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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934. For the fiscal year ended December 31, 1998, or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934. For the transition period from ________ to
________
COMMISSION FILE NO.: 0-19786
PHYCOR, INC.
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(Exact Name of Registrant as Specified in Its Charter)
TENNESSEE 62-1344801
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
30 BURTON HILLS BOULEVARD, SUITE 400
NASHVILLE, TENNESSEE 37215
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(Address of Principal (Zip Code)
Executive Offices)
Registrant's telephone number, including area code: (615) 665-9066
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Securities registered pursuant to Section 12(b) of the Act:
NONE NONE
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(Title of Each Class) (Name of Each Exchange
on Which Registered)
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK; NO PAR VALUE PER SHARE
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(Title of Class)
4.5% CONVERTIBLE SUBORDINATED DEBENTURES DUE 2003
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(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the shares of common stock (based upon
the closing sales price of these shares as reported on the Nasdaq Stock Market's
National Market on March 26, 1999) of the registrant held by non-affiliates on
March 26, 1999, was approximately $378.6 million.
As of March 24, 1999, 76,229,540 shares of the registrant's common
stock were outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Document incorporated by reference and the part of Form 10-K into
which the document is incorporated:
Portions of the Registrant's Definitive Proxy Statement
Relating to the Annual Meeting of Shareholders to be
held on May 25, 1999.....................................Part III
FORWARD-LOOKING STATEMENTS
This report and other information that is provided by PhyCor, Inc.
("PhyCor" or the "Company") contain forward-looking statements, including those
regarding the status of existing clinic and IPA operations, the development of
additional IPAs, the adequacy of PhyCor's capital resources and other statements
regarding trends relating to various revenue and expense items. Many factors,
including PhyCor's ability to successfully restructure and maintain its
relationships with certain of its affiliated physician groups and IPAs and their
payors, could cause actual results to differ materially from those projected in
such forward-looking statements. In addition, factors including competition in
the health care industry, regulatory developments and changes, the nature of
capitated fee arrangements and other methods of payment for medical services,
the risk of professional liability claims, PhyCor's dependence on the revenue
generated by its affiliated clinics, the outcome of pending litigation, risks
associated with Year 2000 related failure and other uncertainties, could also
cause results to differ materially from those expressed or implied in the
forward-looking statements.
For a more detailed discussion of the factors that could affect the
results of operations and financial condition of the Company, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Risk
Factors."
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
We are a medical network management company that operates
multi-specialty medical clinics and develops and manages independent practice
associations ("IPAs"), which are networks of independent physicians who contract
together to provide medical services to individuals whose health care costs are
covered by health maintenance organizations, insurers, employers or other
third-party payors of health care services. In connection with our
multi-specialty clinic operations, we manage and operate two hospitals and four
health maintenance organizations ("HMOs"). We also provide health care
decision-support services, including demand management and disease management
services, to managed care organizations, health care providers, employers and
other group associations.
As of December 31, 1998, we operated 56 clinics with 3,693 physicians
in 27 states. Our IPAs included approximately 22,900 physicians in 35 markets.
Our affiliated physicians provided capitated medical services to approximately
1,643,000 members, including approximately 304,000 Medicare and Medicaid
members. We also provided health care decision-support services to approximately
2.2 million individuals within the United States and approximately 500,000
additional individuals under foreign country license agreements.
Our strategy is to position our affiliated multi-specialty medical
clinics and IPAs to be the physician component of organized health care systems.
We operate multi-specialty medical clinics with established market shares and
reputations for providing quality medical care. We focus our IPA development and
management efforts in markets that have characteristics indicating opportunities
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for rapid enrollment growth and attractive fixed fees or capitation rates. The
Company helps to generate increased demand for the services and capabilities of
its affiliated physician organizations and to achieve growth through the
addition of physicians, the expansion of managed care relationships and the
addition and expansion of ancillary services.
We believe that multi-specialty physician organizations are a critical
element of organized health care systems, because physician decisions determine
the cost and quality of care. PhyCor believes that physician-driven
organizations, including multi-specialty medical clinics, IPAs and the
combination of such organizations, present more attractive alternatives for
physician consolidation than hospital or insurer HMO controlled organizations.
Through the combination of our multi-specialty medical clinic and IPA management
capabilities, we offer management services to substantially all types of
physician organizations.
We implement a number of programs and services at each clinic in order
to promote growth and efficiency. These programs include strategic planning and
budgeting, which focus on, among other things, cost containment and expense
reduction. PhyCor negotiates managed care contracts, enters into national
purchasing agreements, conducts productivity and procedure coding and charge
capturing studies and assists the clinics in physician recruitment efforts. We
maintain, for each clinic, information processing systems that have expanded our
accounting, billing, receivables management, scheduling and reporting systems
capabilities. We have also implemented a quality improvement initiative designed
to enhance the quality of patient service delivery systems at our affiliated
clinics through the maintenance and measurement of performance standards and
collection and review of patient evaluations.
In response to events occurring in the market place, including a
reduction in health care reimbursement and the general difficulties being
experienced by many physicians and companies in the medical network management
industry (including PhyCor), we have modified our approach to structuring
arrangements with physician groups with which we might affiliate in the future.
We seek to acquire additional clinics through this modified affiliation
structure, which reduces significantly the capital investment made by PhyCor at
the initiation of a relationship. This reduced investment reduces the fees paid
by physician groups to PhyCor for management services and allows us to make
additional capital available to the groups during the term of the service
agreement. This capital will be used to assist the physician groups in the
expansion and improvement of their practices. We believe this new structure will
benefit both PhyCor and our affiliated physician organizations. We are also
seeking affiliations with physician organizations which have been created by
hospital systems. Hospital systems generally have experienced significant losses
from the ownership and operation of physician practices, and we believe that
management by PhyCor of these hospital-sponsored physician organizations will
benefit hospitals and hospital systems.
MULTI-SPECIALTY MEDICAL CLINICS
A multi-specialty medical clinic provides a wide range of primary and
specialty physician care and ancillary services through an organized physician
group practice representing various medical specialties. Multi-specialty medical
clinics historically have been locally owned organizations managed by practicing
physicians. As of December 31, 1998, we operated 56 clinics with 3,693
physicians in 27 states. During 1998, we assisted affiliated clinics in
recruiting approximately 492 new physicians and in merging the practices of 58
additional physicians into their clinics.
Clinic Operations
We manage clinics pursuant to long-term service agreements with each of
the affiliated physician groups. Under the terms of the service agreement, we
typically provide each physician group with the equipment and facilities used in
its medical practice, manage clinic operations,
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employ the clinic's non-physician personnel, other than certain diagnostic
technicians, and receive a service fee.
During 1998, we acquired the assets of two multi-specialty clinics
located in New Britain, Connecticut and Huntington, New York, respectively, and
completed the purchase of certain assets of Lakeview Medical Center in Suffolk,
Virginia and numerous smaller medical practices. The Connecticut acquisition was
the Company's first clinic in that state. The principal assets acquired were
accounts receivable, property and equipment, prepaid expenses and service
agreement rights, an intangible asset. The consideration for the acquisitions
consisted of approximately 54% cash, 36% liabilities assumed and 10% convertible
notes. 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. Property and equipment acquired consisted mostly of clinic
operating equipment. The Company is pursuing other possible clinic acquisitions
in both existing and new markets. There can be no assurance that additional
clinic acquisitions will be successfully completed.
In May 1998, we acquired PrimeCare International, Inc. ("PrimeCare"), a
medical network management company serving southern California's Inland Empire
area. PrimeCare's network is comprised of an integrated campus, including the
Desert Valley Medical Group, Desert Valley Hospital and Apple Valley Surgery
Center, as well as the Inland Empire area IPA network. We issued approximately
4.0 million shares of common stock in connection with the PrimeCare transaction.
See "Item 3. Legal Proceedings."
On July 24, 1998, we acquired First Physician Care, Inc. ("FPC"), an
Atlanta-based provider of practice management services. We issued approximately
2.9 million shares of common stock in connection with the FPC transaction. In
September 1998, we announced that certain of FPC's clinics were operating
significantly below expectations because of lower than expected revenues and
higher costs associated with FPC's core business. Additionally, in February
1999, we announced that because certain of FPC's clinics continued to experience
significant negative operating results which ultimately may require the sale of
certain clinic assets and discontinuation of some operations, a pre-tax charge
of $18.1 million was recorded in the fourth quarter of 1998 to recognize the
expected decline in future cash flows. In addition, we expect to record a
pre-tax charge of $1.8 million in the first quarter of 1999 related to severance
and other exit costs in connection with the restructuring of certain FPC
operations and may incur additional costs associated with restructuring or
terminating these or other FPC operations.
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In 1998, we recorded asset revaluation and restructuring charges
associated with clinic operations totaling $193.3 million related to the
disposition of assets of seven clinics and the revaluation of assets related to
certain underperforming clinics. As identified above, the Company expects to
record a pre-tax charge in the first quarter of 1999 totaling $8.0 million
related to severance and other transition costs resulting from the restructuring
and disposition of certain operations. These asset revaluation and restructuring
charges relate to certain group formation clinics and to certain traditional
clinics that were disposed of and certain clinics whose assets were written down
because of a variety of negative operating and market issues, including those
related to market position and clinic demographics, physician relations,
departure rates, declining physician incomes, physician productivity, operating
results and ongoing commitment and viability of the medical group. We
continually review our operations and trends impacting those operations to
determine the appropriate carrying value of our assets. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
There can be no assurance that our efforts to strengthen and improve
each of our individual business operations will be successful, or that future
cash flows generated from our investments in each of our business operations
will be adequate to allow for full recovery of these investments. As a result,
there can be no assurance that future asset revaluation and restructuring
charges will not be necessary as business conditions and operating trends
continue to change.
