billing, receivables management, scheduling and reporting
systems capabilities. The Company has also implemented a quality improvement
initiative designed to enhance the quality of patient service delivery systems
at each affiliated clinic through the maintenance and measurement of performance
standards and collection and review of patient evaluations.
MULTI-SPECIALTY MEDICAL CLINICS
A multi-specialty medical clinic provides a wide range of primary and
specialty physician care and ancillary services through an organized physician
group practice representing various medical specialties. Multi-specialty medical
clinics historically have been locally owned organizations managed by practicing
physicians.
PhyCor targets for acquisition primary care-oriented multi-specialty
clinics typically comprised of between 25 and 200 physicians that have
significant market shares and established reputations for providing quality
medical care. Most of the clinics with which PhyCor seeks to affiliate are the
largest multi-specialty clinics in their local markets. See "Clinic Operations"
below.
The Company generates increased demand for the services and
capabilities of its affiliated physician organizations and achieves growth
through the addition of physicians, the expansion of managed care relationships
and the addition and expansion of ancillary
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services. During 1997, the Company assisted its affiliated clinics in
recruiting approximately 400 new physicians. The Company also merged the
practices of 103 additional physicians into its existing clinics. The Company is
also assisting formerly unaffiliated physicians in particular markets to develop
new physician groups which enter into long-term service agreements with the
Company. In addition, the Company is developing physician networks around its
physician groups to enhance managed care contracting and to provide the
physician component of organized health care systems. Physicians in affiliated
physician groups may participate in IPAs developed and managed by North American
Medical Management, Inc. ("North American"), an entity acquired by the Company
in 1995, or PhyCor Management Corporation ("PMC"), an entity in which PhyCor
purchased a minority interest in 1995 and completed the acquisition of such
interests on March 31, 1998. See "Physician Networks." PhyCor is also
positioning the clinics for participation in organized health care systems by
establishing strategic alliances with HMOs, insurers, hospitals and other health
care providers and by enhancing medical management systems.
Clinic Operations
Upon the acquisition by PhyCor of a clinic's operating assets, the
affiliated physician group simultaneously enters into a long-term service
agreement with the Company. The Company, under the terms of the service
agreement, provides the physician group with the equipment and facilities used
in its medical practice, manages clinic operations, employs most of the clinic's
non-physician personnel, other than certain diagnostic technicians, and receives
a service fee.
During 1997, the Company acquired the assets of 11 multi-specialty
clinics located in California, Florida, Hawaii, Indiana, Maryland, Tennessee,
Virginia and Washington. The Company's California, Hawaii, Maryland and
Washington affiliated clinics are the Company's first clinics in those states.
The Company also entered into an interim management services agreement with
Lakeview Medical Center, Inc. in Suffolk, Virginia in December 1997 and entered
into a long-term service agreement with the 31-physician multi-specialty clinic
effective January 1, 1998. In March 1998,the Company completed the acquisition
of certain assets of a 70-physician multi-specialty group in New Britain,
Connecticut. The Company has also entered into an interim management agreement
and letter of intent to acquire certain assets and enter into a long-term
service agreement with Watson Clinic, a 167-physician multi-specialty group
based in Lakeland, Florida. The Company expects to complete the acquisition in
the third quarter of 1998. The Company is pursuing other possible clinic
acquisitions in both existing and new markets. There can be no assurance that
additional clinic acquisitions will be successfully completed.
In the third quarter of 1997, PhyCor announced that it had signed a
letter of intent with New York and Presbyterian Hospitals Care Network, Inc. to
create and operate a regional managed care contracting network, which will
include hospitals and IPAs in New York City, northern New Jersey and southern
Connecticut.
In addition, on December 19, 1997, the Company executed a definitive
Agreement and Plan of Merger with Atlanta-based First Physician Care, Inc.
("FPC"), a physician management company which currently manages three
multi-specialty physician groups pursuant to long-term service agreements, one
multi-specialty group pursuant to an interim service agreement and directly
delivers medical services through three wholly-owned subsidiaries and owns a 395
physician IPA in New York. FPC is currently affiliated with approximately 200
physicians in the states of Florida, Georgia, Missouri, New York and Texas. On
December 22, 1997, the Company executed an Agreement and Plan of Merger with
Seattle-based CareWise, Inc. ("CareWise"), a demand management
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services company which provides consumer decision support services to patients
to better enable patients to control their medical care. The Company anticipates
that both the FPC and CareWise transactions will be consummated during July of
1998. There can be no assurance that any of the foregoing transactions will be
successfully completed.
In January 1998, the Company announced its plans to restructure or
provide for the divestiture of seven of its multi-specialty clinic operations
with approximately 370 physicians. In connection with these plans, the Company
recorded a pre-tax charge for asset revaluation of approximately $83 million in
the fourth quarter of 1997 and incurred approximately $22 million in the first
quarter of 1998 in pre-tax restructuring charges relating to anticipated costs
which are to provide for consolidating facilities and clinic operations and
reduced overhead costs.
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As of December 31, 1997, the Company operated the following medical
clinics in conjunction with the affiliated physician groups described below:
<TABLE>
<CAPTION>
Percentage
of Primary Number of PhyCor
Year Number of Care Medical Operations Service
Clinic Location Founded Physicians Physicians Specialties Commenced Sites
- ------ -------- ------- ---------- ---------- ----------- --------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Green Clinic................. Ruston, LA 1948 34 44% 16 Oct. 1988 3
Doctors' Clinic.............. Vero Beach, FL 1969 39 46 19 Jan. 1989 3
Nalle Clinic................. Charlotte, NC 1921 127 56 23 Feb. 1990 10
Greeley Medical Clinic....... Greeley, CO 1933 42 55 16 Oct. 1990 6
Pueblo Physicians............ Pueblo, CO 1970 42 57 13 Sept. 1991 6
First Coast Medical Group.... Jacksonville, FL 1921 107 71 19 Nov. 1991 54
Sadler Clinic................ Conroe, TX 1955 44 52 16 Jan. 1992 4
Diagnostic Clinic............ San Antonio, TX 1972 48 56 17 Jan. 1992 4
Virginia Physicians.......... Richmond, VA 1923 109 73 17 Feb. 1992 15
Valley Diagnostic Medical
and Surgical Clinic....... Harlingen, TX 1954 22 41 11 Aug. 1992 1
Laconia Clinic............... Laconia, NH 1938 24 54 13 Sept. 1992 4
Olean Medical Group.......... Olean, NY 1937 36 50 15 Nov. 1992 2
Holston Medical Group........ Kingsport, TN 1975 53 76 12 Jan. 1993 13
The Medical & Surgical
Clinic of Irving.......... Irving, TX 1961 34 71 11 Mar. 1993 6
Simon-Williamson Clinic...... Birmingham, AL 1935 54 63 16 July 1993 12
Medical Arts Center.......... Dixon, IL 1986 31 55 16 Oct. 1993 7
Medical Arts Clinic.......... Corsicana, TX 1952 45 47 18 Jan. 1994 5
Lexington Clinic............. Lexington, KY 1920 168 46 25 Feb. 1994 22
Southern Plains Medical
Center.................... Chickasha, OK 1946 32 53 15 Aug. 1994 3
Holt-Krock Clinic............ Fort Smith, AR 1921 149 43 24 Sept. 1994 21
Burns Clinic Medical Center.. Petoskey, MI 1931 125 47 26 Oct. 1994 11
Boulder Medical Center....... Boulder, CO 1949 49 41 22 Oct. 1994 4
Tidewater Physicians Multi-
Specialty Group........... Newport News, VA 1993 68 84 11 Jan. 1995 30
Northeast Arkansas Clinic.... Jonesboro, AR 1977 73 62 13 Mar. 1995 18
PAPP Clinic.................. Newnan, GA 1939 45 56 13 May 1995 6
Ogden Clinic................. Ogden, UT 1968 38 47 17 June 1995 5
Arnett Clinic................ Lafayette, IN 1922 123 39 24 Aug. 1995 15
Casa Blanca Clinic........... Mesa, AZ 1969 88 64 20 Sept. 1995 7
South Texas Medical Clinics.. Wharton, TX 1985 66 59 19 Nov. 1995 11
South Bend Clinic............ South Bend, IN 1916 62 60 20 Nov. 1995(1) 7
Guthrie Clinic............... Sayre, PA 1910 232 42 29 Nov. 1995(2) 31
Arizona Physicians Center.... Phoenix, AZ 1987 35 77 10 Jan. 1996 2
Clinics of North Texas....... Wichita Falls, TX 1995 79 51 21 Mar. 1996 6
Carolina Primary Care........ Columbia, SC 1995 55 98 5 May 1996 17
Harbin Clinic................ Rome, GA 1948 81 30 17 May 1996 9
Focus Health Services........ Denver, CO 1989 46 87 7 July 1996 16
Clark-Holder Clinic.......... LaGrange, GA 1936 43 35 18 July 1996 7
Medical Arts Clinic.......... Minot, ND 1958 49 57 18 Aug. 1996 2
Wilmington Health Associates. Wilmington, NC 1971 54 50 13 Aug. 1996 4
Gulf Coast Medical Group..... Galveston, TX 1996 21 91 6 Aug. 1996 8
Hattiesburg Clinic........... Hattiesburg, MS 1963 112 45 19 Oct. 1996 25
Toledo Clinic................ Toledo, OH 1926 83 22 18 Nov. 1996 13
Lewis-Gale Clinic............ Roanoke, VA 1909 128 48 24 Nov. 1996 14
Straub Clinic & Hospital..... Honolulu, HI 1921 191 56 26 Jan. 1997(3) 17
The Vancouver Clinic......... Vancouver, WA 1936 76 55 13 Jan. 1997 12
First Physicians Medical
Group..................... Palm Springs, CA 1997 23 57 8 Feb. 1997 16
St. Petersburg-Suncoast
Medical Group............. St. Petersburg, FL 1997 94 37 23 Feb. 1997(4) 9
Greater Chesapeake Medical
Group..................... Anne Arundel, MD 1997 31 90 4 May 1997 8
White Wilson Medical Center.. Ft. Walton, FL 1946 54 52 17 July 1997 7
Welborn Clinic............... Evansville, IN 1947 93 52 23 Aug. 1997 8
The Maui Medical Group....... Maui, HI 1961 33 61 14 Sept. 1997 2
Murfreesboro Medical Clinic.. Murfreesboro, TN 1949 41 59 9 Oct. 1997 1
West Florida Medical Center
Clinic.................... Pensacola, FL 1938 153 32 25 Oct. 1997 18
Northern California Medical
Associates, Inc........... Santa Rosa, CA 1975 35 57 5 Dec. 1997 16
Lakeview Medical Center...... Suffolk, VA 1905 31 52 12 Jan. 1998(5) 5
</TABLE>
- ---------------
(1) Entered into an interim management agreement effective November 1, 1995
and consummated the acquisition of certain assets and entered into a
long-term service agreement effective January 1, 1996.
(2) Entered into a series of agreements whereby PhyCor agreed to provide
management services for up to five years and agreed to acquire certain
assets of the clinic upon the occurrence of certain conditions.
(3) Entered into an administrative services agreement effective October 1,
1996 and consummated the merger with Straub and entered into a
long-term service agreement effective January 17, 1997.
(4) Acquired all of the capital stock of two clinics, combined their
operations and entered into a long-term service agreement with the
newly formed group effective February 28, 1997.
(5) Entered into an interim management agreement effective December 1,
1997 and consummated the acquisition of certain assets and entered into
a long-term service agreement effective January 1, 1998.
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In addition to the 3,863 physicians affiliated with the Company at
December 31, 1997, the PhyCor-affiliated physician groups employ approximately
550 physician extenders, which include physician assistants, nurse practitioners
and other mid-level providers. The Company believes physician extenders comprise
an important component of its integrated network strategy by efficiently
expanding the level of services offered in its clinics.
The physician groups offer a wide range of primary and specialty
physician care and ancillary services. Approximately 53.0% of PhyCor's
affiliated physicians are primary care providers, and approximately 47.0%
practice various medical and surgical specialties. The primary care physicians
are those in family practice, general internal medicine, obstetrics, pediatrics
and emergency and urgent care. The Company is assisting all of its clinics in
recruiting additional primary care physicians. Medical specialties include
allergy, cardiology, dermatology, endocrinology, gastroenterology, infectious
diseases, nephrology, neurology, occupational medicine, oncology, pulmonology
and rheumatology. Surgical specialties include general surgery, ophthalmology,
orthopedics, otolaryngology, thoracic surgery and urology. The clinics vary in
the number and types of specialties offered. Substantially all of the physicians
practicing in the clinics are certified or eligible to be certified by the
applicable medical specialty boards.
The clinics also offer a wide array of ancillary services. Most clinics
provide a range of imaging services, which may include CAT scanning,
mammography, nuclear medicine, ultrasound and x-ray. In addition, many of the
clinics have clinical laboratories and pharmacies. Ambulatory surgery units and
rehabilitation services are in place or being planned in many clinics, in some
cases through joint ventures. Several of the clinics have diabetes centers,
pharmaceutical clinical trial programs and weight management programs. Some
offer renal dialysis and participate, usually by joint venture, in home infusion
therapy. Ancillary revenue accounted for approximately 26.7% of gross clinic
revenue for the year ended December 31, 1997 compared to 25.2% for the year
ended December 31, 1996.
In connection with an acquisition of assets and execution of a service
agreement, the Company investigates the history and reputation of the physician
group and the individual physicians. The Company obtains representations and
covenants from the physician group with respect to historical financial
performance and employment and licensure of individual physicians. As part of
its services performed under the service agreement, PhyCor personnel undertake
administrative tasks in connection with obtaining and maintaining liability
insurance for the physician group, including maintaining and reviewing files
relating to physician licensure and certification. PhyCor does not, however,
control the practice of medicine by physicians or compliance by them with
licensure or certification requirements. PhyCor's affiliated physicians maintain
full professional control over their medical practices, determine which
physicians to hire or terminate and set their own standards of practice in order
to promote high quality health care.
PhyCor Operations
Pursuant to its service agreements with physician groups, PhyCor
manages all aspects of the clinics other than the provision of medical services,
which is controlled by the physician groups. At each clinic, a joint policy
board equally comprised of physicians and
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PhyCor personnel focuses on strategic and operational planning, marketing,
managed care arrangements and other major issues facing the clinic. The joint
policy board involves experienced health care managers in the decision making
process and brings increased discipline and accountability to clinic operations.
PhyCor is not engaged in the practice of medicine.
PhyCor enhances clinic growth by expanding managed care arrangements,
assisting in the recruitment and merger of physicians and expanding and adding
ancillary services. PhyCor works closely with the physician groups in targeting
and recruiting physicians from outside the community and merging physicians in
sole practice or single specialty groups, especially primary care groups, into
the clinics' physician groups. PhyCor assists in the development of new and
expanded ancillary services by providing the needed capital resources and
management services.
Management believes its clinics have the opportunity to form
relationships with managed care organizations, insurance companies and hospitals
to create high-quality, cost-effective health care delivery systems. The Company
is aligning its affiliated clinics with low-cost, high-quality hospitals and
related providers in each of its markets and through various relationships is
seeking to more closely coordinate the overall delivery of health care to
patients. These plans may include participation by affiliated physicians in
physician networks developed and managed by PhyCor or PMC. See "Physician
Networks." Pursuant to certain of the Company's relationships with managed care
organizations and insurance companies, responsibility for physician services,
hospital utilization and overall medical management is assumed by the physician
networks being developed by PhyCor-affiliated clinics. The Company believes that
medical management performed within physician organizations can yield the
greatest value in quality-driven, cost-effective health care and that premiums
collected from purchasers of health care will be allocated based upon the value
of the services performed by the health care provider members of organized
health care systems.
The Company sponsors the PhyCor Institute for Healthcare Management
which provides practical managed care and medical management training for
physicians affiliated or considering affiliation with PhyCor. Through the
Institute's efforts, physicians in many locations work together to achieve
"economies of intellect" and best practice performance through shared data and
experience. The Company believes that, in the future, its ability to
differentiate its physician organizations based upon quality clinical
performance will increasingly impact financial performance.
The Company focuses the attention of the physician groups on practice
patterns. This effort emphasizes outcomes measurement and management and is
intended to improve the physicians' ability to attain the desired clinical
results while containing the utilization of health resources. Similarly, the
Company's quality service initiative seeks to improve the patient's overall
experience with the health care delivered within the Company's affiliated
clinics and networks.
The Company provides support for the selection and implementation of
information systems at its clinics. The Company has selected certain practice
management and other systems considered to be most effective for capitated risk
management, provider profiling and outcomes analysis for implementation at its
clinics. These systems are designed to
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allow physician organizations to successfully capture information that will
enable them to more effectively manage the risk associated with capitated
arrangements.
The Company also negotiates national arrangements that provide cost
savings to its clinics through economies of scale in malpractice insurance,
supplies and equipment. In addition, PhyCor has a service improvement program
that aligns staffing with the volume and service needs of its physician
organizations and focuses on measuring and improving patient satisfaction. Upon
assuming the operations of a clinic, the Company implements certain business
operating policies and reviews procedure coding practices in each clinic.
Service Agreements
The long-term service agreements currently entered into by the Company
are for terms of 40 years. Long-term agreements entered into prior to 1994 are
generally for terms of 30 years. These agreements cannot be terminated by the
Company or the physician groups without cause, which includes material default
or bankruptcy. Upon the expiration of the term of a service agreement or in the
event of termination, the physician group must purchase all of the related
tangible and intangible assets owned by the subsidiary of the Company providing
services to that physician group, generally at then current book value. The
physician group agrees not to compete with PhyCor during the term of the service
agreement and substantially all of the physicians agree not to compete with the
physician group for a period of time or agree to pay liquidated damages if they
compete. The Company agrees not to affiliate with other multi-specialty groups
in the clinic's service area during the term of the service agreement.
Under substantially all of its service agreements, the Company receives
a service fee equal to the clinic expenses it incurred plus a percentage of
operating income of the clinic (net clinic revenue less certain contractually
agreed upon clinic expenses before physician distributions) and, under all other
service agreements except one described below, the Company receives a percentage
of net clinic revenue. In 1997, the Company's revenue was derived from
contracts with the following service fee structures: (i) 94% of revenue was
derived from contracts in which the service fee was based on a percentage,
ranging from 15% to 18%, of clinic operating income plus reimbursement of clinic
expenses; (ii) 1% of revenue was derived from a contract in which the service
fee was based on 51.7% of net clinic revenue; (iii) 4% of revenue was derived
from contracts in which the service fee was based upon a combination of (a) 10%
of clinic operating income, (b) a percentage, ranging from 2.75% to 3.5%, of net
clinic revenue and (c) reimbursement of clinic expenses; and (iv) 1% of revenue
was derived from one contract which is based on a flat fee.
