<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30,
1999.
[ ] 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 Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (615) 665-9066
----------------
NOT APPLICABLE
- --------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
As of November 12, 1999, 73,443,612 shares of the Registrant's Common
Stock were outstanding.
<PAGE> 2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 1999 (unaudited) and December 31, 1998
(All amounts are expressed in thousands)
<TABLE>
<CAPTION>
1999 1998
----------- -----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 85,963 $ 74,314
Accounts receivable, net 251,144 378,732
Inventories 11,879 19,852
Prepaid expenses and other current assets 52,490 55,988
Assets held for sale, net 156,133 41,225
----------- -----------
Total current assets 557,609 570,111
Property and equipment, net 159,982 241,824
Intangible assets, net 535,843 981,537
Other assets 43,117 53,067
----------- -----------
Total assets $ 1,296,551 $ 1,846,539
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt $ 2,879 $ 4,810
Current installments of obligations under capital leases 3,314 5,687
Bank credit facility debt to be amended (note 9) 270,000 --
Accounts payable 40,192 50,972
Due to physician groups 39,089 51,941
Purchase price payable 36,609 73,736
Salaries and benefits payable 29,337 37,077
Incurred but not reported claims payable 44,379 59,333
Other accrued expenses and current liabilities 101,236 98,701
----------- -----------
Total current liabilities 567,035 382,257
Long-term debt, excluding current installments 4,700 388,644
Obligations under capital leases, excluding current installments 1,989 6,018
Purchase price payable 8,898 8,967
Deferred tax credits and other liabilities 46,117 8,663
Convertible subordinated notes payable to physician groups 9,788 47,580
Convertible subordinated notes and debentures 297,063 200,000
----------- -----------
Total liabilities 935,590 1,042,129
----------- -----------
Shareholders' equity:
Preferred stock, no par value; 10,000 shares authorized: -- --
Common stock, no par value; 250,000 shares authorized; issued
and outstanding, 73,494 shares in 1999 and 75,824 shares in 1998 839,190 850,657
Accumulated deficit (478,229) (46,247)
----------- -----------
Total shareholders' equity 360,961 804,410
----------- -----------
Total liabilities and shareholders' equity $ 1,296,551 $ 1,846,539
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE> 3
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three months and nine months ended September 30, 1999
and 1998
(All amounts are expressed in thousands, except for earnings per share)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ----------------------------
1999 1998 1999 1998
--------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Net revenue $ 371,193 $ 408,487 $ 1,181,225 $ 1,102,632
Operating expenses:
Cost of provider services 48,548 52,669 155,160 78,693
Salaries, wages and benefits 122,288 133,616 382,303 381,307
Supplies 54,511 58,138 173,105 167,787
Purchased medical services 8,858 9,876 28,183 28,449
Other expenses 56,636 57,129 174,679 159,688
General corporate expenses 7,086 7,614 22,739 22,755
Rents and lease expense 29,150 33,215 92,455 94,928
Depreciation and amortization 23,634 24,453 72,522 65,463
Provision for asset revaluation and clinic restructuring 393,358 92,500 417,246 114,500
Merger expenses -- -- -- 14,196
--------- --------- ----------- -----------
Net operating expenses 744,069 469,210 1,518,392 1,127,766
--------- --------- ----------- -----------
Loss from operations (372,876) (60,723) (337,167) (25,134)
Other (income) expense:
Interest income (1,133) (791) (3,235) (2,283)
Interest expense 10,211 9,649 30,198 26,452
--------- --------- ----------- -----------
Loss before income taxes, minority
interest and extraordinary item (381,954) (69,581) (364,130) (49,303)
Income tax expense (benefit) 51,955 (22,176) 57,746 (16,438)
Minority interest in earnings of consolidated partnerships 2,801 3,438 11,123 10,163
--------- --------- ----------- -----------
Loss before extraordinary item (436,710) (50,843) (432,999) (43,028)
Extraordinary item - gain from extinguishment
of convertible subordinated debentures 1,018 -- 1,018 --
--------- --------- ----------- -----------
Net loss $(435,692) $ (50,843) $ (431,981) $ (43,028)
========= ========= =========== ===========
Loss per share:
Basic - Continuing operations $ (5.76) $ (0.66) $ (5.70) $ (0.61)
Extraordinary item 0.01 -- 0.01 --
--------- --------- ----------- -----------
(5.75) (0.66) (5.69) (0.61)
========= ========= =========== ===========
Diluted - Continuing operations (5.76) (0.66) (5.70) (0.61)
Extraordinary item 0.01 -- 0.01 --
--------- --------- ----------- -----------
(5.75) (0.66) (5.69) (0.61)
========= ========= =========== ===========
Weighted average number of shares and dilutive
share equivalents outstanding:
Basic 75,722 77,501 75,916 70,448
Diluted 75,722 77,501 75,916 70,448
========= ========= =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three months and nine months ended September 30, 1999
and 1998
(All amounts are expressed in thousands)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ----------------------
1999 1998 1999 1998
--------- -------- --------- ---------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss $(435,692) $(50,843) $(431,981) $ (43,028)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 23,634 24,453 72,522 65,463
Minority interests 2,801 3,438 11,123 10,163
Provision for asset revaluation and clinic restructuring 393,358 92,500 417,246 114,500
Accretion of convertible subordinated debentures 563 -- 563 --
Merger expenses -- -- -- 14,196
Increase (decrease) in cash, net of effects of acquisitions,
due to changes in:
Accounts receivable 9,246 11,100 14,224 (11,022)
Inventories (1,170) (433) (265)
Prepaid expenses and other current assets 1,116 (3,806) (16,462) (12,617)
Accounts payable (987) 1,581 7,244 (1,151)
Due to physician groups (8,876) (5,354) (5,827) (316)
Incurred but not reported claims payable (6,718) (1,535) (11,310) (1,290)
Other accrued expenses and current liabilities 57,412 (32,747) 49,259 (21,721)
--------- -------- --------- ---------
Net cash provided by operating activities 34,687 38,500 106,168 112,912
--------- -------- --------- ---------
Cash flows from investing activities:
Dispositions (acquisitions), net 38,428 (23,546) 2,928 (163,540)
Purchase of property and equipment (13,426) (13,315) (37,262) (51,285)
Payments to acquire other assets (3,993) (17,231) (8,946) (28,364)
--------- -------- --------- ---------
Net cash provided (used) by investing activities 21,009 (54,092) (43,280) (243,189)
--------- -------- --------- ---------
Cash flows from financing activities:
Net proceeds from issuance of convertible notes 94,496 -- 94,496 --
Net proceeds from issuance of common stock 343 1,172 1,613 17,632
Repurchase of common stock (9,027) (2,321) (9,027) (2,321)
Proceeds from long-term borrowings -- 6,000 -- 145,000
Repayment of long-term borrowings (125,338) (3,630) (121,368) (12,686)
Repayment of obligations under capital leases (1,332) (2,160) (5,145) (4,058)
Distributions of minority interests (3,391) (4,007) (11,019) (8,376)
Loan costs incurred (4) (32) (789) (308)
--------- -------- --------- ---------
Net cash provided (used) by financing activities (44,253) (4,978) (51,239) 134,883
--------- -------- --------- ---------
Net increase (decrease) in cash and cash equivalents 11,443 (20,570) 11,649 4,606
Cash and cash equivalents - beginning of period 74,520 63,336 74,314 38,160
--------- -------- --------- ---------
Cash and cash equivalents - end of period $ 85,963 $ 42,766 $ 85,963 $ 42,766
========= ======== ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Three months and nine months ended September 30, 1999 and 1998
(All amounts are expressed in thousands)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- --------------------
1999 1998 1999 1998
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
SUPPLEMENTAL SCHEDULE OF INVESTING ACTIVITIES:
Effects of acquisitions and dispositions, net:
Assets acquired (disposed), net of cash $ (7,885) $ 123,533 $ 25,703 $ 416,479
Liabilities paid (assumed), including
deferred purchase price payments 2,805 4,280 12,225 (37,450)
Cancellation (issuance) of convertible subordinated notes
payable 7,000 (7,000) 7,000 (8,317)
Cancellation (issuance) of common stock and warrants 3,716 (88,820) 4,076 (194,794)
Cash received from disposition of clinic assets (44,064) (8,447) (51,932) (12,378)
-------- --------- -------- ---------
Acquisitions (dispositions), net $(38,428) $ 23,546 $ (2,928) $ 163,540
======== ========= ======== =========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations incurred to acquire
equipment $ 11 $ 151 $ 125 $ 589
======== ========= ======== =========
Conversion of subordinated notes payable
to common stock $ -- $ -- $ 22 $ 2,000
======== ========= ======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Three months and nine months ended September 30, 1999 and 1998
(1) BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial reporting and in accordance with Rule 10-01 of Regulation S-X.
In the opinion of management, the unaudited interim financial statements
contained in this report reflect all adjustments, consisting of only
normal recurring accruals, that are necessary for a fair presentation of
the financial position and the results of operations for the interim
periods presented. The results of operations for any interim period are
not necessarily indicative of results for the full year.
These financial statements, footnote disclosures and other information
should be read in conjunction with the financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.
(2) ACQUISITION PRO FORMA INFORMATION
The unaudited consolidated pro forma net revenue, net loss and per share
amounts of the Company assuming the PrimeCare International, Inc.
(PrimeCare), The Morgan Health Group, Inc. (MHG), CareWise, Inc.
(CareWise) and First Physician Care, Inc. (FPC) acquisitions had been
consummated on January 1, 1998 are as follows (in thousands, except for
earnings per share):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
------------------ ------------------
<S> <C> <C>
Net revenue $ 411,293 $ 1,230,733
Net loss (51,047) (46,516)
Loss per share:
Basic (0.65) (0.61)
Diluted (0.65) (0.61)
</TABLE>
The consolidated statements of operations include the results of the
above businesses from the dates of their respective acquisitions.
(3) NET REVENUE
Net revenue of the Company is comprised of net clinic service agreement
revenue, IPA management revenue, net hospital revenue and other operating
revenues. Clinic service agreement revenue is equal to the net revenue of
the clinics less amounts retained by physician groups. Net clinic revenue
recorded by the physician groups is recorded at established rates reduced
by provisions for doubtful accounts and contractual adjustments.
Contractual adjustments arise as a result of 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. With the
exception of the Company's wholly owned subsidiary, PrimeCare, and
certain clinics acquired as a part of the FPC acquisition, 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.
(Continued)
6
<PAGE> 7
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
IPA management revenue is equal to the difference between the amount of
capitation and risk pool payments payable to the IPAs managed by the
Company less amounts retained by the IPAs. The Company has not
historically been a party to 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. Through the PrimeCare and MHG
acquisitions, the Company became a party to certain managed care
contracts. Accordingly, the cost of provider services for the PrimeCare
and MHG contracts is not included as a deduction to net revenue of the
Company but is reported as an operating expense. The Company commenced
closing its MHG operations effective April 30, 1999 (See Note 5.)
The following represent amounts included in the determination of net
revenue (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------------
1999 1998 1999 1998
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Gross physician group, hospital and other revenue $821,213 $885,078 $2,607,694 $2,605,716
Less:
Provisions for doubtful accounts
and contractual adjustments 359,429 358,471 1,120,656 1,048,365
-------- -------- ---------- ----------
Net physician group, hospital
and other revenue 461,784 526,607 1,487,038 1,557,351
IPA revenue 270,538 230,489 819,479 530,967
-------- -------- ---------- ----------
Net physician group,
hospital, IPA
and other revenue 732,322 757,096 2,306,517 2,088,318
Less amounts retained by physician
groups and IPAs:
Physician groups 155,554 174,198 511,870 537,261
Clinic technical employee compensation 21,137 24,127 66,582 70,922
IPAs 184,438 150,284 546,840 377,503
-------- -------- ---------- ----------
Net revenue $371,193 $408,487 $1,181,225 $1,102,632
======== ======== ========== ==========
</TABLE>
(4) BUSINESS SEGMENTS
The Company has two reportable segments based on the way management has
organized its operations: physician clinics and IPAs. The physician
clinics have been subdivided into multi-specialty and group formation
clinics for purposes of disclosure. The Company derives its revenues
primarily from operating multi-specialty medical clinics and managing
IPAs (See Note 3). In addition, the Company provides health care
decision-support services and operates two hospitals that do not meet the
quantitative thresholds for reportable segments and have therefore been
aggregated within the corporate and other category.
(Continued)
7
<PAGE> 8
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
The Company evaluates performance based on earnings from operations
before asset revaluation and clinic restructuring charges, merger
expenses, minority interest and income taxes. The following is a
financial summary by business segment for the periods indicated (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1999 1998 1999 1998
--------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Multi-specialty clinics:
Net revenue $ 261,228 $ 294,164 $ 834,597 $ 845,545
Operating expenses(1) 238,987 265,692 757,769 753,569
Interest income (455) (358) (1,139) (927)
Interest expense 18,319 19,072 56,754 54,433
Earnings before taxes and minority interest(1) 4,377 9,758 21,213 38,470
Depreciation and amortization 17,121 18,880 53,200 51,831
Segment Assets 811,912 1,406,489 811,912 1,406,489
Group formation clinics:
Net revenue 10,548 21,286 34,071 84,947
Operating expenses(1) 10,020 19,317 31,474 76,634
Interest (income) expense (252) (49) (673) 8
Interest expense 982 3,124 3,464 10,430
Loss before taxes and minority interest(1) 202 1,106 194 2,125
Depreciation and amortization 830 1,358 2,369 5,447
Segment Assets 49,267 88,176 49,267 88,176
IPAs:
Net revenue 86,100 80,205 272,639 153,464
Operating expenses(1) 80,719 72,039 248,212 129,587
Interest income (654) (588) (1,899) (1,217)
Interest expense 2,744 2,609 8,260 6,405
Earnings before taxes and minority interest(1) 3,291 6,145 18,066 18,689
Depreciation and amortization 3,429 2,348 10,427 5,209
Segment Assets 298,803 262,191 298,803 262,191
Corporate and other(2):
Net revenue 13,317 12,832 39,918 18,676
Operating expenses(1) 20,985 19,662 63,691 39,280
Interest (income) expense 228 204 476 (147)
Interest income (11,834) (15,156) (38,280) (44,816)
Earnings before taxes and minority interest(1) 3,938 8,122 14,031 24,359
Depreciation and amortization 2,254 1,867 6,526 2,976
Segment Assets 136,569 133,544 136,569 133,544
</TABLE>
----------------------------
(1) Amounts exclude provision for asset revaluation and clinic
restructuring and merger expenses.
(2) This segment includes all corporate costs and real estate
holdings as well as the results for CareWise and the hospitals
managed by the Company.
(Continued)
8
<PAGE> 9
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(5) ASSET REVALUATION AND CLINIC RESTRUCTURING
During 1999 and 1998, the Company sold clinic operating assets and
terminated the related service agreements with a number of clinics
affiliated with the Company. In the third quarter of 1999, the Company
determined that it was necessary to create more stability for the Company
by identifying those clinics which the Company believed were less likely
to sustain a relationship with the Company in this changed health care
environment and selling the corresponding assets. The Company intends to
maintain a core of clinics that it believes can prosper in the changed
health care environment. This decision to downsize is intended to allow
the Company to focus on strengthening the core clinic operations and to
position the Company to resume its growth. These steps will generate cash
for the Company and result in a smaller company with clinics that are
more stable, have the ability to grow and are committed to the mutual
success of the physician groups and the Company.
In the third quarter of 1999, the Company recorded pre-tax asset
revaluation and restructuring charges totaling approximately $393.4
million. The Company is reducing the number of continuing core clinics to
31, and as a result, recorded $198.7 million of asset revaluation and
restructuring charges related to 17 clinics the Company has classified as
assets held for sale. Three of the 17 clinics represent all of the
Company's remaining operations considered to be "group formation
clinics". Group formation clinics represented the Company's attempt to
create multi-specialty groups by combining the operations of several
small physician groups or individual physician practices. The remaining
14 clinics represent multi-specialty clinics that are being disposed
because of a variety of negative operating and market issues, including
those related to declining reimbursement for Medicare and commercial
patient services, market position and clinic demographics, physician
relations, physician turnover rates, declining physician incomes,
physician productivity, operating results and ongoing viability of the
existing medical group.