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As of December 31, 1998, PhyCor operated the following medical clinics
in conjunction with the affiliated physician groups described below:
<TABLE>
<CAPTION>
Percentage
of Primary Number of PhyCor
Year Number of Care Medical Operations
Clinic Location Founded Physicians Physicians Specialties Commenced
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<S> <C> <C> <C> <C> <C> <C>
Green Clinic Ruston, LA 1948 34 44% 15 Oct. 1988
Doctors' Clinic Vero Beach, FL 1969 35 43 19 Jan. 1989
Nalle Clinic Charlotte, NC 1921 140 58 24 Feb. 1990
Greeley Medical Clinic Greeley, CO 1933 43 54 16 Oct. 1990
Pueblo Physicians Pueblo, CO 1970 37 57 13 Sept. 1991
Sadler Clinic Conroe, TX 1955 49 55 16 Jan. 1992
Diagnostic Clinic San Antonio, TX 1972 42 52 16 Jan. 1992
Virginia Physicians Richmond, VA 1923 70 66 15 Feb. 1992
Laconia Clinic Laconia, NH 1938 22 50 14 Sept. 1992
Olean Medical Group Olean, NY 1937 33 36 20 Nov. 1992
Holston Medical Group Kingsport, TN 1975 49 76 11 Jan. 1993
The Medical & Surgical Irving, TX 1961 35 77 10 Mar. 1993
Clinic of Irving
Simon-Williamson Clinic Birmingham, AL 1935 36 61 15 July 1993
Medical Arts Clinic Corsicana, TX 1952 40 43 18 Jan. 1994
Lexington Clinic Lexington, KY 1920 170 49 25 Feb. 1994
Southern Plains Medical Chickasha, OK 1946 22 64 11 Aug. 1994
Center
Holt-Krock Clinic Fort Smith, AR 1921 79 43 20 Sept. 1994(1)
Burns Clinic Medical Petoskey, MI 1931 100 45 25 Oct. 1994(2)
Center
Boulder Medical Center Boulder, CO 1949 52 46 22 Oct. 1994
Northeast Arkansas Clinic Jonesboro, AR 1977 74 62 15 Mar. 1995
PAPP Clinic Newnan, GA 1939 45 58 11 May 1995
Ogden Clinic Ogden, UT 1968 38 42 18 June 1995
Arnett Clinic Lafayette, IN 1922 129 40 24 Aug. 1995
Casa Blanca Clinic Mesa, AZ 1969 83 69 18 Sept. 1995
South Texas Medical Wharton, TX 1985 65 60 19 Nov. 1995
Clinics
South Bend Clinic South Bend, IN 1916 64 64 18 Nov. 1995(3)
Guthrie Clinic Sayre, PA 1910 235 43 29 Nov. 1995(4)
Clinics of North Texas Wichita Falls, TX 1995 84 46 22 Mar. 1996
Houston Metropolitan Houston, TX 1975 26 100 21 Mar. 1996
Medical Associates
Harbin Clinic Rome, GA 1948 105 31 21 May 1996
Focus Health Services Denver, CO 1989 55 86 8 July 1996
Clark-Holder Clinic LaGrange, GA 1936 42 38 17 July 1996
Medical Arts Clinic Minot, ND 1958 33 58 15 Aug. 1996
Wilmington Health Wilmington, NC 1971 60 47 14 Aug. 1996
Associates
Gulf Coast Medical Group Galveston, TX 1996 24 79 8 Aug. 1996(5)
Hattiesburg Clinic Hattiesburg, MS 1963 123 46 21 Oct. 1996
Toledo Clinic Toledo, OH 1926 85 25 19 Nov. 1996
Lewis-Gale Clinic Roanoke, VA 1909 137 47 25 Nov. 1996
Straub Clinic & Hospital Honolulu, HI 1921 178 56 25 Jan. 1997(6)
The Vancouver Clinic Vancouver, WA 1936 80 56 15 Jan. 1997
First Physicians Medical Palm Springs, CA 1997 21 62 7 Feb. 1997
Group
St. Petersburg-Suncoast St. Petersburg, FL 1997 83 30 22 Feb. 1997(7)
Medical Group
White Wilson Medical Ft. Walton, FL 1946 58 50 17 July 1997
Center
Welborn Clinic Evansville, IN 1947 85 53 21 Aug. 1997
The Maui Medical Group Maui, HI 1961 35 60 14 Sept. 1997
Murfreesboro Medical Murfreesboro, TN 1949 45 62 11 Oct. 1997
Clinic
West Florida Medical Pensacola, FL 1938 160 34 27 Oct. 1997
Center Clinic
Northern California Santa Rosa, CA 1975 35 54 5 Dec. 1997
Medical Associates
Lakeview Medical Center Suffolk, VA 1905 33 55 13 Jan. 1998(8)
Grove Hill Medical Center New Britain, CT 1947 73 47 15 Mar. 1998
Desert Valley Medical Victorville, CA 1985 56 75 16 May 1998
Group
Riverbend Physicians & Alton, IL 1955 16 69 7 July 1998(9)
Surgeons
Health Partners Medical Bedford, TX 1993 48 100 4 July 1998(9)
Group
Doctors Walk-In Clinics, Tampa Bay, FL 1958 25 100 4 July 1998(9)
Inc.
Palm Beach Medical Group Palm Beach, FL 1953 29 72 7 July 1998(9)
Georgia Internal Lithia Springs, GA 1976 4 100 1 July 1998(9)
Medicine
Huntington Medical Group Huntington, NY 1945 34 50 14 Oct. 1998
</TABLE>
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(1) In January 1999, we agreed to sell certain assets to Sparks Regional
Medical Center and Sparks Regional Medical Center Foundation (collectively,
"Sparks"). Sparks is expected to enter into a long-term agreement with
PhyCor to maintain access to certain key physician practice management
resources. There is no assurance this transaction will be completed or
completed as contemplated.
(2) In February 1999, we announced an agreement to sell assets to Healthshare
Group ("HSG"). There is no assurance this transaction will be completed or
completed as contemplated.
(3) Entered into an interim management agreement, effective November 1, 1995,
and consummated the acquisition of certain assets and entered into a
long-term service agreement effective January 1, 1996.
(4) Entered into a series of agreements whereby PhyCor agreed to provide
management services for up to five years and agreed to acquire certain
assets of the clinic upon the occurrence of certain conditions. These
conditions were not met as of March 26, 1999. The Clinic has the option to
renew or terminate the management agreement and purchase the clinic assets
at the end of 1999.
(5) In March 1999, we terminated our affiliation with this group.
(6) Entered into an administrative services agreement, effective October 1,
1996, and consummated the merger with Straub and entered into a long-term
service agreement effective January 17, 1997.
(7) Acquired all of the capital stock of two clinics, combined their operations
and entered into a long-term service agreement with the newly formed group
effective February 28, 1997.
(8) Entered into an interim management agreement, effective December 1, 1997,
and consummated the acquisition of certain assets and entered into a
long-term service agreement effective January 1, 1998.
(9) Each of these clinics was acquired in the FPC transaction in July 1998.
In connection with our multi-specialty clinic operations, we manage and
operate two hospitals and four HMOs. In addition to the 3,693 physicians
affiliated with the Company at December 31, 1998, the PhyCor-affiliated
physician groups employ approximately 617 physician extenders, which include
physician assistants, nurse practitioners and other mid-level providers. We
believe physician extenders comprise an important component of our integrated
network strategy by efficiently expanding the level of services offered in our
clinics.
The physician groups offer a wide range of primary and specialty
physician care and ancillary services. Approximately 52% of PhyCor's affiliated
physicians are primary care providers, and approximately 48% practice various
medical and surgical specialties. The primary care physicians are those in
family practice, general internal medicine, obstetrics and gynecology,
occupational medicine, pediatrics and emergency and urgent care. Medical
specialties include allergy, cardiology, dermatology, endocrinology,
gastroenterology, infectious diseases, nephrology, neurology, oncology,
pulmonology, radiology and rheumatology. Surgical specialties include general
surgery, ophthalmology, orthopedics, otolaryngology, thoracic surgery and
urology. The clinics vary in the number and types of specialties offered.
Substantially all of the physicians practicing in the clinics are certified or
eligible to be certified by the applicable medical specialty boards.
The clinics also offer a wide array of ancillary services. Most clinics
provide a range of imaging services, which may include CAT scanning,
mammography, nuclear medicine, ultrasound and x-ray. In addition, many of the
clinics have clinical laboratories and pharmacies. Ambulatory surgery units and
rehabilitation services are in place or being planned in many clinics, in some
cases through joint ventures. Several of the clinics have diabetes centers,
pharmaceutical clinical trial programs and weight management programs. Some
offer renal dialysis and participate, usually by joint venture, in home infusion
therapy. Ancillary revenue, including both technical and professional fee
components, accounted for approximately 24.4% of gross clinic revenue for the
year ended December 31, 1998 compared to 26.7% for the year ended December 31,
1997.
In connection with an acquisition of assets and execution of a service
agreement, we investigate the history and general reputation of each physician
group. We obtain representations and covenants from the physician group with
respect to historical financial performance and the employment and licensure of
individual physicians. PhyCor does not undertake an independent
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investigation of the backgrounds of each physician member of the clinics. As
part of its services performed under the service agreement, PhyCor personnel
undertake administrative tasks in connection with obtaining and maintaining
liability insurance for the physician group, including maintaining and reviewing
files relating to physician licensure and certification. PhyCor does not control
the practice of medicine by physicians or compliance by them with licensure or
certification requirements. Only the FPC entities in Florida and Georgia employ
physicians. The substantial majority of PhyCor's relationships in those states
are with separate physician groups that employ the physicians and to which
PhyCor provides management services. PhyCor's affiliated physicians maintain
full professional control over their medical practices, determine which
physicians to hire or terminate and set their own standards of practice in order
to promote high quality health care.
PhyCor Operations
Pursuant to our service agreements, we manage all aspects of the
affiliated clinics other than the provision of medical services, which is
controlled solely by the physician groups. The clinic's joint policy board,
equally represented by physicians and PhyCor personnel, focuses on strategic and
operational planning, marketing, managed care arrangements and other major
issues facing the clinic. The joint policy board involves experienced health
care managers in the decision making process and brings increased discipline and
accountability to clinic operations.
We enhance clinic growth by expanding managed care arrangements,
assisting in the recruitment and merger of physicians and expanding and adding
ancillary services. We help the physician groups recruit physicians from outside
the community and merge physicians in sole practices or single specialty groups
from within the community into the clinics' physician groups.
We believe our clinics have the opportunity, in conjunction with
managed care organizations, insurance companies and hospitals, to create
high-quality, cost-effective health care delivery systems. We align our
affiliated clinics with low-cost, high-quality hospitals and related providers
in each of their markets and through various relationships seek to more closely
coordinate the overall delivery of health care to patients. These plans may
include participation by affiliated physicians in physician networks which we
developed and managed. See "IPA and Physician Networks." Certain of our
relationships with managed care organizations and insurance companies require
the physician networks being developed by the clinics to assume responsibility
for physician services, hospital utilization and overall medical management. We
believe that medical management performed within physician organizations can
yield the greatest value in quality-driven, cost-effective health care and that
premiums collected from purchasers of health care will be allocated based upon
the value of the services performed by the health care provider members of
organized health care systems.
We sponsor the PhyCor Institute for Healthcare Management, which
provides practical managed care and medical management training for physicians
affiliated or considering affiliation with PhyCor. Through the Institute's
efforts, physicians in many locations work together to achieve "economies of
intellect" and best practice performance through shared data and experience. We
believe that, in the future, our ability to differentiate our physician
organizations based upon quality clinical performance will positively impact
financial performance.
We try to focus the attention of the physician groups on practice
patterns. This effort emphasizes outcomes measurement and management in order to
attain the desired clinical results while controlling the use of health
resources. Similarly, our quality service initiatives seek to improve the
patient's overall experience with the health care delivered within PhyCor's
affiliated clinics and networks.
We provide support for the selection and implementation of information
systems at our clinics. We have selected certain practice management and other
systems considered to be most effective for capitated risk management, provider
profiling and outcomes analysis for
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implementation at our clinics. These systems are designed to allow physician
organizations to successfully capture information that will enable them to more
effectively manage the risk associated with capitated arrangements.
We negotiate national arrangements that provide cost savings to our
clinics through economies of scale in malpractice insurance, supplies and
equipment. We also provide operational support through a better practice
resource group, which focuses on assisting clinics or departments within clinics
in defining and executing patient services and revenue and expense savings
opportunities. These better practice initiatives may also include organizational
staffing and budget assistance for clinical research. We provide measurement
capabilities for medical outcomes in specific therapeutic areas and compile and
utilize physician productivity information. We also offer a staffing management
system that aligns staffing with the volume and service needs of our clinics. We
launched the PhyCor Online intranet service in 1998, which facilitates
communication between affiliated physicians, provides outcomes information and
supports physician discussion groups for medical and business practices.
Service Agreements - Clinic Operations
Our long-term service agreements are for terms of up to 40 years.
Long-term agreements entered into prior to 1994 are generally for terms of 30
years. The termination provisions of the service agreements provide that the
agreements may not be terminated by PhyCor or the physician groups without
cause, which includes material default or bankruptcy. Upon the expiration of the
term of a service agreement or in the event of termination, the physician group
is obligated to purchase all of the related tangible and intangible assets owned
by our subsidiary that is a party to the service agreement, generally at then
current book value. In the event of a termination, we expect the terminating
group to fulfill its repurchase obligation in accordance with the service
agreement at the effective time of termination and would actively pursue
compliance with such repurchase obligation. The physician group agrees not to
compete with us during the term of the service agreement, and substantially all
of the physicians agree not to compete with their physician group for a period
of time or agree to pay liquidated damages if they compete. We agree not to
affiliate with other multi-specialty groups in the clinic's service area during
the term of the service agreement. Two clinics have recently challenged the
enforceability of the percentage-based management fee structure contained in
their service agreements. While we are defending the enforceability of these
service agreements and would defend the enforceability of other service
agreements, if challenged, there can be no assurance that successful challenges
of the service agreements will not have a material adverse effect on our
operations. See "Item 3. Legal Proceedings."