Each of the service agreements with the Company's affiliated physician
groups provides the affiliated physician group the right to terminate the
service agreement in the event of the bankruptcy or similar event of the
Company's subsidiary that is a party to the service agreement or in the event of
a material breach of the service agreement by the Company or its subsidiary,
provided (i) such breach is not cured generally within 90 days following written
notice and (ii) such termination is approved by the affirmative vote of
generally no less than 75% of the physician shareholders. Many of the service
agreements provide that if any person or persons acquire the right to vote 50%
or more of PhyCor's Common Stock, the physician group may terminate the service
agreement, unless the transaction was approved by PhyCor's Board of Directors or
subsequently approved by two-thirds of PhyCor's directors who are not members of
management or affiliates of the acquiring person. The physician group in
Lexington, Kentucky may also terminate its service agreement if an entity named
therein acquires 15% or more of the Company's outstanding Common Stock. Other
groups may terminate their service agreement in the event of a merger where
PhyCor does not survive or a takeover or sale of substantially all the assets of
PhyCor or in the event of a sale of all or substantially all of the assets or
capital stock of the PhyCor subsidiary with whom the
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service agreement was entered into. Some physician groups have rights of first
refusal to purchase the clinic assets owned by PhyCor if PhyCor determines to
sell such assets. The above provisions could have an adverse effect on any
efforts to take control of PhyCor without the consent of the Board of Directors
and the physician groups having these rights. In addition, the Company may
terminate the service agreement (i) in the event of the bankruptcy or similar
event of the affiliated physician group, or (ii) a material breach of the
service agreement by the affiliated physician group which is not cured within
90 days following written notice. In any event of termination, the affiliated
physician group is required to repurchase all of the tangible and intangible
assets of the Company related to the physician group generally at the then
current net book value.
PHYSICIAN NETWORKS
The Company believes that the health care industry will continue to be
driven by local market factors and that organized providers of health care, like
IPAs, will play a significant role in delivering cost-effective, quality medical
care. IPAs offer physicians an opportunity to participate in expanding organized
health care systems and assistance in contracting with insurance companies and
HMOs, and other large purchasers of health care services. IPAs consolidate
independent physicians by providing general organizational structure and
management to the physician network. IPAs provide or contract for medical
management services to assist physician networks in obtaining and servicing
managed care contracts and enable previously unaffiliated physicians to assume
and more effectively manage capitated risk.
As of December 31, 1997, PhyCor managed IPAs with over 19,000
physicians in 28 markets. The Company establishes management companies through
which all health plan contracts are negotiated. These management companies, in
which physicians may have an equity interest, provide information and operating
systems, actuarial and financial analysis, medical management and provider
contract services to the IPA. PhyCor assists physicians in forming networks to
develop a managed care delivery system in which the IPA accepts fiscal
responsibility for providing a wide range of medical services. PhyCor intends to
continue to develop primary care-oriented health care delivery systems in
certain markets that do not have established managed care networks.
In June 1995, PhyCor purchased a minority interest in PMC and has
managed PMC pursuant to a ten-year administrative services agreement. PMC
develops and manages IPAs and provides other services to physician
organizations. Effective March 31, 1998, PhyCor completed the exercise of its
option to purchase the remaining equity interest of PMC.
REGULATION
General
The health care industry is highly regulated, and there can be no
assurance that the regulatory environment in which the Company operates will not
change significantly in the future. In general, regulation of health care
companies is increasing.
Every state imposes licensing requirements on individual physicians and
on facilities and services operated by physicians. In addition, federal and
state laws regulate HMOs and other managed care organizations. Many states
require regulatory approval, including certificates of need, before establishing
certain types of health care facilities, offering certain services or making
expenditures in excess of statutory thresholds for health care equipment,
facilities or programs. To date, neither the Company's clinics nor its managed
IPAs have been required to obtain certificates of need for their activities.
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In connection with the expansion of existing operations and the entry
into new markets and managed care arrangements, the Company and its affiliated
practice groups as well as its managed IPAs may become subject to compliance
with additional regulation.
The Company and its clinics and managed IPAs are also subject to
federal, state and local laws dealing with issues such as occupational safety,
employment, medical leave, insurance regulations, civil rights and
discrimination, and medical waste and other environmental issues. At an
increasing rate, federal, state and local governments are expanding the
regulatory requirements on businesses, including medical practices. The
imposition of these regulatory requirements may have the effect of increasing
operating costs and reducing the profitability of the Company's operations.
PhyCor's managed IPAs and affiliated physician groups enter into
contracts and joint ventures with licensed insurance companies, such as HMOs,
whereby the IPAs and affiliated physician groups may be paid on a capitated fee
basis. Under capitation arrangements, health care providers bear the risk,
subject to certain loss limits, that the aggregate costs of providing medical
services to members will exceed the premiums received. To the extent that the
IPAs and affiliated physician groups subcontract with physicians or other
providers for those physicians or other providers to provide services on a
fee-for-service basis, the managed IPAs and affiliated physician groups may be
deemed to be in the business of insurance, and thus, subject to a variety of
regulatory and licensing requirements applicable to insurance companies or HMOs
resulting in increased costs to the managed IPAs and affiliated physician
groups, and corresponding lower revenue to PhyCor. There can be no assurance,
however, that the Company or its managed IPAs and affiliated physician groups
will not be adversely affected by such regulations. In connection with two
recent multi-specialty medical clinic acquisitions, the Company acquired HMOs
previously affiliated with the clinics and in another multi-specialty medical
clinic acquisition, the Company agreed to provide management services to the
physician group and the HMO owned by the physician group. The HMO industry is
highly regulated at the state level and is highly competitive. Additionally, the
HMO industry has been subject to numerous legislative initiatives within the
past several years that would increase potential HMO liability to patients,
resulting in increased costs to HMOs and correspondingly reduced revenue to
PhyCor. Certain aspects of health care reform legislation being considered at
the federal level have direct and indirect consequences for the HMO industry.
There can be no assurance that developments in any of these areas will not have
an adverse effect on the Company's wholly-owned HMOs or on HMOs in which the
Company has a partial ownership interest or other financial involvement.
Many of the payor contracts entered into on behalf of PhyCor-managed
IPAs are based on capitated fee arrangements. Under capitation arrangements,
health care providers bear the risk, generally subject to certain loss limits,
that the aggregate costs of providing medical services to the members will
exceed the premiums received. The IPA management fees are based, in part, upon a
share of the remaining portion, if any, of capitated amounts of revenue after
payment of expenses. Some agreements with payors also contain shared risk
provisions under which the Company and IPA can earn additional compensation
based on utilization of hospital services by members and may be required to bear
a portion of any loss in connection with such shared risk provisions. Any such
loss could have a material adverse effect on the Company. The profitability of
the managed IPAs is dependent upon the ability of the providers to effectively
manage the per patient costs of providing medical services and the
11
<PAGE> 12
level of utilization of medical services. The management fees are also based
upon a percentage of revenue collected by the IPAs. Any loss of revenue by the
IPAs as a result of losing affiliated physicians, the termination of third party
payor contracts or otherwise could have a material adverse effect on management
fees derived by the Company from its management of IPAs. Through its service
fees, the Company also shares indirectly in capitation risk assumed by its
affiliated physician groups. Managed care providers and management companies
such as the Company are increasingly subject to liability claims arising from
utilization management, provider compensation arrangements and other activities
designed to control costs by reducing services. A successful claim on this basis
against PhyCor or an affiliated clinic or IPA could have a material adverse
effect on the Company.
Federal and state antitrust laws also prohibit agreements in restraint
of trade, the exercise of monopoly power and other practices that are considered
to be anti-competitive. The Company believes that it is in material compliance
with federal and state antitrust laws in connection with the operation of its
clinics and its managed IPAs.
The Company believes its operations are in material compliance with
applicable law and expects to modify its agreements and operations to conform in
all material respects to future regulatory changes. The ability of the Company
to operate profitably will depend in part upon the Company and its affiliated
physician groups and its managed IPAs obtaining and maintaining all necessary
licenses, certificates of need and other approvals and operating in compliance
with applicable health care regulations. The Company is unable to predict what
additional government regulations, if any, affecting its business may be enacted
in the future or how existing or future laws and regulations might be
interpreted. The failure of the Company or any of its affiliated physician
groups or managed IPAs to comply with applicable law could have a material
adverse effect on the Company.
State Legislation
At the state level, all state laws restrict the unlicensed practice of
medicine and many states also prohibit the splitting or sharing of fees with
non-physician entities and the enforcement of noncompetition agreements against
physicians. Many states also prohibit the corporate practice of medicine by an
unlicensed corporation or other non-physician entity and prohibit referrals to
facilities in which physicians have a financial interest. Additionally, the
Florida Board of Medicine has interpreted the Florida fee-splitting law very
broadly so as to arguably include the payment of any percentage-based management
fee, even to a management company that does not refer patients to a managed
group. PhyCor is affiliated with five physician groups in Florida, the service
agreements with these groups provide for percentage-based management fees. The
Florida Board of Medicine decision has been stayed pending judicial
interpretation of the decision. There can be no assurance that future
interpretations of, or changes in, these laws will not require structural and
organizational modifications of the Company's existing relationships with its
clinics or modifications in the existing relationships with its affiliated IPAs,
and there can be no assurance that the Company would be able to appropriately
modify its relationships. In addition, statutes in some states could restrict
expansion of the operations of the Company to those jurisdictions.
Medicare Payment System
The Company's affiliated physician groups and IPAs derived
approximately 22% of their net revenue in 1997 from payments for services
provided to patients enrolled in the federal Medicare program, including
patients covered by risk contracts. Clinics and IPAs managed by the Company
provide medical services under risk contracts to approximately 174,000 Medicare
members. The prior system of Medicare payments, other than for risk
12
<PAGE> 13
contracts, was based on customary, prevailing and reasonable physician charges
and was phased out from 1992 through 1996 and replaced with an annually-adjusted
resource-based relative value scale ("RBRVS"). The Company believes that the
RBRVS fee scale may provide modest increases from historical levels in the per
patient fee-for-service Medicare revenue received by the physician groups and
IPAs with which the Company is affiliated, but does not believe that such
restraints on fee increases will result in a material adverse change in the
results of operations of the Company.
Medicare Fraud and Abuse and Anti-Referral Provisions
The provisions of the Social Security Act addressing illegal
remuneration (the "anti-kickback statute") prohibit providers and others from
soliciting, receiving, offering or paying, directly or indirectly, any form of
remuneration in return for the referral of, or the arranging for the referral
of, Medicare and other federal or state health program patients or patient care
opportunities, or in return for the purchase, lease arrangements or order of any
item or service that is covered by Medicare, certain other federal health
programs, or a state health program. The applicability of these provisions to
many business transactions in the health care industry, including the Company's
service agreements with physician groups, management agreements with IPAs and
joint ventures with other health care providers, has not been subject to any
significant judicial and regulatory interpretation.
Management believes that although it is receiving remuneration under
its service agreements for management services and management fees under
management agreements for services to IPAs, the Company is not in a position to
make or influence referrals of patients or services reimbursed under Medicare or
state health programs to the physician groups or networks. Consequently, the
Company does not believe that the service fees and management fees payable to it
could be viewed as remuneration for referring or influencing referrals of
patients or services covered by such programs as prohibited by the anti-kickback
statute. Currently, the Company is not a separate provider of Medicare or state
health program reimbursed services, however, upon the consummation of the
Company's pending transaction with FPC, the Company, through its subsidiaries,
will be a provider in the states of Florida and Georgia. To the extent that the
Company is deemed to be a separate provider of medical services under its
service agreements or management agreements and to receive referrals from
physicians, the financial arrangements could be subject to scrutiny under the
anti-kickback statute. The Company does not believe that its operation of one
pharmacy under a provider number that is separate from the clinic's creates a
material risk under the anti-kickback statute.
In connection with the transaction with Straub Clinic & Hospital,
Incorporated ("Straub"), the Company provides certain management services to
both a physician group practice and a hospital owned by the group. Because the
hospital is subject to extensive regulation and because hospital management
companies have, in some instances, been viewed as referral sources by federal
regulatory agencies, the relationship between PhyCor and the physician group
could come under increased scrutiny under the Medicare fraud and abuse law. In
addition, the federal government could in certain circumstances suspend or
prevent Straub from participating in government programs, which would have a
negative impact on PhyCor's revenues under its service agreement with Straub.
In July 1991, the federal government published regulations that provide
exceptions, or "safe harbors," for business transactions that will be deemed not
to violate the
13
<PAGE> 14
anti-kickback statute. In September 1993, additional safe harbors were proposed
for eight activities including referrals within group practices consisting of
active investors. Although the arrangements between the Company, the clinics and
third parties, including the arrangements between North American and providers
and provider groups, do not in all instances fall within the protection offered
by these safe harbors or the proposed safe harbors, the Company believes its
operations are in material compliance with applicable Medicare fraud and abuse
laws. If the arrangements were found to be illegal, the Company, the physician
groups and/or the individual physicians would be subject to civil and criminal
penalties, including exclusion from participation in government reimbursement
programs, which could materially adversely affect the Company.
Under legislation known as the "Stark Bill," referrals of Medicare and
Medicaid patients for certain services to entities by physicians with an
ownership interest in, or financial relationship with, that entity have been
prohibited. The covered services include physical therapy services, occupational
therapy services, radiology services, including MRI, CT and ultrasound,
radiation therapy services, durable medical equipment, parenteral and enteral
nutrients, equipment and supplies, prosthetics, orthotics and prosthetic
devices, home health services, outpatient prescription drugs and inpatient and
outpatient hospital services. The Company believes that its clinics are
operating in compliance with the language of statutory exceptions to the Stark
Bill, including, but not limited to, the exceptions for referrals to in-office
ancillary services within a group practice. As a result, the Company does not
believe that physicians who are members of the group practices practicing at its
clinics are prohibited from making referrals of designated health services to
the clinics.
Impact of Health Care Regulatory Changes
The United States Congress and many state legislatures routinely
consider proposals to reform or modify the health care system, including
measures that would control health care spending, convert all or a portion of
government reimbursement programs to managed care arrangements and balance the
federal budget by reducing spending for Medicare and state health programs.
These measures can affect a health care company's cost of doing business and
contractual relationships. For example, recent developments that affect the
Company's activities include: (i) federal legislation requiring a health plan to
continue coverage for individuals who are no longer eligible for group health
benefits and prohibiting the use of "pre-existing condition" exclusions that
limit the scope of coverage; (ii) a Health Care Financing Administration policy
prohibiting restrictions in Medicare risk HMO plans on a physician's
recommendation of other health plans and treatment options to patients; and
(iii) regulations imposing restrictions on physician incentive provisions in
physician provider agreements. There can be no assurance that such legislation,
programs and other regulatory changes will not have a material adverse effect on
PhyCor.
COMPETITION
The business of providing health care related services is highly
competitive. Many companies, including professionally managed physician practice
management companies, have been organized to pursue the acquisition of medical
clinics, manage such clinics, employ clinic physicians or provide services to
IPAs. Large hospitals, other multi-specialty clinics and health care companies,
HMOs and insurance companies are also involved in
14
<PAGE> 15
activities similar to those of the Company. Some of these competitors have
longer operating histories and significantly greater resources than the Company.
There can be no assurance that the Company will be able to compete effectively,
that additional competitors will not enter the market, or that such competition
will not make it more difficult to acquire the assets of medical clinics or
develop or manage IPAs on terms beneficial to the Company. To the extent that
health care industry reforms make prepaid medical care more attractive and
provide incentives to form organized health care systems, the Company
anticipates facing greater competition. PhyCor's revenues are dependent upon the
continued success of the medical groups with which it has long-term service
agreements and IPAs that it manages. These organizations face competition from
several sources, including sole practitioners, single and multi-specialty groups
and staff model HMOs.
INSURANCE
The Company maintains medical professional liability insurance on a
claims made basis for all of its operations. Insurance coverage under such
policies is contingent upon a policy being in effect when a claim is made,
regardless of when the events which caused the claim occurred. The Company also
maintains general liability and umbrella coverage on an occurrence basis. The
cost and availability of such coverage has varied widely in recent years. While
the Company believes its insurance policies are adequate in amount and coverage
for its current operations, there can be no assurance that the coverage
maintained by the Company is sufficient to cover all future claims or will
continue to be available in adequate amounts or at a reasonable cost. PhyCor and
its subsidiary operating the affiliated physician group are named as additional
insureds on the various policies maintained by each affiliated physician group,
including the professional liability insurance policies carried by the physician
group.
EMPLOYEES
As of December 31, 1997, the Company employed approximately 19,000
people, including 135 in the corporate office. None of the Company's employees
is a member of a labor union, and the Company considers its relations with its
employees to be excellent.
ITEM 2. PROPERTIES
The Company leases approximately 49,000 square feet of rentable space
at 30 Burton Hills Boulevard in Nashville, Tennessee, where the Company's
headquarters are located. The Company pays approximately $83,000 per month in
rent, which rental amount increases over the term of the lease to approximately
$87,000 per month in the final year. The lease expires in 2003. The Company
believes these arrangements and other available space are adequate for its
current uses. The Company plans to build new corporate headquarters adjacent to
its existing headquarters. The Company anticipates the new building, which is
scheduled to be completed in the third quarter of 1999, will be adequate for its
long-term uses. The Company currently is negotiating a synthetic lease
arrangement with Citibank, N.A. to finance the construction of the new building.
The Company intends to sublet its existing facility until the expiration of its
lease in 2003.
The Company leases, subleases or occupies pursuant to its service
agreements the clinic facilities. In many cases, facilities are leased from the
physician groups with the lease cost generally included in the service fees paid
to PhyCor. In connection with the acquisition of the Company's affiliated clinic
in Lexington, Kentucky, the Company
15
<PAGE> 16
acquired the real estate used by the physician group, including the clinic's
main clinic facility in Lexington and other satellite facilities in Lexington
and the surrounding communities. Certain of such properties are subject to
mortgages assumed by the Company as a result of the transaction with an
aggregate outstanding principal balance as of February 28, 1998 of $3.7 million
and bear interest at rates ranging from 8.25% to 10.5%.
In connection with the Company's acquisitions of its affiliated clinics
in Lafayette, Indiana, and St. Petersburg, Florida, the Company acquired the
real estate used by each of the physician groups. At the time of such
acquisitions, certain of the properties were subject to a mortgage, which
indebtedness was assumed by PhyCor as a result of the transactions and repaid in
full. The Company makes these facilities available to the physician groups
pursuant to the long-term service agreements with Lexington Clinic, Arnett
Clinic and St. Petersburg-Suncoast Medical Clinic, respectively.
The Company may from time to time acquire real estate in connection
with the acquisition of clinic assets. The Company anticipates that as the
clinics continue to grow and add new services, expanded facilities will be
required. Such transactions may require PhyCor's assistance in obtaining
financing of the property on behalf of the physician groups.