Net revenue and pre-tax income (losses) from operations disposed of as of
September 30, 1999 were $4.4 million and $300,000 for the three months
ended September 30, 1999, and $59.5 million and ($400,000) for the three
months ended September 30, 1998, respectively. Net revenue and pre-tax
income (losses) from operations disposed of as of September 30, 1999 were
$73.8 million and ($2.1 million) for the nine months ended September 30,
1999, and $171.4 million and $1.6 million for the nine months ended
September 30, 1998, respectively. Net revenue and pre-tax income (losses)
from the remaining operations held for sale were $92.1 million and ($1.5
million) for the three months ended September 30, 1999, and $95.0 million
and $4.3 million for the three months ended September 30, 1998,
respectively. For the nine months ended September 30, 1999, net revenue
and pre-tax income from the remaining operations held for sale were
$287.0 million and $2.2 million and $275.6 million and $15.2 million for
the nine months ended September 30, 1998, respectively.
At September 30, 1999, net assets currently expected to be sold during
the next 12 months totaled approximately $156.1 million after taking into
account the charges discussed above relating to clinics with which the
Company intends to terminate its affiliation. These net assets consisted
of current assets, property and equipment, intangible assets and other
assets less liabilities which are expected to be assumed by purchasers.
(Continued)
9
<PAGE> 10
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
In the third quarter of 1999, the Company recorded approximately $192.5
million of asset revaluation charges related to the impairment of
long-lived assets of certain of its ongoing operating units.
Approximately $172.5 million of these charges relate to clinic operations
with the remainder relating to the operations of PhyCor Management
Corporation ("PMC"), an IPA management company acquired in the first
quarter of 1998. In the third quarter of 1999, events such as the
anticipated downsizing of some clinics, changes in the Company's
expectations relative to efforts to change business mix and improve
margins within certain markets, the failure of certain joint venture or
ancillary consolidation opportunities, and ongoing local market economic
pressure, impacted the Company's estimate of future cash flows for
certain long-lived assets and, in some cases, caused the Company to
change the estimated remaining useful life for certain long-lived assets.
The change in the Company's view on recovery of certain long-lived assets
was also evidenced by the recognition in the third quarter of 1999 of the
need to change its overall business model for its relationship with
medical groups to decrease cash flow to the Company and therefore
increase cash flow to the medical group. Fair value for the long-lived
assets was determined by utilizing the results of both a discounted cash
flow analysis and an earnings before interest, taxes, depreciation and
amortization ("EBITDA") sales multiple analysis based on the Company's
actual past experience with asset dispositions in similar market
conditions.
In the third quarter of 1999, the Company determined to exit the most
significant market in which PMC operates as a result of a variety of
factors including primarily the loss of relationships with physicians in
that market in the current quarter. In addition, of the remaining markets
in which PMC operates, one is expected to be closed in the fourth quarter
of 1999 and the others are not expected to generate significant cash flow
as certain operations in these markets are expected to be closed in the
fourth quarter of 1999 and during 2000. These events impacted the
estimated future cash flows relative to the goodwill recorded in the PMC
acquisition and resulted in an asset impairment charge of approximately
$20.0 million.
In the second quarter of 1999, the Company recorded a pre-tax asset
revaluation charge of $13.7 million. This charge related to the completed
sale of one clinic's operating assets and pending sale of two of its
clinics' operating assets and the termination of the related agreements
with the affiliated physician groups. The factors impacting the decision
to sell these assets and terminate the agreements with the affiliated
physician groups is consistent with the factors described above.
The Company completed the sale of four clinics during the third quarter
of 1999 and received consideration which consisted of $43.2 million in
cash and $3.3 million in notes receivable, in addition to certain
liabilities being assumed by the purchasers. Related to one clinic,
certain proceeds were being held in escrow pending resolution of certain
disputed matters. These matters were resolved in the third quarter of
1999 and the Company recorded an additional asset revaluation charge of
$2.2 million in the third quarter and received $1.1 million in cash in
the fourth quarter of 1999.
The Company recorded net pre-tax restructuring charges totaling
approximately $3.1 million, $675,000 and $9.5 million in the third,
second and first quarters of 1999, respectively. The third quarter 1999
restructuring charge is comprised of a $4.2 million charge less the
reversal of certain asset revaluation charges recorded in the third
quarter of 1998 due to sales proceeds exceeding carrying value. These
charges were comprised of approximately $4.4 million in facility and
lease termination costs, $5.1 million in severance costs and $4.9 million
in other exit costs.
During the third quarter and first nine months of 1999, the Company paid
approximately $600,000 and $1.2 million, respectively, in facility and
lease termination costs, $2.6 million and $4.3 million, respectively, in
severance costs and $650,000 and $4.3 million, respectively, in other
exit costs. At September 30, 1999, accrued expenses payable included
remaining liabilities for clinics to be disposed of and exit costs for
disposed clinic operations of approximately $8.7 million, which included
$3.4 million in facility and lease termination costs, $2.8 million in
severance costs and $2.5 million in other exit costs. The Company
estimates that approximately $6.9 million of the remaining liabilities at
September 30, 1999 will be paid out during the next twelve months. The
remaining $1.8 million primarily relates to long term lease commitments.
(Continued)
10
<PAGE> 11
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(6) CONVERTIBLE SUBORDINATED NOTES
During the second quarter of 1999, the Company announced a definitive
agreement allowing for a strategic investment in the Company of up to
$200.0 million by funds managed by E.M. Warburg, Pincus and Co., LLC
("Warburg, Pincus"). The agreement allows for two separate series of zero
coupon convertible subordinated notes, each resulting in gross proceeds
to PhyCor of $100 million. The first of these series ("Series A Notes")
was issued on September 3, 1999. Both series of notes are non-voting,
have a 6.75% yield, and are convertible at an initial conversion price of
$6.67 at the option of the holder into approximately 15.0 million shares
of PhyCor common stock. Each series of notes will accrete to a maturity
value of approximately $266.4 million at the 15-year maturity date and
includes an investor option to put the notes to PhyCor at the end of ten
years. The Company used the net proceeds from the Series A Notes of $94.5
million to repay indebtedness outstanding under the Company's credit
facility. Issuance of the second series of notes ("Series B Notes") under
the current terms is dependent upon market conditions and shareholder
approval. There is no assurance that the Series B Notes can be issued or
any other investment in the Company by Warburg, Pincus be made under
terms mutually acceptable to both parties.
(7) INCOME TAXES
Income tax expense of $57.7 million for the nine months ended September
30, 1999 consisted primarily of an increase in the valuation allowance
against all deferred tax assets which represented the expected benefits
of operating loss carryforwards recorded in previous periods. The
realization of such assets is not more likely than not to occur based on
historical results and industry trends. The Company will incur no federal
income tax and make no federal income tax payments during the foreseeable
future as a result of available net operating loss carryforwards.
(8) EXTRAORDINARY ITEM
During the third quarter of 1999, the Company purchased $3.5 million of
its convertible subordinated debentures for a total consideration of
approximately $2.5 million, resulting in an extraordinary gain of
approximately $1.0 million.
(9) SUBSEQUENT EVENTS
In November 1999, the Company announced that it had determined to sell
the assets of 17 of its affiliated clinics and, as a result, was reducing
the number of continuing core clinics to 31. Also, during the third
quarter of 1999, the Company concluded that it would begin taking
significant steps in the fourth quarter of 1999 to change the
relationships with the continuing core clinics by restructuring the
current service agreements in order to better align incentives and
strengthen these groups. These changes in the way the Company structures
its relationships with clinics will separate the value of the management
services from the provision of capital. The Company estimates these
changes will reduce pre-tax earnings by approximately $8.0 million per
year, but should provide a more stable relationship with the core
clinics. The Company believes that these service agreement amendments
should be completed by the end of the first quarter of 2000. The ultimate
impact of the changes to the service agreements on pre-tax earnings and
cash flow is expected to be determined in the fourth quarter of 1999.
There can be no assurance the Company can effect these changes in the
manner or time in which it currently anticipates.
As a result of the asset revaluation and restructuring charges taken in
the third quarter of 1999, the Company was not in compliance with certain
financial covenants in its bank credit facility and synthetic lease
facility as of September 30, 1999. In November 1999, the Company received
waivers of compliance with such covenants as of that date through
December 30, 1999 and is in the process of obtaining an amendment to the
credit facility and the synthetic lease facility. Until the amendment is
obtained, amounts outstanding under the bank credit facility are
classified as a current liability pursuant to the requirements of the
Emerging Issues Task Force Issue 86-30 "Classification of Obligations
When a Violation Is Waived by the Creditor".
In November 1999, the Company entered into a management agreement with
the Rockford Health System, a health care delivery system serving
northern Illinois and southern Wisconsin, to provide practice management
and support services to its related 170-physician group and health plan.
The Company also announced an affiliation with Carolina Premier Medical
Group, a multi-specialty medical group with 29 physicians serving the
Research Triangle area of North Carolina, to provide long-term management
services to the medical group effective December 1, 1999.
(Continued)
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<PAGE> 12
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(10) COMMITMENTS AND CONTINGENCIES
Litigation
The Company and certain of its current and former officers and directors
have been named defendants in securities fraud class action lawsuits
filed in state and federal courts. The factual allegations of the
complaints in all lawsuits are substantially identical and assert that
during various periods between April 22, 1997 and September 22, 1998, the
defendants issued false and misleading statements which materially
misrepresented the earnings and financial condition of the Company and
its clinic operations and misrepresented and failed to disclose various
other matters concerning the Company's operations in order to conceal the
alleged failure of the Company's business model. Plaintiffs further
assert that the alleged misrepresentations caused the Company's
securities to trade at inflated levels while the individual defendants
sold shares of the Company's stock at such levels. In each of the
lawsuits, the plaintiff seeks to be certified as the representative of a
class of all persons similarly situated who were allegedly damaged by the
defendants' alleged violations during the "class period." Each of the
lawsuits seeks damages in an indeterminate amount, interest, attorneys'
fees and equitable relief, including the imposition of a trust upon the
profits from the individual defendants' trades. The federal court class
action lawsuits have been consolidated in the U.S. District Court for the
Middle District of Tennessee. Defendants' motion to dismiss is pending
before that court. On June 24, 1999, a lawsuit was filed in that court on
behalf of investors in the Company's debt securities. It is anticipated
that this lawsuit will be consolidated with the shareholder suits. The
state court class action lawsuits have been consolidated in Davidson
County, Tennessee. After the Court granted the defendants' motion to
dismiss, the plaintiffs filed an amended complaint on July 20, 1999
naming KPMG LLP, the Company's certified public accounting firm, as an
additional defendant. KPMG LLP removed the case to federal court.
Defendants intend to file a motion to dismiss the amended complaint. The
federal court has ordered the parties to participate in mediation. On
August 19, 1999, a shareholder derivative action was filed in the
Chancery Court of Davidson County, Tennessee. On October 14, 1999, the
Chancery Court stayed the case pending the outcome of the federal court
litigation. The Company believes that it has meritorious defenses to all
of the claims, and intends to defend vigorously against these actions.
There can be no assurance, however, that such defenses will be successful
or that the lawsuits will not have a material adverse effect on the
Company. The Company's Restated Charter provides that the Company shall
indemnify the officers and directors for any liability arising from these
suits unless a final judgment establishes liability (a) for a breach of
the duty of loyalty to the Company or its shareholders, (b) for acts or
omissions not in good faith or which involve intentional misconduct or a
knowing violation of law or (c) for an unlawful distribution.
On January 23, 1999, the Company and Holt-Krock Clinic, P.L.C.
("Holt-Krock") entered into a settlement agreement with Sparks Regional
Medical Center and Sparks Regional Medical Center Foundation
(collectively, "Sparks") to resolve their lawsuits and all related claims
between the parties and certain former Holt-Krock physicians. Effective
as of August 1, 1999, Holt-Krock, Sparks and the Company consummated the
transactions contemplated in the settlement agreement and mutually
dismissed their lawsuits and related claims between the parties. The
Company intends to seek recovery of certain of its remaining assets
through litigation against several physicians formerly affiliated with
Holt-Krock who did not join Sparks.
On February 2, 1999, the former majority shareholder of PrimeCare filed
suit against the Company and certain of its current and former directors
and executive officers in United States District Court for the Central
District of California. The complaint asserts fraudulent inducement
relating to the PrimeCare transaction and that the defendants issued
false and misleading statements which materially misrepresented the
earnings and financial condition of the Company and its clinic operations
and misrepresented and failed to disclose various other matters
concerning the Company's operations in order to conceal the alleged
failure of the Company's business model. The Court granted the Company's
motion to dismiss the action with respect to all of its officers and
directors, but the plaintiff has amended and refiled his complaint.
Discovery has begun in this litigation. The Company believes that it has
meritorious defenses to all of the claims and intends to vigorously
defend this suit, however, there can be no assurance that if the Company
is not successful in litigation, that this suit will not have a material
adverse effect on the Company.
(Continued)
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<PAGE> 13
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
On February 6, 1999, White-Wilson Medical Center, P.A. ("White - Wilson")
filed suit against PhyCor of Fort Walton Beach, Inc., the PhyCor
subsidiary with which it is a party to a service agreement, in the United
States District Court for the Northern District of Florida. White-Wilson
is seeking a declaratory judgment regarding the enforceability of the fee
arrangement in light of an opinion of the Florida Board of Medicine and
OIG Advisory Opinion 98-4. On November 3, 1999, the Court granted the
parties' motion to extend all deadlines by 90 days because of the
imminent settlement of all disputes between the parties. Additionally, on
March 17, 1999, the Clark-Holder Clinic, P.A. filed suit against PhyCor
of LaGrange, Inc., the PhyCor subsidiary with which it is a party to a
service agreement, in Georgia Superior Court for Troup County, Georgia
similarly questioning the enforceability of the fee arrangement in light
of OIG Advisory Opinion 98-4. On April 27, 1999, the Company filed a
motion to remove the case to the federal district court in Georgia. On
October 7, 1999, the Court granted PhyCor of LaGrange, Inc.'s motion to
dismiss the action brought by the physician group.
Certain litigation is pending against the physician groups affiliated
with the Company and IPAs managed by the Company. Certain plaintiffs in
such litigation have attempted to join the Company as responsible in
whole or in part for activities of the physician groups, IPAs or their
physicians. The Company has not assumed any liability in connection with
such litigation, and intends to vigorously challenge any theory that the
Company is liable for the activities of medical groups, IPAs or their
physicians. Claims against the physician groups and IPAs could result in
substantial damage awards to the claimants that 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.
The U.S. Department of Labor (the "Department") is conducting an
investigation of the administration of the PhyCor, Inc. Savings and
Profit Sharing Plan (the "Plan"). The Department has not completed its
investigation, but has raised questions involving certain administrative
practices of the Plan in early 1998. The Department has not recommended
enforcement action against PhyCor, nor has it identified an amount of
liability or penalty that could be assessed against PhyCor. Based on the
nature of the investigation, PhyCor believes that its financial exposure
is not material. PhyCor intends to cooperate with the Department's
investigation. There can be no assurance, however, that PhyCor will not
have a monetary penalty imposed against it.
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<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
PhyCor, Inc. ("PhyCor" or the "Company") is a medical network
management company that operates multi-specialty medical clinics, develops and
manages independent practice associations ("IPAs"), provides contract management
services to hospitals and health systems and provides health care
decision-support services, including demand management and disease management
services, to managed care organizations, health care providers, employers and
other group associations. In connection with multi-specialty clinic operations,
the Company manages and operates two hospitals and four health maintenance
organizations. At September 30, 1999, the Company operated 48 clinics with 3,158
physicians in 25 states, of which 17 clinics affiliated with 1,038 physicians
are held for sale, and managed IPAs with approximately 24,000 physicians in 30
markets. On such date, the Company's affiliated physicians provided medical
services under capitated contracts to approximately 1,506,000 patients,
including approximately 337,000 Medicare/Medicaid eligible patients. The Company
also provided health care decision-support services to approximately 3.3 million
individuals within the United States and an additional 500,000 under foreign
country license agreements.
The Company's strategy is to position its affiliated multi-specialty
medical groups and IPAs to be the physician component of organized health care
systems. PhyCor believes that physician organizations are a critical element of
organized health care systems because physician decisions determine the cost and
quality of care.
A substantial majority of the Company's revenue in the first nine
months of 1999 and 1998 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.
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.
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.