Under substantially all of our service agreements, we receive a service
fee equal to the clinic expenses incurred plus a percentage of operating income
of the clinic (net clinic revenue less certain clinic expenses before physician
distributions) and, under all other service agreements except one described
below, we receive a percentage of net clinic revenue. In 1998, our service
agreement revenue was derived from contracts with the following service fee
structures: (i) 92.1% of revenue was derived from contracts in which the service
fee was based on a percentage, ranging from 11% to 18%, of clinic operating
income plus reimbursement of clinic expenses; (ii) .8% of revenue was derived
from a contract in which the service fee was based on 51.7% of net clinic
revenue; (iii) 5.9% of revenue was derived from contracts in which the service
fee was based upon a combination of (a) 10% of clinic operating income, plus (b)
a percentage, ranging from 2.75% to 3.5%, of net clinic revenue and plus (c)
reimbursement of clinic expenses; and (iv) 1.2% of revenue was derived from a
flat fee contract.
The service agreements allow the affiliated physician group to
terminate the service agreement in the event of the bankruptcy or similar event
of PhyCor's subsidiary that is a party to the service agreement or in the event
of a material breach of the service agreement by the Company or its subsidiary,
provided (i) such breach is not cured generally within 90 days following written
notice and (ii) such termination is approved by the affirmative vote of
generally no less than 75% of
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the physician shareholders. Many of the service agreements allow the physician
group to terminate the service agreement if any person or persons acquire the
right to vote 50% or more of PhyCor's common stock, unless the transaction was
approved by PhyCor's Board of Directors or subsequently approved by two-thirds
of PhyCor's directors who are not members of management or affiliates of the
acquiring person. The physician group in Lexington, Kentucky may also terminate
its service agreement if an entity named therein acquires 15% or more of the
Company's outstanding common stock. Other groups may terminate their service
agreement in the event of a merger where PhyCor does not survive or a takeover
or sale of substantially all the assets of PhyCor or in the event of a sale of
all or substantially all of the assets or capital stock of the PhyCor subsidiary
that is a party to the service agreement. Some physician groups have rights of
first refusal to purchase the clinic assets owned by PhyCor if PhyCor determines
to sell such assets. The above provisions could have an adverse effect on any
efforts to take control of PhyCor without the consent of the Board of Directors
and the physician groups having these rights. In addition, the Company may
terminate a service agreement (a) in the event of the bankruptcy or similar
event of the affiliated physician group, or (b) a material breach of the service
agreement by the affiliated physician group which is not cured within 90 days
following written notice. In any event of termination, the affiliated physician
group is required by the terms of the service agreement to repurchase all of the
tangible and intangible assets of the Company related to the physician group
generally at the then current net book value.
IPA AND PHYSICIAN NETWORKS
We believe that the health care industry will continue to be driven by
local market factors and that organized providers of health care, like IPAs,
will play a significant role in delivering cost-effective, quality medical care.
IPAs offer physicians an opportunity to participate in expanding organized
health care systems and assistance in contracting with insurance companies,
HMOs, employers and other large purchasers of health care services. IPAs
consolidate independent physicians by providing general organizational structure
and management to the physician network. IPAs provide or contract for medical
management services to assist physician networks in obtaining and servicing
managed care contracts and enable previously unaffiliated physicians to assume
and more effectively manage capitated risk. In certain instances we are required
to underwrite letters of credit to the managed care payor to help ensure payment
of health care costs for which our affiliated IPAs assume responsibility. As of
March 24, 1999, we had issued to managed care payors letters of credit through
our credit facility totaling approximately $14.6 million. We would seek
reimbursement from an IPA if there was a draw on a letter of credit. While no
draws on any of these letters of credit have occurred, there can be no assurance
that draws will not occur on the letters of credit in the future.
As of December 31, 1998, we managed IPAs with approximately 22,900
physicians in 35 markets. The IPA segment of our business accounted for
approximately 16% of our 1998 revenues. We typically establish management
companies for IPAs through which all health plan contracts are negotiated. Each
of these management companies provides information and operating systems,
actuarial and financial analysis, medical management and provider contract
services to the IPAs. In some cases, physicians have an equity interest in the
management company. We assist physicians in forming networks to develop a
managed care delivery system in which the IPA accepts fiscal responsibility for
providing a wide range of medical services. We intend to continue to develop
health care delivery systems in certain markets that do not have established
managed care networks.
We are developing physician networks around our physician groups to
enhance managed care contracting and to expand our role as a significant
physician component of organized health care systems. Physicians in affiliated
physician groups may participate, in conjunction with unaffiliated physicians,
in IPAs we develop and manage. Substantially all of our IPAs are developed and
managed by North American Medical Management, Inc. ("NAMM"). PhyCor purchased a
minority interest in PhyCor Management Corporation ("PMC") in 1995 and completed
the acquisition of the remaining interests in PMC on March 31, 1998. PMC, which
also provided management services to
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physician networks, was fully integrated into NAMM during 1998. Additionally,
through our acquisition of PrimeCare, we operate PrimeCare's IPAs in California.
In July 1998, we acquired The Morgan Health Group, Inc. ("MHG"), 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 (the "MHG Acquisition"). In
September 1998, we announced that the earnings of MHG were significantly below
target because of higher than expected costs from MHG's managed care contracts.
In February 1999, we announced that because MHG's costs significantly exceeded
revenues under its principal payor contract which accounted for approximately
90% of its revenue (the "Payor Contract"), we were going to record a pre-tax
asset revaluation charge of approximately $31.6 million in the fourth quarter of
1998 to write-off goodwill that was recorded in connection with the MHG
Acquisition. In addition, the Company expects to record a $0.7 million pre-tax
charge in the first quarter of 1999 related to the termination of the Payor
Contract. The Payor Contract will terminate by mutual agreement on April 30,
1999. On February 19, 1999, we notified the former owners of MHG of our
rescission offer of all consideration we received in the MHG Acquisition and
demand for rescission of the transactions contemplated by the MHG Acquisition.
The former owners of MHG have rejected our demand for rescission. The former
owners have since requested certain financial information regarding MHG. We are
currently responding to that request and continuing discussions with the former
MHG shareholders as well as considering other available options.
In October 1998, we formed a joint venture with Physician Partners
Company, L.L.C., a physician organization created by physicians to develop an
IPA, to operate an IPA management business and to develop and manage a regional
managed care contracting network, which is anticipated to include IPAs in New
York City, northern New Jersey, southern Connecticut and Long Island.
Subsequent to year end, we completed agreements with two IPA
organizations to provide managed care services. We entered into an agreement
with the Southern Nevada Healthcare Network in Las Vegas, Nevada, on January 1,
1999, which provided management of capitated health care services
contracts for 54,000 HMO enrollees through approximately 300 physicians. On
March 1, 1999, we also began managing the New Century Physicians IPA in the
Kansas City metropolitan area with approximately 10,000 enrollees and 120
physicians.
OTHER OPERATIONS
We provide health care decision-support services, including demand
management and disease management services, to managed care organizations,
health care providers, employers and other group associations through CareWise,
Inc. ("CareWise"). We acquired CareWise on July 1, 1998 in exchange for
approximately 3.1 million shares of common stock. CareWise is a nationally
recognized leader in the health care decision-support industry. At December 31,
1998, through CareWise, we provided healthcare decision-support services to
approximately 2.2 million individuals within the United States and approximately
500,000 additional individuals under foreign country license agreements.
We are also seeking to affiliate with physician organizations which
have been created by hospital systems. Hospital systems generally have
experienced significant losses from the ownership and operation of physician
practices. We believe that our management of these hospital-sponsored
organizations will benefit hospitals and hospital systems.
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REGULATION
General
The health care industry is highly regulated, and the regulatory
environment in which the Company operates may change significantly in the
future. In general, regulation of health care companies is increasing.
Every state imposes licensing requirements on individual physicians and
on facilities and services operated by physicians. In addition, federal and
state laws regulate HMOs and other managed care organizations. Many states
require regulatory approval, including certificates of need, before establishing
certain types of health care facilities, offering certain services or making
expenditures in excess of statutory thresholds for health care equipment,
facilities or programs. To date, none of our clinics nor our managed IPAs have
been required to obtain certificates of need for their activities.
In connection with the expansion of existing operations and the entry
into new markets and managed care arrangements, PhyCor and its affiliated
practice groups and managed IPAs may become subject to compliance with
additional regulation.
The Company and its clinics and managed IPAs are also subject to
federal, state and local laws dealing with issues such as occupational safety,
employment, medical leave, insurance regulations, civil rights and
discrimination, and medical waste and other environmental issues. At an
increasing rate, federal, state and local governments are expanding the
regulatory requirements on businesses, including medical practices. The
imposition of these regulatory requirements may have the effect of increasing
operating costs and reducing the profitability of the Company's operations.
PhyCor's managed IPAs and affiliated physician groups enter into
contracts and joint ventures with licensed insurance companies, such as HMOs,
whereby the IPAs and affiliated physician groups may be paid on a capitated fee
basis. Under capitation arrangements, health care providers bear the risk,
subject to certain loss limits, that the total costs of providing medical
services to members will exceed the premiums received. To the extent that the
IPAs and affiliated physician groups subcontract with physicians or other
providers for their services on a fee-for-service basis, the managed IPAs and
affiliated physician groups may be deemed to be in the business of insurance. If
deemed to be an insurer they will be subject to a variety of regulatory and
licensing requirements applicable to insurance companies or HMOs resulting in
increased costs to the managed IPAs and affiliated physician groups, and
corresponding lower revenue to PhyCor. The Company or its managed IPAs and
affiliated physician groups may be adversely affected by such regulations.
In connection with two multi-specialty medical clinic acquisitions, the
Company owns HMOs previously affiliated with the clinics and in another
multi-specialty medical clinic acquisition, the Company agreed to provide
management services to the physician group and the HMO owned by the physician
group. The Company also owns a 50% interest in another HMO affiliated with a
physician group and provides management services to that HMO. The HMO industry
is highly regulated at the state level and is highly competitive. Additionally,
the HMO industry has been subject to numerous legislative initiatives within the
past several years that would increase potential HMO liability to patients,
resulting in increased costs to HMOs and correspondingly reduced revenue to
PhyCor. Certain aspects of health care reform legislation being considered at
the federal level have direct and indirect consequences for the HMO industry.
There can be no assurance that developments in any of these areas will not have
an adverse effect on the Company's wholly-owned HMOs or on HMOs in which the
Company has a partial ownership interest or other financial involvement.
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<PAGE> 13
Many of the PhyCor-managed IPA contracts with third party payors are
based on fixed or capitated fee arrangements. Under these capitation
arrangements, health care providers receive a fixed fee per plan member per
month and providers bear the risk, generally subject to certain loss limits,
that the total costs of providing medical services to the members will exceed
the fixed fee. The IPA management fees are based, in part, upon a share of the
portion, if any, of the fixed fee that exceeds actual costs incurred. Some
agreements with payors also contain "shared risk" provisions under which PhyCor,
through the IPA, can share additional fees or can share in additional costs,
depending on the utilization rates of the members and the success of the IPAs.
Any significant costs could have a material adverse effect on the Company.
The health care providers' ability to effectively manage the patient's
use of medical services and the costs of such services determines the
profitability of a capitated fee. The management fees are also based upon a
percentage of revenue collected by the IPA. Any loss of revenue by the IPAs
because of the loss of affiliated physicians, the termination of third party
payor contracts or other changes in plan membership or capitated fees may reduce
our management fees. We, like other managed care management entities, are often
subject to liability claims arising from activities such as utilization
management and compensation arrangements, designed to control costs by reducing
services. A successful claim on this basis against us, an affiliated clinic or
IPA could have a material adverse effect on us.