ITEM 3. LEGAL PROCEEDINGS
Certain litigation is pending against the physician groups affiliated
with the Company and IPAs managed by the Company. The Company has not assumed
any liability in connection with such litigation. Claims against the physician
groups and IPAs could result in substantial damage awards to the claimants which
may exceed applicable insurance coverage limits. While there can be no assurance
that the physician groups and IPAs will be successful in any such litigation,
the Company does not believe any such litigation will have a material adverse
effect on the Company. Certain other litigation is pending against the Company
and certain subsidiaries of the Company none of which management believes would
have a material adverse effect on the Company's financial position or results of
operations on a consolidated basis. Certain litigation is pending against
subsidiaries of North American which was outstanding prior to the acquisition of
North American by the Company. The Company is indemnified by certain former
shareholders of North American for any damages as a result of the litigation and
the amount of any additional payments to be made to the former shareholders of
North American would be offset by any damages resulting from such litigation.
While there can be no assurance that the North American subsidiaries will be
successful in any such litigation, the Company does not believe that the gross
contingency related to North American is material and the Company does not
believe that any such litigation will have a material adverse effect on the
Company.
Additionally, in April 1998, approximately 38 physicians at the
Holt-Krock Clinic in Fort Smith, Arkansas ("Holt-Krock") filed a declaratory
judgment seeking a ruling regarding the enforceability of their several
agreements with the Company, its Fort Smith subsidiary and Holt-Krock. A similar
suit has been file against the Company and its Jacksonville subsidiary by ten
physicians in the Company's affiliated Jacksonville clinic. The Company intends
to vigorously defend the enforceability of its agreements. Management of the
Company does not believe that the outcome of either of these actions will be
material to the Company, although there can be no assurance that PhyCor, its
subsidiaries or the affiliated clinics will be successful in such litigation or
that the outcome of such litigation will not have a material adverse effect on
the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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<PAGE> 17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Information relating to the Common Stock is set forth in the Company's
1997 Annual Report to Shareholders under the caption "Corporate and Investor
Information - Common Stock" and is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Year ended December 31, 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Income Data:
Net revenue $1,119,594 $ 766,325 $441,596 $242,485 $167,381
Operating expenses:
Clinic salaries, wages and benefits 421,716 291,361 166,031 88,443 63,202
Clinic supplies 181,565 119,081 67,596 37,136 25,031
Purchased medical services 31,171 21,330 17,572 11,778 8,920
Other clinic expenses 171,480 125,947 71,877 40,939 28,174
General corporate expenses 26,360 21,115 14,191 9,417 5,418
Rents and lease expense 100,170 65,577 36,740 23,413 16,441
Depreciation and amortization 62,522 40,182 21,445 12,229 8,394
Nonrecurring charge(1) 83,445 - - - -
- ------------------------------------------------------------------------------------------------------------------------
Operating expenses 1,078,429 684,593 395,452 223,355 155,580
- ------------------------------------------------------------------------------------------------------------------------
Earnings from operations 41,165 81,732 46,144 19,130 11,801
Interest income (3,323) (3,867) (1,816) (1,334) (309)
Interest expense 23,507 15,981 5,230 3,963 3,878
- ------------------------------------------------------------------------------------------------------------------------
Earnings before income taxes and minority 20,981 69,618 42,730 16,501 8,232
interest
Income tax expense 6,098 22,775 13,923 4,826 1,092
Minority interest 11,674 10,463 6,933 - -
- ------------------------------------------------------------------------------------------------------------------------
Net earnings $ 3,209(2) $ 36,380 $ 21,874 $ 11,675(3) $ 7,140(3)
========================================================================================================================
Earnings per share(4)
Basic $ .05 $ .67 $ .45 $ .35 $ .31
Diluted .05 .60 .41 .32(3) .27(3)
Diluted-before nonrecurring charge .85 .60 .41 .32(3) .27(3)
- ------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding(4)
Basic 62,899 54,608 48,817 33,240 23,348
Diluted 66,934 61,096 53,662 42,988 26,571
========================================================================================================================
December 31, 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------
Balance Sheet Data:
Working capital $ 203,301 $ 182,553 $111,420 $ 80,533 $ 46,927
Total assets 1,562,776 1,118,581 643,586 351,385 171,174
Long-term debt 501,107 444,207 140,633 94,653 69,014
Total shareholders' equity 710,488 451,703 388,822 184,125 70,005
</TABLE>
- ---------------
(1) Non-recurring charge to earnings relates to revaluation of assets of seven
of the Company's affiliated clinics. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" for a more detailed discussion
of the non-recurring charge.
(2) Excluding the effect of the non-recurring charge described in Note 1, the
Company's net earnings would have been approximately $57.0 million.
(3) Excluding the effect of the utilization of a net operating loss carry
forward to reduce income taxes in 1993 and 1994, net earnings and earnings per
share-diluted would have been $5.1 million, or $.19 per share, and $10.2
million, or $.28 per share, in such years.
(4) Per share amounts and weighted average shares outstanding have been adjusted
for the three-for-two stock splits effected in June 1996, September 1995, and
December 1994.
17
<PAGE> 18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company acquires and operates primary care-oriented multi-specialty
medical clinics and develops and manages IPAs. A substantial majority of the
Company's revenue in 1997 and 1996 was earned under service agreements with
multi-specialty clinics. Revenue earned under substantially all of the service
agreements is equal to the net revenue of the clinics, less amounts retained by
physician groups. The service agreements contain financial incentives for the
Company to assist the physician groups in increasing clinic revenues and
controlling expenses.
Upon the acquisition by PhyCor of a clinic's operating assets, the
affiliated physician group simultaneously enters into a long-term service
agreement with the Company. Under the terms of the service agreement, the
Company provides the physician group with the equipment and facilities used in
its medical practice, manages clinic operations, employs most of the clinic's
non-physician personnel, other than certain diagnostic technicians, and receives
a service fee.
The affiliated physicians maintain full professional control over their
medical practices, determine which physicians to hire or terminate and set their
own standards of practice in order to promote high quality health care. Pursuant
to its service agreements with physician groups, PhyCor manages all aspects of
the clinic other than the provision of medical services, which is controlled by
the physician groups. At each clinic, a joint policy board equally comprised of
physicians and PhyCor personnel focuses on strategic and operational planning,
marketing, managed care arrangements and other major issues facing the clinic.
To increase clinic revenue, the Company works with the affiliated
physician groups to recruit additional physicians, merge other physicians
practicing in the area into the affiliated physician groups, negotiate contracts
with managed care organizations and provide additional ancillary services. To
reduce or control expenses, among other things, PhyCor utilizes national
purchasing contracts for key items, reviews staffing levels to make sure they
are appropriate and assists the physicians in developing more cost-effective
clinical practice patterns.
Under substantially all of its service agreements, the Company receives
a service fee equal to the clinic expenses it has incurred plus a percentage of
operating income of the clinic (net clinic revenue less certain contractually
agreed upon clinic expenses before physician distributions) and, under all other
service agreements except one described below, the Company receives a percentage
of net clinic revenue. In 1997, the Company's revenue was derived from contracts
with the following service fee structures: (i) 94% of revenue was derived from
contracts in which the service fee was based on a percentage, ranging from 15%
to 18%, of clinic operating income plus reimbursement of clinic expenses; (ii)
1% of revenue was derived from a contract in which the service fee was based on
51.7% of net clinic revenue; (iii) 4% of revenue was derived from contracts in
which the service fee was based upon a combination of (a) 10% of clinic
operating income, (b) a percentage, ranging from 2.75% to 3.5%, of net clinic
revenue and (c) reimbursement of clinic expenses; and (iv) 1% of revenue was
derived from one contract which is based on a flat fee.
The Company has historically amortized the goodwill and other
intangible assets related to its service agreements over the periods during
which the agreements are effective, ranging from 25 to 40 years. Effective April
1, 1998, the Company adopted a maximum of 25 years as the useful life for
amortization of its intangible assets, including those acquired in prior years.
Had this policy been in place for 1997, the effect would have been an
approximate reduction of $0.10 in diluted earnings per share before the
non-recurring charge discussed below in "Liquidity and Capital Resources."
Assuming a tax rate of 37% and projected diluted shares outstanding, this change
is expected to result in a reduction of diluted earnings per share of
approximately $0.08 in the last three quarters of 1998.
Each of the service agreements with the Company's affiliated physician
groups provides the affiliated physician group the right to terminate the
service agreement in the event of the bankruptcy or similar event of the
Company's subsidiary that is a party to the service agreement or in the event of
a material breach of the service agreement by the Company or its subsidiary (i)
which is not cured within 90 days, generally, following written notice and (ii)
which termination is approved by the affirmative vote of no less than 75%,
generally, of the physician shareholders. Many of the service agreements
provide that if any person or persons acquire the right to vote 50% or more of
PhyCor's Common Stock, the physician group may terminate the service agreement,
unless the transaction was approved by PhyCor's Board of Directors or
subsequently approved by two-thirds of PhyCor's directors who are not members of
management or affiliates of the acquiring person. The physician group in
Lexington, Kentucky may also terminate its service agreement if an entity named
therein acquires 15% or more of the Company's outstanding Common Stock. Other
groups may terminate their service agreement in the event of a merger where
PhyCor does not survive or a takeover or sale of substantially all the assets of
PhyCor or in the event of a sale of all or substantially all of the assets or
capital stock of the PhyCor subsidiary with whom the service agreement was
entered into. Some physician groups have rights of first refusal to purchase the
clinic assets owned by PhyCor if PhyCor determines to sell such assets. The
above provisions could have an adverse effect on any efforts to take control of
PhyCor without the consent of the Board of Directors and the physician groups
having these rights. In addition, the Company may terminate the service
agreement (i) in the event of the bankruptcy or similar event of the affiliated
physician group, or (ii) a material breach of the service agreement by the
affiliated physician group which is not cured within 90 days, generally,
following written notice. In any event of termination, the affiliated physician
group is required to repurchase all of the tangible and intangible assets of the
Company related to the physician group generally at the then current net book
value.
Pursuant to the Company's service agreements with its affiliated
clinics, the physician groups affiliated with the clinics agree to repurchase at
book value all of the assets associated with the clinic, including intangible
assets, upon termination of the service agreement. The Company's ability to
recover the net book value associated with a terminated clinic is largely
dependent upon the circumstances of the termination and the financial position
of the physicians affiliated with the clinic. The Company owns all of the
tangible assets related to the operations of its affiliated clinics, which
assets provide collateral for a portion of the purchase requirement in the event
of termination. Tangible assets represent an average of approximately 48% of a
clinic's total assets. The intangible assets of all of the Company's affiliated
clinics totaled $732.8 million as of December 31, 1997. In connection with the
disposal of certain clinic operations, the Company determined that a sale of
assets below book value provided a more cost effective means to terminate its
relationship with a clinic rather than seeking to collect the full net book
value of the assets through the enforcement of its contractual remedies under
the service agreement with the clinic. See "--Liquidity and Capital Resources."
The Company does not anticipate similar outcomes upon the termination of service
agreements with clinics in the future, but there can be no assurance that the
circumstances of any such termination will not result in a similar outcome. The
Company evaluates on an individual basis, the appropriate course of action upon
termination of a service agreement and will pursue the most appropriate remedy,
given the facts and circumstances of the termination, to recover the amounts
owed as a result of any such termination.
18
<PAGE> 19
In November 1997, the Emerging Issues Task Force reached a consensus on
EITF 97-2, "Application of APB Opinion No. 16 and FASB Statement No. 94 to
Physician Practice Entities", which was passed in November 1997, and relates
primarily to the consolidation of physician practices controlled by a company.
The Company has not consolidated the physician practices it manages as it does
not have operating control as defined in EITF 97-2.
The Company has increased its focus on the development of IPAs to
enable the Company to provide services to a broader range of physician
organizations, to enhance the operating performance of existing clinics and to
further develop physician relationships. The Company develops IPAs that include
affiliated clinic physicians to enhance the clinics' attractiveness as providers
to managed care organizations. Fees earned from managing the IPAs are based upon
a percentage of revenue collected by the IPAs and also upon a share of surplus,
if any, of capitated revenue of the IPAs. In 1997, approximately 6% of the
Company's revenue was earned under IPA management agreements. The Company is
not a party to the capitated contracts entered into by the IPAs but is exposed
to losses to the extent of its share of deficits, if any, of the capitated
revenue of the IPAs.
The table below indicates the number of clinics and physicians
affiliated with the Company and provides certain information with respect to the
Company's IPA operations at the end of the years indicated:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Clinic operations:
Number of affiliated clinics 55 44 31 22 18
Number of affiliated physicians 3,863 3,050 1,955 1,143 674
IPA operations:
Number of markets 28 17 13 7(1) --
Number of physicians 19,000 8,700 5,300 3,600(1)
Number of commercial members 420,000 306,000 180,000 105,000(1) --
Number of Medicare members 99,000 69,000 38,000 24,000(1) --
- ----------------------------------------------------------------------------------
</TABLE>
(1)Information as of January 1, 1995
The table below indicates the payor mix of the aggregate net clinic
revenue earned by the physician groups and IPAs currently affiliated with the
Company.
<TABLE>
<CAPTION>
Year ended December 31, 1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Medicare 22% 20% 20% 29% 32%
Medicaid 4 3 3 3 4
Managed care(1) 41 42 37 25 24
Private payor and insurance 33 35 40 43 40
- --------------------------------------------------------------------------------
100% 100% 100% 100% 100%
</TABLE>
(1)Includes HMO, PPO, Medicare risk contracts and direct employer contracts, of
which approximately two-thirds of 1997 revenue was attributable to capitated
contracts.
The payor mix varies from clinic to clinic and changes as acquisitions
are made. Since 1993, managed care revenue as a percentage of all revenue has
19
<PAGE> 20
increased with significant increases since 1994 relating to the management of
IPAs. PhyCor believes that this trend will continue as a greater portion of the
population in the Company's markets joins managed care plans. The Company also
believes that the revenue received from managed care plans will increasingly be
in the form of capitation rather than fee-for-service contracts. Other changes
in payor mix have resulted from the acquisition of clinics with payor mixes
different from historical payor mixes experienced by the Company's affiliated
groups.
Many of the payor contracts entered into on behalf of PhyCor-managed
IPAs are based on capitated fee arrangements. Under capitation arrangements,
health care providers bear the risk, subject to certain loss limits, that the
aggregate costs of providing medical services to members will exceed the
payments received. The IPA management fees are based, in part, upon a share of
the remaining portion, if any, of capitated amounts of revenues after payment of
expenses. Agreements with payors also contain shared risk provisions under which
the Company and the IPA can earn additional compensation based on utilization of
hospital services by members and may be required to bear a portion of any loss
in connection with such shared risk provisions. The profitability of the managed
IPAs is dependent upon the ability of the providers to effectively manage the
per patient costs of providing medical services and the level of utilization of
medical services. The management fees are also based upon a percentage of
revenue collected by the IPAs. Through its service fees, the Company also shares
indirectly in capitation risk assumed by its affiliated physician groups.
During 1997, PhyCor affiliated with 11 multi-specialty clinics and
numerous smaller medical practices, and completed its previously announced
merger with Straub, located in Honolulu, Hawaii, adding $430.8 million in
assets. The principal assets acquired were accounts receivable, property and
equipment and service agreement costs, an intangible asset. The consideration
for the 1997 clinic acquisitions consisted of approximately 65% cash, 30%
liabilities assumed and 5% stock and convertible notes. The cash portion of the
consideration was funded by a combination of operating cash flow and borrowings
under the Company's bank credit facility. Property and equipment acquired
consisted mostly of clinic operating equipment, although the Company has
purchased certain land and buildings. Service agreement costs are amortized over
the life of the related service agreement, with recoverability assessed
periodically.
In the third quarter of 1997, PhyCor announced that it had signed a
letter of intent with New York and Presbyterian Hospitals Care Network, Inc. to
create and operate a regional managed care contracting network, which will
include hospitals and IPAs in New York City, northern New Jersey and southern
Connecticut.
In December 1997, the Company announced that it had signed two separate
agreements to purchase Atlanta-based First Physician Care, Inc., a provider of
practice management services, and Seattle-based CareWise, Inc., a nationally
recognized leader in the consumer decision support industry. Both transactions,
which are expected to be accounted for as pooling-of-interests, are expected to
close in July of 1998. The Company expects to issue approximately 5.9 million
shares of Common Stock in conjunction with these transactions.
20
<PAGE> 21
RESULTS OF OPERATIONS
The following table shows the percentage of net revenue represented by
various expense categories reflected in the Company's Consolidated Statements of
Income.
<TABLE>
<CAPTION>
Year ended December 31, 1997 1996 1995
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Net revenue 100.0% 100.0% 100.0%
Operating expenses:
Clinic salaries, wages and benefits 37.7 38.0 37.6
Clinic supplies 16.2 15.5 15.3
Purchased medical services 2.8 2.8 4.0
Other clinic expenses 15.3 16.4 16.3
General corporate expenses 2.4 2.8 3.2
Rents and lease expense 8.9 8.6 8.3
Depreciation and amortization 5.6 5.2 4.8
Nonrecurring charge 7.4 -- --
- -----------------------------------------------------------------------------------
Operating expenses 96.3(1) 89.3 89.5
Earnings from operations 3.7(1) 10.7 10.5
Interest income (0.3) (0.5) (0.4)
Interest expense 2.1 2.1 1.2
- -----------------------------------------------------------------------------------
Earnings before income taxes and
minority interest 1.9(1) 9.1 9.7
Income tax expense 0.5(1) 3.0 3.1
Minority interest 1.1 1.4 1.6
- -----------------------------------------------------------------------------------
Net earnings 0.3%(1) 4.7% 5.0%
===================================================================================
</TABLE>
(1)Excluding the effect of the nonrecurring charge in 1997, net operating
expenses, earnings from operations, earnings before income taxes and minority
interest, income tax expense and net earnings, as a percent of net revenue,
would have been 88.9%, 11.1%, 9.3%, 3.2% and 5.1%, respectively.
1997 COMPARED TO 1996
Net revenue increased $353.3 million from $766.3 million for 1996 to
$1.12 billion for 1997, an increase of 46.2%. The increase in clinic net
revenues in 1997 as compared to 1996 of $333.1 million included $278.5 million
in service fees resulting from newly acquired clinics in 1997 or the timing of
entering into new service agreements in 1996 and was comprised of (i) a $294.2
million increase in service fees for reimbursement of clinic expenses incurred
by the Company and (ii) a $38.9 million increase in the Company's share of
clinic operating income and net physician group revenue. Net revenue from the 31
service agreements and 13 IPA markets in effect for both years increased $75.3
million, or 12.8%, in 1997 compared with 1996. Same market growth resulted from
the addition of new physicians, the expansion of ancillary services, and
increases in patient volume and fees. The remaining increase results from the
addition of new clinic service agreements in 1997 and the timing of entering
into new service agreements in 1996.