The Company continues to seek additional affiliations with
multi-specialty clinics and IPAs, however, the Company anticipates that its
acquisition growth will continue to be slower than in previous years. During the
first nine months of 1999, the Company affiliated with several smaller medical
practices, made deferred acquisition payments to certain physician groups
pursuant to the terms of their respective agreements and completed purchase
accounting for acquisitions consummated within the last twelve months, adding a
total of approximately $24.2 million in assets. The principal asset acquired was
service agreement rights, which is an intangible asset. The consideration for
the acquisitions consisted of approximately 53% cash and 47% liabilities
assumed. The cash portion of the aggregate purchase price was funded by a
combination of operating cash flow and borrowings under the Company's bank
credit facility.
In November 1999, the Company announced that it had determined to sell
the assets of 17 of its affiliated clinics and, as a result, was reducing the
number of continuing core clinics to 31. Also, during the third quarter of 1999,
the Company concluded that it would begin taking significant steps in the fourth
quarter of 1999 to change the
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<PAGE> 15
relationships with the continuing core clinics by restructuring the current
service agreements in order to better align incentives and strengthen these
groups. These changes in the way the Company structures its relationships with
clinics will separate the value of the management services from the provision of
capital. The Company estimates these changes will reduce pre-tax earnings by
approximately $8.0 million per year, but should provide a more stable
relationship with the core clinics. The ultimate impact of the changes to the
service agreements is expected to be determined during the fourth quarter of
1999. There can be no assurance the Company can effect these changes in the
manner or time in which it currently anticipates.
In November 1999, the Company entered into a management agreement with
the Rockford Health System, a health care delivery system serving northern
Illinois and southern Wisconsin, to provide practice management and support
services to its related 170-physician group and health plan. The Company also
announced an affiliation with Carolina Premier Medical Group, a multi-specialty
medical group with 29 physicians serving the Research Triangle area of North
Carolina, to provide long-term management services to the medical group
effective December 1, 1999.
The Company has historically amortized goodwill and other intangible
assets related to its service agreements over the periods during which the
agreements are expected to be 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 effect for the first quarter of 1998, amortization
expense would have increased by approximately $3.3 million. Applying the
Company's historical tax rate, diluted earnings per share would have been
reduced by $.03 in the first quarter of 1998.
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<PAGE> 16
RESULTS OF OPERATIONS
The following table shows the percentage of net revenue represented by
various expenses and other income items reflected in the Company's Consolidated
Statements of Operations:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenue .............................. 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Cost of provider services ............. 13.1 12.9 13.2 7.1
Salaries, wages and benefits .......... 32.9 32.7 32.4 34.6
Supplies .............................. 14.7 14.2 14.6 15.2
Purchased medical services ............ 2.4 2.4 2.4 2.6
Other expenses ........................ 15.3 14.0 14.8 14.5
General corporate expenses ............ 1.9 1.9 1.9 2.1
Rents and lease expense ............... .8 8.1 7.8 8.6
Depreciation and amortization ......... 6.4 6.0 6.1 5.9
Provision for asset revaluation
and clinic restructuring .......... 106.0 22.6 35.3 10.4
Merger expenses ....................... -- -- -- 1.3
------ ------ ------ ------
Net operating expenses ................... 200.5(A) 114.8(A) 128.5(A) 102.3(A)
Loss from operations .............. (100.5)(A) (14.8)(A) (28.5)(A) (2.3)(A)
Interest income .......................... (0.3) (0.2) (0.3) (0.2)
Interest expense ......................... 2.7 2.4 2.6 2.4
------ ------ ------ ------
Loss before income taxes, minority
interest and extraordinary item (102.9)(A) (17.0)(A) (30.8)(A) (4.5)(A)
Income tax expense (benefit) ............. 14.0(A) (5.4)(A) 4.9 (A) (1.5)(A)
Minority interest ........................ 0.8 0.9 1.0 0.9
------ ------ ------ ------
Loss before extraordinary item .... (117.7) (12.5) (36.7) (3.9)
Extraordinary item ....................... 0.3 -- 0.1 --
------ ------ ------ ------
Net loss .......................... (117.4)%(A) (12.5)%(A) (36.6)%(A) (3.9)%(A)
====== ====== ====== ======
</TABLE>
(A) Excluding the effect of the provision for asset revaluation and clinic
restructuring and merger expenses in 1999 and 1998, net operating expenses,
earnings from operations, earnings before income taxes and minority interest,
income tax expense and net earnings, as a percentage of net revenue, would have
been 94.5%, 5.5%, 3.1%, 1.0% and 1.6%, respectively, for the three months ended
September 30, 1999, 92.2%, 7.8%, 5.6%, 1.8% and 2.9%, respectively, for the
three months ended September 30, 1998, 93.2%, 6.8%, 4.5%, 1.4% and 2.3%,
respectively, for the nine months ended September 30, 1999, and 90.6%, 9.4%,
7.2%, 2.4% and 3.9%, respectively, for the nine months ended September 30, 1998.
1999 Compared to 1998
Net revenue decreased $37.3 million, or 9.1%, from $408.5 million for
the third quarter of 1998 to $371.2 million for the third quarter of 1999, and
increased from $1.1 billion for the first nine months of 1998 to $1.2 billion
for the first nine months of 1999, an increase of 9.1%. Net revenue from
multi-specialty and group formation clinics ("Clinic Net Revenue") decreased in
the third quarter of 1999 from the third quarter of 1998 by $43.7 million,
comprised of (i) a $32.4 million decrease in service fees for reimbursement of
clinic expenses incurred by the Company and (ii) a $11.3 million decrease in the
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<PAGE> 17
Company's fees from clinic operating income and net physician group revenue.
The decreases in Clinic Net Revenue, excluding same clinic revenue increases
discussed below, were comprised of $1.1 million from clinics acquired during
1998, $41.9 million from clinic operations disposed of in 1998 and through
September 30, 1999 and $2.9 million from clinics whose assets are held for sale
at September 30, 1999. Clinic Net Revenue decreased in the first nine months of
1999 from the first nine months of 1998 by $61.8 million, comprised of (i) a
$56.9 million decrease in service fees for reimbursement of clinic expenses
incurred by the Company and (ii) a $4.9 million decrease in the Company's fees
from clinic operating income and net physician group revenue. Excluding same
clinic revenue increases discussed below, increases in Clinic Net Revenue of
$17.2 million from clinics acquired during 1998 and $11.5 million from clinics
whose assets are held for sale at September 30, 1999 were offset by reductions
in Clinic Net Revenue of $101.7 million as a result of clinic operations
disposed of in 1998 and through September 30, 1999. Included in the changes in
Clinic Net Revenue is the impact of declining reimbursement for services
rendered by the physician groups. Specifically, the provision for doubtful
accounts and contractual adjustments on gross physician group, hospital and
other revenue increased to 43.8% for the third quarter of 1999 from 40.5% for
the third quarter of 1998, and increased to 43.0% for the nine months ended
September 30, 1999 from 40.2% for the nine months ended September 30, 1998. Net
revenue from the service agreements (excluding clinics being restructured or
related assets sold) in effect for all of 1999 and 1998 increased by $2.2
million for the third quarter of 1999 and $11.2 million for the nine months
ended September 30, 1999, compared with the same periods in 1998. Same market
service agreement net revenue growth resulted from the addition of new
physicians, the expansion of ancillary services and increases in patient volume
and fees.
Net revenue from IPAs increased $5.9 million, or 7.4%, from $80.2
million for the third quarter of 1998 to $86.1 million for the third quarter of
1999, and from $153.5 million for the first nine months of 1998 to $272.6
million for the first nine months of 1999, an increase of $119.1 million or
77.6%. These increases resulted primarily from increases in net revenues from
the acquisition of PrimeCare International, Inc. ("PrimeCare") in 1998 of
approximately $9.3 million and $81.5 million, respectively, for the third
quarter and nine months ended September 30, 1999, and additional IPA markets
entered into subsequent to the first quarter of 1998 of approximately $4.8
million and $17.4 million, respectively, for the third quarter and nine months
ended September 30, 1999. Net revenues were also impacted by increases
(decreases) in net revenues from the acquisition in 1998 and subsequent closing
in 1999 of The Morgan Health Group, Inc. ("MHG") of approximately ($13.2
million) and $4.1 million, respectively, for the third quarter and nine months
ended September 30, 1999. (The Company commenced closing MHG operations
effective April 30, 1999. See "Asset Revaluation and Clinic Restructuring.") Net
revenue from the IPA markets in effect for all of 1999 and 1998 increased by
$5.0 million, or 22.8%, for the third quarter of 1999 and $16.1 million, or
25.5%, for the nine months ended September 30, 1999, compared with the same
periods in 1998. Same market IPA growth resulted from the addition of new
physicians, increases in IPA enrollment and increases in patient volume and
fees.
During the third quarter of 1999, most categories of operating expenses
were relatively stable as a percentage of net revenue when compared to the same
period in 1998. The addition of cost of provider services is a result of the
acquisitions of PrimeCare and MHG in 1998. PrimeCare and MHG own and manage
IPAs, and each is a party to certain managed care contracts, resulting in the
Company presenting revenue from these operations on a "grossed-up basis." Under
this method, unlike the majority of the Company's IPAs, the cost of provider
services (payments to physicians and other providers under compensation,
sub-capitation and other reimbursement contracts) is not included as a deduction
to net revenue of the Company but is reported as an operating expense. This
revenue reporting resulted in a new cost of provider services expense line item
and in general would cause other expense line items to decrease as a percentage
of net revenue when compared to periods prior to the acquisitions of PrimeCare
and MHG. As a result, during the first nine months of 1999, most categories of
operating expenses decreased as a percentage of net revenue when compared to the
same period in 1998. During the third quarter of 1999, supplies expense, other
expenses and depreciation and amortization had more than a marginal increase as
a percentage of net revenue in the third quarter of 1999 over the same period in
1998. The increase in supplies expense is a result of the continued increases in
costs of drugs and medications. Other expenses increased as a result of the
Company incurring costs associated with information systems and software
conversions in its IPA markets during 1999. The increase in depreciation and
amortization expense resulted from a significant amount of capital expenditures
during 1999 related to conversions of information systems in the Company's
affiliated clinics and IPAs. During the third
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<PAGE> 18
quarter of 1999, rents and lease expense had more than a marginal decrease as a
percentage of net revenue when compared to the same period in 1998. This
decrease is a result of the disposition of certain of the Company's group
formation clinics during the third and fourth quarters of 1998. These clinics'
rents and lease expense as a percentage of net revenue was higher than that of
the current base of clinics.
The Company also incurred merger expenses of approximately $14.2
million in the first quarter of 1998 relating to the termination of its merger
agreement with MedPartners, Inc. This charge represents PhyCor's share of
investment banking, legal, travel, accounting and other expenses incurred during
the merger negotiation process.
Income tax expense of $57.7 million for the nine months ended September
30, 1999 consisted primarily of an increase in the valuation allowance against
all deferred tax assets which represented the expected benefits of operating
loss carryforwards recorded in previous periods. The realization of such assets
is not more likely than not to occur based on historical results and industry
trends. The Company will incur no federal income tax expense and make no federal
income tax payments during the foreseeable future as a result of available net
operating loss carryforwards.
ASSET REVALUATION AND CLINIC RESTRUCTURING
Assets Held for Sale
During 1998 and 1999, the health care industry has undergone rapid changes
that have significantly impacted physicians and other health care providers.
Declining reimbursement from Medicare and commercial payors has negatively
impacted physician revenues and incomes. It has taken significant time for
physicians and other health care providers to fully understand and accept the
sustaining impact of changes in reimbursement. The Company and its physicians
have attempted to react to this development by devising and implementing plans
to reduce overhead, increase patient volume, increase physician productivity and
change payor mixes. In some clinics, physicians have been slow to engage in
necessary changes because of medical group culture or other market factors and,
as a result, these strategies have been only marginally successful or in some
cases not successful. Physician groups that have weak governance structures or
marginal market presence, among other factors, have experienced difficulty
dealing with the impact of these financial pressures. This difficulty has
affected the relationships among physicians within the groups and between the
physician groups and the Company.
As a result, during 1998 and 1999 the Company sold clinic operating assets
and terminated the related service agreements with a number of clinics
affiliated with the Company. In the third quarter of 1999, the Company
determined that it was necessary to create more stability for the Company by
identifying those clinics which the Company believed were less likely to sustain
a relationship with the Company in this changed health care environment and
selling the corresponding assets. The Company intends to maintain a core of
clinics that it believes can prosper in the changed health care environment.
This decision to downsize is intended to allow the Company to focus on
strengthening the core clinic operations and to position the Company to resume
its growth. These steps will generate cash for the Company and result in a
smaller company with clinics that are more stable, have the ability to grow and
are committed to the mutual success of the physician groups and the Company. As
part of the decision to downsize the number of clinic operations, the Company is
taking significant steps in the fourth quarter of 1999 to change its
relationship with its core clinics in order to strengthen these clinics and
ensure their long-term viability. For additional discussion of the changes in
these relationships, see "Overview" and "Liquidity and Capital Resources."
In the third quarter of 1999, the Company recorded pre-tax asset
revaluation and restructuring charges totaling approximately $393.4 million,
consisting of $198.7 million related to assets held for sale, $2.2 million
related to assets previously held for sale and $192.5 million related to asset
impairments. The Company is reducing the number of continuing core clinics to
31, and as a result recorded $198.7 million of asset revaluation and
restructuring charges related to 17 clinics the Company has classified as assets
held for sale. The third quarter 1999 asset revaluation charge related to assets
held for sale included current assets, property and equipment, other assets and
intangible assets of $9.2 million, $19.8 million, $13.3 million and $153.3
million, respectively.
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<PAGE> 19
Three of the 17 clinics represent all of the Company's remaining
operations considered to be "group formation clinics." Group formation clinics
represented the Company's attempt to create multi-specialty groups by combining
the operations of several small physician groups or individual physician
practices. The Company has not been able to successfully consolidate the
operations of these clinics as a result of a variety of factors including lack
of medical group governance or leadership, inability to agree on income
distribution plans, separate information systems, redundant overhead structures
and lack of group cohesiveness. The Company has therefore determined to sell the
clinic operating assets and terminate the agreements related to these clinics.
The asset revaluation and restructuring charge related to these clinics in the
third quarter of 1999 was $14.3 million. The net assets held for sale at
September 30, 1999 for these clinics were $20.4 million. Net revenue and pre-tax
income (losses) from these group formation clinics were $10.4 million and
($300,000) for the three months ended September 30, 1999, and $10.4 million and
$300,000 for the three months ended September 30, 1998, respectively. For the
nine months ended September 30, 1999, net revenue and pre-tax income from these
group formation clinics were $32.1 million and $100,000, respectively, compared
to $29.7 million and $1.0 million, respectively, for the nine months ended
September 30, 1998.
The remaining 14 clinics represent multi-specialty clinics that are
being disposed because of a variety of negative operating and market issues,
including those related to declining reimbursement for Medicare and commercial
patient services, market position and clinic demographics, physician relations,
physician turnover rates, declining physician incomes, physician productivity,
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 these factors at the clinics held for sale resulted in clinic
operations that were difficult to effectively manage. Therefore, the Company
determined in the third quarter of 1999 to sell the clinic operating assets and
terminate the agreements related to these clinics. The asset revaluation and
restructuring charge related to these clinics in the third quarter of 1999 was
$184.4 million. The net assets held for sale at September 30, 1999 for these
clinics were $135.7 million. Net revenue and pre-tax income (losses) from these
14 clinics were $81.7 million and ($1.2 million), respectively, for the three
months ended September 30, 1999, and $84.6 million and $4.0 million,
respectively, for the three months ended September 30, 1998. For the nine months
ended September 30, 1999, net revenue and pre-tax income from these clinics were
$254.9 million and $2.1 million, respectively, compared to $245.9 million and
$14.2, respectively, for the nine months ended September 30, 1998. Included in
these 14 clinics are the net assets of the clinics operating in Lexington,
Kentucky and Sayre, Pennsylvania. In the second quarter of 1999, the Company
disclosed that it did not expect to extend the interim management agreement with
the Guthrie Clinic in Sayre, Pennsylvania, beyond November 1999 and discussed
certain risks associated with the Lexington Clinic operation. In the third
quarter of 1999, the Company reached agreements on the sales of these assets to
the respective physician groups. The transaction with the Guthrie Clinic closed
in the fourth quarter of 1999. The transaction with the Lexington Clinic is
expected to close in the fourth quarter of 1999.