Federal and state antitrust laws also prohibit agreements in restraint
of trade, the exercise of monopoly power and other practices that are considered
to be anti-competitive. We believe that we are in material compliance with
federal and state antitrust laws in connection with the operation of our clinics
and our IPAs and physician networks.
We believe our operations are in material compliance with applicable
law and expect to modify our agreements and operations to conform in all
material respects to future regulatory changes. Our ability to be profitable
will depend in part upon our affiliated physician groups and managed IPAs
obtaining and maintaining all necessary licenses, certificates of need and other
approvals and operating in compliance with applicable health care regulations.
We are unable to determine what additional government regulations, if any,
affecting our business may be enacted in the future or how existing or future
laws and regulations might be interpreted by the relevant regulatory
authorities. The failure of the Company or any of our affiliated physician
groups or managed IPAs to comply with applicable law could have a material
adverse effect on the Company.
State Legislation
At the state level, all state laws restrict the unlicensed practice of
medicine, and many states also prohibit the splitting or sharing of fees with
non-physician entities and the enforcement of noncompetition agreements against
physicians. Many states also prohibit the corporate practice of medicine by an
unlicensed corporation or other non-physician entity and prohibit referrals to
facilities in which physicians have a financial interest. Additionally, the
Florida Board of Medicine has interpreted the Florida fee-splitting law very
broadly. This interpretation may prohibit the payment of any percentage-based
management fee, even to a management company that does not refer patients to a
managed group. The Florida Board of Medicine stayed its own decision pending a
judicial determination of its decision. We have filed a friend of the court
brief advocating that the court not uphold the decision of the Florida Board of
Medicine. Oral argument before the court has been set for May 1999, and it is
possible that the court will announce its ruling by late 1999. Two of our
affiliated physician groups have filed suit seeking a declaratory judgment
regarding the enforceability of the fee arrangements under their service
agreements with PhyCor in light of the OIG Advisory Opinion 98-4, described
below. One of the groups located in Florida, also challenged the fee arrangement
under the Florida Board of Medicine opinion. See "Item 3. Legal Proceedings." Of
our six affiliated physician groups in Florida, we manage four
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<PAGE> 14
groups under service agreements for which we are paid a percentage-based
management fee, and we own and operate the other two Florida groups. Our service
agreements provide that any changes in laws shall result in agreed upon
modifications to the applicable service agreements to comply with laws. Future
interpretations of, or changes in, state laws may require structural and
organizational modifications of our existing relationships with our clinics.
Changes in the laws may also necessitate modifications in our relationships with
our affiliated IPAs. There can be no assurance that we would be able to
appropriately modify our relationships with our physician groups and IPAs to
ensure that the Company and its operations would not be adversely affected by
such changes in the laws. Statutes in some states could restrict expansion of
the operations of the Company to the applicable jurisdictions. In addition, one
of our subsidiaries holds a limited Knox-Keene license in the state of
California, and as a result is subject to an increased level of state oversight
by the California Department of Corporations.
Medicare Payment System
Our affiliated physician groups and IPAs derived approximately 19% of
their net revenue in 1998 from payments for services provided to patients
enrolled in the federal Medicare program, including patients covered by risk
contracts. Clinics and IPAs managed by the Company provide medical services
under risk contracts to approximately 258,000 Medicare members. The prior system
of Medicare payments, other than for risk contracts, was based on customary,
prevailing and reasonable physician charges and was phased out from 1992 through
1996 and replaced with an annually-adjusted resource-based relative value scale
("RBRVS").
Medicare Fraud and Abuse and Anti-Referral Provisions
There are many provisions in the Social Security Act that are intended
to address fraud and abuse among providers and other health care companies. One
of the fraud and abuse provisions (the "anti-kickback statute") prohibits
providers and others from soliciting, receiving, offering or paying, directly or
indirectly, any form of remuneration in return for the referral of, or the
arranging for the referral of, Medicare and other federal or state health care
program patients or patient care opportunities. It also prohibits payments in
return for the purchase, lease, arrangement, or order of any item or service
that is covered by Medicare, certain other federal health care programs, or a
state health program.
In July 1991, the federal government published regulations that provide
exceptions, or "safe harbors", for business transactions that will be deemed not
to violate the anti-kickback statute. In September 1993, additional safe harbors
were proposed for eight activities, including referrals within group practices
consisting of active investors. In April 1998, the HHS Office of the Inspector
General released Advisory Opinion 98-4, which states that a percentage-based
management fee paid to a medical network management company does not fit within
any safe harbor. The opinion concludes that, because a percentage-based fee does
not fit within a safe harbor, such a fee could implicate the Anti-Kickback Law
if any part of the management fee is intended to compensate the manager for its
efforts in arranging for referrals to the managed group. The opinion
acknowledges, however, that a management fee that does not fit within a safe
harbor is not necessarily illegal. Both the opinion and the preamble to the
government's published safe harbors state that arrangements that do not fall
within safe harbors are nevertheless legal as long as there is no intent on the
part of either party to pay for or accept payment for referrals. Although many
of our management fees are percentage-based fees, and many of our other
arrangements, including the arrangements between NAMM and providers and provider
groups, do not in all instances fall within the protection offered by these safe
harbors or the proposed safe harbors, we believe our operations are in material
compliance with
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<PAGE> 15
applicable Medicare fraud and abuse laws. As discussed above, two of our
affiliated physician groups filed lawsuits seeking declaratory judgments
regarding the enforceability of the fee arrangement contained in their service
agreements with PhyCor in light of OIG Advisory Opinion 98-4.
We believe our operations are in material compliance with the
anti-kickback law. Although we are receiving remuneration under our service
agreements and management agreements for the services we provide to our
affiliated clinics and IPAs, we are not in a position to make or influence
referrals of federal or state health care program patients or services to the
physician groups or networks. Moreover, we believe that the fees we receive
represent fair value for our services. No part of the fees we receive are
intended to be remuneration for improper activities. Consequently, we do not
believe that the service fees and management fees that we receive from our
affiliated groups and IPAs could be viewed as remuneration for referring or
influencing referrals of patients or services covered by federal or state health
care programs as prohibited by the anti-kickback statute. We are a separate
provider of Medicare and state health program reimbursed services on a limited
basis in the states of Florida and Georgia because we own certain groups in
those states that employ physicians. To the extent that we are deemed to be a
separate provider of medical services under our service agreement or management
agreement arrangements and to receive referrals from physicians, our financial
arrangements could be subject to greater scrutiny under the anti-kickback
statute. The Company also operates one pharmacy under a provider number that is
separate from the clinic. We do not believe that our operation of this pharmacy
or our operation of providers in Florida and Georgia creates a material risk
under the anti-kickback statute because all of our operations are structured to
fit as closely as possible within an applicable safe harbor.
In connection with the transaction with Straub Clinic & Hospital,
Incorporated ("Straub"), we provide certain management services to both the
physician group practice and a hospital owned by the group. In addition, in
connection with the PrimeCare transaction, the Company acquired a hospital in
California. Because hospitals are subject to extensive regulation and because
hospital management companies have, in some instances, been viewed as referral
sources by federal regulatory agencies, the relationship between PhyCor and the
Straub physician group, and the relationship between PhyCor and its California
hospital and affiliated California medical groups, could come under increased
scrutiny under the anti-kickback statute.
If any of our arrangements were found to be in violation of the
anti-kickback law, the Company, the physician groups and/or the individual
physicians would be subject to civil and criminal penalties, including possible
exclusion from participation in government health care. These penalties could
have a materially adverse affect on the Company.
Under legislation known as the Stark Law, physicians who have an
ownership interest or a compensation arrangement with certain providers of
"designated health services" are prohibited from referring Medicare and Medicaid
patients to those providers, unless an exception exists. The "designated health
services" covered by the Stark Law include physical therapy services;
occupational therapy services; radiology services, including MRI, CT and
ultrasound; radiation therapy services; durable medical equipment; parenteral
and enteral nutrients, equipment and supplies; prosthetics, orthotics and
prosthetic devices; home health services; outpatient prescription drugs; and
inpatient and outpatient hospital services. We believe that our clinics are
operating in compliance with the statutory exceptions to the Stark Law,
including, but not limited to, the exceptions for referrals to in-office
ancillary services within a group practice. As a result, we believe that
physicians who are members of our affiliated clinics may make referrals of
designated health services to the clinics. If any of the affiliated clinics or
their physicians are found to be in violation of the Stark Law, they could be
subject to significant penalties, including possible exclusion from further
participation in the Medicare or Medicaid programs. Such penalties could have a
material adverse effect on the Company.
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Impact of Health Care Regulatory Changes
Congress and many state legislatures routinely consider proposals to
control health care spending. Government efforts to reduce health care expenses
through the use of managed care or the reduction of Medicare and Medicaid
reimbursement may adversely affect our cost of doing business and contractual
relationships. For example, recent developments that affect the Company's
activities include: (a) federal legislation requiring a health plan to continue
coverage for individuals who are no longer eligible for group health benefits
and prohibiting the use of "pre-existing condition" exclusions that limit the
scope of coverage; (b) a Health Care Financing Administration policy prohibiting
restrictions in Medicare risk HMO plans on a physician's recommendation of other
health plans and treatment options to patients; and (c) regulations imposing
restrictions on physician incentive provisions in physician provider agreements.
These types of legislation, programs and other regulatory changes may have a
material adverse effect on PhyCor.
COMPETITION
Managing medical networks is a highly competitive business. Many
businesses compete with the Company to acquire medical clinics, manage such
clinics, employ clinic physicians or provide services to IPAs. These competitors
include other medical network management companies, large hospitals, other
multi-specialty clinics and health care companies, HMOs and insurance companies.
Although many of the medical network management companies formerly competing
with the Company have exited or are exiting the market, several of the remaining
competitors have longer operating histories and significantly greater resources
than the Company. We may not be able to compete effectively with existing or new
competitors. Additional competition may make it more difficult to acquire the
assets of medical clinics or develop or manage IPAs on beneficial terms. To the
extent that health care industry reforms make prepaid medical care more
attractive and provide incentives to form organized health care systems, the
Company anticipates facing greater competition. PhyCor's revenues are dependent
upon the continued stability and economic viability of the medical groups with
which it has long-term service agreements and IPAs that it manages. These
organizations face competition from several sources, including sole
practitioners, single and multi-specialty groups and staff model HMOs.
INSURANCE
The Company maintains medical professional liability insurance on a
claims made basis for all of its operations. Insurance coverage under such
policies is contingent upon a policy being in effect when a claim is made,
regardless of when the events which caused the claim occurred. The Company also
maintains general liability and umbrella coverage on an occurrence basis. The
cost and availability of such coverage has varied widely in recent years. While
the Company believes its insurance policies are adequate in amount and coverage
for its current operations, there can be no assurance that the coverage
maintained by the Company is sufficient to cover all future claims or will
continue to be available in adequate amounts or at a reasonable cost. PhyCor and
its subsidiary operating each affiliated physician group are named as additional
insureds on the various policies maintained by each affiliated physician group,
including the professional liability insurance policies carried by the physician
group.
EMPLOYEES
As of December 31, 1998, the Company employed approximately 21,700
people, including 145 in the corporate office. None of the Company's employees
is a member of a labor union, and the Company considers its relations with its
employees to be very good.
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ITEM 2. PROPERTIES
The Company leases approximately 52,000 square feet of rentable space
at 30 Burton Hills Boulevard in Nashville, Tennessee, where the Company's
headquarters are located. The Company pays approximately $83,000 per month in
rent, which rental amount increases over the term of the lease to approximately
$93,000 per month in the final year. The lease expires in 2003. The Company
believes these arrangements and other available space are adequate for its
current needs. The Company has a $60 million synthetic lease facility on which
the total drawn cost is .50% to 1.25% above the applicable eurodollar rate. The
Company has also leased through its synthetic lease facility, and has an option
to acquire, an adjacent, unimproved parcel of land which the Company could use
for additional or replacement facilities in the future. The Company has no
current plans to build such facilities. Of the $60 million available under the
synthetic lease facility, $26.0 million has been committed to lease properties
associated with two of PhyCor's affiliated clinics. The remaining synthetic
lease facility is expected to be used for, among other projects, the
construction or acquisition of medical office buildings related to our
operations.