During 1997, most categories of operating expenses were relatively
stable as a percentage of net revenue when compared to 1996, despite the large
increase in the dollar amounts resulting from acquisitions and clinic growth.
The decrease in clinic salaries, wages and benefits and other clinic expenses as
a percentage of net revenue resulted from the acquisition of clinics with lower
levels of these expenses compared to the existing base of clinics. The increase
in clinic supplies and rents and lease expense as a percentage of net
21
<PAGE> 22
revenue resulted from the acquisition of clinics with higher levels of these
expenses compared to the existing base of clinics. The addition of pharmacies at
certain existing clinics and new clinics which operate pharmacies also resulted
in increased clinic supplies expense as a percentage of net revenue. While
general corporate expenses decreased as a percentage of net revenue, the dollar
amount of general corporate expenses increased as a result of the addition of
corporate personnel to accommodate increased acquisition activity and to respond
to increasing physician group needs for support in managed care negotiations,
information systems implementation and clinical outcomes management programs.
The non-recurring charge of $83.4 million in 1997 relates to the asset
revaluation of seven of the Company's multi-specialty clinics. This charge
addresses issues which developed in four of the Company's multi-specialty
clinics which represent the Company's earliest developments of such clinics
through the formation of new groups. The clinics were considered to have an
impairment of certain current assets, property and equipment, other assets and,
primarily, intangible assets because of certain groups of physicians within a
larger clinic terminating their relationship with the medical group affiliated
with the Company and therefore affecting future cash flows. Net revenue and
pre-tax income (loss) for the four clinics that were part of new group
formations included in the charge were $88.4 million and ($2.9 million) and
$78.7 million and $188,000 for 1997 and 1996, respectively. The Company has
modified its approach to this type of group formation, and its recent group
formations have proven more successful. Net revenue and total assets of other
new group formations not included in the non-recurring charge totaled $38.7
million, and $61.4 million, respectively, in 1997, and $13.0 million and $37.2
million, respectively, in 1996. The current operating characteristics of these
clinics are considerably more favorable than those included in the non-recurring
charge. Three other clinics included in the charge represent clinics being
disposed of because of a variety of negative operating and market issues,
including those related to market position and clinic demographics, physician
relations, operating results and ongoing viability of the existing medical
group. Net revenue and pre-tax income (loss) for the three clinics to be
disposed of were $25.5 million and ($1.0 million) and $26.5 million and $772,000
for 1997 and 1996, respectively.
The Company's effective tax rate was approximately 38.5% in 1997 and
1996.
1996 COMPARED TO 1995
Net revenue increased $324.7 million from $441.6 million for 1995 to
$766.3 million for 1996, an increase of 73.5%. The increase in clinic net
revenues in 1996 as compared to 1995 of $304.5 million included $242.6 million
in service fees resulting from newly acquired clinics in 1996 or the timing of
entering into new service agreements in 1995 and was comprised of (i) a $267.7
million increase in fees for reimbursement of clinic expenses incurred by the
Company and (ii) a $36.8 million increase in the Company's share of clinic
operating income and net physician group revenue. Net revenue from the 23
service agreements in effect as of January 1, 1995 increased $62.1 million, or
16.1%, in 1996. Same clinic growth resulted from the addition of new physicians,
the expansion of ancillary services, increases in both patient volume and fees.
The remaining increase results from the addition of new clinic service
agreements in 1996 and the timing of entering into new service agreements in
1995.
During 1996, most categories of operating expenses were relatively
stable as a percentage of net revenue when compared to 1995, despite the large
increase in the dollar amounts resulting from acquisitions and clinic growth.
The increase in clinic salaries, wages and benefits resulted from the
acquisition of clinics with higher levels of these expenses compared to the
existing base of clinics and the addition of primary care physicians at existing
clinics. The ratio of staffing costs to net revenues is higher for primary care
practices than for specialty care. The reduction in purchased medical services
as a percentage of net revenue resulted from the Company's continuing efforts to
reduce clinic operating costs by improving the productivity of non-physician
personnel and limiting payments for outside medical services. While general
corporate expenses decreased as a percentage of net revenue, the dollar amount
of general corporate expenses increased as a result of the addition of corporate
personnel to accommodate increased acquisition activity and to respond to
increasing physician group needs for support in managed care negotiations,
information systems implementation and clinical outcomes management programs.
Income tax expense increased from the prior year as a result of the
Company's increased profitability. The Company's effective tax rate was
approximately 38.5% in 1996.
SUMMARY OF OPERATIONS BY QUARTER
The following table presents unaudited quarterly operating results for
1997 and 1996. The Company believes that all necessary adjustments have been
included in the amounts stated below to present fairly the quarterly results
when read in conjunction with the Consolidated Financial Statements. Results of
operations for any particular quarter
22
<PAGE> 23
are not necessarily indicative of results of operations for a full year or
predictive of future periods.
<TABLE>
<CAPTION>
1997 Quarter Ended 1996 Quarter Ended
Mar 31 June 30 Sept 30 Dec 31 Mar 31 June 30 Sept 30 Dec 31
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
In thousands, except per
share
Net revenue $250,652 $267,354 $284,291 $317,297 $162,501 $176,643 $196,418 $230,763
Earnings (loss) before taxes 20,011 22,395 24,576 (57,675)(1) 12,504 13,690 14,753 18,208
Net (loss) earnings 12,307 13,706 15,040 (37,844)(1) 7,690 8,419 9,073 11,198
Earnings (loss) per
share-diluted $.19 $.20 $.22 $(.56)(1) $.13 $.14 $.15 $.18
</TABLE>
- ----------
(1) Excluding the effect of nonrecurring charges, the Company's earnings before
taxes, net earnings and net earnings per share-diluted for the fourth quarter of
1997 would have been approximately $25.8 million, $16.0 million and $.24,
respectively.
(2) Adjusted to reflect the three-for-two stock split effected June 1996.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had $203.3 million in working
capital, up from $182.6 million as of December 31, 1996. Also, the Company
generated $116.0 million of cash flow from operations in 1997 compared to $75.1
million in 1996. At December 31, 1997, net accounts receivable of $391.7 million
amounted to 72 days of net clinic revenue compared to $295.4 million and 73 days
at the end of the prior year.
In the first quarter of 1997, the Company completed a public offering
of 7,295,000 shares of its Common Stock at a price of $30.00 per share. Net
proceeds from the offering of approximately $210.0 million were used to repay
bank debt and accrued interest. As a result of the issuance of Common Stock
during 1997, debt was 41.4% of total capitalization at December 31, 1997,
compared to 49.6% at the end of 1996.
In 1997, $14.8 million of convertible subordinated notes issued in
connection with physician group asset acquisitions were converted into Common
Stock. These conversions, the issuance of Common Stock, option exercises and net
earnings for 1997 resulted in an increase of $258.8 million in shareholders'
equity compared to December 31, 1996.
Capital expenditures during 1997 totaled $66.5 million. The Company is
responsible for capital expenditures at its affiliated clinics under the terms
of its service agreements. The Company expects to make approximately $75 million
in capital expenditures during 1998.
Effective January 1, 1995, the Company completed its acquisition of
North American. The Company paid $20.0 million at closing and has made
additional payments pursuant to an earn-out formula during 1996 and 1997,
totaling $35.0 million. A final payment of $35.0 million will be made pursuant
to the earnout formula in 1998. A portion of the final payment will be paid in
shares of the Company's Common Stock.
23
<PAGE> 24
In addition, deferred acquisition payments are payable to physician
groups in the event such physician groups attain predetermined financial targets
during established periods of time following the acquisitions. If each group
satisfied its applicable financial targets for the periods covered, the Company
would be required to pay an aggregate of approximately $83.0 million of
additional consideration over the next five years, of which a maximum of $19.2
million would be payable during 1998.
In the fourth quarter of 1997, PhyCor recorded a non-recurring pre-tax
charge to earnings of $83.4 million related to the revaluation of assets of
seven of the Company's multi-specialty clinics. In the first quarter of 1998,
the Company also recorded an additional charge of approximately $22.0 million
relating to these clinics that are being restructured or sold. The non-recurring
pre-tax charge was partially in response to issues which arose in four of the
Company's multi-specialty clinics which represent the Company's earliest
developments of such clinics through the formation of new groups. The clinics
were considered to have an impairment of certain current assets, property and
equipment, other assets and, primarily, intangible assets because of certain
groups of physicians within a larger clinic terminating their relationship with
the medical group affiliated with the Company and therefore affecting future
cash flows. The Company has modified its approach to this type of group
formation, and recent group formations have been more successful. Three other
clinics included in the charge represent clinics being disposed of because of a
variety of negative operations and market issues including those related to
market position and clinic demographics, physician relations, operating results
and ongoing viability of the existing medical group. Although these factors
have been present individually from time to time in various affiliated clinics
and could occur in future clinic operations, the combined effect of the
existence of these factors at the clinics disposed of resulted in clinic
operations that made it difficult for the Company to effectively manage the
clinics. One of these practices was sold in the first quarter of 1998 and the
second sale was completed April 1, 1998. The remaining practice is expected to
be disposed of at the end of 1998. Losses on the two clinics divested equaled
approximately $19.5 million which approximated the amounts accrued. These
clinics were sold below book value because of the reasons noted above, and given
such facts, a sale at a discount to carrying value was considered more cost
effective than a closure which would subject the Company to additional costs.
The Company is not aware of circumstances that suggest that the clinics included
in the non-recurring charge are indicative of a trend in the Company's
operations or the industry in which the Company operates. There can be no
assurance, however, that in the future a similar combination of negative
characteristics will not develop at a clinic affiliated with the Company and
result in the termination of the applicable service agreement or that in the
future additional clinics will not terminate their relationships with the
Company in a manner that may materially adversely affect the Company. For
additional discussion of the non-recurring charge, see "Results of
Operations--1997 Compared to 1996."
The Company also recorded a pre-tax charge to earnings of approximately
$14.0 million in the first quarter of 1998 relating to its terminated merger
with MedPartners, Inc. This charge represents PhyCor's share of
investment-banking, legal, travel, accounting and other expenses incurred during
the merger process.
In June 1995, the Company purchased a minority interest of
approximately 9% in PMC and has managed PMC pursuant to a 10-year administrative
services agreement. PMC develops and manages IPAs and provides other services to
physician organizations. PhyCor acquired the remaining interests of PMC on March
31, 1998 for approximately 956,300 shares of the Company's Common Stock.
PhyCor has been the subject of an audit by the Internal Revenue Service
("IRS") covering the years 1988 through 1993. The IRS has proposed adjustments
relating to the timing of recognition for tax purposes of certain revenue and
deductions relating to uncollectible accounts and the Company's relationship
with affiliated physician groups. PhyCor disagrees with the positions asserted
by the IRS, including any recharacterization, and is vigorously contesting these
proposed adjustments. The Company believes that any adjustments resulting from
resolution of this disagreement would not affect reported net earnings of
PhyCor, but would defer tax benefits and change the levels of current and
deferred tax assets and liabilities. For the years under audit, and potentially,
for subsequent years, any such adjustments could result in material cash
payments by the Company. PhyCor does not believe the resolution of this matter
will have a material adverse effect on its financial condition or results of
operations, although there can be no assurance as to the outcome of this matter.
In July 1997, the Company completed modifications to its bank credit
facility, which included the revision of certain terms and condition and the
addition of seven participating financial institutions. The Company's bank
credit facility provides for a five-year, $250.0 million revolving line of
credit for use by the Company prior to July 2002 and a $150.0 million 364-day
facility for acquisitions, working capital, capital expenditures and general
corporate purposes. The total drawn cost under the facility is either .375% to
.75% above the applicable eurodollar rate or the agents base rate plus .10% to
.225% per annum. On
24
<PAGE> 25
October 17, 1997, the Company entered into an interest rate swap agreement to
fix the interest rate on $100.0 million of debt at 5.85% for a two-year period.
In March 1998, the Company obtained commitments from its bank group to expand
the existing bank credit facility to a total of $500.0 million. The expanded
facility, with terms similar to the existing facility, is expected to close in
the second quarter of 1998.
The Company's current bank credit facility contains covenants which,
among other things, require the Company to maintain certain financial ratios and
impose certain limitations or prohibitions on the Company with respect to: (i)
the incurrence of certain indebtedness, (ii) the creation of security interests
on the assets of the Company, (iii) the payment of cash dividends on, and the
redemption or repurchase of, securities of the Company, (iv) investments and (v)
acquisitions. The Company is required to obtain bank consent for an acquisition
with an aggregate purchase price of $75.0 million or more. The Company was in
compliance with such covenants at December 31, 1997.
The Company has two stock option plans and two stock purchase plans.
Compensation expense calculated in determining pro forma earnings per share in
accordance with FAS 123, Earnings per Share, decreased diluted earnings per
share $0.27, $0.11 and $0.02 in 1997, 1996 and 1995, respectively. Pro forma
diluted earnings per share will likely continue to be significantly below
diluted earnings per share because the Company plans to continue to grant stock
options in future periods.
PhyCor has assessed its practice management systems, managed care
information systems, business information systems and other clinic systems for
compliance with the Year 2000 issue. The Company is in its normal process of
standardizing the various systems utilized by its clinics and IPAs. This
standardization includes implementation of Year 2000 compliant systems. The
Company has performed an assessment of its various clinics and IPAs to identify
which systems specifically require replacement or upgrade due to the Year 2000
issue in order to ensure timely upgrade or installation. The Company believes it
has a replacement strategy in place such that the Year 2000 issue will not have
a significant effect on its operations. Total capital costs to implement new
systems and to address the Year 2000 issue are expected to be less than $20.0
million.
At March 19, 1998, the Company had cash and cash equivalents of
approximately $38.0 million and $134.6 million available under its current bank
credit facility. The Company believes that the combination of funds available
under the Company's anticipated expanded bank credit facility, together with
cash reserves and cash flow from operations, should be sufficient to meet the
Company's current planned acquisition, expansion, capital expenditure and
working capital needs through 1998. In addition, in order to provide the funds
necessary for the continued pursuit of the Company's long-term expansion
strategy, the Company expects to continue to incur, from time to time,
additional short-term and long-term indebtedness and to issue equity and debt
securities, the availability and terms of which will depend upon market and
other conditions. There can be no assurance that such additional financing will
be available on terms acceptable to the Company or that the expanded bank credit
facility will be entered into.
RISK FACTORS
This discussion also identifies important cautionary factors that could
cause PhyCor's actual results to differ materially from those projected in
forward-looking statements of PhyCor and included herein or incorporated by
reference. In particular, forward-looking statements including, but not limited
to, those regarding future business prospects, the acquisition of additional
clinics, the development of additional IPAs, the adequacy of PhyCor's capital
resources, the future profitability of capitated fee arrangements and other
statements regarding trends relating to various revenue and expense items, could
be affected by a number of risks and uncertainties including those described
below.
25
<PAGE> 26
No Assurance of Continued Rapid Growth
PhyCor's continued growth will be primarily dependent upon its ability
to achieve significant consolidation of multi-specialty medical clinics, to
sustain and enhance the profitability of those clinics and to develop and manage
IPAs. The process of identifying suitable acquisition candidates and proposing,
negotiating and implementing an economically feasible affiliation with a
physician group or formation or management of a physician network is lengthy and
complex. Clinic and physician network operations require intensive management in
a dynamic marketplace increasingly subject to cost containment pressures. There
can be no assurance that PhyCor will be able to sustain its historically rapid
rate of growth. The success of PhyCor's strategy to develop and manage IPAs is
largely dependent upon its ability to form networks of physicians, to obtain
favorable payor contracts, to manage and control costs and to realize economies
of scale. Many of the agreements entered into by physicians participating in
PhyCor-managed IPAs are not exclusive arrangements. The physicians, therefore,
could join competing networks or terminate their relationships with the IPAs.
There can be no assurance that PhyCor will be successful in acquiring additional
physician practice assets or PPMs, establishing new IPA networks or maintaining
relationships with affiliated physicians.
Additional Financings
PhyCor's multi-specialty medical clinic acquisition and expansion
program and its IPA development and management plans require substantial capital
resources. The operations of existing clinics require ongoing capital
expenditures for renovation and expansion and the addition of costly medical
equipment and technology utilized in providing ancillary services. PhyCor, in
certain circumstances, has acquired real estate in connection with clinic
acquisitions. PhyCor will require additional financing for the development of
additional IPAs and expansion and management of existing IPAs. PhyCor expects
that its capital needs over the next several years will exceed capital generated
from operations. PhyCor plans to incur indebtedness and to issue, from time to
time, additional debt or equity securities, including the issuance of PhyCor
Common Stock or convertible notes in connection with acquisitions. PhyCor's bank
credit facility requires the lenders' consent for borrowings in connection with
the acquisition of certain clinic assets. There can be no assurance that
sufficient financing will be available on terms satisfactory to PhyCor or at
all.
Competition
The business of providing health care related services is highly
competitive. Many companies, including professionally managed PPM companies like
PhyCor have been organized to pursue the acquisition of medical clinics, manage
such clinics, employ clinic physicians or provide services to IPAs. Large
hospitals, other multi-specialty clinics and health care companies HMOs and
insurance companies are also involved in activities similar to those of PhyCor.
Some of these competitors have longer operating histories and significantly
greater resources than PhyCor. There can be no assurance that PhyCor will be
able to compete effectively, that additional competitors will not enter the
market, or that such competition will not make it more difficult to acquire the
assets of multi-specialty clinics on terms beneficial to PhyCor.
26
<PAGE> 27
Dependence on Affiliated Physicians
Substantially all of PhyCor's revenue is derived from service or
management agreements with PhyCor's affiliated clinics, the loss of certain of
which could have a material adverse effect on PhyCor as a result of the loss of
revenue from such agreements and the loss of any funds advanced by PhyCor to
cover expenses of such clinics. In addition, any material decline in revenue by
PhyCor's affiliated physician groups, whether as a result of physicians leaving
the affiliated physician groups or otherwise, could have a material adverse
effect on PhyCor.
Dependence on Operating Results of Affiliated Clinics
Substantially all of the Company's revenue is derived from the service
fees it receives pursuant to the Company's service agreements with its
affiliated clinics. The service fees are typically based on a percentage of the
affiliated clinics' operating income plus reimbursement of clinic expenses.
Accordingly, if the operating results of the Company's affiliated clinics are
adversely affected, the Company's results will also be adversely affected.
Additionally, if the Company fails to assist its affiliated clinics in achieving
enhanced operating efficiencies as a result of its services, the affiliated
clinics may seek to terminate their service agreements with the Company. Such
terminations could have a material adverse effect on the Company's operating
results.