At September 30, 1999, net assets currently expected to be sold during
the next 12 months totaled approximately $156.1 million after taking into
account the charges discussed above relating to clinics with which the Company
intends to terminate its affiliation. These net assets consisted of current
assets, property and equipment, intangible assets and other assets less
liabilities which are expected to be assumed by purchasers. The Company intends
to recover these amounts during the next 12 months as the asset sales occur.
However, there can be no assurance that the Company will recover this entire
amount. Of this amount, clinic net assets totaling approximately $59.2 million
are expected to be sold during the fourth quarter of 1999. As of November 12,
1999, the Company had completed the sale of three clinics in the fourth quarter
and received approximately $23.8 million of proceeds on those assets held for
sale, of which $18.4 million represents notes receivable, with the purchasers
assuming certain liabilities. Additional clinic net assets totaling
approximately $35.4 million are expected to be sold during the fourth quarter of
1999.
In the second quarter of 1999, the Company recorded a pre-tax asset
revaluation charge of $13.7 million. This charge related to the completed sale
of one clinic's operating assets and pending sale of two of its clinics'
operating assets and the termination of the related agreements with the
affiliated physician groups. This asset revaluation charge included current
assets, property and equipment, and intangible assets of $2.0 million, $1.5
million and $10.2 million, respectively. As of June 30, 1999 the
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Company was also in negotiations relating to the sale of the assets of three
additional clinics (including Holt-Krock Clinic ("Holt-Krock") which is
discussed below). The factors impacting the decision to sell these assets and
terminate the agreements with the affiliated physician groups is consistent with
the factors described in the discussion of the third quarter of 1999 asset
revaluation charge above. The Company completed the sale of one of these groups
during the second quarter of 1999 and four of these groups during the third
quarter of 1999,receiving consideration which consisted of approximately $44.5
million in cash and $3.3 million in notes receivable, in addition to certain
liabilities being assumed by the purchasers. With respect to the Holt-Krock
sale, certain proceeds were being held in escrow pending resolution of certain
disputed matters. These matters were resolved in the third quarter of 1999 and
the Company recorded an additional asset revaluation charge of $2.2 million in
the third quarter and received $1.1 million in cash in the fourth quarter of
1999. One clinic remains held for sale as of September 30, 1999. Net revenue and
pre-tax income from the five clinics that have been sold were $4.4 million and
$300,000, respectively, for the three months ended September 30, 1999, and $23.1
million and $300,000, respectively, for the three months ended September 30,
1998. For the nine months ended September 30, 1999, net revenue and pre-tax
income (losses) from these clinics were $40.9 million and ($2.1 million),
respectively, compared to $68.2 million and $2.7 million, respectively, for the
nine months ended September 30, 1998.
In the fourth quarter of 1998, the Company recorded a pre-tax asset
revaluation charge of $110.4 million of which $75.7 million related to assets to
be sold. The fourth quarter 1998 asset revaluation charge related to assets held
for sale included current assets, property and equipment, other assets and
intangible assets of $2.4 million, $2.9 million, $1.4 million and $69.0 million,
respectively. $26.0 million of this charge related to adjustments of the
carrying value of the Company's assets at Holt-Krock and Burns Clinic Medical
Center ("Burns") as a result of agreements to sell certain assets associated
with these service agreements. The factors impacting the decision to sell these
assets and terminate the agreements with the affiliated physician groups is
consistent with the factors described in the discussion of the third quarter of
1999 asset revaluation charge above. The Company completed the sale of
Holt-Krock assets in the third quarter of 1999, as discussed above. The Company
completed the sale of Burns assets in the second quarter of 1999 and received
proceeds totaling approximately $6.4 million in cash in addition to certain
liabilities being assumed by the purchaser. For the three months ended September
30, 1999, net revenue and pre-tax income from Burns was $19,000 and zero,
respectively, compared to $8.9 million and $700,000, respectively, for the three
months ended September 30, 1998. For the nine months ended September 30, 1999,
net revenue and pre-tax income from Burns was $8.3 million and $200,000,
respectively, compared to $26.8 million and $1.8 million, respectively, for the
nine months ended September 30, 1998.
In addition, the fourth quarter 1998 charge provided for the write-off
of $31.6 million of goodwill recorded in connection with the July 1998 MHG
acquisition. MHG was an Atlanta-based IPA whose network at such time included
approximately 400 primary care physicians and 1,800 specialists who provided
care to approximately 57,000 managed care members under capitated contracts. In
September 1998, PhyCor announced that the earnings of MHG were significantly
below target because of higher than expected costs from MHG's managed care
contracts. Subsequent to the closing of this acquisition, the claims received
from its principal payor for costs arising before the acquisition revealed that
MHG's costs significantly exceeded its revenues under the payor contract prior
to the date of acquisition. PhyCor continued to fund the premium deficiency
under this principal payor contract, which accounted for approximately 90% of
MHG's revenues, while attempting to renegotiate payment terms with the payor to
allow for this principal payor contract to be economically viable. In January of
1999, a mutually beneficial agreement could not be reached. The payor contract
terminated by mutual agreement on April 30, 1999. PhyCor commenced closing its
MHG operation effective April 30, 1999 and is attempting to recover its
investment in MHG from the sellers of MHG, but there can be no assurance of a
recovery. For the three months and nine months ended September 30, 1999, net
revenue from MHG was zero and $18.1 million, respectively, compared to $13.2
million and $13.9 million, respectively, for the three months and nine months
ended September 30, 1998. MHG recognized no pre-tax income (losses) for the
three months and nine months ended September 30, 1999, compared to ($200,000)
and $500,000, respectively, for the three months and nine months ended September
30, 1998.
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Also included in the fourth quarter 1998 pre-tax charge is $18.1
million related to one of the clinics included in the acquisition of First
Physician Care ("FPC") that was experiencing significant problems similar to
those the Company had previously experienced with group formation clinics.
PhyCor recorded the asset revaluation charge primarily to write down goodwill
from the FPC acquisition to recognize the expected decline in future cash flows
of the investment. The net assets held for sale for this FPC clinic at December
31, 1998 was approximately $3.0 million. The Company completed the termination
of its agreements with the FPC clinic in the second quarter of 1999. No net
revenues or pre-tax income was recorded from this FPC clinic for the three
months ended September 30, 1999, compared to $4.0 million and $200,000,
respectively, for the three months ended September 30, 1998. For the nine months
ended September 30, 1999, net revenue and pre-tax income from this FPC clinic
was $5.2 million and $300,000, respectively, compared to $4.0 million and
$200,000, respectively, for the nine months ended September 30, 1998.
In the third quarter of 1998, the Company recorded a net pre-tax asset
revaluation charge of $92.5 million, which is comprised of a $103.3 million
charge less the reversal of certain restructuring charges recorded in the first
quarter of 1998. This charge related to deteriorating negative operating trends
for three group formation clinic operations which were included in the fourth
quarter 1997 asset revaluation charge and the corresponding decision to dispose
of those assets when the restructuring plan was unsuccessful. Additionally, this
charge provided for the disposition of assets of two group formation clinics
that were not included in the fourth quarter 1997 asset revaluation charge. The
third quarter 1998 asset revaluation charge related to assets held for sale
included current assets, property and equipment, other assets and intangible
assets of $3.4 million, $3.6 million, $6.7 million and $62.2 million,
respectively. The Company completed the termination of its agreements with three
of these clinics in the third quarter of 1998, one clinic in the fourth quarter
of 1998 and one clinic in the first quarter of 1999. Total consideration
received from these terminations consisted of approximately $11.3 million in
cash and $10.4 million in notes receivable, in addition to certain liabilities
being assumed by the purchasers. For the three months ended September 30, 1998,
net revenue and pre-tax losses from these clinics was $9.7 million and $1.4
million, respectively. For the nine months ended September 30, 1998, net revenue
and pre-tax losses from these clinics was $50.4 million and $3.3 million,
respectively.
In summary, net revenue and pre-tax income (losses) from operations
disposed of as of September 30, 1999 were $4.4 million and $300,000,
respectively, for the three months ended September 30, 1999, and $59.5 million
and ($400,000), respectively, for the three months ended September 30, 1998. For
the nine months ended September 30, 1999, net revenue and pre-tax income
(losses) from operations disposed of as of September 30, 1999 were $73.8 million
and ($2.1 million), respectively, and $171.4 million and $1.6 million,
respectively, for the nine months ended September 30, 1998. Net revenue and
pre-tax income (losses) from the remaining operations held for sale were $92.1
million and ($1.5 million), respectively, for the three months ended September
30, 1999, and $95.0 million and $4.3 million, respectively, for the three months
ended September 30, 1998. For the nine months ended September 30, 1999, net
revenue and pre-tax income from the remaining operations held for sale were
$287.0 million and $2.2 million, respectively, and $275.6 million and $15.2
million, respectively, for the nine months ended September 30, 1998.
There can be no assurance 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 service agreement or that in the
future additional clinics will not terminate relationships with the Company in a
manner that may adversely affect the Company.
Asset Impairments
As previously discussed in "Asset Revaluation and Clinic Restructuring
- - Assets Held for Sale," 1998 and 1999 have been periods of rapid changes for
physicians and physician groups. Factors such as unexpected physician
departures, declining Medicare and commercial reimbursement, changing market
conditions, demographics, group governance and leadership, and continued
increasing pressure on operating costs contribute to stagnant and, in some
cases, expected declines in physician incomes and operating results of these
clinic operations. It has taken significant time for physicians and other health
care providers to fully understand and accept the sustaining impact of changes
in reimbursement in the current year. The Company and its physicians have
continued to attempt to react to this development by devising and implementing
plans to reduce overhead, increase patient volume, increase physician
productivity and change payor mixes. In some clinics, physicians have been slow
to engage in necessary changes because of medical group culture or other market
factors, therefore making these strategies only marginally successful. In the
third quarter of 1999, events such as the anticipated downsizing of some
clinics, changes in the Company's expectations relative to efforts to change
business mix and improve margins within certain markets, the failure of certain
joint venture or ancillary consolidation opportunities, and ongoing local market
economic pressure, impacted the Company's estimate of future cash flows for
certain long-lived assets and, in some cases, caused the Company to change the
estimated remaining useful life for certain long-lived assets. The change in the
Company's view on recovery of certain long-lived assets was also evidenced by
the recognition in the third quarter of 1999 of the need to change its overall
business model for its relationship with medical groups to decrease cash flow to
the Company and therefore increase cash flow to the medical group. Fair value
for the long-lived assets was determined by utilizing the results of both a
discounted cash flow analysis and an earnings before interest, taxes,
depreciation and amortization ("EBITDA") sales multiple analysis based on the
Company's actual past experience with asset dispositions in similar market
conditions.
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In the third quarter of 1999, the Company recorded approximately $192.5
million of asset revaluation charges related to the impairment of long-lived
assets of certain of its ongoing operating units. Approximately $172.5 million
of these charges relate to certain clinic operations with the remainder relating
to the operations of PhyCor Management Corporation ("PMC"), an IPA management
company acquired in the first quarter of 1998. The Company determined to exit
the most significant market in which PMC operates as a result of a variety of
factors, including primarily the loss of relationships with physicians in that
market in the current quarter. In addition, of the remaining markets in which
PMC operates, one is expected to be closed in the fourth quarter of 1999 and the
others are not expected to generate significant cash flow as certain operations
in these markets are expected to be closed in the fourth quarter of 1999 and
during 2000. These events are expected to impair the estimated future cash flows
from the PMC acquisition and resulted in an asset impairment charge of
approximately $20.0 million.
Restructuring Charges
In the third quarter of 1999, the Company recorded net pre-tax
restructuring charges totaling approximately $3.1 million, which is comprised of
a $4.2 million charge less the reversal of certain asset revaluation charges
recorded in the third quarter of 1998 due to sales proceeds exceeding carrying
value. This net charge relates to three clinics where management adopted plans
in the third quarter of 1999 to dispose of assets and cease operations. These
charges were comprised of approximately $2.3 million in facility and lease
termination costs, $1.6 million in severance costs and $300,000 in other exit
costs. These plans involve the involuntary termination of 22 employees and are
expected to be completed over the next six months. During the third quarter of
1999, the Company paid approximately $50,000 in exit costs related to the
current quarter charge.
In the second quarter of 1999, the Company recorded pre-tax
restructuring charges totaling $675,000 with respect to operations that were
being sold or closed. Of these charges, $400,000 related to a clinic and the
remaining $275,000 related to a small IPA. These charges were comprised of
approximately $165,000 in facility and lease termination costs, $380,000 in
severance costs and $130,000 in other exit costs. During the third quarter and
first nine months of 1999, the Company paid approximately $100,000 in facility
and lease termination costs and $400,000 in severance costs related to the
second quarter 1999 charge.
In the first quarter of 1999, the Company recorded pre-tax
restructuring charges totaling approximately $9.5 million with respect to
operations that were being sold or restructured whose asset revaluation charges
were taken in the fourth quarter of 1998. Of these charges, approximately $8.8
million related to clinics and the remaining $700,000 related to MHG. These
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charges were comprised of approximately $1.9 million in facility and lease
termination costs, $3.1 million in severance costs and $4.5 million in other
exit costs. During the third quarter and first nine months of 1999, the Company
paid approximately $200,000 and $600,000, respectively, in facility and lease
termination costs, $900,000 and $2.1 million, respectively, in severance costs
and $500,000 and $2.8 million, respectively, in other exit costs related to the
first quarter 1999 charge.
In the first quarter of 1998, the Company recorded pre-tax
restructuring charges totaling $22.0 million with respect to clinics that were
being sold or restructured whose asset revaluation charges were taken in the
fourth quarter of 1997. These charges were comprised of approximately $15.3
million in facility and lease termination costs, $4.6 million in severance costs
and $2.1 million in other exit costs. During the third quarter and first nine
months of 1999, the Company paid approximately $300,000 and $500,000,
respectively, in facility and lease termination costs, $1.3 million and $1.8
million, respectively, in severance costs and $100,000 and $1.4 million,
respectively, in other exit costs related to the first quarter 1998 charge.
During 1998, the Company paid approximately $3.0 million in facility and lease
termination costs, $2.7 million in severance costs and $1.4 million in other
exit costs related to the first quarter 1998 charge.
In summary, during the third quarter and first nine months of 1999, the
Company paid approximately $600,000 and $1.2 million, respectively, in facility
and lease termination costs, $2.6 million and $4.3 million, respectively, in
severance costs and $650,000 and $4.3 million, respectively, in other exit
costs. At September 30, 1999, accrued expenses payable included remaining
liabilities for clinics to be disposed of and exit costs for disposed clinic
operations of approximately $8.7 million, which included $3.4 million in
facility and lease termination costs, $2.8 million in severance costs and $2.5
million in other exit costs. The Company estimates that approximately $6.9
million of the remaining liabilities at September 30, 1999 will be paid out
during the next 12 months. The remaining $1.8 million primarily relates to long
term lease commitments.
The Company currently anticipates recording a charge in the fourth
quarter of 1999 of no more than $20.0 million with respect to markets associated
with the third quarter 1999 asset revaluation charge. The ultimate liability
associated with exiting these markets will be determined in the fourth quarter
of 1999.
There can be no assurance 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 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.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, excluding bank credit facility debt expected to
be amended of $270.0 million which is classified as a current liability during
the Waiver Period (see discussion below), the Company had $260.6 million in
working capital, compared to $187.9 million as of December 31, 1998. The Company
generated $34.7 million of cash flow from operations for the third quarter of
1999 compared to $38.5 million for the third quarter of 1998 and $106.2 million
for the first nine months of 1999 compared to $112.9 million for the same period
in 1998. At September 30, 1999, net accounts receivable of $251.1 million
amounted to 58 days of net clinic revenue compared to $378.7 million and 64 days
at the end of 1998.
The Company repurchased approximately 2.6 million shares of common
stock for approximately $12.6 million in 1998. The Company has repurchased
approximately 2.9 million shares of common stock for approximately $13.5 million
to date in 1999, of which $9.0 million was settled as of September 30, 1999. The
remaining $4.5 million was settled during October 1999. During the third quarter
of 1999, the Company purchased $3.5 million of its convertible subordinated
debentures for a total consideration of approximately $2.5 million, resulting in
an extraordinary gain of approximately $1.0 million.