The Company leases, subleases or occupies facilities pursuant to its
service agreements with each of our clinics. In many cases, facilities are
leased from the physician groups with the lease cost generally included in the
service fees paid to PhyCor. In connection with the acquisition of the Company's
affiliated clinic in Lexington, Kentucky, the Company acquired the real estate
used by the physician group, including the clinic's main clinic facility in
Lexington and other satellite facilities in Lexington and the surrounding
communities. In connection with the Company's acquisitions of its affiliated
clinics in Lafayette, Indiana, and St. Petersburg, Florida, the Company acquired
the real estate used by each of the physician groups. At the time of such
acquisitions, certain of the properties were subject to a mortgage, which
indebtedness was assumed by PhyCor as a result of the transactions and repaid in
full. The Company makes these facilities available to the physician groups
pursuant to the long-term service agreements with Lexington Clinic, Arnett
Clinic and St. Petersburg-Suncoast Medical Clinic, respectively.
In conjunction with the acquisition of PrimeCare, the Company assumed
leases for the real estate related to PrimeCare's operations and has an option
to purchase in 1999 the primary facilities used by PrimeCare. Certain of these
properties are subject to mortgages with an aggregate outstanding principal
balance as of February 28, 1999 of $7.9 million and bearing interest at rates
ranging from 8.25% to 10.5%.
The Company may from time to time acquire real estate in connection
with the acquisition of clinic assets. The Company anticipates that as the
clinics continue to grow and add new services, expanded facilities will be
required. Such transactions may require PhyCor's assistance in obtaining
financing of the property on behalf of the physician groups.
ITEM 3. LEGAL PROCEEDINGS
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 have been named
defendants in nine securities fraud class actions filed between September 8 and
October 23, 1998. The factual allegations of the complaints in all nine actions
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 nine actions, the plaintiff seeks
to be certified as the representative of a class of all persons similarly
situated who
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were allegedly damaged by the defendants' alleged violations during the "class
period." Each of the actions 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 actions
have been consolidated in the U.S. District Court for the Middle District of
Tennessee. Defendants' motion to dismiss is pending before that court. The state
court actions have been consolidated in Davidson County, Tennessee. The Company
believes that it has meritorious defenses to all of the claims, and intends to
vigorously defend 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. As a result, Sparks is expected to acquire certain
assets from PhyCor, offer employment to a substantial number of Holt-Krock
physicians and enter into a long-term agreement whereby PhyCor will provide
physician practice management resources to Sparks. These transactions are
expected to be completed on or before May 31, 1999, upon execution of definitive
agreements, however, there can be no assurance that the transaction will be
completed or that it will be completed on the terms described above. See Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- 1998 Compared to 1997."
On February 2, 1999, Prem Reddy, M.D., the former majority shareholder
of PrimeCare, a medical network management company acquired by the Company in
May 1998, filed suit against the Company and certain of its current and former
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 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 the Florida Board of Medicine opinion discussed above (See "Item 1.
Regulation - State Legislation") and OIG Advisory Opinion 98-4. 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. The terms of the service agreements provide that the agreements
shall be modified if the laws are changed, modified or interpreted in a way that
requires a change in the agreements. PhyCor intends to vigorously defend the
enforceability of the structure of the management fee against these suits,
however, there can be no assurance that if the Company is not successful in such
litigation, that these suits will not have a material adverse effect on the
Company.
Certain litigation is pending against the physician groups affiliated
with the Company and IPAs managed by the Company. The Company has not assumed
any liability in connection with such litigation. Claims against the physician
groups and IPAs could result in substantial damage awards to the claimants which
may exceed applicable insurance coverage limits. While there can be no assurance
that the physician groups and IPAs will be successful in any such litigation,
the Company does not believe any such litigation will have a material adverse
effect on the Company. Certain
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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 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's common stock is traded on the Nasdaq Stock Market under
the symbol PHYC. The Company's 4.5% convertible subordinated debentures due
2003, are traded on the Nasdaq Stock Market under the symbol PHYCH. The
Company's initial public offering took place on January 22, 1992.
<TABLE>
<CAPTION>
1997 HIGH LOW
---------------------------------------------------------------
<S> <C> <C>
First Quarter $ 35.38 $ 26.50
Second Quarter 35.50 22.88
Third Quarter 34.75 27.63
Fourth Quarter 33.25 22.75
<CAPTION>
1998 HIGH LOW
---------------------------------------------------------------
<S> <C> <C>
First Quarter 28.50 18.88
Second Quarter 23.81 14.13
Third Quarter 17.38 4.50
Fourth Quarter 7.69 3.94
<CAPTION>
1999 HIGH LOW
---------------------------------------------------------------
<S> <C> <C>
First Quarter (through $ 8.38 $ 4.50
March 26, 1999)
</TABLE>
As of March 26, 1999, the Company had approximately 29,742
shareholders, including 3,842 shareholders of record and approximately 25,900
persons or entities holding common stock in nominee name.
19
<PAGE> 20
The Company has never declared or paid a dividend on its common stock,
except in the form of three-for-two stock splits effected in December 1994,
September 1995 and June 1996, each of which was paid in the form of a 50% stock
dividend. The Company intends to retain its earnings to finance the growth of
its businesses. The declaration of other dividends is currently prohibited by
the Company's bank credit facility and its synthetic lease facility, and it is
anticipated that other loan agreements and leases which the Company may enter
into in the future will also contain restrictions on the payment of dividends by
the Company.
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Year ended December 31, 1998 1997 1996 1995 1994
- -------------------------------------- ----------- ----------- ----------- --------- ---------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net revenue $ 1,512,499 $ 1,119,594 $ 766,325 $ 441,596 $ 242,485
Operating expenses:
Cost of provider services 134,302 -- -- -- --
Salaries, wages and benefits 513,646 421,716 291,361 166,031 88,443
Supplies 227,440 181,565 119,081 67,596 37,136
Purchased medical services 37,774 31,171 21,330 17,572 11,778
Other expenses 218,359 171,480 125,947 71,877 40,939
General corporate expenses 29,698 26,360 21,115 14,191 9,417
Rents and lease expense 126,453 100,170 65,577 36,740 23,413
Depreciation and amortization 90,238 62,522 40,182 21,445 12,229
Provision for asset revaluation
and clinic restructuring(1) 224,900 83,445 -- -- --
Merger expenses 14,196 -- -- -- --
----------- ----------- ----------- --------- ---------
Net operating expenses 1,617,006 1,078,429 684,593 395,452 223,355
----------- ----------- ----------- --------- ---------
Earnings (loss) from operations (104,507) 41,165 81,732 46,144 19,130
Interest income (3,032) (3,323) (3,867) (1,816) (1,334)
Interest expense 36,266 23,507 15,981 5,230 3,963
----------- ----------- ----------- --------- ---------
Earnings (loss) before income (137,741) 20,981 69,618 42,730 16,501
taxes and minority interest
Income tax expense (benefit) (39,890) 6,098 22,775 13,923 4,826
Minority interest 13,596 11,674 10,463 6,933 --
----------- ----------- ----------- --------- ---------
Net earnings (loss) $ (111,447)(2) $ 3,209(2) $ 36,380 $ 21,874 $ 11,675(3)
========== ======== =========== ========= =========
Net earnings (loss) per share(4)
Basic $ (1.55)(2) $ .05(2) $ .67 $ .45 $ .35(3)
Diluted $ (1.55)(2) $ .05(2) $ .60 $ .41 $ .32(3)
========== ======== =========== ========= =========
Weighted average shares outstanding(4)
Basic 71,822 62,899 54,608 48,817 33,240
Diluted 71,822 66,934 61,096 53,662 42,988
========== ======== =========== ========= =========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998 1997 1996 1995 1994
----------- ----------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital $ 187,854 $ 203,301 $ 182,553 $ 111,420 $ 80,533
Total assets 1,846,539 1,562,776 1,118,581 643,586 351,385
Long-term debt 651,209 501,107 444,207 140,633 94,653
Total shareholders' equity 804,410 710,488 451,703 388,822 184,125
</TABLE>
- ----------
1 Provision for asset revaluation and clinic restructuring relates to
revaluation of assets of certain of the Company's affiliated clinics and MHG.
2 Excluding the effect of the asset revaluation, clinic restructuring and merger
charges in 1997 and 1998, the Company's net earnings, net earnings per share -
basic and net earnings per share - diluted would have been approximately $57.0
million, or $.91 per share - basic, and $.85 per share - diluted, and $54.7
million, or $.76 per share-basic and $.74 per share-diluted, respectively, in
such years.
3 Excluding the effect of the utilization of a net operating loss carry forward
to reduce income taxes in 1994, net earnings, net earnings per share-basic and
net earnings per share-diluted would have been $10.2 million, or $.31 per
share-basic and $.28 per share-diluted.
4 Per share amounts and weighted average shares outstanding have been adjusted
for the three-for-two stock splits effected December 1994, September 1995 and
June 1996.
20
<PAGE> 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
The Company operates multi-specialty medical clinics, develops and
manages IPAs 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 the Company's multi-specialty clinic operations, we manage and operate two
hospitals and four HMOs. A substantial majority of the Company's revenue in 1997
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.
When PhyCor acquires a clinic's operating assets, it simultaneously
enters into a long-term service agreement with the affiliated physician group.
Under the service agreement, PhyCor provides the physician group with the
equipment and facilities used in its medical practice, manages clinic
operations, employs the clinic's non-physician personnel, other than certain
diagnostic technicians, and receives a service fee.
The affiliated physicians maintain full professional control over their
medical practices, determine which physicians to hire or terminate and set their
own standards of practice in order to promote high quality health care. Pursuant
to its service agreements with physician groups, PhyCor manages all aspects of
the clinic other than the provision of medical services, which is controlled by
the physician groups. At each clinic, a joint policy board equally represented
by physicians and PhyCor personnel focuses on strategic and operational
planning, marketing, managed care arrangements and other major issues facing the
clinic.
To increase clinic revenue, the Company works with the affiliated
physician groups to recruit additional physicians, merge other physicians
practicing in the area into the affiliated physician groups, negotiate contracts
with managed care organizations and provide additional ancillary services. To
reduce or control expenses, among other things, PhyCor utilizes national
purchasing contracts for key items, reviews staffing levels to make sure they
are appropriate and assists the physicians in developing more cost-effective
clinical practice patterns.
Under substantially all of its service agreements, the Company receives
a service fee equal to the clinic expenses it has incurred plus a percentage of
operating income of the clinic (net clinic revenue less certain contractually
agreed upon clinic expenses before physician distributions) and, under all other
service agreements except one described below, the Company receives a percentage
of net clinic revenue. In 1998, the Company's service agreement revenue was
derived from contracts with the following service fee structures: (i) 92.1% of
revenue was derived from contracts in which the service fee was based on a
percentage, ranging from 11% to 18%, of clinic operating income plus
reimbursement of clinic expenses; (ii) 0.8% of revenue was derived from a
contract in which the service fee was based on 51.7% of net clinic revenue;
(iii) 5.9% of revenue was derived from contracts in which the service fee was
based upon a combination of (a) 10% of clinic operating income, (b) a
percentage, ranging from 2.75% to 3.5%, of net clinic revenue and (c)
reimbursement of clinic expenses; and (iv) 1.2% of revenue was derived from a
flat fee contract.
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,
21
<PAGE> 22
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 1997, amortization expense would have increased by approximately $11.2
million for the year. Applying the Company's historical tax rate, diluted
earnings per share would have been reduced by $.10 for 1997. On the same basis,
for the first quarter of 1998, amortization expense would have increased by
approximately $3.3 million, resulting in an increase in diluted loss per share
of $0.03.