Risks Associated with Managed Care and Capitation; Reliance on
Physician Networks
Many of the payor contracts entered into on behalf of PhyCor-managed
IPAs are based on capitated fee arrangements. Under capitation arrangements,
health care providers bear the risk, subject to certain loss limits, that the
aggregate costs of providing medical services to the members will exceed the
premiums received. The IPA management fees are based, in part, upon a share of
the remaining portion, if any, of capitated amounts of revenue. Some agreements
with payors also contain "shared risk" provisions under which the Company and
IPA can earn additional compensation and may be required to bear a portion of
any loss in connection with such shared risk provisions based on utilization of
hospital services by members. Any such losses could have a material adverse
effect on PhyCor. The profitability of a capitated fee arrangement is dependent
upon the ability of the providers to effectively manage the per patient costs of
providing medical services and the level of utilization of medical services. The
management fees are also based upon a percentage of revenue collected by the
IPA. Any loss of revenue by the IPAs as a result of losing affiliated
physicians, the termination of third party payor contracts or otherwise could
have a material adverse effect on management fees derived by PhyCor. Managed
care providers and management entities such as PhyCor are increasingly subject
to liability claims arising from utilization management, provider compensation
arrangements and other activities designed to control costs by reducing
services. A successful claim on this basis against PhyCor or an affiliated
clinic or IPA could have a material adverse effect on PhyCor.
Risks of Changes in Payment for Medical Services
The United States Congress and many state legislatures routinely
consider proposals to reform or modify the health care system, including
measures that would control health care spending, convert all or a portion of
government reimbursement programs to managed care arrangements and reduce
spending for Medicare and state health programs. These measures can affect a
health care company's cost of doing business and contractual relationships. For
example, recent developments that affect PhyCor's activities include: (i)
federal legislation requiring a health plan to continue coverage for individuals
who are no longer eligible for group health benefits and prohibiting the use of
"pre-existing condition" exclusions that limit the scope of coverage; (ii) a
Health Care Financing Administration policy prohibiting restrictions in Medicare
risk HMO plans on a physician's recommendation of other health plans and
treatment options to patients; and (iii) regulations imposing restrictions on
physician incentive provisions in physician
27
<PAGE> 28
provider agreements. There can be no assurance that such legislation, programs
and other regulatory changes will not have a material adverse effect on PhyCor.
The profitability of PhyCor may be adversely affected by Medicare and
Medicaid regulations, cost containment decisions of third party payors and other
payment factors over which PhyCor has no control. The federal Medicare program
has undergone significant legislative and regulatory changes in the
reimbursement and fraud and abuse areas, including the adoption of the
resource-based relative value scale ("RBRVS") schedule for physician
compensation under Medicare, which may continue to have a negative impact on
PhyCor's revenue. Efforts to control the cost of health care services are
increasing. Many of PhyCor's physician groups are becoming affiliated with
provider networks, managed care organizations and other organized health care
systems, which often provide fixed fee schedules or capitation payment
arrangements that are lower than standard charges. Future profitability in the
changing health care environment, with differing methods of payment for medical
services, is likely to be affected significantly by management of health care
costs, pricing of services and agreements with payors. Because PhyCor derives
its revenues from the revenues generated by its affiliated physician groups and
from managed IPAs, further reductions in payments to physicians generally or
other changes in payment for health care services could have a material adverse
effect on PhyCor.
Additional Regulatory Risks
The health care industry and physicians' medical practices are highly
regulated at the state and federal levels. At the state level, all state laws
restrict the unlicensed practice of medicine, and many states also prohibit the
splitting or sharing of fees with nonphysician entities and the enforcement of
noncompetition agreements against physicians. Furthermore, most state
fee-splitting laws provide that it is a violation only if a physician shares
fees with a referral source. PhyCor is not a referral source for its managed
groups, and therefore the fee-splitting laws in most states should not restrict
the payment of a management fee by the physician groups to PhyCor. Many states
also prohibit the "corporate practice of medicine" by an unlicensed corporation
or other nonphysician entity that employs physicians. Currently, PhyCor merely
manages physician groups, and the physicians continued to be employed at the
group level by professional associations or corporations, which are specifically
authorized under most state laws to employ physicians. Upon consummation of the
FPC transaction, however, subsidiaries of PhyCor will directly employ physicians
in the states of Florida and Georgia.
Additionally, the Florida Board of Medicine has interpreted the Florida
fee-splitting law very broadly so as to arguably include the payment of any
percentage-based management fee, even to a management company that does not
refer patients to a managed group. PhyCor is affiliated with five physician
groups in Florida, the service agreements with which provide for
percentage-based management fees. The Florida Board of Medicine decision has
been stayed pending judicial interpretation of the decision. Because of the
structure of the relationships of PhyCor with its affiliated physician groups
and managed IPAs, and because of the recent broad fee-splitting interpretation
in the State of Florida, there can be no assurance that review of PhyCor's
business by courts or health care, or other regulatory authorities will not
result in determinations that could adversely affect the financial condition or
results of operations of PhyCor. If for any reason PhyCor were found to have
violated the corporate practice of medicine or fee-splitting statutes, possible
consequences could include revocation or suspension of the physicians' license,
resulting in lowered revenue to PhyCor. Courts could also refuse to uphold the
contracts between PhyCor and its managed physicians on the
28
<PAGE> 29
grounds that PhyCor was engaging in the unlicensed practice of medicine and that
therefore its contracts were invalid.
On the federal level, federal law prohibits the offer, payment,
solicitation, or receipt of any form of remuneration in return for the referral
of, or the arranging for the referral of, Medicare or other federal or state
health program patients or patient care opportunities, or in return for the
purchase, lease or order of items or services that are covered by Medicare or
other federal or state health programs. This law applies to non-health care
providers as well as providers. The Office of Inspector General ("OIG") of the
Department of Health and Human Services ("DHHS") has released an advisory
opinion (OIG Advisory Opinion No. 98-4) stating that a percentage based
management arrangement between a physician practice management company and
physician group could violate the federal anti-kickback law if one purpose of
the arrangement is intended to compensate the applicable management company for
its efforts to "arrange for" referrals for the managed group. In addition,
federal law prohibits physicians with certain financial relationships with
health care providers from referring certain types of Medicare or Medicaid
reimbursed "designated health services" to those providers unless the referral
fits within an exception to the law. One of the exceptions that is used most
often requires that physician groups be included within a definition of "group
practice" in order to be permitted to make referrals within the group. Federal
antitrust laws also prohibit conduct that may result in price fixing or other
anticompetitive conduct.
The PhyCor arrangements have been carefully structured so that the
physician groups being managed fit within the definition of "group practice",
and all referrals from those physicians to ancillary centers are structured to
fit within an applicable exception to federal law. In addition, PhyCor does not
make or influence or arrange for referrals to its managed or employed
physicians, and the compensation received by PhyCor is not directly related to
any referral levels between the parties, nor is it intended in any way to
compensate PhyCor for arranging for referrals to its affiliated physician
groups. Nevertheless, because of the structure of the relationships of PhyCor
with its affiliated physician groups and managed IPAs, there can be no assurance
that review of PhyCor's business by courts or healthcare, tax, regulatory
authorities will not result in determinations that could adversely affect the
financial condition or results of operations of PhyCor, or that the health care
regulatory environment will not change in the manner that would restrict
PhyCor's existing operations or limit the expansion of PhyCor's business or
otherwise adversely affect PhyCor. In addition to civil and, in some cases,
criminal penalties for violation of Medicare and Medicaid statutes, violators of
these statutes may be excluded from further participation in Medicare or state
health care programs.
Increased Government Scrutiny of Health Care Arrangements
There is increasing scrutiny by law enforcement authorities, the OIG,
the courts, and the United States Congress of arrangements between health care
providers and potential referral sources to ensure that the arrangements are not
designed as a mechanism to exchange remuneration for patient care referrals and
opportunities. Investigators have also demonstrated a willingness to look behind
the documents evidencing a business transaction to determine the underlying
purpose of payments between health care providers and potential referral
sources. Enforcement actions have increased. Although, to its knowledge PhyCor
is not currently the subject of any investigation which is likely to have a
material adverse effect on its respective businesses, there can be no assurance
that they will not be the subject of investigations or inquiries in the future.
29
<PAGE> 30
Risks Associated with Straub Transaction
In January 1997, PhyCor consummated its merger with Straub, an
integrated health care system with a 152-physician multi-specialty clinic and
159-bed acute care hospital located in Honolulu, Hawaii. In connection with the
transaction with Straub, PhyCor agreed to provide certain management services to
both a physician group practice and a hospital owned by the group. Because the
hospital is subject to extensive regulation and because hospital management
companies have, in some instances, been viewed as referral sources by federal
regulatory agencies, the relationship between PhyCor and the physician group
could come under increased scrutiny under the Medicare fraud and abuse law.
Tax Audit
PhyCor has been subject to an audit by the IRS covering the years 1988
through 1993. The IRS has proposed adjustments relating to the timing of
recognition for tax purposes of certain revenue and deductions relating to
uncollectible accounts and PhyCor's relationship with affiliated physician
groups. PhyCor disagrees with the positions asserted by the IRS including any
recharacterization and is vigorously contesting these proposed adjustments.
PhyCor believes that any adjustments resulting from resolution of this
disagreement would not affect reported net earnings of PhyCor but would defer
tax benefits and change the levels of current and deferred tax assets and
liabilities. For the years under audit and, potentially, for subsequent years,
any such adjustments could result in material cash payments by PhyCor. PhyCor
does not believe the resolution of this matter will have a material adverse
effect on its financial condition, although there can be no assurance as to the
outcome of this matter.
Applicability of Insurance Regulations
PhyCor's managed IPAs enter into contracts and joint ventures with
licensed insurance companies, such as HMOs, whereby the IPAs may be paid on a
capitated fee basis. Under capitation arrangements, health care providers bear
the risk, subject to certain loss limits, that the aggregate costs of providing
medical services to members will exceed the premiums received. To the extent
that the IPAs subcontract with physicians or other providers for those
physicians or other providers to provide services on a fee-for-service basis,
the managed IPAs may be deemed to be in the business of insurance, and thus,
subject to a variety of regulatory and licensing requirements applicable to
insurance companies or HMOs resulting in increased costs to the managed IPAs,
and corresponding lower revenue to PhyCor. In connection with multi-specialty
medical clinic acquisitions, PhyCor has and may continue to acquire HMOs
previously affiliated with such clinics. The HMO industry is highly regulated at
the state level and is highly competitive. Additionally, the HMO industry has
been subject to numerous legislative initiatives within the past several years,
including initiatives that would pose additional liabilities on HMOs for patient
malpractice, thereby increasing costs to HMOs, which would result in
correspondingly lower revenue to PhyCor. There can be no assurance that
developments in any of these areas will not have an adverse effect on PhyCor's
wholly-owned HMOs or on HMOs in which PhyCor has a partial ownership interest or
other financial involvement.
30
<PAGE> 31
Risks Inherent in Provision of Medical Services
The physician groups with which PhyCor affiliates and the physicians
participating in networks developed and managed by PhyCor are involved in the
delivery of medical services to the public and, therefore, are exposed to the
risk of professional liability claims. Claims of this nature, if successful,
could result in substantial damage awards to the claimants which may exceed the
limits of any applicable insurance coverage. Insurance against losses related to
claims of this type can be expensive and varies widely from state to state.
PhyCor does not control the practice of medicine by affiliated physicians or the
compliance with certain regulatory and other requirements directly applicable to
physicians, physician networks and physician groups. PhyCor is indemnified under
its service agreements for claims against the physician groups, maintains
liability insurance for itself and negotiates liability insurance for the
physicians affiliated with its clinics and under its management agreements for
claims against the IPAs and physician members. Successful malpractice claims
asserted against the physician groups, the managed IPAs or PhyCor, however,
could have a material adverse effect on PhyCor. Moreover, PhyCor may in the
future acquire entities, such as other PPMs that directly employ physicians. The
acquisition of such companies would subject PhyCor to increased risk of
malpractice liability, as well as increased scrutiny under healthcare
regulations and laws.
Anti-takeover Considerations
PhyCor is authorized to issue up to 10,000,000 shares of preferred
stock, the rights of which may be fixed by the Board of Directors. In February
1994, the Board of Directors approved the adoption of a Shareholder Rights Plan
(the "PhyCor Rights Plan"). The PhyCor Rights Plan is intended to encourage
potential acquirers to negotiate with PhyCor's Board of Directors and to
discourage coercive, discriminatory and unfair proposals. PhyCor's stock
incentive plans provide for the acceleration of the vesting of options in the
event of a change in control. The PhyCor Charter provides for the classification
of its Board of Directors into three classes, with each class of directors
serving staggered terms of three years. Provisions in the executive officers'
employment agreements provide for post-termination compensation, including
payment of certain of the executive officers' salaries for 24 months, following
a change in control. Most physician groups may terminate their service
agreements with PhyCor in certain events, including a change in control of
PhyCor which is not approved by a majority of PhyCor's Board of Directors. A
change in control of PhyCor also constitutes an event of default under PhyCor's
bank credit facility. The foregoing matters may, together or separately, have
the effect of discouraging or making more difficult an acquisition or change of
control of PhyCor.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements and the related notes, together with
the report of KPMG Peat Marwick LLP thereon, are set forth in the Company's 1997
Annual Report to Shareholders and are incorporated herein by reference.
31
<PAGE> 32
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Financial Statements
December 31, 1997, 1996, and 1995
(With Independent Auditors' Report Thereon)
32
<PAGE> 33
PHYCOR, INC. AND SUBSIDIARIES
Index to Financial Statements
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................................................ 34
Consolidated Balance Sheets................................................................. 35
Consolidated Statements of Income........................................................... 36
Consolidated Statements of Shareholders' Equity............................................. 37
Consolidated Statements of Cash Flows....................................................... 38 - 39
Notes to Consolidated Financial Statements.................................................. 40 - 59
</TABLE>
33
<PAGE> 34
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
PhyCor, Inc.:
We have audited the consolidated balance sheets of PhyCor, Inc.
and subsidiaries as of December 31, 1997 and 1996 and the related
consolidated statements of income, shareholders' equity and cash flows
for each of the years in the three-year period ended December 31, 1997.
These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position
of PhyCor, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 1997, in conformity
with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
Nashville, Tennessee
February 18, 1998
34
<PAGE> 35
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1997 and 1996
(All amounts are expressed in thousands)
<TABLE>
<CAPTION>
ASSETS 1997 1996
------ ---------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 38,160 30,530
Accounts receivable, less allowances of $208,534 in 1997 and
$134,556 in 1996 391,668 295,437
Inventories 18,578 15,185
Prepaid expenses and other current assets (notes 15 and 16) 48,158 42,275
---------- ---------
Total current assets 496,564 383,427
Property and equipment, net (notes 4, 10, and 11) 235,685 160,228
Intangible assets (notes 3 and 6) 807,726 559,705
Other assets (note 5 and 15) 22,801 15,221
---------- ---------
Total assets $1,562,776 1,118,581
========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current installments of long-term debt (notes 7 and 10) $ 1,144 424
Current installments of obligations under capital leases (note 11) 3,564 1,237
Accounts payable 34,622 24,103
Due to physician groups (notes 2 and 3) 50,676 42,636
Purchase price payable (note 3) 114,971 63,097
Salaries and benefits payable 37,141 23,120
Other accrued expenses and liabilities 51,145 46,257
---------- ---------
Total current liabilities 293,263 200,874
Long-term debt, excluding current installments (notes 7 and 10) 210,893 123,112
Obligations under capital leases, excluding current installments (note 11) 5,093 1,467
Purchase price payable (note 3) 23,545 35,710
Deferred tax credits and other liabilities (note 13) 57,918 21,797
Convertible subordinated notes payable to physician groups (notes 7 and 8) 61,576 83,918
Convertible subordinated debentures (notes 7 and 9) 200,000 200,000
---------- ---------
Total liabilities 852,288 666,878
---------- ---------
Shareholders' equity (notes 8, 9, 12, and 13):
Preferred stock, no par value, 10,000 shares authorized -- --
Common stock, no par value; 250,000 shares authorized; issued and outstanding,
64,530 shares in 1997 and 54,831 shares in 1996 645,288 389,712
Retained earnings 65,200 61,991
---------- ---------
Total shareholders' equity 710,488 451,703
---------- ---------
Commitments, contingencies and subsequent event (notes 3, 11, 12, 14 and 17)
Total liabilities and shareholders' equity $1,562,776 1,118,581
========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
35
<PAGE> 36
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Income
Years ended December 31, 1997, 1996,
and 1995 (All amounts are expressed in thousands,
except for earnings per share)
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Net revenue (note 2) $ 1,119,594 766,325 441,596
Operating expenses:
Clinic salaries, wages and benefits 421,716 291,361 166,031
Clinic supplies 181,565 119,081 67,596
Purchased medical services 31,171 21,330 17,572
Other clinic expenses 171,480 125,947 71,877
General corporate expenses 26,360 21,115 14,191
Rents and lease expense 100,170 65,577 36,740
Depreciation and amortization 62,522 40,182 21,445
Nonrecurring charge (note 13) 83,445 _ -
----------- ------- -------
Net operating expenses 1,078,429 684,593 395,452
----------- ------- -------
Earnings from operations 41,165 81,732 46,144
Other (income) expense:
Interest income (3,323) (3,867) (1,816)
Interest expense 23,507 15,981 5,230
----------- ------- -------
Earnings before income taxes and minority interest 20,981 69,618 42,730
Income tax expense (note 13) 6,098 22,775 13,923
Minority interest in earnings of consolidated partnerships 11,674 10,463 6,933
----------- ------- -------
Net earnings $ 3,209 36,380 21,874
=========== ======= =======
Earnings per share:
Basic $ .05 .67 .45
Diluted .05 .60 .41
=========== ======= =======
Weighted average number of shares and diluted shares equivalents outstanding
(note 12):
Basic 62,899 54,608 48,817
Diluted 66,934 61,096 53,662
=========== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
36
<PAGE> 37
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Years ended December 31, 1997, 1996, and 1995
(All amounts are expressed in thousands)
<TABLE>
<CAPTION>
COMMON STOCK
-------------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
------ -------- -------- -------
<S> <C> <C> <C> <C>
Balances at December 31, 1994 37,899 $180,388 3,737 184,125
Issuance of common stock and warrants, net of
placement commissions and
offering expenses totaling $5,760 7,835 127,773 -- 127,773
Conversion of subordinated debentures
to common stock 4,882 27,566 -- 27,566
Conversion of notes payable to
common stock 2,670 26,405 -- 26,405
Stock options exercised and related tax benefits 113 1,079 -- 1,079
Net earnings for the year ended
December 31, 1995 -- -- 21,874 21,874
------ -------- ------ -------
Balances at December 31, 1995 53,399 363,211 25,611 388,822
Issuance of common stock and warrants, net of
placement commissions
and offering expenses totaling $192 261 10,312 -- 10,312
Conversion of notes payable
to common stock 859 11,450 -- 11,450
Stock options exercised and related tax benefits 312 4,739 -- 4,739
Net earnings for the year ended
December 31, 1996 -- -- 36,380 36,380
------ -------- ------ -------
Balances at December 31, 1996 54,831 $389,712 61,991 451,703
Issuance of common stock and warrants, net of
placement commissions
and offering expenses totaling $8,957 8,109 232,422 -- 232,422
Conversion of notes payable
to common stock 1,046 14,816 -- 14,816
Stock options exercised and related tax benefits 544 8,338 -- 8,338
Net earnings for the year ended
December 31, 1997 -- -- 3,209 3,209
------ -------- ------ -------
Balances at December 31, 1997 64,530 $645,288 65,200 710,488
====== ======== ====== =======
</TABLE>
See accompanying notes to consolidated financial statements.