During the second quarter of 1999, the Company announced a definitive
agreement allowing for a strategic investment in the Company of up to $200.0
million by funds managed by E.M. Warburg, Pincus and Co., LLC ("Warburg,
Pincus"). The agreement allows for two separate series of zero coupon
convertible subordinated notes, each resulting in gross proceeds to PhyCor of
$100 million. The first of these series ("Series A Notes") was issued on
September 3, 1999. Both series of notes are non-voting, have a 6.75% yield, and
are convertible at an initial conversion price of $6.67 at the option of the
holder into approximately 15.0 million shares of PhyCor common stock. Each
series of notes will accrete to a maturity
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value of approximately $266.4 million at the 15-year maturity date and includes
an investor option to put the notes to PhyCor at the end of ten years. The
Company used the net proceeds from the Series A Notes of $94.5 million to repay
indebtedness outstanding under the Company's credit facility. Issuance of the
second series of notes ("Series B Notes") under the current terms is dependent
upon market conditions and shareholder approval. There is no assurance that the
Series B Notes can be issued or any other investment in the Company by Warburg,
Pincus can be made under terms mutually acceptable to both parties.
Option exercises and other issuances of common stock combined with
repurchases of common stock and net losses for the first nine months of 1999
resulted in an decrease of $443.4 million in shareholders' equity compared to
December 31, 1998.
Capital expenditures during the first nine months of 1999 totaled $37.3
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 $10.0 million in additional capital expenditures during the
remainder of 1999.
Deferred acquisition payments are payable to certain 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 $33.0 million of additional
consideration over the next five years, of which a maximum of $9.4 million would
be payable during the next twelve months.
During 1998 and 1999, the Company sold clinic operating assets and
terminated the related service agreements with a number of clinics affiliated
with the Company. For additional discussion related to these clinics and the
asset revaluation and restructuring charges associated with these clinics, see
"Asset Revaluation and Clinic Restructuring - Assets Held for Sale" and "Asset
Revaluation and Clinic Restructuring - Restructuring Charges". During the third
quarter of 1999, the Company received consideration which consisted of
approximately $43.2 million in cash and $3.3 million in notes receivable, in
addition to certain liabilities being assumed by the purchasers, related to the
sale of assets associated with Holt-Krock and three other clinics. The amounts
received upon disposition of the assets approximated the post-charge net
carrying value, with the exception of Holt-Krock for which an additional charge
of $2.2 million was recorded in the third quarter of 1999. In October 1999, the
Company received an additional $1.1 million in proceeds related to the sale of
assets to Sparks Regional Medical Center ("Sparks"). These proceeds had been
held in escrow pending the resolution of certain disputed matters. The Company
also intends to seek recovery of certain of its remaining assets through
litigation against several physicians formerly affiliated with Holt-Krock who
did not join Sparks. For the nine months ended September 30, 1999, the Company
received consideration which consisted of approximately $51.9 million in cash
and $8.2 million in notes receivable, in addition to certain liabilities being
assumed by the purchasers, related to the sale of clinic assets. For the year
ended December 31, 1998, the Company received consideration which consisted of
approximately $16.1 million in cash and $5.6 million in notes receivable, in
addition to certain liabilities being assumed by the purchasers, related to the
sale of clinic assets.
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During 1998 and 1999, the Company has recorded restructuring charges
related to operations that are being sold, restructured or closed. These charges
primarily relate to facility and lease termination costs, severance costs, and
other exit costs incurred or expected to be incurred when these assets are sold,
restructured, or closed. For additional discussion, see "Asset Revaluation and
Clinic Restructuring - Restructuring Charges". During the third quarter and
first nine months of 1999, the Company paid approximately $600,000 and $1.2
million, respectively, in facility and lease termination costs, $2.6 million and
$4.3 million, respectively, in severance costs and $650,000 and $4.3 million,
respectively, in other exit costs. During 1998, the Company paid approximately
3.0 million in facility and lease termination costs, $2.7 million in severance
costs and $1.4 million in other exit costs. The Company estimates that
approximately $6.9 million of the remaining liabilities at September 30, 1999
will be paid out during the next twelve months.
During the third quarter of 1999, the Company concluded that it would
begin taking significant steps in the fourth quarter of 1999 to change the
relationships with the core clinics by restructuring the current service
agreements in order to better align incentives and strengthen these groups.
These changes in the way the Company structures its relationship with the
clinics will separate the value of management services from the provision of
capital. The Company estimates these changes will reduce pre-tax earnings by
approximately $8.0 million and cash flow by approximately $14.0 million per
year. While this affects earnings and cash flow, it should provide a more stable
relationship with the core clinics. The Company believes that these service
agreement amendments should be completed by the end of the first quarter of
2000. The ultimate impact of the changes to the service agreements on pre-tax
earnings and cash flow is expected to be determined in the fourth quarter of
1999. There can be no assurance that the Company can effect these changes in the
manner or time in which it currently anticipates.
During the third quarter of 1999, the Company favorably resolved its
outstanding Internal Revenue Service ("IRS") examinations for the years
1988-1995. The IRS had proposed adjustments relating to the timing of
recognition for tax purposes of certain revenue and deductions related to
accounts receivable, the Company's relationship with affiliated physician
groups, and various other timing differences. The tax years 1988 through 1995
have been closed with respect to all issues without a material financial impact,
and the Company is currently not under examination by the IRS for any other
taxable year, except for two subsidiaries which are currently under examination
for the 1995 and 1996 tax years. The Company acquired the stock of these
subsidiaries during 1996. The Company does not believe the resolution of these
examinations will have a material adverse effect on its financial condition. In
August 1999, the Company received a $13.7 million tax refund as a result of
applying the 1998 loss carryback to recover taxes paid in 1996 and 1997. The
Company has approximately $450.0 million in net operating loss carryforwards;
accordingly, the Company does not expect to pay current federal income taxes for
the foreseeable future.
The Company amended its bank credit facility in March and September
1999. The Company's bank credit facility, as amended, provides for a five-year,
$500.0 million revolving line of credit for use by the Company prior to April
2003 for acquisitions, working capital, capital expenditures and general
corporate purposes. The total drawn cost under the facility is either (i) the
applicable eurodollar rate plus .875% to 1.75% per annum or (ii) the agent's
base rate plus .175% to .40% per annum. The total weighted average drawn cost of
outstanding borrowings at September 30, 1999 was 6.95%. The amended
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bank credit facility also provides for up to $75 million for the aggregate
amount of letters of credit which may be issued by the Company and provides that
in the event of a reduced rating by certain rating agencies, the Company would
be required to pledge as security for repayment of the credit facility the
capital stock the Company holds in certain of its subsidiaries. The amended
facility also provides for acquisitions without bank approval of up to $25
million individually or $150 million in the aggregate during any 12-month
period. The September bank credit facility amendment allows for $35 million
of securities repurchases.
The Company also amended its synthetic lease facility in March and
September 1999. The Company's synthetic lease facility, as amended, provides
off-balance sheet financing of $60 million with an option to purchase leased
facilities at the end of the lease term. The total drawn cost under the
synthetic lease facility is .875% to 1.75% above the applicable eurodollar rate.
At September 30, 1999, of the $60 million available under the synthetic lease
facility, an aggregate of approximately $26.3 million was drawn. The amended
synthetic lease facility is not project specific but is expected to be used for,
among other projects, the construction or acquisition of certain medical office
buildings related to the Company's operations.
The Company's bank credit facility and synthetic lease facility contain
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 incurring 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. As a result of the asset revaluation and
restructuring charges taken in the third quarter of 1999, the Company was not in
compliance with certain of these covenants as of September 30, 1999. The Company
received waivers of compliance with such covenants as of that date through
December 30, 1999 ("Waiver Period") and expects to obtain an amendment to the
bank credit facility and the synthetic lease facility in the fourth quarter of
1999. Until this amendment is obtained, amounts outstanding under the bank
credit facility are classified as a current liability pursuant to the
requirements of the Emerging Issues Task Force Issue 86-30 "Classification of
Obligations When a Violation Is Waived by the Creditor". During the Waiver
Period, outstanding borrowings and letters of credit under the credit facility
are limited to $375 million in the aggregate and under the synthetic lease
facility, outstanding borrowings are limited to $30 million. In addition, the
Company has agreed not to repurchase any of its securities during the Waiver
Period. There can be no assurance that the bank credit facility and the
synthetic lease facility can be amended on terms acceptable to the Company.
At September 30, 1999, notional amounts under interest rate swap
agreements totaled $210.2 million. Fixed interest rates range from 5.14% to
5.78% relative to the one month or three month floating LIBOR. Up to an
additional $15.8 million may be fixed at 5.28% as additional amounts are drawn
under the synthetic lease facility prior to April 28, 2000. The swap agreements
mature at various dates from July 2003 to April 2005. The lender may elect to
terminate the agreement covering $100 million beginning September 2000 and
another $100 million beginning October 2000. The FASB has issued Statement of
Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities, which will require the Company to mark
certain of its interest rate swap agreements to market due to lender optionality
features included in those swap agreements. SFAS No. 133 was amended by the
issuance of Statement of Financial Accounting Standards (SFAS) No. 137,
Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133 - an amendment of FASB Statement No.
133, which defers the required date of adoption by the Company to the first
quarter of 2001. Had the Company adopted the requirements of SFAS No. 133 for
the nine months ended September 30, 1999, the Company estimates it would have
recorded pre-tax non-cash earnings of $472,000. The Company has historically not
engaged in trading activities in its interest rate swap agreements and does not
intend to do so in the future.
At September 30, 1999, the Company had cash and cash equivalents of
approximately $86.0 million and at November 15, 1999, approximately $48.6
million available under its current bank credit facility. The Company believes
that the combination of funds available under the Company's bank credit facility
and synthetic lease facility, together with cash reserves, cash flow from
operations and proceeds from asset dispositions should be sufficient to meet the
Company's current
26
<PAGE> 27
planned acquisition, expansion, capital expenditure and working capital needs
over the next year. In addition, in order to provide the funds necessary for the
continued pursuit of the Company's long-term acquisition and expansion strategy,
the Company may 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. The outcome of certain pending legal proceedings described in
Part II, Item 1 hereof may have an impact on the Company's liquidity and capital
resources.
Year 2000
The Following Material is Designated as Year 2000 Readiness Disclosure for
Purposes of the Year 2000 Information and Readiness Disclosure Act.
PhyCor has developed a program designed to identify, assess, and
remediate potential malfunctions and failures that may result from the inability
of computers and embedded computer chips within the Company's information
systems and equipment to appropriately identify and utilize date-sensitive
information relating to periods subsequent to December 31, 1999. This issue is
commonly referred to as the "Year 2000 issue" and affects not only the Company,
but virtually all companies and organizations with which the Company does
business. The Company is dependent upon Year 2000 compliant information
technology systems and equipment in applications critical to the Company's
business. The Company's information technology systems ("IT systems") can be
broadly categorized into the following areas: (i) practice management, (ii)
managed care information, (iii) consumer decision support system that supports
the operations of CareWise, (iv) ancillary information systems, including
laboratory, radiology, pharmacy and clinical ancillary systems, and (v) other
administrative information systems including accounting, payroll, human resource
and other desktop systems and applications.
The Company generally owns and provides to its various affiliated
multi-specialty clinics the IT systems in use at those locations, and such
systems represent a variety of vendors. In addition, the Company generally owns
and provides biomedical equipment (laboratory equipment, radiology equipment,
diagnostic equipment and medical treatment equipment) for use by its affiliated
physician groups and by its Company-owned hospitals, as well as other equipment
in use at Company-owned or leased facilities such as telephone and HVAC systems.
Such non-information technology ("Non-IT") equipment often contains embedded
computer chips that could be susceptible to failure or malfunction as a result
of the Year 2000 issue.
To address the Year 2000 issue, the Company formed a Year 2000
committee comprised of representatives from a cross-section of the Company's
operations as well as the Company's senior management. Beginning in August 1997,
the committee, with the assistance of outside consultants, developed a
comprehensive plan to address the Year 2000 issue within all facets of the
Company's operations. The plan includes processes to inventory, assess,
remediate or replace as necessary, and test the Company's IT and Non-IT systems
and equipment. In addition, the Company has appointed local project coordinators
at all Company-owned facilities that are responsible for overseeing and
implementing the comprehensive project management activities at the local
subsidiary level. Each project coordinator is responsible for developing a local
project plan that includes processes to inventory, assess, remediate or replace
as necessary, and test the Company's IT and Non-IT systems and equipment. Each
local project coordinator is also responsible for assessing the compliance of
the electronic trading partners and business critical vendors for that location.
However, the compliance of certain vendors providing business critical IT
systems in wide use within the Company is being addressed by the Company's
senior management.
The Company has completed the inventory and assessment phase of
business critical IT systems and is in the process of upgrading or replacing
those business critical IT systems found not to be compliant, either internally
or through the upgrades provided by the Company's vendors. In certain cases, the
Company's plan provides for verification of Year 2000 compliance of
vendor-supplied IT systems by obtaining warranties and legal representations of
the vendors. Much of the remediation is being accomplished as a part of the
Company's normal process of standardizing various IT systems utilized by its
affiliated clinics and IPAs, although in certain cases the standardization
process is moving at an accelerated pace as a result
27
<PAGE> 28
of the Year 2000 issue. As of September 30, 1999, management believed
approximately 90% of the Company's business critical IT systems at the Company
and its subsidiaries to be Year 2000 compliant as a result of upgrades,
replacements or testing. The Company anticipates that all remediation and
testing of its business critical IT systems will be completed by December 1999
with the exception of the Company's Houston IPA market, which is anticipated to
be completed during December 1999.
The Company is completing the inventory and assessment phase of its
Non-IT systems and equipment, which are comprised primarily of medical equipment
with embedded chip technology that are located throughout the subsidiaries'
facilities. The Company is relying primarily on its local project coordinators
and on the equipment vendors' representations in order to complete the inventory
and assessment phase and either remediate or replace non-compliant equipment. As
of September 30, 1999, substantially all of the Company's subsidiaries had
completed the inventory and assessment phase, and those facilities had completed
approximately 95% of the remediation and testing of Non-IT systems and
equipment. The Company estimates that substantially all of its subsidiaries will
have substantially completed remediation and testing of Non-IT systems and
medical equipment by December 1999.
The Company is substantially dependent on a wide variety of third
parties to operate its business. These third parties include medical equipment
and IT software and hardware vendors, medical claims processors that act as
intermediaries between the Company's medical practice subsidiaries and the
payors of such claims, and the payors themselves, which includes the Health Care
Financing Administration ("HCFA"). HCFA paid to the Company Medicare claims that
comprised approximately 17% of the Company's net physician group, hospital and
IPA revenue during the first nine months of 1999. In most cases, these third
party relationships originate and are managed at the local clinic level.
Information concerning the Year 2000 readiness of the most significant third
parties has been received and analyzed by the Company. Together with its trade
associations and other third parties, the Company is monitoring the status and
progress of HCFA's Year 2000 compliance. HCFA has represented that its systems
are or will soon be Year 2000 compliant. Effective April 5, 1999, HCFA began
requiring all Medicare providers that submit Medicare claims electronically to
do so in an approved Year 2000 compliant format. The process of billing and
collecting for Medicare claims involves a number of third parties that the
Company does not control, including intermediaries and HCFA independent
contractors. The Company believes that most of these third parties are able to
comply with HCFA billing requirements. The Company is completing the process of
verifying the Year 2000 compliance of third parties upon which the Company
relies to process claims, including significant third party payors.
The Company currently is working at the parent company level and with
local project coordinators in each of its subsidiary locations to finalize
contingency plans for business critical IT systems and Non-IT medical equipment
to minimize business interruptions and avoid disruption to patient care as a
result of Year 2000 related issues. The Company anticipates that contingency
plans for non-compliant business critical IT systems and non-compliant Non-IT
medical equipment will be completed by December 1999.