Each of the service agreements with the Company's affiliated physician
groups provides the affiliated physician group the right to terminate the
service agreement in the event of the bankruptcy or similar event of the
Company's subsidiary that is a party to the service agreement or in the event of
a material breach of the service agreement by the Company or its subsidiary (i)
which is not cured within 90 days, generally, following written notice and (ii)
which termination is approved by the affirmative vote of no less than 75%,
generally, of the physician shareholders. Many of the service agreements provide
that if any person or persons acquire the right to vote 50% or more of PhyCor's
common stock, the physician group may terminate the service agreement, unless
the transaction was approved by PhyCor's Board of Directors or subsequently
approved by two-thirds of PhyCor's directors who are not members of management
or affiliates of the acquiring person. The physician group in Lexington,
Kentucky may also terminate its service agreement if an entity named therein
acquires 15% or more of the Company's outstanding common stock. Other groups may
terminate their service agreement in the event of a merger where PhyCor does not
survive or a takeover or sale of substantially all the assets of PhyCor or in
the event of a sale of all or substantially all of the assets or capital stock
of the PhyCor subsidiary with whom the service agreement was entered into. Some
physician groups have rights of first refusal to purchase the clinic assets
owned by PhyCor if PhyCor determines to sell such assets. The above provisions
could have an adverse effect on any efforts to take control of PhyCor without
the consent of the Board of Directors and the physician groups having these
rights. In addition, the Company may terminate a service agreement (i) in the
event of the bankruptcy or similar event of the affiliated physician group, or
(ii) a material breach of the service agreement by the affiliated physician
group which is not cured within 90 days, generally, following written notice. In
any event of termination, the affiliated physician group is obligated to
repurchase all of the tangible and intangible assets of the Company related to
the physician group generally at the then current net book value.
Pursuant to the Company's service agreements with its affiliated
clinics, the physician groups affiliated with the clinics are obligated to
repurchase at book value all of the assets associated with the clinic, including
intangible assets, upon termination of the service agreement. The Company's
ability to recover the net book value associated with a terminated service
agreement is largely dependent upon the circumstances of the termination, the
willingness of the physicians to honor their agreement with the Company and the
financial position of the physicians affiliated with the clinic. In the event of
a termination of a service agreement, PhyCor expects the terminating group to
fulfill its repurchase obligation at the effective time of termination. The
Company owns substantially all of the tangible assets related to the operations
of its affiliated clinics, which assets provide collateral for a portion of the
purchase requirement in the event of termination. Tangible assets associated
with clinics represented approximately 51% of the Company's total assets
associated with the clinics. The intangible assets of the Company related to the
affiliated clinics totaled $696.8 million as of December 31, 1998. In connection
with the disposal of certain clinic operations, the Company determined that a
sale of assets below book value provided a more cost-effective means to
terminate its relationship with certain clinics rather than attempting to
collect the full net book value of the assets through the enforcement of its
contractual rights under the service agreement with the clinic. See "Liquidity
and Capital Resources." The Company has evaluated, on an individual basis, the
appropriate course of action for each of its terminated service agreements and
expects to pursue the most appropriate and effective course, given the facts and
circumstances of any termination, to recover the amounts owed as a result of any
such termination.
22
<PAGE> 23
In November 1997, the Emerging Issues Task Force reached a consensus on
EITF 97-2, "Application of APB Opinion No. 16 and FASB Statement No. 94 to
Physician Practice Entities", which was adopted in November 1997, and relates
primarily to the consolidation of physician practices controlled by a company.
The Company has not consolidated the physician practices it manages as it does
not have operating control of these practices as defined in EITF 97-2. Physician
practices and IPAs which are owned and operated by the Company are consolidated
for such purposes.
The Company has increased its focus on the development of IPAs to
enable the Company to provide services to a broader range of physician
organizations, to enhance the operating performance of existing clinics and to
further develop physician relationships. The Company develops IPAs that include
affiliated clinic physicians to enhance the clinics' attractiveness as providers
to managed care organizations. Fees earned from managing the IPAs are based upon
a percentage of revenue collected by the IPAs and also upon a share of surplus,
if any, of capitated revenue of the IPAs. In 1998, approximately 16% of the
Company's revenue was earned under IPA management agreements. The Company is not
a party to the capitated contracts entered into by the IPAs not owned by the
Company, but is exposed to losses to the extent of its share of the excess of
costs, if any, over the capitated revenue of the IPAs. The Company is a party to
capitated contracts entered into by the PrimeCare and MHG IPAs.
The table below indicates the number of clinics and physicians
affiliated with the Company and provides certain information with respect to the
Company's IPA operations at the end of the years indicated:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------- ------ ------ ------ --------
<S> <C> <C> <C> <C> <C>
Clinic operations:
Number of affiliated clinics 56 55 44 31 22
Number of affiliated physicians 3,693 3,863 3,050 1,955 1,143
IPA operations:
Number of markets 35 28 17 13 7(1)
Number of physicians 22,900 19,000 8,700 5,300 3,600(1)
Number of commercial members 730,000 420,000 306,000 180,000 105,000(1)
Number of Medicare members 171,000 99,000 69,000 38,000 24,000(1)
</TABLE>
- ----------------
(1) Information is as of January 1, 1995.
The table below indicates the payor mix of the aggregate net clinic
revenue earned by the physician groups and IPAS currently affiliated with the
Company.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Medicare 19% 22% 20% 20% 29%
Medicaid 3 4 3 3 3
Managed care(1) 51 41 42 37 25
Private payor and insurance 27 33 35 40 43
--- --- --- --- ---
100% 100% 100% 100% 100%
</TABLE>
- ----------------
(1) Includes HMO, PPO, Medicare risk contracts and direct employer
contracts, of which approximately 70% of 1998 managed care revenue was
attributable to capitated contracts.
The payor mix varies from clinic to clinic and changes as acquisitions
are made. Since 1993, managed care revenue as a percentage of all revenue has
increased significantly primarily as a result of the Company's management of
IPAs for which all revenue is derived from managed care contracts. PhyCor
believes that this trend will continue as a greater portion of the population in
the Company's
23
<PAGE> 24
markets joins managed care plans. Other changes in payor mix have resulted from
the acquisition of clinics with payor mixes different from historical payor
mixes experienced by the Company's affiliated groups.
Many of the payor contracts entered into on behalf of PhyCor-managed
IPAs are based on capitated fee arrangements. Under capitation arrangements,
health care providers bear the risk, subject to certain loss limits, that the
aggregate costs of providing medical services to members will exceed the
payments received. The IPA management fees are based, in part, upon a share of
the remaining portion, if any, of capitated amounts of revenues after payment of
expenses. Agreements with payors also contain shared risk provisions under which
the Company and the IPA can earn additional compensation based on utilization of
hospital services by members and may be required to bear a portion of any loss
in connection with such shared risk provisions. The profitability of the managed
IPAs is dependent upon the ability of the providers to effectively manage the
per patient costs of providing medical services and the level of utilization of
medical services. The management fees are also based upon a percentage of
revenue collected by the IPAs. Through its service fees, the Company also shares
indirectly in capitation risk assumed by its affiliated physician groups.
In May 1998, the Company acquired PrimeCare, a medical network
management company serving southern California's Inland Empire area. PrimeCare's
network is comprised of an integrated campus, including the Desert Valley
Medical Group, Desert Valley Hospital and Apple Valley Surgery Center, as well
as the Inland Empire area IPA network. The total consideration for PrimeCare was
approximately $170.0 million, consisting of approximately 4.0 million shares of
common stock, assumed liabilities and cash. See Item 3. "Legal Proceedings."
On July 1, 1998, the Company acquired Seattle-based CareWise, a
nationally recognized leader in the health care decision-support industry, which
as of December 31, 1998, provided health care decision-support services to
approximately 2.7 million individuals worldwide. The total consideration for
CareWise was approximately $67.5 million, consisting of approximately 3.1
million shares of common stock and assumed liabilities.
In July 1998, the Company acquired MHG, 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. The total consideration for MHG was approximately
$33.1 million, consisting of 500,000 shares of common stock and assumed
liabilities. See Item 1. "Business - Physician Networks."
On July 24, 1998, the Company acquired FPC, an Atlanta-based provider
of practice management services. The total consideration for FPC was
approximately $60.4 million, consisting of 2.9 million shares of common stock
and assumed liabilities.
In addition, in 1998 the Company purchased certain assets of two
multi-specialty clinics, numerous smaller medical practices and completed its
purchase of certain operating assets of Lakeview Medical Center located in
Suffolk, Virginia, which was operated under a management agreement during
December 1997.
In October 1998, the Company formed a joint venture with Physician
Partners Company, L.L.C., a physician organization created by physicians to
develop an IPA management business and to develop and manage a regional managed
care contracting network, which is anticipated to include IPAs in New York City,
northern New Jersey, southern Connecticut and Long Island.
As a result of 1998 transactions, the Company acquired total assets of
$459.7 million. The principal assets acquired were accounts receivable, property
and equipment, prepaid expenses, goodwill and service agreement rights, an
intangible asset. The consideration for the acquisitions consisted of
approximately 21% cash, 38% liabilities assumed, 39% common stock and 2%
convertible notes. The cash portion of the aggregate purchase price was funded
by a combination of operating
24
<PAGE> 25
cash flow and borrowings under the Company's bank credit facility. Property and
equipment acquired consists mostly of clinic and hospital operating equipment.
The Company recorded asset revaluation and restructuring charges in
1998 totaling $224.9 million related to the disposition of assets of seven
clinics, the write-off of goodwill related to MHG and the revaluation of assets
at certain underperforming clinics, including certain FPC clinics. The Company
expects to record a pre-tax charge in the first quarter of 1999 totaling $8.7
million related to severance and other transition costs in connection with the
restructuring and disposition of operations. These asset revaluation and
restructuring charges relate to certain group formation clinics and to certain
traditional clinics that were disposed of and certain clinics whose assets were
written down because of a variety of negative operating and market issues,
including those related to market position and clinic demographics, physician
relations, departure rates, declining physician incomes, physician productivity,
operating results and ongoing commitment and viability of the medical group.
In September 1998, PhyCor adopted a common stock repurchase program
pursuant to which it may repurchase up to $50.0 million of PhyCor common stock.
In October 1998, PhyCor expanded the program into a securities repurchase
program to include its 4.5% convertible subordinated debentures and other
securities, the economic terms of which are derived from the common stock or
debentures. In conjunction with the securities repurchase program, PhyCor has
repurchased approximately 2.6 million shares of common stock for approximately
$12.6 million, 2.2 million shares of which were repurchased in the fourth
quarter. Recent changes to the Company's bank credit facility limit the amount
of the Company's securities the Company may repurchase. See "Liquidity and
Capital Resources."
25
<PAGE> 26
RESULTS OF OPERATIONS
The following table shows the percentage of net revenue represented by
various expense categories reflected in the Company's Consolidated Statements of
Operation.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------- ---- ---- ----
<S> <C> <C> <C>
Net revenue 100.0% 100.0% 100.0%
Operating expenses:
Cost of provider services 8.9 -- --
Salaries, wages and benefits 33.9 37.7 38.0
Supplies 15.0 16.2 15.5
Purchased medical services 2.5 2.8 2.8
Other expenses 14.4 15.3 16.4
General corporate expenses 2.0 2.4 2.8
Rents and lease expense 8.4 8.9 8.6
Depreciation and amortization 6.0 5.6 5.2
Provision for asset revaluation and clinic restructuring 14.9 7.4 --
Merger expenses 0.9 -- --
----- ----- -----
Net operating expenses 106.9(1) 96.3(1) 89.3
Earnings (loss) from operations (6.9)(1) 3.7(1) 10.7
Interest income (0.2) (0.3) (0.5)
Interest expense 2.4 2.1 2.1
----- ----- -----
Earnings (loss) before income taxes
and minority interest (9.1)(1) 1.9(1) 9.1
Income tax expense (benefit) (2.6)(1) 0.5(1) 3.0
Minority interest 0.9 1.1 1.4
----- ----- -----
Net earnings (loss) (7.4)%(1) 0.3%(1) 4.7%
==== ===== =====
</TABLE>
- ----------------
(1) Excluding the effect of the provision for asset revaluation and clinic
restructuring and merger expenses in 1997 and 1998, net operating
expenses, earnings from operations, earnings before income taxes and
minority interest, income tax expense and net earnings, as a percent of
net revenue, would have been 88.9%, 11.1%, 9.3%, 3.2% and 5.1%,
respectively, for 1997, and 91.1%, 8.9%, 6.7%, 2.2%, and 3.6%,
respectively, for 1998.