37
<PAGE> 38
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1997, 1996, and 1995
(All amounts are expressed in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 3,209 36,380 21,874
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation and amortization 62,522 40,182 21,445
Deferred income taxes (9,677) 9,616 2,948
Minority interests 11,674 10,463 6,933
Nonrecurring charge 83,445 -- --
Increase (decrease) in cash, net of effects of acquisitions, due to
changes in:
Accounts receivable, net (28,920) (36,376) (12,179)
Inventories (1,929) (1,880) (1,280)
Prepaid expenses and other current assets 137 (16,481) (1,749)
Accounts payable 2,211 (3,291) 5,474
Due to physician groups 10,396 13,489 8,595
Other accrued expenses and liabilities (17,020) 23,006 2,204
--------- -------- --------
Net cash provided by operating activities 116,048 75,108 54,265
--------- -------- --------
Cash flows from investing activities:
Payments for acquisitions, net (299,191) (252,270) (145,075)
Purchase of property and equipment (66,486) (50,053) (29,292)
Payments to acquire other assets (12,711) (4,719) (2,943)
--------- -------- --------
Net cash used by investing activities (378,388) (307,042) (177,310)
--------- -------- --------
Cash flows from financing activities:
Net proceeds from issuance of stock and warrants 226,458 4,975 113,594
Net proceeds from issuance of convertible debentures -- 194,395 --
Proceeds from long-term borrowings 295,000 161,000 130,400
Repayment of long-term borrowings (235,972) (104,546) (100,144)
Repayment of obligations under capital leases (4,088) (1,811) (1,965)
Distributions of minority interests (11,107) (10,291) (6,204)
Loan costs incurred (321) (85) (269)
--------- -------- --------
Net cash provided by financing activities 269,970 243,637 135,412
--------- -------- --------
Net increase in cash and cash equivalents 7,630 11,703 12,367
Cash and cash equivalents - beginning of year 30,530 18,827 6,460
--------- -------- --------
Cash and cash equivalents - end of year $ 38,160 30,530 18,827
========= ======== ========
</TABLE>
38
<PAGE> 39
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
<TABLE>
<CAPTION>
1997 1996 1995
--------- ------- -------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 23,005 13,745 4,674
Income taxes, net of refunds 18,314 13,991 10,760
========= ======= =======
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Effects of acquisitions (note 3):
Assets acquired, net of cash $ 450,872 384,807 270,925
Liabilities assumed (131,681) (89,326) (50,015)
Issuance of convertible subordinated notes payable (11,286) (36,084) (62,942)
Issuance of common stock and warrants (8,714) (7,127) (12,893)
--------- ------- -------
Payment for assets acquired $ 299,191 252,270 145,075
========= ======= =======
Capital lease obligations incurred to acquire equipment $ 555 471 173
Conversion of subordinated debentures and notes payable to common stock 14,816 11,450 53,971
========= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
39
<PAGE> 40
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1997, 1996, and 1995
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(A) DESCRIPTION OF BUSINESS
PhyCor, Inc. (Company) is a physician practice management company
that acquires and operates multi-specialty medical clinics and
develops and manages independent practice associations ("IPAs").
PhyCor's objective is to organize physicians into professionally
managed networks that assist physicians in assuming increased
responsibility for delivering cost-effective medical care while
attaining high-quality clinical outcomes and patient satisfaction.
The Company, through wholly-owned subsidiaries, acquires certain
assets of and operates clinics under long-term service agreements
with affiliated physician groups that practice exclusively through
such clinics. The Company provides administrative and technical
support for professional services rendered by the physician groups
under service agreements. Under substantially all of its service
agreements, the Company receives a service fee equal to the clinic
expenses it incurred plus a percentage of operating income of the
clinic (net clinic revenue less certain contractually agreed upon
clinic expenses before physician distributions) and, under all
other services agreements except one described below, the Company
receives a percentage of net clinic revenue. In 1997, the
Company's revenue was derived from contracts with the following
service fee structures: (i) 94% of revenue was derived from
contracts in which the service fee was based on a percentage,
ranging from 15% to 18%, of clinic operating income plus
reimbursement of clinic expenses; (ii) 1% of revenue was derived
from a contract in which the service fee was based on 51.7% of net
clinic revenue; (iii) 4% of revenue was derived from contracts in
which the service fee was based upon a combination of (a) 10% of
clinic operating income, (b) a percentage, ranging from 2.75% to
3.5%, of net clinic revenue and (c) reimbursement of clinic
expenses; and (iv) 1% of revenue was derived from one contract
which is based on a flat fee. As of December 31, 1997, the Company
operated 55 clinics in 28 states.
The Company also manages IPAs which are networks of independent
physicians. Fees earned from managing the IPAs are based upon a
percentage of revenue collected by the IPAs and also upon a share
of surplus, if any, of capitated revenue of the IPAs. The Company
is not a party to the capitated contracts entered into by the
IPAs but is exposed to losses to the extent of its share of
deficits, if any, of the capitated revenue of the IPAs. At
December 31, 1997, these IPAs include over 19,000 physicians in 28
markets which provide capitated medical services to approximately
1,132,000 members, including approximately 174,000 Medicare
members.
(B) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its majority owned subsidiaries, partnerships and
other entities in which the company has more than 50% ownership
interest or exercises control. All significant intercompany
balances and transactions are eliminated in consolidation. The
Company does not consolidate the physician practices it manages as
it does not have operating control as defined in EITF 97-2,
"Application of APB Opinion No. 16 and FASB Statement No. 94 to
Physician Practice Entities."
(C) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a
maturity of three months or less when purchased to be cash
equivalents. Cash and cash equivalents as of December 31, 1997
include approximately $2,943,000 of consolidated partnership cash.
These balances may only be used for the operations of the
respective partnerships.
(D) ACCOUNTS RECEIVABLE
Accounts receivable principally represent receivables from
patients and third-party payors for medical services provided by
physician groups. Terms of the service agreements require the
Company to purchase receivables generated by the physician groups
on a monthly basis. Such amounts are recorded net of contractual
allowances and estimated bad debts. Accounts receivable are a
function of net clinic revenue rather than net revenue of the
Company (See note 2).
(Continued)
40
<PAGE> 41
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(E) INVENTORIES
Inventories are comprised primarily of medical supplies,
medications and other materials used in the delivery of health
care services by the physician groups at the Company's clinics.
The Company values inventories at the lower of cost or market with
cost determined using the first-in, first-out (FIFO) method.
(F) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Equipment held under
capital leases is stated at the present value of minimum lease
payments at the inception of the related leases. Depreciation of
property and equipment is calculated using the straight-line
method over the estimated useful lives of the assets. Equipment
held under capital leases and leasehold improvements are amortized
on a straight line basis over the shorter of the lease term or
estimated useful life of the assets.
(G) INTANGIBLE ASSETS
CLINIC SERVICE AGREEMENTS
Costs of obtaining clinic service agreements are amortized using
the straight-line method over the periods during which the
agreements are effective, currently twenty-five to forty years.
Clinic service agreements represent the exclusive right to operate
the Company's clinics in affiliation with the related physician
groups during the term of the agreements. In the event of
termination of a service agreement, the related physician group is
required to purchase all clinic assets, including the unamortized
portion of intangible assets, generally at then current net book
value.
EXCESS OF COST OF ACQUIRED ASSETS OVER FAIR VALUE
Excess of cost of acquired assets over fair value (goodwill) is
amortized using the straight line method over thirty years.
OTHER INTANGIBLE ASSETS
Other intangible assets include costs associated with obtaining
long-term financing which are being amortized systematically over
the terms of the related debt agreements.
41
<PAGE> 42
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
AMORTIZATION AND RECOVERABILITY
The Company periodically reviews its intangible assets to assess
whether recoverability and impairments would be recognized in the
statement of operations if a permanent impairment were determined
to have occurred. Recoverability of intangibles is determined
based on undiscounted future operating cash flows from the related
business unit or activity. The amount of impairment, if any, is
measured based on discounted future operating cash flows using a
discount rate reflecting the Company's average cost of funds or
based on the fair value of the related business unit or activity.
The assessment of the recoverability of intangible assets will be
impacted if estimated future operating cash flows are not
achieved. Amortization of intangibles amounted to $23,865,000,
$15,150,000, and $7,441,000, and for 1997, 1996 and 1995,
respectively.
(H) IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used
is measured by a comparison of the carrying amount of an asset to
future net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount
of the assets exceeded the fair value of the assets.
(I) INCOME TAXES
Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in the tax rates
is recognized in income in the period that includes the enactment
date.
(J) FINANCIAL INSTRUMENTS
In 1997, the Company entered into an interest rate swap agreement
to reduce the exposure to fluctuating interest rates with respect
to $100,000,000 of its bank credit facility. The interest rate
swap agreement matures in October 2002, with a lender's option to
terminate beginning October 1999, and is accounted for on the
accrual method. Gains and losses resulting from this instrument
are recognized in the same period as the related interest expense.
Gains and losses are included in interest expense. The Company
does not use interest rate swap agreements or other derivative
financial instruments for speculative or trading purposes.
(Continued)
42
<PAGE> 43
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(K) STOCK OPTION PLANS
The Company accounts for its compensation and stock option plans
in accordance with the provisions of Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees,
and related interpretations. As such, compensation expense would
be recorded on the date of grant only if the current market price
of the underlying stock exceeded the exercise price. In accordance
with SFAS No. 123, Accounting for Stock-Based Compensation (SFAS
No. 123), the Company provides pro forma net income and pro forma
earnings per share disclosures for employee stock option grants
made in 1995 and future years as if the fair-value-based method
defined in SFAS No. 123 had been applied.
(L) EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting Standards
No. 128, Earnings Per Share, in 1997. This statement requires that
a dual presentation of both Basic and Diluted earnings per share.
Basic earnings per share is computed based on weighted average
shares outstanding and excludes any potential dilution. Diluted
earnings per share reflects the potential dilution from the
exercise or conversion of all dilutive securities into common
stock based on the average market price of common shares
outstanding during the period. All periods presented have been
restated to conform with the provisions of the new statement.
(M) USE OF ESTIMATES
Management of the Company has made certain estimates and
assumptions relating to the reporting of assets and liabilities
and the disclosure of contingent assets and liabilities to prepare
these consolidated financial statements in conformity with
generally accepted accounting principles. Actual results could
differ from those estimates.
(N) RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to
the 1997 presentation.
(2) NET REVENUE
Clinic service agreement revenue is equal to the net revenue of the
clinics, less amounts retained by physician groups. Net clinic revenue is
recorded by the physician groups at established rates reduced by
provisions for doubtful accounts and contractual adjustments. Contractual
adjustments arise due to the terms of certain reimbursement and managed
care contracts. Such adjustments represent the difference between charges
at established rates and estimated recoverable amounts and are recognized
in the period the services are rendered. Any differences between
estimated contractual adjustments and actual final settlements under
reimbursement contracts are recognized as contractual adjustments in the
year final settlements are determined. The physician groups, rather than
the Company, enter into managed care contracts. Through calculation of
its service fees, the Company shares indirectly in any capitation risk
assumed by its affiliated physician groups.
IPA management revenue is equal to the difference between the amount of
capitation and risk pool payments due to the IPAs managed by the
Company, less amounts retained by the IPA. The Company is not a party to
the capitated contracts entered into by the IPAs but it is exposed to
losses to the extent of its share of deficits, if any, of the capitated
revenue of the IPAs.
(Continued)
43
<PAGE> 44
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following represent amounts included in the determination of net
revenue (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
---------- --------- ---------
<S> <C> <C> <C>
Gross physician group revenue $2,849,646 1,928,045 1,069,033
Less:
Provisions for doubtful accounts
and contractual adjustments 1,090,329 699,186 359,653
---------- --------- ---------
Net physician group revenue 1,759,317 1,228,859 709,380
IPA revenue 411,912 255,181 146,975
---------- --------- ---------
Net physician group and IPA revenue 2,171,229 1,484,040 856,355
Less amounts retained by physician groups and IPAs:
Physician groups 634,983 459,179 266,725
Clinic technical employee compensation 74,715 50,395 29,435
IPAs 341,937 208,141 118,599
---------- --------- ---------
Net revenue $1,119,594 766,325 441,596
========== ========= =========
</TABLE>
The Company derives most of its net revenue from 55 physician groups located in
28 states with which it has service agreements at December 31, 1997. The
Company's affiliated physician groups derived approximately 20% of their net
revenues from services provided under the Medicare program for the years ended
December 31, 1997, 1996 and 1995. Other than the Medicare program, the physician
groups have no customers which represent more than 10% of aggregate net clinic
revenue or 5% of accounts receivables at December 31, 1997 and 1996.
(Continued)
44
<PAGE> 45
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(3) ACQUISITIONS
(A) MULTI-SPECIALTY MEDICAL CLINICS
During 1997, 1996, and 1995, the Company, through wholly-owned
subsidiaries, acquired certain operating assets of the following
clinics:
<TABLE>
<CAPTION>
CLINIC EFFECTIVE DATE LOCATION
------ ----------- ---------
<S> <C> <C>
1997:
Vancouver Clinic January 1, 1997 Vancouver, Washington
First Physicians Medical Group February 1, 1997 Palm Springs, California
St. Petersburg-Suncoast
Medical Group February 28, 1997 St. Petersburg, Florida
Greater Chesapeake Medical Group May 1, 1997 Annapolis, Maryland
Welborn Clinic June 1, 1997 Evansville, Indiana
White-Wilson Medical Center July 1, 1997 Ft. Walton Beach, Florida
Maui Medical Group September 1, 1997 Maui, Hawaii
Murfreesboro Medical Clinic October 1, 1997 Murfreesboro, Tennessee
West Florida Medical Center Clinic October 1, 1997 Pensacola, Florida
Northern California Medical
Association December 1, 1997 Santa Rosa, California
Lakeview Medical Center(A) December 1, 1997 Suffolk, Virginia
1996:
Arizona Physicians Center January 1, 1996 Phoenix, Arizona
Clinics of North Texas March 1, 1996 Wichita Falls, Texas
Carolina Primary Care May 1, 1996 Columbia, South Carolina
Harbin Clinic May 1, 1996 Rome, Georgia
Focus Health Services July 1, 1996 Denver, Colorado
Clark-Holder Clinic July 1, 1996 LaGrange, Georgia
Medical Arts Clinic August 1, 1996 Minot, North Dakota
Wilmington Health Associates August 1, 1996 Wilmington, North Carolina
Gulf Coast Medical Group August 1, 1996 Galveston, Texas
Hattiesburg Clinic October 1, 1996 Hattiesburg, Mississippi
Straub Clinic & Hospital (B) October 1, 1996 Honolulu, Hawaii
Toledo Clinic November 1, 1996 Toledo, Ohio
Lewis-Gale Clinic November 1, 1996 Roanoke, Virginia
</TABLE>
(Continued)
45
<PAGE> 46
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
<S> <C> <C>
1995:
Tidewater Physicians Multi-specialty
Group January 1, 1995 Newport News, Virginia
Northeast Arkansas Clinic March 1, 1995 Jonesboro, Arkansas
PAPP Clinic May 1, 1995 Newnan, Georgia
Ogden Clinic June 1, 1995 Ogden, Utah
Arnett Clinic August 1, 1995 Lafayette, Indiana
Casa Blanca Clinic September 1, 1995 Mesa, Arizona
South Texas Medical Clinics November 1, 1995 Wharton, Texas
South Bend Clinic (C) November 1, 1995 South Bend, Indiana
Guthrie Clinic (D) November 17, 1995 Sayre, Pennsylvania
</TABLE>
(A) Lakeview Medical Center was operated under a management agreement
during December 1997. Effective January 1, 1998, the Company completed
the purchase of certain clinic operating assets and entered into a
long-term service agreement with the affiliated physician group.
(B) Straub Clinic & Hospital (Straub) was operated under an administrative
service agreement effective October 1, 1996. The Company completed its
merger and entered into a long-term service agreement with Straub
effective January 17, 1997.
(C) The South Bend Clinic was operated by the Company under a management
agreement between November 1, 1995 and December 31, 1995. Effective
January 1, 1996 the Company completed the purchase of certain clinic
operating assets and entered into a long-term service agreement with
the affiliated physician group.
(D) The Company has entered into a series of agreements with Guthrie Clinic
whereby the Company agreed to provide management services for up to
five years and agreed, pending satisfaction of certain conditions, to
acquire certain assets of the clinic prior to the termination or
expiration of the interim management agreement.
In addition, the Company acquired certain operating assets of various
individual physician practices and single specialty groups which were
merged into clinics already operated by the Company.
The Company acquires operating assets and liabilities in exchange for cash,
convertible debentures, common stock or a combination thereof. Such
consideration for the above clinic acquisitions and single specialty mergers was
$430,757,000 for 1997, $357,458,000 for 1996, and $239,620,000 for 1995. The
acquisitions were accounted for as purchases, and the accompanying consolidated
financial statements include the results of their operations from the dates of
acquisition. Simultaneous with each acquisition, the Company entered into a
long-term service agreement with each physician group. In conjunction with
certain acquisitions, the Company is obligated at December 31, 1997 to make
deferred payments to physician groups of which $100,988,000 are due on demand or
within one year and $18,366,000, $4,300,000, and $879,000 are due in 1999, 2000,
and 2001, respectively. Such payments are included in purchase price payable in
the accompanying consolidated balance sheets.
(Continued)
46
<PAGE> 47
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(B) NORTH AMERICAN MEDICAL MANAGEMENT, INC. (NORTH AMERICAN)
Effective January 1, 1995, the Company completed its acquisition of
North American, an operator and manager of IPAs. The Company made
additional payments for the North American acquisition pursuant to
an earn-out formula during 1996 and 1997 totaling $35,000,000. A
final payment of $35,000,000, of which $14,000,000 is included in
current purchase price payable, will be made pursuant to the
earn-out formula during the first quarter of 1998. Of the final
payment to be made, a portion may be paid in shares of the
Company's common stock.