There are a number of risks arising out of Year 2000 related failure,
any of which could have a material adverse effect on the Company's financial
condition or results of operations. These risks include (i) failures or
malfunctions in practice management applications that could prevent automated
scheduling, accounts receivable management and billing and collection on which
each of the subsidiary locations is substantially dependent, (ii) failures or
malfunctions of claims processing intermediaries or payors that may result in
substantial payment delays that could negatively impact cash flows, or (iii) the
failure of certain critical pieces of medical equipment that could result in
personal injury or misdiagnosis of patients treated at the Company's affiliated
clinics or hospitals. The Company has a number of ongoing obligations that could
be materially adversely impacted by one or more of the above described risks. If
the Company has insufficient cash flow to meet its expenses as a result of a
Year 2000 related failure, it will need to borrow available funds under its
credit lines or obtain additional financing. There can be no assurance that such
funds or any other additional financing will be available in the future when
needed.
To date, the Company estimates that it has spent approximately $28.0
million on the development and
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<PAGE> 29
implementation of its Year 2000 compliance plan. Of those costs, an estimated
$24.0 million has been incurred to acquire replacement systems and equipment,
including amounts spent in connection with standardizing certain of the
Company's IT systems that it would have spent regardless of the Year 2000
initiative.
The foregoing estimates and conclusions regarding the Company's Year
2000 plan contain forward looking statements and are based on management's best
estimates of future events. Risks to completing the Year 2000 plan include the
availability of resources, the Company's ability to discover and correct
potential Year 2000 problems that could have a serious impact on specific
systems, equipment or facilities, the ability of material third party vendors
and trading partners to achieve Year 2000 compliance, the proper functioning of
new systems and the integration of those systems and related software into the
Company's operations. Some of these risks are beyond the Company's control.
FORWARD-LOOKING STATEMENTS
Forward-looking statements of PhyCor included herein or incorporated by
reference including, but not limited to, those regarding future business
prospects, including the future stability and strength of core clinics to be
retained by PhyCor and the profitability and acceptance by the physicians of the
new relationship being structured between the PhyCor and its physician groups,
the acquisition of additional clinics, the development of additional IPAs, the
adequacy of PhyCor's capital resources, the adequacy of recent and proposed
asset impairment and restructuring charges, 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,
uncertainties, and other factors described in the Company's Annual Report on
Form 10-K for the year ended December 31, 1998.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
During the nine months ended September 30, 1999, there were no material
changes to the Company's quantitative and qualitative disclosures about the
market risks associated with financial instruments as described in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company and certain of its current and former officers and
directors, Joseph C. Hutts, Derril W. Reeves, Richard D. Wright (who is no
longer with the Company), Thompson S. Dent, and John K. Crawford (who is no
longer with the Company) have been named defendants in securities fraud class
action lawsuits filed in state and federal courts. The factual allegations of
the complaints in all lawsuits are substantially identical and assert that
during various periods between April 22, 1997 and September 22, 1998, the
defendants issued false and misleading statements which materially
misrepresented the earnings and financial condition of the Company and its
clinic operations and misrepresented and failed to disclose various other
matters concerning the Company's operations in order to conceal the alleged
failure of the Company's business model. Plaintiffs further assert that the
alleged misrepresentations caused the Company's securities to trade at inflated
levels while the individual defendants sold shares of the Company's stock at
such levels. In each of the lawsuits, the plaintiff seeks to be certified as the
representative of a class of all persons similarly situated who were allegedly
damaged by the defendants' alleged violations during the "class period." Each of
the lawsuits seeks damages in an indeterminate amount, interest,
29
<PAGE> 30
attorneys' fees and equitable relief, including the imposition of a trust upon
the profits from the individual defendants' trades. The federal court class
action lawsuits have been consolidated in the U.S. District Court for the Middle
District of Tennessee. Defendants' motion to dismiss is pending before that
court. On June 24, 1999, a lawsuit was filed in that court on behalf of
investors in the Company's debt securities. It is anticipated that this lawsuit
will be consolidated with the shareholder suits. The state court class action
lawsuits have been consolidated in Davidson County, Tennessee. After the Court
granted the defendants' motion to dismiss, the plaintiffs filed an amended
complaint on July 20, 1999 naming KPMG LLP, the Company's certified public
accounting firm, as an additional defendant. KPMG LLP removed the case to
federal court. Defendants intend to file a motion to dismiss the amended
complaint. The federal court has ordered the parties to participate in
mediation. On August 19, 1999, a shareholder derivative action was filed in the
Chancery Court of Davidson County, Tennessee. On October 14, 1999, the Chancery
Court stayed the case pending the outcome of the federal court litigation. The
Company believes that it has meritorious defenses to all of the claims, and
intends to defend vigorously against these actions. There can be no assurance,
however, that such defenses will be successful or that the lawsuits will not
have a material adverse effect on the Company. The Company's Restated Charter
provides that the Company shall indemnify the officers and directors for any
liability arising from these suits unless a final judgment establishes liability
(a) for a breach of the duty of loyalty to the Company or its shareholders, (b)
for acts or omissions not in good faith or which involve intentional misconduct
or a knowing violation of law or (c) for an unlawful distribution.
On January 23, 1999, the Company and Holt-Krock Clinic, P.L.C.
("Holt-Krock") entered into a settlement agreement with Sparks Regional Medical
Center and Sparks Regional Medical Center Foundation (collectively, "Sparks") to
resolve their lawsuits and all related claims between the parties and certain
former Holt-Krock physicians. Effective as of August 1, 1999, Holt-Krock, Sparks
and PhyCor consummated the transactions contemplated in the settlement agreement
and mutually dismissed their lawsuits and related claims between the parties. In
October 1999, the Company received from Sparks approximately $1.1 million from
an escrow account in payment of its remaining assets subject to the escrow. The
Company also intends to seek recovery of certain of its remaining assets through
litigation against several physicians formerly affiliated with Holt-Krock who
did not join Sparks.
On February 2, 1999, Prem Reddy, M.D., the former majority shareholder
of PrimeCare International, Inc., a medical network management company acquired
by the Company in May 1998, filed suit against the Company and certain of its
current and former directors and executive officers in United States District
Court for the Central District of California. The complaint asserts fraudulent
inducement relating to the PrimeCare transaction and that the defendants issued
false and misleading statements which materially misrepresented the earnings and
financial condition of the Company and its clinic operations and misrepresented
and failed to disclose various other matters concerning the Company's operations
in order to conceal the alleged failure of the Company's business model. The
Court granted the Company's motion to dismiss the action with respect to all of
its officers and directors, but the plaintiff has amended and refiled his
complaint. Discovery has begun in this litigation. The Company believes that it
has meritorious defenses to all of the claims and intends to vigorously defend
this suit, however, there can be no assurance that if the Company is not
successful in litigation, that this suit will not have a material adverse effect
on the Company.
On February 6, 1999, White-Wilson Medical Center, P.A. ("White -
Wilson") filed suit against PhyCor of Fort Walton Beach, Inc., the PhyCor
subsidiary with which it is a party to a service agreement, in the United States
District Court for the Northern District of Florida. White-Wilson is seeking a
declaratory judgment regarding the enforceability of the fee arrangement in
light of an opinion of the Florida Board of Medicine and OIG Advisory Opinion
98-4. On November 3, 1999, the Court granted the parties' motion to extend all
deadlines by 90 days because of the imminent settlement of all disputes between
the parties. Additionally, on March 17, 1999, the Clark-Holder Clinic, P.A.
filed suit against PhyCor of LaGrange, Inc., the PhyCor subsidiary with which it
is a party to a service agreement, in Georgia Superior Court for Troup County,
Georgia similarly questioning the enforceability of the fee arrangement in light
of OIG Advisory Opinion 98-4. On April 27, 1999, the Company filed a motion to
remove the case to the federal district court in Georgia. On October 7, 1999,
the Court granted PhyCor of LaGrange, Inc.'s motion to dismiss the action
brought by the physician group.
30
<PAGE> 31
Certain litigation is pending against the physician groups affiliated
with the Company and IPAs managed by the Company. Certain plaintiffs in such
litigation have attempted to join the Company as responsible in whole or in part
for activities of the physician groups, IPAs or their physicians. The Company
has not assumed any liability in connection with such litigation, and intends to
vigorously challenge any theory that the Company is liable for the activities of
medical groups, IPAs or their physicians. Claims against the physician groups
and IPAs could result in substantial damage awards to the claimants that 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.
The U.S. Department of Labor (the "Department") is conducting an
investigation of the administration of the PhyCor, Inc. Savings and Profit
Sharing Plan (the "Plan"). The Department has not completed its investigation,
but has raised questions involving certain administrative practices of the Plan
in early 1998. The Department has not recommended enforcement action against
PhyCor, nor has it identified an amount of liability or penalty that could be
assessed against PhyCor. Based on the nature of the investigation, PhyCor
believes that its financial exposure is not material. PhyCor intends to
cooperate with the Department's investigation. There can be no assurance,
however, that PhyCor will not have a monetary penalty imposed against it.
The Company's forward-looking statements relating to the
above-described litigation reflect management's best judgment based on the
status of the litigation to date and facts currently known to the Company and
its management and, as a result, involve a number of risks and uncertainties,
including the possible disclosure of new facts and information adverse to the
Company in the discovery process and the inherent uncertainties associated with
litigation.
31
<PAGE> 32
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
On September 3, 1999, the Company issued the Series A Notes to funds
managed by Warburg, Pincus resulting in gross proceeds to the Company of $100
million. The Series A Notes accrete to a maturity value of $266,389,621 on the
fifteenth anniversary of the issuance date and are convertible at an initial
conversion price of $6.67 into 14,992,408 shares of the Company's common stock.
The Company issued the Series A Notes in a transaction intended to be exempt
from the registration requirements of the Securities Act of 1933, as amended,
pursuant to Section 4(2) thereunder. The Company used the net proceeds from the
Series A Notes to repay indebtedness under the Company's credit facility.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
<S> <C>
3.1 -- Restated Charter of PhyCor (1)
3.2 -- Amendment to Restated Charter of PhyCor (2)
3.3 -- Amendment to Restated Charter of PhyCor (3)
3.4 -- Amended Bylaws of PhyCor (1)
4.1 -- Specimen of Common Stock Certificate (4)
4.2 -- Shareholder Rights Agreement, dated February 18, 1994, between PhyCor and First Union
National Bank of North Carolina (5)
10.1 -- PhyCor, Inc. 1999 Incentive Stock Plan (6)
10.2 -- Amendment, dated August 23, 1999, to the Securities Purchase Agreement for Zero Coupon
Convertible Subordinated Notes due 2014, dated as of June 15, 1999 (7)
10.3 -- Amendment No. 3 and Consent dated as of September 1, 1999, to the Second Amended and Restated
Revolving Credit Agreement, dated as of April 2, 1998, among the Registrant, the Banks named
therein and Citibank, N.A. (6)
27 -- Financial Data Schedule (for SEC use only)(6)
</TABLE>
- -------------
(1) Incorporated by reference to exhibits filed PhyCor's Annual Report on Form
10-K for the year ended December 31, 1994, Commission No. 0-19786.
(2) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-3, Registration No. 33-93018.
(3) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-3, Registration No. 33-98528.
(4) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-1, Registration No. 33-44123.
(5) Incorporated by reference to exhibits filed with PhyCor's Current Report on
Form 8-K dated February 18, 1994, Commission No. 0-19786.
(6) Filed herewith.
(7) Incorporated by reference to exhibits filed with PhyCor's Current Report on
Form 8-K dated September 7, 1999, Commission No. 0-19786.
(B) REPORTS ON FORM 8-K.
The Company filed a Current Report on Form 8-K on September 7, 1999
announcing the issuance and sale of the Series A Notes to E. M. Warburg, Pincus
& Co., LLC, resulting in gross proceeds to the Company of $100 million, pursuant
to Item 5 of Form 8-K.
32
<PAGE> 33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHYCOR, INC.
By: /s/ W. Carl Whitmer
-------------------------------------
W. Carl Whitmer
Vice President and Treasurer
(principal financial and accounting
officer)
Date: November 15, 1999
33
<PAGE> 34
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
<S> <C>
3.1 -- Restated Charter of PhyCor (1)
3.2 -- Amendment to Restated Charter of PhyCor (2)
3.3 -- Amendment to Restated Charter of PhyCor (3)
3.4 -- Amended Bylaws of PhyCor (1)
4.1 -- Specimen of Common Stock Certificate (4)
4.2 -- Shareholder Rights Agreement, dated February 18, 1994, between PhyCor and First Union
National Bank of North Carolina (5)
10.1 -- PhyCor, Inc. 1999 Incentive Stock Plan (6)
10.2 -- Amendment, dated August 23, 1999, to the Securities Purchase Agreement for Zero Coupon
Convertible Subordinated Notes due 2014, dated as of June 15, 1999 (7)
10.3 -- Amendment No. 3 and Consent dated as of September 1, 1999, to the Second Amended and Restated
Revolving Credit Agreement, dated as of April 2, 1998, among the Registrant, the Banks named
therein and Citibank, N.A. (6)
27 -- Financial Data Schedule (for SEC use only)(6)
</TABLE>
- -------------
(1) Incorporated by reference to exhibits filed PhyCor's Annual Report on Form
10-K for the year ended December 31, 1994, Commission No. 0-19786.
(2) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-3, Registration No. 33-93018.
(3) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-3, Registration No. 33-98528.
(4) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-1, Registration No. 33-44123.
(5) Incorporated by reference to exhibits filed with PhyCor's Current Report on
Form 8-K dated February 18, 1994, Commission No. 0-19786.
(6) Filed herewith.
(7) Incorporated by reference to exhibits filed with PhyCor's Current Report on
Form 8-K dated September 7, 1999, Commission No. 0-19786.
<PAGE> 1
EXHIBIT 10.1
PHYCOR, INC.
1999 INCENTIVE STOCK PLAN
1. Name of the Plan. This incentive stock plan has been established by
action of the board of directors of PhyCor, Inc. (the "Board") on April 5, 1999,
as the PhyCor, Inc. 1999 Incentive Stock Plan.
2. The Purpose of the Plan. The Plan is intended to provide an
opportunity for individuals performing services to PhyCor, Inc., a Tennessee
corporation (the "Corporation"), including officers, directors and key employees
of the Corporation and its subsidiaries ("Subsidiaries"), as subsidiaries are
defined in Section 424(f) of the Internal Revenue Code of 1986 (the "Code"), to
acquire shares of the Corporation's common stock, no par value per share
("Common Stock"), and to provide for additional compensation based on
appreciation of the Corporation's stock. The Plan provides for the (i) grant of
incentive stock options, as defined in section 422 of the Code, ("Incentive
Stock Options") and (ii) stock options not qualifying as Incentive Stock Options
("Non-Qualified Stock Options"), each providing an equity interest in the
Corporation's business as an incentive for service or continued service with the
Corporation and to aid the Corporation in retaining and obtaining key personnel
of outstanding ability. As used herein, "Option" refers to an Incentive Stock
Option or a Non-Qualified Stock Option.
3. Stock Subject to the Plan. The maximum numbers of shares of Common
Stock which may be issued under Options granted under the Plan is 4,500,000
(subject to adjustments pursuant to Section 8), which may be either authorized
and unissued shares or shares that are held in the treasury of the Corporation,
as shall be determined by the Board. If an Option expires or terminates for any
reason without being exercised in full, the shares of Common Stock represented
by such Option shall again be available for purposes of the Plan.
4. Administration of the Plan. This Plan shall be administered by a
committee composed of at least two individuals (or such number that satisfies
section 162(m)(4)(C) of the Code and Rule 16b-3 of the Securities Exchange Act
of 1934 (the "Exchange Act")) who are "non-employee directors" as defined in
Rule 16b-3(b) of the Exchange Act and would be considered "outside directors" as
defined in Treasury Regulation Section 1.162-27(e)(2), and who are designated by
the Board as the "compensation committee" or are otherwise designated to
administer the Plan (the "Committee"). The Committee shall have full authority
in its discretion to determine the eligible persons to whom Options shall be
granted and the terms and provisions of the option grants subject to the Plan.
In making such determinations, the Committee may take into account the nature of
the services rendered and to be rendered by such persons, their present and
potential contributions to the Corporation and any other factors which the
Committee deems relevant. Subject to the provisions of the Plan, the Committee
shall have full and conclusive authority to interpret the Plan; to prescribe,
amend and rescind rules and regulations relating to the Plan; to determine the
terms and provisions of the respective agreements which represent each Option
(hereinafter, an "Agreement"), which need not be identical; to determine the
<PAGE> 2
restrictions on transferability of Common Stock acquired upon exercise of
Options; and to make all other determinations necessary or advisable for the
proper administration of the Plan.