1998 COMPARED TO 1997
Net revenue increased $392.9 million from $1.12 billion for 1997 to
$1.51 billion for 1998, an increase of 35.1%. The increase in clinic net revenue
in 1998 as compared to 1997 was $182.0 million, including $177.2 million in
service fees resulting from newly acquired clinics in 1998 or the timing of
entering into new service agreements in 1997, and was comprised of (i) a $161.4
million increase in service fees for reimbursement of clinic expenses incurred
by the Company and (ii) a $20.6 million increase in the Company's fees from
clinic operating income and net physician group revenue. The increases in clinic
net revenue have been reduced by $49.5 million as a result of termination of
affiliations in 1998. Net revenue from the 35 service agreements (excluding
clinics being restructured or affiliations terminated) and 27 IPA markets in
effect for both years increased by $54.3 million, or 11.2%, in 1998 compared
with 1997. Same market growth resulted from, among other factors, the addition
of new physicians, the expansion of ancillary services, increases in patient
volume and fees and increases in capitated lives served by IPAs.
During 1998, most categories of operating expenses changed as a
percentage of net revenue when compared to 1997. 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 are a party to
26
<PAGE> 27
certain managed care contracts, resulting in the Company presenting such revenue
as its revenue on a "grossed-up basis." Under this method, 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 has an impact on the Company's operating expenses as a
percentage of net revenue. Excluding the impact of PrimeCare's and MHG's revenue
reporting, there were no significant variances in the operating expenses as a
percentage of net revenue compared to 1997. Excluding the impact of PrimeCare's
and MHG's revenue reporting, supplies expense, other expenses, rents and lease
expense and depreciation and amortization increased as a percentage of net
revenue. The increase in supplies expense is a result of continued increases in
costs of drugs and medications, the addition of pharmacies at certain existing
clinics and recent affiliations with clinics that operate pharmacies. Other
expenses and rents and lease expense increased as a result of the reduction of
physicians in certain of the Company's group formation clinics which resulted in
these clinics not operating at full capacity but still being responsible for
certain fixed costs obligations. The increase in depreciation and amortization
expense resulted from the change in amortization policy with respect to
intangible assets and the impact of recent acquisitions. Excluding the impact of
PrimeCare's and MHG's revenue reporting, salaries, wages and benefits decreased
as a percentage of net revenue. This decrease is a result of the Company's
continuing efforts to control overhead costs. While general corporate expenses
decreased as a percentage of net revenue, the dollar amount increased as a
result of the Company's response to increasing physician group needs for
practice management services, including managed care negotiations, information
system implementations and clinical outcomes management programs.
The total provision for asset revaluation and clinic restructuring for
the year ended December 31, 1998 totaled $224.9 million, consisting of $22.0
million in the first quarter of 1998, a net $92.5 million in the third quarter
of 1998 and $110.4 million in the fourth quarter of 1998. The provision for
clinic restructuring of $22.0 million in the first quarter of 1998 related to
seven of the Company's clinics that were being restructured or disposed of and
included facility and lease termination costs, severance and other exit costs.
In the fourth quarter of 1997, the Company recorded a pre-tax charge of $83.4
million related to asset revaluation at these same clinics. The charges
addressed operating issues that developed in four of the Company's
multi-specialty clinics that represent the Company's earliest developments of
such clinics through the formation of new groups. Three other clinics included
in the 1997 charge represent clinics disposed of during 1998 because of a
variety of negative operating and market-specific issues.
In the third quarter of 1998, the Company recorded a net pre-tax asset
revaluation charge of $92.5 million. 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. Additionally, this charge
provided for the disposition of assets of two other group formation clinics not
included in the fourth quarter 1997 asset revaluation charge and the revaluation
of primarily intangible assets at an additional group formation clinic that may
be disposed of or restructured. The third quarter 1998 asset revaluation charge
included current assets, property and equipment, other assets and intangible
assets of $4.2 million, $3.8 million, $6.7 million and $77.8 million,
respectively.
In the fourth quarter of 1998, the Company recorded a pre-tax asset
revaluation charge of $110.4 million. A portion 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 pre-tax charge related to
these clinics was $26.0 million and assumes the successful completion of those
transactions as reflected in the agreements. In addition, this charge provided
for the write-off of $31.6 million of goodwill recorded in connection with the
MHG acquisition. The future operations of MHG have been impaired, and PhyCor is
attempting to recover its investment in MHG, but there can be no assurance of
any recovery. See Item 1. "Business -- IPA and Physician Networks". Also
included in the fourth quarter pre-tax charge is $18.1 million related to
certain FPC clinics that are experiencing
27
<PAGE> 28
significant negative operating results. The asset revaluation charge includes
primarily the write-down of goodwill from the FPC acquisition to recognize the
decline in future cash flows of the investment. The ultimate solution in these
markets may involve the sale of certain clinic assets and discontinuation of
some operations. Lastly, the Company recorded a pre-tax asset revaluation charge
related to the Lexington Clinic in the fourth quarter of approximately $34.7
million. This charge reduces to net realizable value the investments in numerous
satellite operations and provides a reserve for amounts owed by the Lexington
Clinic based upon expected future cash flows. The fourth quarter 1998 asset
revaluation charge included current assets, property and equipment, other
assets and intangible assets of $3.7 million, $3.7 million, $27.0 million and
$76.0 million, respectively. In connection with all of the plans mentioned
above, the Company estimates it will record a pre-tax restructuring charge of
approximately $8.7 million in the first quarter of 1999 related to severance and
other exit costs.
Net revenue and pre-tax loss for operations disposed of during 1998
were $54.0 million and $3.0 million in 1998 and $103.5 million and $2.5 million
in 1997, respectively. The Company recorded no gain or loss resulting from the
disposition of these clinics based on adjusted asset values. Net revenue and
pre-tax income from the remaining operations to be disposed of in 1999 were
$121.4 million and $984,000 in 1998 and $82.8 million and $4.0 million and 1997,
respectively. See "Liquidity and Capital Resources."
The Company also recorded a pre-tax charge to earnings of approximately
$14.2 million in the first quarter of 1998 relating to the termination of its
merger agreement with MedPartners, Inc. This charge represented PhyCor's share
of investment banking, legal, travel, accounting and other expenses incurred
during the merger negotiation process.
The Company expects an effective tax rate of approximately 37.6% in
1998 before the tax benefit of the provision for clinic restructuring and merger
expenses discussed above as compared to a rate of 38.5% in 1997.
1997 COMPARED TO 1996
Net revenue increased $353.3 million from $766.3 million for 1996 to
$1.12 billion for 1997, an increase of 46.2%. The increase in clinic net
revenues in 1997 as compared to 1996 of $333.1 million included $278.5 million
in service fees resulting from newly acquired clinics in 1997 or the timing of
entering into new service agreements in 1996 and was comprised of (i) a $294.2
million increase in service fees for reimbursement of clinic expenses incurred
by the Company and (ii) a $38.9 million increase in the Company's share of
clinic operating income and net physician group revenue. Net revenue from the 31
service agreements and 13 IPA markets in effect for both years increased $75.3
million, or 12.8%, in 1997 compared with 1996. Same market growth resulted from
the addition of new physicians, the expansion of ancillary services, and
increases in patient volume and fees. The remaining increase results from the
addition of new clinic service agreements in 1997 and the timing of entering
into new service agreements in 1996.
During 1997, most categories of operating expenses were relatively
stable as a percentage of net revenue when compared to 1996, despite the large
increase in the dollar amounts resulting from acquisitions and clinic growth.
The decrease in salaries, wages and benefits and other expenses as a percentage
of net revenue resulted from the acquisition of clinics with lower levels of
these expenses compared to the existing base of clinics. The increase in
supplies and rents and lease expense as a percentage of net revenue resulted
from the acquisition of clinics with higher levels of these expenses compared to
the existing base of clinics. The addition of pharmacies at certain existing
clinics and new clinics which operate pharmacies also resulted in increased
clinic supplies expense as a percentage of net revenue. While general corporate
expenses decreased as a percentage of net revenue, the dollar amount of general
corporate expenses increased as a result of the addition of corporate personnel
to accommodate increased acquisition activity and to respond to increasing
physician group needs for support in managed care negotiations, information
systems implementation and clinical outcomes management programs.
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<PAGE> 29
The asset revaluation charge of $83.4 million in 1997 related to the
asset revaluation of seven of the Company's multi-specialty clinics, and
included current assets, property and equipment, other assets and intangible
assets of $6.4 million, $4.9 million, $5.3 million and $66.8 million,
respectively. This charge addressed issues which developed in four of the
Company's multi-specialty clinics which represented the Company's earliest
developments of such clinics through the formation of new groups. The clinics
were considered to have an impairment of certain current assets, property and
equipment, other assets and, primarily, intangible assets because of certain
groups of physicians within a larger clinic terminating their relationship with
the medical group affiliated with the Company and therefore affecting future
cash flows. Net revenue and pre-tax income (loss) for the four clinics that were
part of new group formations included in the charge were $88.4 million and
($2.9) million in 1997 and $78.7 million and $188,000 in 1996, respectively. Net
revenue and total assets of other new group formations not included in the asset
revaluation charge totaled $38.7 million and $61.4 million, respectively, in
1997, and $13.0 million and $37.2 million, respectively, in 1996. Three other
clinics included in the charge represented clinics being disposed of because of
a variety of negative operating and market issues, including those related to
market position and clinic demographics, physician relations, operating results
and ongoing viability of the existing medical group. Net revenue and pre-tax
income (loss) for the three clinics to be disposed of were $25.5 million and
($1.0 million) in 1997 and $26.5 million and $772,000 in 1996, respectively.
The Company's effective tax rate was approximately 38.5% in 1997 and
1996.
SUMMARY OF OPERATIONS BY QUARTER
The following table presents unaudited quarterly operating results for
1998 and 1997. The Company believes that all necessary adjustments have been
included in the amounts stated below to present fairly the quarterly results
when read in conjunction with the Consolidated Financial Statements. Results of
operations for any particular quarter are not necessarily indicative of results
of operations for a full year or predictive of future periods.
<TABLE>
<CAPTION>
1998 QUARTER ENDED
-----------------------------------------------
MAR 31 JUNE 30 SEPT 30 DEC 31
--------- --------- -------- ---------
<S> <C> <C> <C> <C>
Net revenue $322,695 $371,450 $408,487 $409,867
Earnings (loss) before taxes (10,753)(1) 24,306 (73,019)(2) (91,871)(3)
Net earnings (loss) (7,498)(1) 15,313 (50,843)(2) (68,419)(3)
Earnings (loss) per
share--diluted $ (.12)(1) $ .22 $ (.66)(2) $ (.90)(3)
</TABLE>
<TABLE>
<CAPTION>
1997 QUARTER ENDED
-----------------------------------------
MAR 31 JUNE 30 SEPT 30 DEC 31
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenue $250,652 $267,354 $284,291 $317,297
Earnings (loss) before taxes 20,011 22,395 24,576 (57,675)(4)
Net earnings (loss) 12,307 13,706 15,040 (37,844)(4)
Earnings (loss) per
share--diluted $ .19 $ .20 $ .22 $ (.56)(4)
</TABLE>
- -------------------------------
(1) Excluding the effects of asset revaluation and clinic restructuring
charges and merger expenses, the Company's earnings before taxes, net
earnings and net earnings per share-diluted for the first quarter of
1998 would have been approximately $25.4 million, $16.0 million and
$.24, respectively.