(4) PROPERTY AND EQUIPMENT
Property and equipment at December 31, are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Land and improvements $ 6,018 3,326
Buildings and leasehold improvements 70,558 50,154
Equipment 211,959 142,745
Equipment under capital leases 20,080 9,571
Construction in progress 13,318 10,470
-------- -------
321,933 216,266
Less accumulated depreciation and amortization 86,248 56,038
-------- -------
Property and equipment, net $235,685 160,228
======== =======
</TABLE>
(5) INVESTMENT IN PHYCOR MANAGEMENT CORPORATION (PMC)
In June 1995, the Company purchased a minority interest of approximately
9% in PMC and manages PMC pursuant to a 10-year administrative services
agreement. PMC develops and manages IPA's and provides other services to
physician organizations. PhyCor will exercise its option to purchase the
remaining equity interest of PMC on March 31, 1998. In accordance with
the terms of the option, the aggregate purchase price for these shares
will be approximately $23,000,000 and paid in shares of the Company's
common stock. In connection with the PMC transaction, the Company
established a revolving line of credit of $2,000,000 for PMC for a period
of five years of which $1,550,000 was outstanding as of December 31, 1997
and none was outstanding at December 31, 1996.
47
<PAGE> 48
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(6) INTANGIBLE ASSETS
Intangible assets at December 31, consist of the following (in
thousands):
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Clinic service agreements $777,972 533,014
Excess of cost of acquired assets over fair value 71,524 44,511
Franchise rights 2,717 2,710
Loan issuance costs 7,552 7,230
-------- -------
859,765 587,465
Less accumulated amortization 52,039 27,760
-------- -------
Intangible assets, net $807,726 559,705
======== =======
</TABLE>
Recognition of impairment of clinic service agreement assets in 1997 totaled
$49,041,000. See additional discussion in footnote 13, "Non-recurring
Charge."
(7) FAIR VALUE OF FINANCIAL INSTRUMENTS
As of December 31, 1997 and 1996, the fair value of the Company's cash
and cash equivalents, accounts receivable, accounts payable, due to
physician groups, and accrued expenses approximated their carrying value
because of the short maturities of those financial instruments. The fair
value of the Company's long-term debt also approximates its carrying
value since the related notes bear interest at current market rates.
The estimated fair value of the convertible subordinated notes payable to
physician groups was approximately $65,218,000 and $102,723,000 as of
December 31, 1997 and 1996, respectively. The carrying value of these
notes was approximately $61,576,000 and $83,918,000 at December 31, 1997
and 1996, respectively. The estimated fair value of these convertible
securities is based on the greater of their face value and the closing
market value of the common shares into which they could have been
converted at the respective balance sheet date. The estimated fair value
of the Company's convertible subordinated debentures was $195,000,000 and
$198,000,000 as of December 31, 1997 and 1996, respectively, compared to
a carrying value of $200,000,000. The estimated fair value of these
convertible debentures is based on current market indicators or quotes
from brokers.
(8) CONVERTIBLE SUBORDINATED NOTES PAYABLE TO PHYSICIAN GROUPS
At December 31, 1997 and 1996, the Company had outstanding subordinated
convertible notes payable to affiliated physician groups in the aggregate
principal amount of approximately $61,576,000 and $83,918,000,
respectively. These notes bear interest at rates of 5.84% to 7.0% and are
convertible into shares of the Company's common stock at conversion
prices ranging from $9.59 to $57.78 per share. A convertible subordinated
note of $33,295,000 issued in connection with the Guthrie Clinic
transaction will be convertible into approximately 903,000 shares of
common stock upon the Company's acquisition of the clinic's assets prior
to November 17, 2005. If the then current price of the common stock is
less than the conversion price, PhyCor will pay the clinic the principal
amount of the note. The remaining convertible notes may be converted into
approximately 1,263,000 shares of common stock, with 648,000 shares
convertible at December 31, 1997 and 615,000 shares convertible
commencing on varying dates in 1998 through 2002 at the option of the
holders.
(Continued)
48
<PAGE> 49
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(9) CONVERTIBLE SUBORDINATED DEBENTURES
At December 31, 1994, the Company had $28,655,000 of convertible
subordinated debentures outstanding. The debentures had a coupon rate of
6.5% and were convertible into the Company's common stock at $5.87 per
share. The Company called for redemption effective January 20, 1995, all
outstanding debentures at a redemption price of 105.2% of par value plus
accrued interest. In January 1995, prior to the redemption date, the
debentures were converted into common stock of the Company.
During February 1996, the Company completed a public offering of
convertible subordinated debentures, which mature in 2003. Gross and net
proceeds from the offering were $200,000,000 and approximately
$194,395,000, respectively. The debentures were priced at par with a
coupon rate of 4.5% and are convertible into the Company's common stock
at $38.67 per share. The debentures may not be redeemed at the Company's
option prior to February 15, 1998. From February 15, 1998 to February 15,
1999, the bonds may be redeemed only if the price of the Company's common
stock exceeds $54.13. From February 15, 1999 to maturity, the bonds may
be redeemed at prices decreasing from 102.572% of face value to face
value.
(10) LONG-TERM DEBT
Long-term debt at December 31, consists of the following (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Bank credit facility, bearing interest at a weighted average
rate of 6.75% at December 31, 1997 $204,000 119,000
Mortgages payable, bearing interest at rates ranging from
8.00% to 10.5%, secured by land, building, and
certain equipment 3,704 3,899
Other notes payable 4,333 637
-------- -------
Total long-term debt 212,037 123,536
Less current installments 1,144 424
-------- -------
Long-term debt, excluding current installments $210,893 123,112
======== =======
</TABLE>
In July 1997, the Company completed modifications to its bank credit
facility (Bank Credit Facility), which included the revision of certain
terms and conditions and the addition of seven participating financial
institutions. The revised Bank Credit Facility provides for a five-year,
$250,000,000 revolving line of credit and a $150,000,000 364-day facility
for use by the Company prior to July 2002, for acquisitions, working
capital, capital expenditures and general corporate purposes. The total
drawn cost of borrowings under the Bank Credit Facility ranges from .375%
to .75% above the applicable eurodollar rate or the agent's base rate
plus .10% to .225% per annum. In 1997, the Company entered into an
interest rate swap agreement to reduce the exposure to fluctuating
interest rates with respect to $100,000,000 of its bank credit facility
which has been fixed at the rate of 5.85% relative to the three month
floating LIBOR. The interest rate swap agreement matures in October 2002,
with a lender's option to terminate beginning October 1999.
(Continued)
49
<PAGE> 50
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The Bank Credit Facility contains covenants which, among other things, require
the Company to maintain certain financial ratios and impose certain limitations
or prohibitions on the Company with respect to (i) the incurrence of certain
indebtedness, (ii) the creation of security interest on the assets of the
Company, and (iii) the payment of cash dividends on, and the redemption or
repurchase of, securities of the Company, (iv) investments and (v) acquisitions.
The Company is required to obtain bank consent for acquisitions with an
aggregate purchase price of $75.0 million or more. The Company was in compliance
with such covenants at December 31, 1997.
The aggregate maturities of long-term debt at December 31, 1997, are as follows
(in thousands):
<TABLE>
<CAPTION>
<S> <C>
1998 $ 1,144
1999 969
2000 880
2001 752
2002 204,774
Thereafter 3,518
--------
$212,037
========
</TABLE>
(11) LEASES
The Company has entered into operating leases of commercial property and
clinic equipment with affiliated physician groups and third parties.
Commercial properties under operating leases include clinic buildings,
satellite operations, and administrative facilities. Capital leases
relating to clinic equipment expire at various dates during the next five
years.
The future minimum lease payments under noncancelable operating leases
and the present value of future minimum capital lease payments at
December 31, 1997, are as follows (in thousands):
<TABLE>
<CAPTION>
NET
CAPITAL OPERATING
LEASES LEASES
------- -------
<S> <C> <C>
1998 $ 4,134 2,932
1999 2,902 2,577
2000 2,208 1,721
2001 723 1,375
2002 138 1,325
Thereafter 14 1,094
------- ------
Total minimum lease payments $10,119 11,024
======
Less amount representing interest (at rates ranging from 10% to 13%) 1,462
-------
Present value of net minimum capital lease payments 8,657
Less current installments of obligations under capital leases 3,564
-------
Obligations under capital leases, excluding current installments $ 5,093
=======
</TABLE>
(Continued)
50
<PAGE> 51
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At December 31, 1997 and 1996, equipment with a cost of approximately
$20,080,000 and $9,571,000, and accumulated depreciation of approximately
$8,215,000 and $6,054,000, respectively, was held under capital leases.
Net payments under operating leases include total commitments of $801,769,000
reduced by amounts to be reimbursed under clinic service agreements of
$790,745,000. Payments due under operating leases include $434,479,000 payable
to physician groups and their affiliates. In the event of a service agreement
termination, any related lease obligations are also terminated.
(12) SHAREHOLDERS' EQUITY
(A) COMMON STOCK
On June 23, 1995, the Company completed a public offering of
6,955,000 shares of its common stock. Net proceeds from the
offering were approximately $110.9 million. In the first quarter
of 1997, the Company completed an additional public offering of
7,295,000 shares of its common stock. Net proceeds from the
offering were approximately $210.0 million.
On August 18, 1995, the Company declared a three-for-two stock
split to shareholders of record on September 1, 1995. Another
three-for-two stock split was declared on May 17, 1996 to
shareholders of record on May 31, 1996. All common share and per
share data included in the accompanying consolidated financial
statements and footnotes thereto have been restated to reflect
these stock splits.
(B) PREFERRED STOCK
The Company has 10,000,000 shares of authorized but unissued
preferred stock. The Company has reserved for issuance 500,000
shares of Series A Junior Participating Preferred Stock issuable
in the event of certain change-in-control events.
51
<PAGE> 52
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(C) WARRANTS
In June 1995, the Company issued warrants for the purchase of
348,001 shares of common stock in connection with the PMC
offering, which consisted of the warrants and shares of PMC's
Class B common stock. The exercise price of the warrants is
$15.40. The warrants are exercisable at any time prior to May
2005. In connection with certain clinic transactions, the Company
has issued warrants for the purchase of a total of 546,010 shares
of common stock. The following represents a summary of warrants
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
EXERCISABLE AT
GRANT EXPIRATION NUMBER EXERCISE DECEMBER 31,
DATE DATE OF SHARES PRICE 1997
----- ----- -------- ----- ------
<S> <C> <C> <C> <C>
February 1992 2002 7,188 $ 4.74 7,188
June 1995 2005 348,001 15.40 348,001
November 1995 2003 387,967 25.78 --
April 1996 2002 50,208 29.87 --
July 1996 2002 67,835 44.23 --
February 1997 2007 250,000 31.13 --
May 1997 2007 250,000 27.75 --
August 1997 2002 40,000 33.16 --
-------- --------
1,401,199 355,189
======== ========
</TABLE>
(D) 1988 STOCK INCENTIVE PLAN AND DIRECTORS' STOCK PLAN
The Company has two stock option plans. Under the Amended 1988
Incentive Stock Plan ("Incentive Plan"), the Company has reserved
17,000,000 shares of its common stock for issuance pursuant to
option and stock grants to employees and directors. Under the
Amended 1992 Directors Stock Plan ("Directors Plan"), 337,500
shares of common stock are reserved. Under both plans, stock
options are granted with an exercise price equal to the estimated
fair market value of the Company's common stock on the date of
grant. All options have a term of ten years and become exercisable
in installments over periods ranging up to five years. In addition
to options granted under the two plans, the Company has granted
options for the purchase of 25,313 shares of its common stock to a
director of the Company and a consultant.
At December 31, 1997, there were approximately 2,758,000 and
134,000 additional shares available for grant under the Incentive
Plan and the Directors Plan, respectively.
The per share weighted-average fair value of stock options granted
during 1997, 1996 and 1995 was $15.18, $16.97, and $9.25 on the
date of grant using the Black Scholes option-pricing model with
the following assumptions: an expected dividend yield of 0.0% for
all years, expected volatility of 56% in 1997 and 1996, and 43% in
1995, risk-free interest rate ranging from 5.88% to 6.63% in 1997,
5.25% to 6.63% in 1996 and 5.50% to 7.75% in 1995, and an expected
life of five years for all years.
(Continued)
52
<PAGE> 53
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The Company applies APB Opinion No. 25 in accounting for its Plans and,
accordingly, no compensation cost has been recognized for its stock options in
the financial statements. Had the Company determined compensation cost based on
the fair value at the grant date for its stock options under SFAS No. 123, the
Company's net income would have been reduced to the pro forma amounts indicated
below (in thousands except for earnings per share):
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C> <C>
Net income (loss) As reported $ 3,209 36,380 21,874
Pro forma (13,806) 30,133 20,673
Basic earnings (loss) per share As reported $ .05 .67 .45
Pro forma (.22) .55 .42
Diluted earnings (loss) per share As reported $ .05 .60 .41
Pro forma (.22) .49 .39
</TABLE>
Pro forma net income reflects only options granted beginning in 1995. Therefore,
the full impact of calculating compensation cost for stock options under SFAS
No. 123 is not reflected in the pro forma net income amounts presented above
because compensation cost is reflected over the options' vesting period and
compensation cost for options granted prior to January 1, 1995 is not
considered.
Stock option activity during the periods indicated is as follows (shares in
thousands):
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
------ ----------------
<S> <C> <C>
Balance at December 31, 1994 4,870 $ 7.13
Granted 2,924 19.81
Exercised (113) 4.27
Forfeited (127) 9.36
------
Balance at December 31, 1995 7,554 11.93
Granted 3,164 30.55
Exercised (297) 5.25
Forfeited (134) 19.49
------
Balance at December 31, 1996 10,287 17.84
Granted 3,542 27.81
Exercised (544) 6.14
Forfeited (302) 22.91
------ ------
Balance at December 31, 1997 12,983 $20.99
====== ======
</TABLE>
(Continued)
53
<PAGE> 54
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At December 31, 1997, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $2.97 - $38.33 and 8.16
years, respectively.
At December 31, 1997, 1996, and 1995, the number of options exercisable was
2,268,000, 1,392,000, and 854,000, respectively, and the weighted-average
exercise price of those options was $7.02, $5.23, and $4.15, respectively.
(E) STOCK PURCHASE PLANS
The Company has reserved 843,750 common shares for issuance pursuant to its
employee stock purchase plan. During 1997 and 1996, approximately 82,000 and
110,000 shares were issued relative to the plan. Shares issued under the
employee stock purchase plan will generally be priced at the lower of 85% of the
fair market value of the Company's common stock on the first or the last trading
days of the plan year.
The Company also established the 1996 Affiliate Stock Purchase Plan and has
reserved 2,250,000 common shares for this plan. Eligible participants generally
include physicians and other employees of medical clinics with which the Company
has a management or service agreement and employees of limited liability
companies and partnerships in which the Company has an equity interest of at
least 50%. Shares issued under the plan will be priced using a similar method as
that of the employee stock purchase plan. During 1997, approximately 343,000
shares were issued under this plan and no shares were issued in 1996.
Pro forma compensation expense included in the pro forma calculation above is
recognized for the fair value of each stock purchase right estimated on the date
of grant using the Black Scholes pricing model. The following assumptions were
used for stock purchases: an expected dividend yield of 0.0% for all years,
expected volatility of 56% in 1997 and 1996, risk-free interest rate of 6.0% in
1997 and 6.25% in 1996 and an expected life of one year for all years.
(Continued)
54
<PAGE> 55
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(F) RECONCILIATION OF EARNINGS PER SHARE CALCULATION
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for net earnings:
<TABLE>
<CAPTION>
INCOME SHARES PER
(NUMERATOR) (DENOMINATOR) SHARE
----------- ------------- -----
<S> <C> <C> <C>
FOR THE YEAR ENDED DECEMBER 31, 1997
- ------------------------------------
BASIC EPS
Income available to common shareholders $ 3,209 62,899 .05
===
EFFECT OF DILUTIVE SECURITIES
Options -- 2,353
Warrants -- 225
Convertible Notes -- 1,457
------- ------
DILUTED EPS
Income available to common shareholders $ 3,209 66,934 .05
======= ====== ===
FOR THE YEAR ENDED DECEMBER 31, 1996
BASIC EPS
Income available to common shareholders $36,380 54,608 .67
===
EFFECT OF DILUTIVE SECURITIES
Options -- 4,520
Warrants -- 290
Convertible Notes -- 1,678
------- ------
DILUTED EPS
Income available to common shareholders $36,380 61,096 .60
======= ====== ===
FOR THE YEAR ENDED DECEMBER 31, 1995
BASIC EPS
Income available to common shareholders $21,874 48,817 .45
===
EFFECT OF DILUTIVE SECURITIES
Options -- 2,937
Warrants -- 87
Convertible Notes -- 1,669
Convertible Debentures 49 152
------- ------
DILUTED EPS
Income available to common shareholders $21,923 53,662 .41
======= ====== ===
</TABLE>
(Continued)
55
<PAGE> 56
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Options and warrants to purchase 162,000 and 18,000 shares of common stock were
outstanding during 1997 and 1996, respectively, but were not included in the
computation of diluted EPS because the options' exercise price was greater than
the average market price of the common shares, resulting in the options being
antidilutive. Interest paid on the convertible notes is offset by service
agreement fees received by the Company of an equal amount.
(13) NON-RECURRING CHARGE
The following table sets forth the components of the non-recurring charge (in
thousands):
<TABLE>
<S> <C>
Writedown of assets to be disposed of to fair value less costs to sell $29,220
Recognition of impairment of assets acquired and related
service agreement intangibles 54,225
-------
$83,445
</TABLE>
The Company determined to dispose of certain clinics in the fourth quarter of
1997 due to circumstances arising in that quarter that indicated to the Company
that those clinics could not be operated at an acceptable profit level. The
Company expects to dispose of the assets and service agreements related to such
clinics in 1998. Clinic net assets to be disposed composed of current assets,
property and equipment, intangibles and other assets totaling $3,237,000 have
been included in prepaid expense and other current assets. Net losses from the
clinics to be disposed of totaled $666,000 in 1997.
In addition, the Company reviewed certain of its clinics, consistent with SFAS
121, when specific events occurred in the fourth quarter that indicated that the
individual clinics involved could be impaired (i.e. physician group declared
bankruptcy, notifications of physician termination, etc.). The Company
determined that an impairment had occurred and wrote down the associated clinic
assets and service agreement intangibles to fair value determined by discounting
future operating cash flows of the related physician groups.