The Committee may delegate authority to the president or chief
executive officer of the Corporation to amend any Agreement in the manner
specified in a written delegation to modify the exercisability or vesting of the
Option or in any other manner that is specified in a written delegation by the
Committee.
5. Eligibility and Limits. Non-Qualified Stock Options may be granted
to employees and directors as are selected by the Committee. Incentive Stock
Options may only be granted to employees of the Corporation and its present or
future Subsidiaries. The aggregate fair market value (determined as of the time
an Incentive Stock Option is granted) of the Common Stock with respect to which
Incentive Stock Options are exercisable by an individual for the first time
during any calendar year, taking into account Incentive Stock Options granted
under this Plan and under all other plans of the Corporation or Subsidiary
corporations shall not exceed $100,000. No employee of the Company or a
Subsidiary may receive Options with respect to more than 750,000 shares of
Common Stock during any calendar year (which number of shares shall be subject
to adjustments pursuant to Section 8 herein).
6. Incentive Stock Options and Non-Qualified Stock Options. At the time
any Option is granted under this Plan, the Committee shall determine whether
said Option is to be an Incentive Stock Option or a Non-Qualified Stock Option,
and the Option shall be clearly identified to designate its status as an
Incentive Stock Option or a Non-Qualified Stock Option. The number of shares as
to which Incentive Stock Options and Non-Qualified Stock Options shall be
granted shall be determined by the Committee in its sole discretion, subject to
the limitations of Section 3 and Section 5. At the time any Incentive Stock
Option granted under this Plan is exercised, the certificates representing the
shares of Common Stock purchased pursuant to said Option shall be clearly
identified by legend as representing shares purchased upon exercise of an
Incentive Stock Option.
7. Terms and Conditions of Options. Subject to the following
provisions, all Options shall be in such form and upon such terms and conditions
as the Committee, in its discretion, may from time to time determine.
(a) Option Price.
(i) Incentive Stock Options. The Option price per
share shall in no event be less than 100% of the fair market
value per share of the Common Stock on the date the Option is
granted. If the employee owns (as defined in Code section 424)
more than 10% of the total combined voting power of all
classes of the Corporation's stock or of the stock of its
parent or Subsidiary, the Option price per share shall not be
less than 110% of the fair market value per share of the
Common Stock on the date the Option is granted.
(ii) Non-Qualified Options. The Option price per share
shall not be less than 85% of the fair market value per share of the
Common Stock on the date the Option is granted.
<PAGE> 3
(iii) Fair Market Value. For purposes of this Plan,
and as used herein, the "fair market value" of a share of
Common Stock is the closing sales price on the date in
question (or, if there was no reported sale on such date, on
the last preceding day on which any reported sale occurred) of
the Common Stock as reported on the Nasdaq National Market
System (or such other exchange that is, at the time, the
primary exchange on which the Common Stock is traded).
(b) Date of Grant. The date the Option is granted shall be the
date on which the Committee has determined the recipient of the Option, the
number of shares covered by the Option and has taken all such other action as is
necessary to complete the grant of the Option. Accordingly, the date an Option
is granted may be deemed to be prior to the time that an Agreement is executed
by a Participant and the Company.
(c) Option Term. No Option shall be exercisable after the expiration
of ten years from the date the Option is granted, unless provided otherwise in
an Agreement that covers a Non-Qualified Stock Option. No Incentive Stock Option
granted to an employee who at the time of grant owns (as defined in Code section
424) more than 10% of the total combined voting power of all classes of the
Corporation's stock or of the stock of its parent or Subsidiary shall be
exercisable after the expiration of five years from the date it is granted.
(d) Payment. Unless otherwise provided by the Agreement, payment of
the exercise price of an Option shall be made in cash, Common Stock that was
acquired at least six months prior to the exercise of the Option, other
consideration acceptable to the Committee, or a combination thereof. Such
payment shall be made at the time that the Option or any part thereof is
exercised, and no shares shall be issued until full payment therefor has been
made.
(e) Status of Option Holder. The holder of an Option shall, as such,
have none of the rights of a stockholder.
(f) Nontransferability of Options. In general, Options shall not be
transferable or assignable except by will or by the laws of descent and
distribution and shall be exercisable, during the holder's lifetime, only by
him; provided, however, that a Participant may transfer a Non-Qualified Stock
Option to the extent permitted by the Committee and set forth in the Agreement
evidencing the Option.
(g) Termination of Employment; Disability; Retirement or Death.
Except as provided below, an Option may not be exercised by a holder unless he
has been an employee continually from the date of the grant until the date
ending three months before the date of exercise. If the holder of an Option
dies, such Option may be exercised by a legatee or legatees of the holder under
his last will, or by his personal representative or distributee, at any time
during the twelve-month period following his death. If a holder is discharged as
an employee, or removed as a director, for cause, as determined by the
Committee, Options held by him shall not be exercisable after such discharge or
removal, unless otherwise provided herein. If a holder ceases to be an employee
by reason of permanent disability, within the meaning of section 22(e)(3) of the
Code ("Disability"), all Options held by the holder may be exercised at any time
during the twelve-month period
<PAGE> 4
following the Disability. Upon a holder's Retirement (as defined below),
Disability or Death, all Options held by the holder shall become fully
exercisable as to the full number of shares covered thereby notwithstanding any
vesting schedule contemplated in the Option. As used herein, "retirement" shall
mean (i) the holder is at least 60 years old and has continuously been employed
by the Corporation or a subsidiary for a period of at least five years, or is at
least 55 years old and has continuously been employed by the Corporation or a
subsidiary for a period of at least twenty years, and (ii) the holder has given
written notice in a form satisfactory to the Committee of his permanent
retirement. Notwithstanding this Section 7(g), no Incentive Stock Option may be
exercised more than ten years after the date on which it was granted, and a
holder shall be deemed to be an employee or director so long as the holder is an
employee or director of a parent or Subsidiary of the Corporation or by another
corporation (or a parent or subsidiary corporation of such other corporation)
which has assumed the Option of the holder in a transaction to which section
424(a) of the Code is applicable. The provisions of this Section 7(g) shall be
deemed to apply to any outstanding Option without regard to when such Option was
granted by the Committee.
(h) Limited Rights of Exercise. Notwithstanding any vesting
schedule contained in an Agreement, an Option may be exercised during the Option
term as to the full number of shares covered by the Option, if: (1) a tender
offer or exchange offer has been made for shares of Common Stock, provided that
the corporation, person or other entity making such offer purchases or otherwise
acquires shares of Common Stock pursuant to such offer; (2) the stockholders of
the Corporation have approved a definitive agreement (a "Merger Agreement") to
merge or consolidate with or into another corporation pursuant to which the
Corporation will not survive or will survive only as a subsidiary of another
corporation (the "Transaction"), or to sell or otherwise dispose of all or
substantially all of its assets, (3) any person or group (as such terms are
defined in section 13(d) of the Securities Exchange Act of 1934, as amended (the
"Act")), becomes the beneficial owner (as such term is defined in Rule 13(d)
pursuant to the Act) of 50% or more of the outstanding shares of Common Stock,
or (4) the individuals who, as of the date of this Plan, are members of the
Board (the "Incumbent Board"), cease for any reason to constitute at least a
majority of the members of the Board; provided, however, that if the election,
or nomination for election by PhyCor's stockholders, of any new director was
approved by a vote of at least a majority of the Incumbent Board, such new
director shall, for purposes of this Plan, be considered as a member of the
Incumbent Board; provided, further, however, that no individual shall be
considered a member of the Incumbent Board if such individual initially assumed
office as a result of either an actual or threatened "Election Contest" (as
described in Rule 14a-11 promulgated under the Exchange Act) or other actual or
threatened solicitation of proxies or consents by or on behalf of a Person other
than the Board (a "Proxy Contest") including by reason of any agreement intended
to avoid or settle any Election Contest or Proxy Contest. If any of the events
specified in this subparagraph (g) (a "Change in Control") have occurred, the
Option shall be fully exercisable: (x) in the event of a tender offer or
exchange offer as described in clause (1) above, during the term of the tender
or exchange offer and for a period of 30 days thereafter; (y) in the event of
execution of a Merger Agreement as defined in clause (2) above, within a 30-day
period commencing on the date of execution of a Merger Agreement, and the Option
holder may condition such exercise upon the consummation of the Transaction; (z)
in the event of an event described in clause (3) above, within a 30-day
<PAGE> 5
period commencing on the date upon which the Corporation is provided a copy of
Schedule 13D or 13G (filed pursuant to section 13(d) or 13(g) of the Act and the
rules and regulations promulgated thereunder) indicating that any person or
group has become the beneficial owner of 50% or more of the outstanding shares
of Common Stock or, if the Corporation is not subject to section 13(d) of the
Act, within a 30-day period commencing on the date upon which the Corporation
receives written notice that any person or group has become the beneficial owner
of 50% or more of the outstanding shares of Common Stock or (a) if a change in
the Incumbent Board occurs pursuant to clause (4) above, within a 30 day period
commencing upon the date the Option holder was given notice of the change in the
Board composition. The provisions of this Section 7(h) shall be deemed to apply
to any outstanding Option without regard to when such Option was granted by the
Committee. Moreover, unless the Option holder specifically elects otherwise, if
the Option holder exercises less than all the Options as to which vesting is
accelerated pursuant to this Section 7(h), the Options exercised shall be deemed
to be those which had the latest vesting date.
(i) Upon exercise of a Nonqualified Stock Option, the
Participant shall, upon notification of the amount due and prior to or
concurrently with the delivery of the certificates representing the shares, pay
to the Corporation amounts necessary to satisfy applicable federal, state and
local withholding tax requirements or shall otherwise make arrangements
satisfactory to the Corporation for such requirements. Such withholding
requirements shall not apply to the exercise of an Incentive Stock Option, or to
a disqualifying disposition of Common Stock that is acquired with an Incentive
Stock Option, unless the Committee gives the Participant notice that withholding
described in this Section is required.
8. Changes in Capitalization; Merger; Liquidation. The number of shares
of Common Stock as to which Options may be granted, the number of shares covered
by each outstanding Option, and the price per share in each outstanding Option,
shall be proportionately adjusted for (i) any increase or decrease in the number
of issued shares of Common Stock resulting from a subdivision or combination of
shares, (ii) the payment of a stock dividend in shares of Common Stock to
holders of outstanding shares of Common Stock or (iii) any other increase or
decrease in the number of such shares effected without receipt of consideration
by the Corporation.
If the Corporation shall be the surviving corporation in any merger,
share exchange or consolidation, recapitalization, reclassification of shares or
similar reorganization, the holder of each outstanding Option shall be entitled
to receive or purchase, as applicable, at the same times and upon the same terms
and conditions as are then provided in the relevant Agreement, the number and
class of shares of Common Stock or other securities to which a holder of the
number of options or shares of Common Stock at the time of such transaction
would have been entitled to receive as a result of such transaction.
In the event of any such changes in capitalization of the Corporation,
the Committee may make such additional adjustments in the number and class of
shares of Common Stock or other securities with respect to which outstanding
Options are exercisable and with respect to which future Options may be granted
as the Committee in its sole discretion shall deem equitable or appropriate,
subject to the provisions of this Section 8.
<PAGE> 6
A dissolution or liquidation of the Corporation shall cause each
outstanding Option to terminate.
Upon a merger, share exchange, consolidation or other business
combination in which the Corporation is not the surviving corporation, the
surviving corporation shall substitute another option with equivalent terms and
value as the outstanding Option in a manner consistent with section 424(a) of
the Code. In the event of a change of the Corporation's shares of Common Stock
with par value into the same number of shares with a different par value or
without par value, the shares resulting from any such change shall be deemed to
be the Common Stock within the meaning of the Plan. Except as expressly provided
in this Section 8, the holder of a Option shall have no rights by reason of any
subdivision or combination of shares of Common Stock of any class or the payment
of any stock dividend or any other increase or decrease in the number of shares
of Common Stock of any class or by reason of any dissolution, liquidation,
merger, share exchange or consolidation or distribution to the Corporation's
stockholders of assets of stock of another corporation, and any issue by the
Corporation of shares of Common Stock of any class, or securities convertible
into shares of Common Stock of any class, shall not affect, and no adjustment by
reasons thereof shall be made with respect to, the number or price of shares of
Common Stock subject to the Option. The existence of the Plan and the Options
granted pursuant to the Plan shall not affect in any way the right or power of
the Corporation to make or authorize any adjustment, reclassification,
reorganization or other change in its capital or business structure, any merger,
share exchange or consolidation of the Corporation, any issue of debt or equity
securities having preferences or priorities as to the Common Stock or the rights
thereof, the dissolution or liquidation of the Corporation, any sale or transfer
of all or any part of its business or assets, or any other corporate act or
proceeding.
9. Termination and Amendment of the Plan. The Plan shall remain in
effect until terminated by the Board. Upon termination of the Plan, no Options
shall be granted under the Plan after that date, but any Options granted before
termination of the Plan shall remain exercisable thereafter until they expire or
lapse according to their terms. The Board may amend or terminate this Plan at
any time; provided, however, an amendment that would have a material adverse
effect on the rights of a Participant under an outstanding Option is not valid
with respect to such Option without the Participant's consent, except as
necessary for Incentive Stock Options to maintain qualification under the Code;
and provided, further, that the shareholders of the Corporation must approve the
following:
(a) within 12 months before or after the date of adoption, any
amendment that increases the aggregate number of shares of Stock that may be
issued pursuant to Incentive Options or changes the employees (or class of
employees) eligible to receive Incentive Options;
(b) before the effective date thereof, any amendment that changes
the number of shares which may be issued in the aggregate pursuant to Options
granted under the Plan;
(c) before the effective date thereof, any amendment that
increases the period during which Options may be granted or exercised; and
<PAGE> 7
(d) before the date that compensation is paid with respect thereto,
any amendment that changes the number of Options which may be granted to an
employee of the Corporation or a Subsidiary under the Plan during a specified
period.
10. Effective Date of Plan. This Plan is effective upon its adoption by
the Board; provided that any Incentive Stock Options granted with respect to
shares of Common Stock that were reserved for the Plan on the date of Board
adoption shall become void if this Plan is not approved by a majority of the
votes cast by holders of Common Stock entitled to vote at a meeting of
shareholders at which a quorum is present within 12 months of the date of the
adoption of the Plan by the Board. No Incentive Stock Option may be granted
under this Plan with respect to the shares of Common Stock identified in Section
3 more than ten years after the date that this Plan was adopted by the Board.
Incentive Stock Options granted before such date shall remain valid in
accordance with their terms.
11. Incentive Stock Option Plan. All Incentive Stock Options to be
granted hereunder are intended to comply with sections 421 and 422 of the Code.
All Options are intended to be treated as "performance-based compensation"
within the meaning of Section 162(m) of the Code. The provisions of this Plan
and all Options granted hereunder shall be construed in such manner as to
effectuate such intent.
IN WITNESS WHEREOF, the undersigned officer of the Corporation has
executed this instrument on this the 5th day of April, 1999.
PHYCOR, INC.
By: John K. Crawford
Its: Executive Vice President and
Chief Financial Officer
<PAGE> 1
EXHIBIT 10.3
AMENDMENT NO. 3 AND CONSENT
Dated as of September 1, 1999
To the banks, financial institutions and
other institutional lenders (collectively,
the "BANKS") party to the Credit Agreement
referred to below, to Citibank, N.A., as
administrative agent (the "AGENT") for the
Banks, to SunTrust Bank, Nashville, N.A., as
the swing line bank, and to NationsBank,
N.A., as documentation agent
Ladies and Gentlemen:
We refer to the Second Amended and Restated Revolving Credit
Agreement dated as of April 2, 1998, as amended by Amendment No.1 and Consent
thereto dated as of September 22, 1998 and Amendment No. 2 and Consent thereto
dated as of March 10, 1999 (such Credit Agreement, as so amended, the "CREDIT
AGREEMENT") among the undersigned and you. Capitalized terms not otherwise
defined in this Amendment No. 3 and Consent have the same meanings as specified
in the Credit Agreement.
It is hereby agreed by you and us as follows:
The Credit Agreement is, effective as of the effective date of
this Amendment No. 3 and Consent, hereby amended as follows:
(a) Section 1.01 is amended by adding thereto in the correct
alphabetical order the following definitions:
"`Securities Repurchase Amount' means, at any time,
$35,000,000 plus, after the issuance of any Series B Zero
Coupon Convertible Subordinated Notes, 50% of the gross
proceeds received by the Borrower from the issuance of such
Series B Zero Coupon Convertible Subordinated Notes.
"`Series A Zero Coupon Convertible Subordinated Notes'
means the Series A Zero Coupon Convertible Subordinated Notes
issued by the Borrower for aggregate gross proceeds received
by the Borrower of not less than $100,000,000 and having the
terms and conditions set forth on Exhibit H hereto, which
shall include terms stating that such Series A Zero Coupon
Convertible Subordinated Notes shall have no requirement for
cash payments at any time that any Notes remain unpaid or any
Letter of Credit is outstanding or any Bank shall have a
Commitment under the Credit Agreement."
1
<PAGE> 2
"`Series B Zero Coupon Convertible Subordinated Notes'
means the Series B Zero Coupon Convertible Subordinated Notes
issued by the Borrower for aggregate gross proceeds received
by the Borrower not in excess of $100,000,000 and having the
terms and conditions set forth on Exhibit H hereto, which
shall include terms stating that such Series B Zero Coupon
Convertible Subordinated Notes shall have no requirement for
cash payments at any time that any Notes remain unpaid or any
Letter of Credit is outstanding or any Bank shall have a
Commitment under the Credit Agreement."
"`Zero Coupon Convertible Subordinated Notes' means,
collectively, the Series A Zero Coupon Convertible
Subordinated Notes and the Series B Zero Coupon Convertible
Subordinated Notes."
(b) The definition of "Debt" in Section 1.01 is amended by
adding at the end thereof a new sentence to read as follows:
"The obligations of the Borrower and its subsidiaries
under the Zero Coupon Convertible Subordinated Notes shall
be deemed not to be Debt."
(c) The definition of "EBITDA" in Section 1.01 is amended by
adding at the end thereof (a) new clause (xiv) to read as follows:
"plus (xiv) to the extent deducted in the calculation of Net
Income for such period, the aggregate amount of any reduction
in Net Income attributable to the charge-off of any intangible
assets in existence at or prior to June 30, 1999 made in
accordance with generally accepted accounting principles."
(d) The definition of "Applicable Eurodollar Rate Margin" in
Section 1.01 is amended by deleting such in its entirety and
substituting therefor the following:
"`Applicable Eurodollar Rate Margin' means, for the initial
Effective Period (as defined below), the percentage set forth
in the chart below based on the Consolidated Debt/EBITDA Ratio
of the Borrower and its Subsidiaries for the period ended June
30, 1999 (calculated taking into account the Debt repaid or
otherwise satisfied in full with the proceeds of the Zero
Coupon Convertible Subordinated Notes) and thereafter, for
each subsequent Effective Period, 1.3500% per annum; provided,
however, that if the Borrower, for a subsequent Effective
Period shall have satisfied the Consolidated Debt/EBITDA Ratio
test indicated in the table below, the Applicable Eurodollar
Rate Margin for the Effective Period as to which such test is
satisfied shall be the percentage rate per annum set forth
opposite the appropriate test for the Commitment in the table
below.
2
<PAGE> 3
<TABLE>
<CAPTION>
Applicable Eurodollar
"Consolidated Rate Margin for
Debt/EBITDA Ratio Advances
----------------- --------
<S> <C>
Greater than 3.50 to 1.00 1.3500%
Less than or equal to 3.50 to 1.00 but greater
than 3.00 to 1.00 1.1750%
Less than or equal to 3.00 to 1.00 but greater
than 2.50 to 1.00 1.0000%
Less than or equal to 2.50 to 1.00 but greater
than 2.00 to 1.00 0.8000%
Less than or equal to 2.00 to 1.00 0.7000%"
</TABLE>
The Applicable Eurodollar Rate Margin shall be determined by
the Agent each quarter on the basis of quarterly certified
Consolidated financial statements and a schedule evidencing
financial covenant compliance delivered to the Banks pursuant
to Section 6.04(b). The "Effective Period" with respect to the
Applicable Eurodollar Rate Margin shall be the period
commencing on the date of effectiveness of Amendment No. 3 and
Consent to this Agreement and ending on the fifth Business Day
after the Quarterly Delivery for such quarter (commencing with
the fiscal quarter ended September 30, 1999) and each period
thereafter commencing the fifth Business Day after the
Quarterly Delivery for the then most recent fiscal quarter and
ending on the fifth Business Day of the Quarterly Delivery for
the then immediately following fiscal quarter. Notwithstanding
the foregoing, the Applicable Eurodollar Rate Margin shall be
deemed to be 1.3500% per annum in respect of Advances made on
any day as of which the deliveries required to calculate the
Applicable Eurodollar Rate Margin shall not have been made."
(e) The definition of "Applicable Letter of Credit Fee Rate"
in Section 1.01 is amended by deleting such in its entirety and
substituting therefor the following:
"`Applicable Letter of Credit Fee Rate' means, for the initial
Effective Period (as defined below), the percentage set forth
in the chart below based on the Consolidated Debt/EBITDA Ratio
of the Borrower and its Subsidiaries for the period ended June
30, 1999 (calculated taking into account the Debt repaid or
otherwise satisfied in full with the proceeds of the Zero
Coupon Convertible Subordinated Notes) and thereafter, for
each subsequent Effective Period, 1.2250% per annum; provided,
however, that if the Borrower, for a subsequent Effective
Period shall have satisfied the Consolidated Debt/EBITDA Ratio
test indicated in the table below, the Applicable Letter of
Credit Fee Rate for the Effective Period as to which such test
is satisfied shall be the percentage rate per annum set forth
opposite the appropriate test for the Commitment in the table
below.
3
<PAGE> 4
<TABLE>
<CAPTION>
Applicable
"Consolidated Letter of Credit
Debt/EBITDA Ratio Fee Rate
----------------- --------
<S> <C>
Greater than 3.50 to 1.00 1.2250%
Less than or equal to 3.50 to 1.00 but greater 1.0500%
than 3.00 to 1.00
Less than or equal to 3.00 to 1.00 but greater 0.8750%
than 2.50 to 1.00
Less than or equal to 2.50 to 1.00 but greater 0.6750%
than 2.00 to 1.00
Less than or equal to 2.00 to 1.00 0.5750%"
</TABLE>
The Applicable Letter of Credit Fee Rate shall be determined
by the Agent each quarter on the basis of quarterly certified
Consolidated financial statements and a schedule evidencing
financial covenant compliance delivered to the Banks pursuant
to Section 6.04(b). The "Effective Period" with respect to the
Applicable Letter of Credit Fee Rate shall be the period
commencing on the date of effectiveness of Amendment No. 3 and
Consent to this Agreement and ending on the fifth Business Day
after the Quarterly Delivery for such quarter (commencing with
the fiscal quarter ended September 30, 1999) and each period
thereafter commencing the fifth Business Day after the
Quarterly Delivery for the then most recent fiscal quarter and
ending on the fifth Business Day of the Quarterly Delivery for
the then immediately following fiscal quarter. Notwithstanding
the foregoing, the Applicable Letter of Credit Fee Rate shall
be deemed to be 1.2250% per annum in respect of Advances made
on any day as of which the deliveries required to calculate
the Applicable Eurodollar Rate Margin shall not have been
made.
(f) The definition of "Applicable Utilization Fee Rate" in
Section 1.01 is deleted in its entirety.
(g) The definition of "Total Liabilities" in Section 1.01 is
amended by adding at the end thereof a new sentence to read as follows:
"The obligations of the Borrower and its subsidiaries
under the Zero Coupon Convertible Subordinated Notes
shall be deemed not to be Total Liabilities."
(h) Section 3.01 is amended by deleting the figure
"$50,000,000" in the fifth line thereof and substituting therefor the
figure "$75,000,000".
(i) Section 6.02(e)(i)(C) is amended by deleting clauses (1),
(2) and (3) therein and replacing such clauses with the phrase "the
Securities Repurchase Amount".
(j) Section 6.02(f)(iv) is amended by adding immediately after
the phrase "aggregate amount" therein the parenthetical "(together with
the aggregate amount of capital investments made pursuant to clause
(v)).
4
<PAGE> 5
(k) Section 6.02(f)(viii) is amended by deleting clauses (1),
(2) and (3) therein and replacing such clauses with the phrase "the
Securities Repurchase Amount".
(l) Section 6.02(f) is amended by adding at the end thereof a
new clause (x) to read as follows:
"(x) the Borrower and its Subsidiaries may make
investments consisting of notes receivables financing sale
or other disposition of assets permitted hereunder in an
aggregate amount not to exceed $45,000,000."
(m) Section 6.02(f)(v) is amended by deleting the figure
"$15,000,000" therein and replacing such figure with the phrase
(together with the aggregate amount of capital investments made
pursuant to clause (iv)) $50,000,000.
(n) Section 6.2(j) is amended by adding immediately after each
reference therein (prior to the proviso contained therein) to "Debt"
the phrase "or the Zero Coupon Convertible Subordinated Notes".
(o) Section 6.02(j)(vii) is amended by deleting clauses (1),
(2) and (3) therein and replacing such clauses with the phrase "the
Securities Repurchase Amount".
(p) Section 6.03(a) is amended by deleting such in its
entirety and substituting therefor the following:
"(a) Consolidated Net Worth. Permit at any date of
determination the Consolidated Net Worth of the Borrower and
its Subsidiaries to be less than $683,000,000, plus (i)(A) 80%
of the net proceeds received from the issuance, sale or
disposition of the Borrower's Securities (common, preferred or
special), securities converted into or exchanged for
Securities, and any rights, options, warrants and similar
instruments from December 31, 1997 to such date of
determination minus (B)(x) the aggregate amount not in excess
of $6,500,000 paid to acquire shares of Common Stock of the
Borrower and (y) after the issuance of the Series B Zero
Coupon Convertible Subordinated Notes, the aggregate amount
not in excess of $78,500,000 paid to acquire shares of Common
Stock of the Borrower plus (ii) 50% of positive Consolidated
Net Income (if any) earned from December 31, 1997 through such
date of determination (without regard for net losses)."
(q) Section 6.03(c) is amended by deleting clause (y) therein
and replacing such clause with the following clauses:
"(y) for each such period ending thereafter but prior to
March 31, 2000, 3.75 to 1.00 and (z) for each period
thereafter, 3.50 to 1.00.
(r) Section 7.01(j) is amended by deleting the figure "5%"
therein and replacing such figure with the figure "10%".
(s) Section 7.01(o) is amended in full to read "[Intentionally
Omitted]."
5
<PAGE> 6
(t) The Credit Agreement is hereby amended by adding thereto
Exhibit H to read as set forth in Schedule I hereto.
Notwithstanding the provisions of Section 7.01(j), the
Majority Banks hereby consent to the termination of the Service Agreements
listed on Schedule II hereto.
This Amendment No. 3 and Consent shall become effective as of
the date first above written when, and only when, (i) the Agent shall have
received by 5:00 pm (New York City time) on September 1, 1999, counterparts of
this Amendment No. 3 and Consent executed by the undersigned, the Issuing Bank
and the Majority Banks or, as to any of the Banks, advice satisfactory to the
Agent that such Bank has executed this Amendment No. 3 and Consent (all such
Banks that shall have so executed this Amendment No. 3 and Consent being the
"APPROVING BANKS"), (ii) the Agent shall have received no later than the date of
the issuance of the Series A Zero Coupon Convertible Subordinated Notes, for the
ratable account of each Approving Bank, a consent fee of of one percent of each
such Approving Bank's Commitment (which fee the Agent will distribute to such
Approving Banks no later than the first Business Day after the date this
Amendment No. 3 and Consent becomes effective), (iii) the consent attached
hereto executed by each Guarantor and (iv) the Borrower shall have, prior to
December 1, 1999, (A) issued the Series A Zero Coupon Convertible Subordinated
Notes for net cash proceeds of not less than $92,000,000 and (B) applied at
least $92,000,000 of such net cash proceeds to prepay Advances under the Credit
Agreement. This Amendment No. 3 and Consent is subject to the provisions of
Section 9.01 of the Credit Agreement.
On and after the effectiveness of this Amendment No. 3 and
Consent, each reference in the Credit Agreement to "this Agreement",
"hereunder", "hereof" or words of like import referring to the Credit Agreement,
and each reference in the Notes and each of the other Loan Documents to "the
Credit Agreement", "thereunder", "thereof" or words of like import referring to
the Credit Agreement, shall mean and be a reference to the Credit Agreement, as
amended by this Amendment No. 3 and Consent.
The Credit Agreement, the Notes and each of the other Loan
Documents, as specifically amended by this Amendment No. 3 and Consent, are and
shall continue to be in full force and effect and are hereby in all respects
ratified and confirmed. The execution, delivery and effectiveness of this
Amendment No. 3 and Consent shall not, except as expressly provided herein,
operate as a waiver of any right, power or remedy of any Bank or the Agent under
any of the Loan Documents, nor constitute a waiver of any provision of any of
the Loan Documents.
If you agree to the terms and provisions hereof, please
evidence such agreement by executing and telecopying one signature page to Mario
Murillo at Citibank, N.A. (Telecopier No. (212) 793-5963) and returning at least
three counterparts of this Amendment No. 3 and Consent to Philip Strauss at
Shearman & Sterling, 555 California Street, San Francisco, CA 94104 (Telecopier
No. (415) 616-1199).
This Amendment No. 3 and Consent may be executed in any number
of counterparts and by different parties hereto in separate counterparts, each
of which when so executed shall be deemed to be an original and all of which
taken together shall constitute one and the same agreement. Delivery of an
executed counterpart of a signature page to this Amendment No. 3 and Consent by
telecopier shall be effective as delivery of a manually executed counterpart of
this Amendment No. 3 and Consent.
6
<PAGE> 7
This Amendment No. 3 and Consent shall be governed by, and
construed in accordance with, the laws of the State of New York.
Very truly yours,
PHYCOR, INC.
By /s/ John K. Crawford
-----------------------------------
Title: Executive Vice President and
Chief Financial Officer
7
<PAGE> 8
Agreed as of the date first above written:
CITIBANK, N.A.,
as Agent, as an Issuing Bank and as Bank
By /s/ James J. McCarthy
-------------------------------------
Title: Vice President
8
<PAGE> 9
BANK OF AMERICA, N.A.
as Documentation Agent
By /s/ Ashley Crabtree
-------------------------------------
Title: Managing Director
9
<PAGE> 10
AMSOUTH BANK
By /s/ Cathy M. Wind
-------------------------------------
Title: Vice President
10
<PAGE> 11
BANK OF AMERICA, N.A.
By /s/ Ashley Crabtree
-------------------------------------
Title: Managing Director
11
<PAGE> 12
BANKERS TRUST COMPANY
By /s/ David J. Bell
-------------------------------------
Title: Principal
12
<PAGE> 13
THE BANK OF NOVA SCOTIA
By /s/ W. J. Brown
-------------------------------------
Title: Vice President
13
<PAGE> 14
CREDIT LYONNAIS NEW YORK BRANCH
By /s/ Henry J. Reukauf
-------------------------------------
Title: Vice President
14
<PAGE> 15
FIRST AMERICAN NATIONAL BANK
By /s/ Allison H. Jones
-------------------------------------
Title: Senior Vice President
15
<PAGE> 16
THE FIRST NATIONAL BANK OF CHICAGO
By /s/ Erik C. Back
-------------------------------------
Title: Assistant Vice President
16
<PAGE> 17
FIRST UNION NATIONAL BANK
By /s/ Carolyn Hannon
-------------------------------------
Title: Director
17
<PAGE> 18
FLEET NATIONAL BANK
By /s/ Lori H. Jou
-------------------------------------
Title: Assistant Vice President
18
<PAGE> 19
MELLON BANK, N.A.
By /s/ Marsha Wicker
-------------------------------------
Title: Vice President
19
<PAGE> 20
COOPERATIEVE CENTRALE RAIFFEISEN
BOERENLEENBANK B.A., "RABOBANK NEDERLAND",
NEW YORK BRANCH
By /s/ Terrell Boyle
-------------------------------------
Title: Vice President
By /s/ Ian Reece
-------------------------------------
Title: Senior Credit Officer
20
<PAGE> 21
SUNTRUST, NASHVILLE, N.A.
as Swing Line Bank
By /s/ Mark D. Mattson
-------------------------------------
Title: Vice President
21
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<S> <C>
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0
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