(14) INCOME TAX EXPENSE
Income tax expense for the years ended December 31, 1997, 1996, and 1995,
consists of (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------ ------
<S> <C> <C> <C>
Current:
Federal $ 12,724 10,935 9,476
State 3,051 2,224 1,499
Deferred:
Federal (10,391) 9,354 2,564
State 714 262 384
-------- ------ ------
$ 6,098 22,775 13,923
======== ====== ======
</TABLE>
(Continued)
56
<PAGE> 57
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For federal income tax purposes, the Company receives a deduction arising from
the exercise of non-qualified stock options equal to the difference between the
fair market value at date of exercise and the exercise price. This tax benefit
was recorded as a credit to common stock in the amount of $5,464,000,
$2,940,000, and $625,000 in 1997, 1996, and 1995, respectively.
Total income tax expense differed from the amount computed by applying the U.S.
federal income tax rate of 35 percent in 1997, 1996, and 1995 to earnings before
income taxes as a result of the following (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- ------
<S> <C> <C> <C>
Computed "expected" tax expense $ 3,257 20,704 12,529
Increase (reduction) in income taxes resulting from:
State income taxes, net of federal income tax benefit 2,447 1,616 1,224
Increase in deferred tax rate -- -- 160
Amortization of nondeductible goodwill 791 499 --
Other (397) (44) 10
------- ------- ------
Total income tax expense $ 6,098 22,775 13,923
======= ======= ======
</TABLE>
The tax effects of temporary differences that give rise to significant portions
of the deferred tax asset and deferred tax liability at December 31 are
presented below (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Deferred tax assets:
Reserves for incurred but not reported self-insurance claims $ 9,289 3,013
Operating loss carryforwards 9,668 4,921
Cash to accrual adjustment 14,883 --
Other 2,406 1,427
-------- -------
Total gross deferred tax asset 36,246 9,361
Less valuation allowance (12,315) (3,441)
-------- -------
Net deferred tax asset $ 23,931 5,920
-------- -------
Deferred tax liability:
Plant and equipment, principally due to differences in depreciation $ 10,398 6,968
Capital leases 3,672 2,347
Clinic service agreements 24,971 10,265
Prepaid expenses 2,033 1,726
Income from partnerships 4,889 1,506
Accounts receivable 3,811 --
Other 1,397 382
-------- -------
Total gross deferred tax liability 51,171 23,194
-------- -------
Net deferred tax liability $ 27,240 17,274
======== =======
</TABLE>
(Continued)
57
<PAGE> 58
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The significant components of the deferred tax expense as of December
31, 1997 and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- -----
<S> <C> <C>
Change in net deferred tax liability $ 9,966 9,616
Deferred taxes of acquired entities (19,643) --
-------- -----
Deferred tax (benefit) expense $ (9,677) 9,616
======== =====
</TABLE>
The net change in the total valuation allowance for the year ended
December 31, 1997, which primarily relates to federal and state net
operating loss carryforwards and expenses relating to the nonrecurring
charge not expected to be deductible for state tax purposes, was an
increase of $8,874,000. Included in curret tax expense is a benefit of
$725,000 for deductible expenses associated with the non-recurring
charge. Additionally, $28.5 million related to the non-recurring charge
was recognized as a deferred tax asset as it is more likely than not to
be realized in future periods. As of December 31, 1997, the Company had
approximately $6,950,000 of federal and $118,034,000 of state net
operating loss carryforwards which begin to expire in 2007. The
utilization of these carryforwards is subject to the future level of
taxable income of the applicable subsidiaries.
The Company has been the subject of an audit by the IRS since 1991, and
the IRS has proposed adjustments relating to the timing of recognition
for tax purposes of certain revenue and deductions relating to
uncollectable accounts. PhyCor disagrees with the positions asserted by
the IRS and is vigorously contesting these proposed adjustments. The
Company believes that any adjustments resulting from resolution of this
disagreement would not affect reported net earnings of PhyCor but would
defer tax benefits and change the levels of current and deferred tax
assets and liabilities.
(15) EMPLOYEE BENEFIT PLANS
As of January 1, 1989, the Company adopted the PhyCor, Inc. Savings and
Profit Sharing Plan. The Plan is a defined contribution plan covering
substantially all employees. Company contributions are based on specified
percentages of employee compensation. The Company funds contributions as
accrued. The contributions for 1997, 1996, and 1995 amounted to
$10,245,000, $7,803,000, and $3,976,000, respectively.
In connection with certain of the Company's acquisitions, the Company
adopted employee retirement plans previously sponsored solely by the
physician groups. The Company has recognized as expense its required
contributions to be made to the plans of approximately $4,789,000,
$3,174,000, and $1,248,000 relative to its employees for 1997, 1996, and
1995, respectively.
(Continued)
58
<PAGE> 59
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(16) COMMITMENTS AND CONTINGENCIES
(A) EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with certain of
its management employees, which include, among other terms,
noncompete provisions and salary and benefits continuation.
(B) COMMITMENTS TO PHYSICIAN GROUPS
Under terms of certain of its service agreements, the Company is
committed to provide capital for the improvement and expansion of
clinic facilities. The commitments vary depending on such factors
as total capital expenditures, the number of physicians practicing
at each clinic, and the cost of specific planned projects. All
projects funded under these commitments must be approved by the
Company before they commence.
The Company is also committed to provide, under certain
circumstances, advances to physician groups to principally finance
the recruitment of new physicians. These advances will be repaid
out of the physician groups' share of future clinic revenue. At
December 31, 1997 and 1996, $4,038,000, and $2,230,000,
respectively, of such advances were outstanding.
(C) LITIGATION
The Company is subject to various claims and legal actions which
arise in the ordinary course of business, certain of which could
be material. In the opinion of management, the ultimate resolution
of such matters will be adequately covered by the insurance and
will not have a material adverse effect on the Company's financial
position, results of operations or liquidity.
(D) INSURANCE
The Company and its affiliated physician groups are insured with
respect to medical malpractice risks on a claims-made basis. There
are known claims and incidents that may result in the assertion of
additional claims, as well as claims from unknown incidents that
may be asserted. Management is not aware of any claims against it
or its affiliated physician groups which might have a material
impact on the Company's financial position.
(E) CONTINGENT CONSIDERATION
In connection with the acquisition of clinic operating assets, the
Company is contingently obligated to pay an estimated additional
$83,000,000 in future years, depending on the achievement of
certain financial and operational objectives by the related
physician groups. Such liability, if any, will be recorded in the
period in which the outcome of the contingency becomes known. Any
payment made will be allocated among the assets acquired and will
not immediately be charged to expense.
(17) SUBSEQUENT EVENT (UNAUDITED)
Effective April 1, 1998, the Company changed its policy with respect to
amortization of intangible assets. All existing and future intangible assets
will be amortized over a period not to exceed 25 years from the inception of the
respective intangible assets. Had the Company adopted this policy at the
beginning of 1997, net income would have been decreased by approximately $7.0
million and diluted earnings per share would have been decreased by
approximately $0.10.
59
<PAGE> 60
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
60
<PAGE> 61
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to the executive officers of the Company is
set forth in the Company's Definitive Proxy Statement relating to the Annual
Meeting of Shareholders to be held on May 21, 1998 under the caption "Executive
Compensation - Executive Officers of the Company" and is incorporated herein by
reference. Information with respect to the directors of the Company is set forth
in the Company's Definitive Proxy Statement relating to the Annual Meeting of
Shareholders to be held on May 21, 1998 under the caption "Election of
Directors" and is incorporated herein by reference. Information with respect to
compliance with Section 16(a) of the Securities Exchange Act of 1934 is set
forth in the Company's Definitive Proxy Statement relating to the Annual Meeting
of Shareholders to be held on May 21, 1998 under the caption "Compliance With
Reporting Requirements of the Exchange Act" and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is set forth in the
Company's Definitive Proxy Statement relating to the Annual Meeting of
Shareholders to be held on May 21, 1998 under the caption "Executive
Compensation" and is incorporated herein by reference, except that the
Comparative Performance Graph and the Compensation Committee Report on Executive
Compensation included in the Definitive Proxy Statement are expressly not
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to the security ownership of certain
beneficial owners and management is set forth in the Company's Definitive Proxy
Statement relating to the Annual Meeting of Shareholders to be held on May 21,
1998 under the caption "Voting Securities and Principal Holders Thereof" and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to certain relationships and related
transactions is set forth in the Company's Definitive Proxy Statement relating
to the Annual Meeting of Shareholders to be held on May 21, 1998 under the
caption "Certain Relationships and Related Transactions" and is incorporated
herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Index to Consolidated Financial Statements, Financial Statement Schedules
and Exhibits
(1) FINANCIAL STATEMENTS: See Item 8 herein.
61
<PAGE> 62
(2) FINANCIAL STATEMENT SCHEDULES:
Independent Auditors' Report...............................S-1
Schedule II - Valuation and Qualifying Accounts............S-2
All other schedules are omitted, because they are not applicable or not
required, or because the required information is included in the consolidated
financial statements or notes thereto.
62
<PAGE> 63
(3) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------
<S> <C> <C>
3.1 -- Amended Bylaws of the Registrant (1)
3.2 -- Restated Charter of the Registrant (1)
3.3 -- Amendment to Restated Charter of the Registrant (2)
3.4 -- Amendment to Restated Charter of the Registrant (3)
4.1 -- Form of 4.5% Convertible Subordinated Debenture due 2003 (4)
4.2 -- Form of Indenture by and between the Registrant and First
American National Bank, N.A. (4)
10.1 -- Form of Amended and Restated Employment Agreements dated
August 1, 1997 entered into by each of Messrs. Hutts, Reeves,
Dent and Wright (5)
10.2 -- Registrant's Amended 1988 Incentive Stock Plan (6)
10.3 -- Registrant's Amended 1992 Non-Qualified Stock Option Plan for
Non-Employee Directors (6)
10.4 -- Registrant's 1991 Amended Employee Stock Purchase Plan (7)
10.5 -- Registrant's Savings and Profit Sharing Plan (7)
10.6 -- $150,000,000 Amended and Restated Credit Agreement, dated as
of July 1, 1997, among the Registrant, the Banks named
therein and Citibank, N.A. (5)
10.7 -- $250,000,000 Amended and Restated Revolving Credit Agreement
dated as of July 1, 1997, among the Registrant, the Banks
named therein and Citibank, N.A. (5)
10.8 -- Amended and Restated Agreement of Merger, dated October 1,
1996, by and between the Registrant and Straub Clinic &
Hospital, Incorporated (8)
10.9 -- Service Agreement, dated as of January 17, 1997, by and between
PhyCor of Hawaii, Inc. and Straub Clinic & Hospital, Inc. (8)
10.10 -- Supplemental Executive Retirement Plan (5)
21 -- List of subsidiaries of the Registrant (5)
23 -- Consent of KPMG Peat Marwick LLP
27.1 -- Financial Data Schedule for fiscal year ended December 31,
1997(for SEC use only) (5)
27.2 -- Financial Data Schedule for fiscal year ended December 31,
1996(for SEC use only) (5)
</TABLE>
- ---------------
(1) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1994,
Commission No. 0-19786.
(2) Incorporated by referenced to exhibits filed with the Registrant's
Registration Statement on Form S-3, Commission No. 33-93018.
(3) Incorporated by referenced to exhibits filed with the Registrant's
Registration Statement on Form S-3, Commission No. 33-98528.
(4) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-3, Registration No. 333-328.
(5) Previously filed.
(6) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1993,
Commission No. 0-19786.
(7) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1991,
Commission No. 0-19786.
(8) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-4, Commission No. 333-15459.
63
<PAGE> 64
EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS
The following is a list of all executive compensation plans and
arrangements filed as exhibits to this Annual Report on Form 10-K:
(1) Form of Amended Employment Agreement, dated as of August 1, 1997,
between the Registrant and each of Messrs. Hutts, Reeves, Dent
and Wright (filed as Exhibit 10.1)
(2) Registrant's Amended 1988 Incentive Stock Plan (filed as Exhibit
10.2)
(3) Registrant's Amended 1992 Non-Qualified Stock Option Plan for
Non-Employee Directors (filed as Exhibit 10.3)
(4) Supplemental Executive Retirement Plan (filed as Exhibit 10.10)
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K dated October 31, 1997
announcing the execution of a definitive merger agreement with
MedPartners, Inc.
(c) Exhibits
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14(a)(3)
(d) Financial Statement Schedules
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14(a)(2).
64
<PAGE> 65
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of
Nashville, State of Tennessee, on May 14, 1998.
PHYCOR, INC.
By: /s/ Joseph C. Hutts
----------------------------------
Joseph C. Hutts
Chairman of the Board,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed by the following persons on behalf of the Registrant
and in the capacities and on the date indicated.
<TABLE>
<S> <C> <C>
/s/ Joseph C. Hutts Chairman of the Board, President May 14, 1998
- ----------------------------------- and Chief Executive Officer
Joseph C. Hutts (Principal Executive Officer)
and Director
/s/ Derril W. Reeves Executive Vice President, May 14, 1998
- ----------------------------------- Development and Director
Derril W. Reeves
/s/ John K. Crawford Vice President and Chief Financial May 14, 1998
- ----------------------------------- Officer (Principal Financial and
John K. Crawford Accounting Officer)
/s/ Thompson S. Dent Executive Vice President, May 14 1998
- ----------------------------------- Operations and Director
Thompson S. Dent
/s/ Richard D. Wright Executive Vice President, May 14, 1998
- ----------------------------------- Corporate Services and Director
Richard D. Wright
/s/ Ronald B. Ashworth Director May 14, 1998
- -----------------------------------
Ronald B. Ashworth
/s/ Sam A. Brooks, Jr. Director May 14, 1998
- -----------------------------------
Sam A. Brooks, Jr.
/s/ Winfield Dunn Director May 14, 1998
- -----------------------------------
Winfield Dunn
/s/ C. Sage Givens Director May 14, 1998
- -----------------------------------
C. Sage Givens
/s/ Joseph A. Hill, M.D. Director May 14, 1998
- -----------------------------------
Joseph A. Hill, M.D.
/s/ James A. Moncrief, M.D. Director May 14, 1998
- -----------------------------------
James A. Moncrief, M.D.
/s/ Kay Coles James Director May 14, 1998
- -----------------------------------
Kay Coles James
</TABLE>
65
<PAGE> 66
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
PhyCor, Inc.:
Under date of February 18, 1998, we reported on the consolidated balance sheets
of PhyCor, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the years in the three-year period ended December 31, 1997, as
contained in the 1997 annual report to shareholders. These consolidated
financial statements and our report thereon are incorporated by reference in the
annual report on Form 10-K for the year 1997. In connection with our audits of
the aforementioned consolidated financial statements, we also audited the
related consolidated financial statement schedule. The financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion on the financial statement schedule based on our
audits.
In our opinion, the financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly,
in all material respects, the information set forth therein.
/s/ KPMG PEAT MARWICK LLP
Nashville, Tennessee
February 18, 1998
S-1
<PAGE> 67
PHYCOR, INC. AND SUBSIDIARIES
Schedule II
Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
BALANCE ADDITIONS BALANCE
BEGINNING EXPENSE DEDUCTIONS OTHER (1) ENDING
--------- --------- ---------- --------- -------
<S> <C> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL
ACCOUNTS AND CONTRACTUAL
ADJUSTMENTS (IN THOUSANDS)
December 31, 1995 $ 68,860 359,652 (360,684) 14,377 82,205
======== ========= ========== ====== =======
December 31, 1996 $ 82,205 699,186 (688,276) 41,441 134,556
======== ========= ========== ====== =======
December 31, 1997 $134,556 1,090,329 (1,050,164) 33,813 208,534
======== ========= ========== ====== =======
</TABLE>
- ---------------
(1) Represents allowances of acquired clinics.
S-2
<PAGE> 68
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------
<S> <C> <C>
3.1 -- Amended Bylaws of the Registrant (1)
3.2 -- Restated Charter of the Registrant (1)
3.3 -- Amendment to Restated Charter of the Registrant (2)
3.4 -- Amendment to Restated Charter of the Registrant (3)
4.1 -- Form of 4.5% Convertible Subordinated Debenture due 2003 (4)
4.2 -- Form of Indenture by and between the Registrant and First
American National Bank, N.A. (4)
10.1 -- Form of Amended and Restated Employment Agreements dated
August 1, 1997 entered into by each of Messrs. Hutts, Reeves,
Dent and Wright (5)
10.2 -- Registrant's Amended 1988 Incentive Stock Plan (6)
10.3 -- Registrant's Amended 1992 Non-Qualified Stock Option Plan for
Non-Employee Directors (6)
10.4 -- Registrant's 1991 Amended Employee Stock Purchase Plan (7)
10.5 -- Registrant's Savings and Profit Sharing Plan (7)
10.6 -- $150,000,000 Amended and Restated Credit Agreement, dated as
of July 1, 1997, among the Registrant, the Banks named
therein and Citibank, N.A. (5)
10.7 -- $250,000,000 Amended and Restated Revolving Credit Agreement
dated as of July 1, 1997, among the Registrant, the Banks
named therein and Citibank, N.A. (5)
10.8 -- Amended and Restated Agreement of Merger, dated October 1,
1996, by and between the Registrant and Straub Clinic &
Hospital, Incorporated (8)
10.9 -- Service Agreement, dated as of January 17, 1997, by and between
PhyCor of Hawaii, Inc. and Straub Clinic & Hospital, Inc. (8)
10.10 -- Supplemental Executive Retirement Plan (5)
21 -- List of subsidiaries of the Registrant (5)
23 -- Consent of KPMG Peat Marwick LLP
27.1 -- Financial Data Schedule for fiscal year ended December 31,
1997(for SEC use only) (5)
27.2 -- Financial Data Schedule for fiscal year ended December 31,
1996(for SEC use only) (5)
</TABLE>
- ---------------
(1) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1994,
Commission No. 0-19786.
(2) Incorporated by referenced to exhibits filed with the Registrant's
Registration Statement on Form S-3, Commission No. 33-93018.
(3) Incorporated by referenced to exhibits filed with the Registrant's
Registration Statement on Form S-3, Commission No. 33-98528.
(4) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-3, Registration No. 333-328.
(5) Previously filed.
(6) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1993,
Commission No. 0-19786.
(7) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1991,
Commission No. 0-19786.
(8) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-4, Commission No. 333-15459.
<PAGE> 1
Exhibit 23
The Board of Directors and Shareholders
PhyCor, Inc.
We consent to incorporation by reference in the registration statements of
PhyCor, Inc. on Form S-3 (No. 33-98528), Form S-4 (Nos. 33-66210, 33-98530,
333-45017, and 333-45209) and Form S-8 (Nos. 33-65228 and 33-85726) of our
reports dated February 18, 1998, relating to the consolidated balance sheets of
PhyCor, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, shareholders' equity, and cash flows for
each of the years in the three-year period ended December 31, 1997, and all
related schedules, which reports appear in the December 31, 1997 annual report
on Form 10-K, as amended by the annual report on Form 10 K/A, of PhyCor, Inc.
/s/ KPMG Peat Marwick LLP
Nashville, Tennessee
May 14, 1998