(2) Excluding the effects of asset revaluation and clinic restructuring
charges, the Company's earnings before taxes, net earnings and net
earnings per share-diluted for the third quarter of 1998 would have
been approximately $19.5 million, $12.0 million and $.15, respectively.
(3) Excluding the effects of asset revaluation and clinic restructuring
charges, the Company's earnings before taxes, net earnings and net
earnings per share-diluted for the fourth quarter of 1998 would have
been approximately $18.5 million, $11.4 million and $.15, respectively.
(4) Excluding the effects of asset revaluation and clinic restructuring
charges, the Company's earnings before taxes, net earnings and net
earnings per share-diluted for the fourth quarter of 1997 would have
been approximately $25.8 million, $16.0 million and $.24, respectively.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had $187.9 million in working
capital, compared to $203.3 million as of December 31, 1997. Also, the Company
generated $161.2 million of cash flow from operations in 1998 compared to $116.0
million in 1997. At December 31, 1998, net accounts receivable of $378.7 million
amounted to 64 days of net clinic revenue compared to $391.7 million and 72 days
at the end of the prior year.
29
<PAGE> 30
In conjunction with the securities repurchase program, PhyCor has
repurchased approximately 2.6 million shares of common stock for approximately
$12.6 million, 2.2 million shares of which were repurchased in the fourth
quarter of 1998.
In 1998, $2.0 million of convertible subordinated notes issued in
connection with physician group asset acquisitions were converted into common
stock. These conversions, the issuance of common stock and option exercises, net
of repurchases of common stock, increased shareholders' equity $205.3 million.
This increase in shareholders' equity, less losses in 1998 of $111.4 million,
resulted in a net increase in shareholders' equity of $93.9 million at December
31, 1998 compared to December 31, 1997.
Capital expenditures during 1998 totaled $67.6 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 $70 million
in capital expenditures during 1999.
In June 1995, the Company purchased a minority interest of
approximately 9% in PMC and managed PMC pursuant to a ten year administrative
services agreement. PMC developed and managed IPAs and provided other services
to physician organizations. PhyCor acquired the remaining interests of PMC on
March 31, 1998 for approximately 956,300 shares of the Company's common stock
and integrated PMC's operations into NAMM.
Effective January 1, 1995, the Company completed its acquisition of
NAMM. The Company paid $20.0 million at closing and made additional payments
pursuant to an earn-out formula during 1996 and 1997, totaling $35.0 million. A
final payment of $35.0 million was made in April 1998, of which $13.0 million
was paid in shares of the Company's common stock.
In addition, deferred acquisition payments are payable to physician
groups in the event such physician groups attain predetermined financial targets
during established periods of time following the acquisitions. If each group
satisfied its applicable financial targets for the periods covered, the Company
would be required to pay an aggregate of approximately $63.0 million of
additional consideration over the next five years, of which a maximum of $15.8
million would be payable during 1999.
In the fourth quarter of 1997, PhyCor recorded a pre-tax charge to
earnings of $83.4 million related to the revaluation of assets of seven of the
Company's multi-specialty clinics, which included current assets, property and
equipment, other assets and intangible assets of $6.4 million, $4.9 million,
$5.3 million and $66.8 million, respectively. In the first quarter of 1998, the
Company also recorded an additional charge of approximately $22.0 million
relating to these clinics that are being restructured or disposed of including
facility lease exit costs, severance and other exit costs. These pre-tax charges
were partially in response to issues which arose in four of the Company's
multi-specialty clinics which represented the Company's earliest developments of
such clinics through the formation of new groups. The clinics were considered to
have an impairment of certain current assets, property and equipment, other
assets and intangible assets because of certain groups of physicians within a
larger clinic terminating their relationship with the medical group affiliated
with the Company and therefore affecting future cash flows. Three other clinics
included in the charge represented clinics being disposed of because of a
variety of negative operating and market issues, including those related to
market position and clinic demographics, physician relations, departure 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 the existence of
these factors at the clinics disposed of resulted in clinic operations that made
it difficult for the Company to effectively manage the clinics. One of these
practices was sold in the first quarter of 1998 and the second sale was
completed April 1, 1998. The remaining practice was disposed of in July 1998.
These clinics were sold below book value because of the reasons noted above, and
given such facts, a sale at a discount to carrying
30
<PAGE> 31
value was considered more cost effective than a closure which would subject the
Company to additional costs. The Company recorded no gain or loss on the final
disposition of these assets.
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 of 1997 asset revaluation charge and the corresponding decision to
dispose of those assets. Additionally, this charge provided for the disposition
of assets of two group formation clinics, which dispositions were not included
in the fourth quarter of 1997 asset revaluation charge, and the revaluation of
primarily intangible assets at an additional group formation clinic that may be
disposed of or restructured. The third quarter 1998 asset revaluation charge
included current assets, property and equipment, other assets and intangible
assets of $4.2 million, $3.8 million, $6.7 million and $77.8 million,
respectively. Amounts received upon the dispositions of the assets approximated
the post-charge net carrying value.
In the fourth quarter of 1998, the Company recorded a pre-tax asset
revaluation charge of $110.4 million. Approximately $26.0 million of this charge
related to adjustments of the carrying value of the Company's assets at
Holt-Krock and Burns as a result of agreements to sell certain assets associated
with these service agreements. The pre-tax charge assumes the successful
completion of these transactions as reflected in the agreements with these
clinics. In addition, this charge provided for the write-off of $31.6 million of
goodwill recorded in connection with the MHG Acquisition. Subsequent to the
closing of this acquisition, MHG received claims from its major payor for costs
arising before the acquisition that revealed that MHG's costs significantly
exceeded its revenues under the Payor Contract prior to the date of acquisition.
PhyCor continued to fund losses under this Payor Contract while attempting to
renegotiate payment terms with the payor to allow for this Payor Contract to be
economically viable. A mutually beneficial agreement could not be reached. The
Payor Contract will terminate by mutual agreement on April 30, 1999. The future
operations of MHG have been impaired, and PhyCor is attempting to recover its
investment in MHG but there can be no assurance of a recovery.
Also included in the fourth quarter pre-tax charge is $18.1 million
related to certain FPC clinics that are experiencing significant negative
operating results. PhyCor recorded the asset revaluation charge primarily to
write down goodwill from the FPC acquisition to recognize the decline in future
cash flows of the investment. Depending upon future events and business
conditions, the Company may sell certain of FPC clinic assets and discontinue
clinic operations. Lastly, the Company had invested significantly in the
operation of the Lexington Clinic to support the growth and expansion of the
Lexington Clinic and its affiliated HMO. Lexington Clinic's financial
performance has been negatively impacted by the combination of poor financial
performance at a number of satellite locations, a challenging and extended
information system conversion, a potential loss arising from a dispute with one
of the HMO's payors and the repayment of funds used to finance the Lexington
Clinic's and the HMO's growth. In light of the existing circumstances,
realization of certain of PhyCor's assets related to the Lexington Clinic was
unlikely. Accordingly, the Company recorded an asset revaluation pre-tax charge
in the fourth quarter of approximately $34.7 million to reduce to net realizable
value of its investments in numerous satellite operations and to provide a
reserve for amounts owed by Lexington Clinic based upon expected future cash
flows. The fourth quarter 1998 asset revaluation charge included current assets,
property and equipment, other assets and intangible assets of $3.7 million, $3.7
million, $27.0 million and $76.0 million, respectively. In connection with all
of the plans mentioned above, the Company estimates it will record a pre-tax
restructuring charge of approximately $8.7 million in the first quarter of 1999
related to severance and other exit costs.
At December 31, 1998, the Company had a total of five group formation
clinics and two FPC clinics that have characteristics similar to group formation
clinics. These remaining clinics include two clinics associated with the charges
discussed above, one of which was disposed of in March 1999. The total assets
and intangible assets of the remaining five group formation clinics and similar
FPC
31
<PAGE> 32
clinics totaled $56.8 million and $21.0 million, respectively, at December 31,
1998. Net revenue and pre-tax income (loss) for the group formation and similar
FPC clinics for 1998 were $63.7 million and ($1.0) million, respectively, and
for 1997 were $44.4 million and $519,000, respectively.
At December 31, 1998, net assets currently expected to be sold in 1999,
after taking into account the charges discussed above, relating to clinics with
which we intend to terminate our affiliation totaled approximately $41.2
million, which consisted of current assets, property and equipment, intangibles
and other assets. The Company intends to recover these amounts during 1999 as
the asset sales occur, provided, however there can be no assurance that the
Company will recover this entire amount.
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. For
additional discussion, see "Results of Operations - 1998 Compared to 1997" and
"Results of Operations - 1997 Compared to 1996."
The Company also recorded a pre-tax charge to earnings of approximately
$14.2 million in the first quarter of 1998 relating to its terminated merger
with MedPartners, Inc. This charge represents PhyCor's share of investment
banking, legal, travel, accounting and other expenses incurred during the merger
process.
PhyCor has been the subject of an audit by the Internal Revenue Service
("IRS") covering the years 1988 through 1993. The IRS has proposed adjustments
relating to the timing of recognition for tax purposes of deductions relating to
uncollectible accounts. PhyCor disagrees with the positions asserted by the IRS
and is vigorously contesting these proposed adjustments. Most of the issues
originally raised by the IRS as to revenues and deductions and the Company's
relationship with affiliated physician groups have been resolved by the National
Office of the IRS in favor of the Company and with respect to these issues, no
additional taxes, penalties or interest are owed by the Company related to such
claims. The IRS Appeals Office has raised a related issue concerning the
recognition of income with respect to accounts receivable, but it is unclear
whether the IRS will pursue this issue. The Company is prepared to continue to
vigorously contest any proposed adjustment on this related issue. The Company
believes that any adjustments resulting from resolution of this disagreement
would not affect the reported net earnings of PhyCor, but would defer tax
benefits and change the levels of current and deferred tax assets and
liabilities. For the years under audit, and potentially, for subsequent years,
any such adjustments could result in material cash payments by the Company. Any
successful adjustment by the IRS would cause an interest expense to be incurred.
PhyCor does not believe the resolution of this matter will have a material
adverse effect on its financial condition, although there can be no assurance as
to the outcome of this matter. In addition, the IRS is in the process of
examining the Company's 1994 and 1995 federal tax returns.
The Company modified its bank credit facility in April and September
1998 and March 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 during 1998
was either (i) the applicable eurodollar rate plus .50% to 1.25% per annum or
(ii) the agent's base rate plus .25% to .575% per annum. The total weighted
average drawn cost of outstanding borrowings at December 31, 1998 was 6.18%.
Effective in March 1999, total drawn cost is now either (i) the applicable
eurodollar rate plus .625% to 1.50% per annum or (ii) the agent's base rate plus
.40% to .65% per annum.
The March 1999 amendment also provides for an increase from $25 million
to $50 million for the aggregate amount of letters of credit which may be issued
by the Company and provides that in
32
<PAGE> 33
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 March 1999
modifications provide for acquisitions without bank approval of up to $25
million individually or $150 million in the aggregate during any 12-month period
and limit the amount of its securities PhyCor may repurchase based upon certain
financial criteria.
In 1997, the Company entered into an interest rate swap agreement to
reduce the exposure to fluctuating interest rates with respect to $100 million
of its bank credit facility. During 1998, the Company amended the previous
interest rate swap agreement and entered into additional swap agreements. At
December 31, 1998, 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 the Company will be required to adopt in the first quarter of
2000. Adoption of SFAS No. 133 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. Had the Company adopted SFAS No. 133 as of
March 24, 1999, the Company estimates it would have recorded a non-cash charge
to earnings of $3.7 million. 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.
The Company also entered into a $100 million synthetic lease facility
in April 1998. The synthetic lease facility provides off balance sheet financing
with an option to purchase the leased facilities at the end of the lease term.
The total drawn cost under the synthetic lease facility during 1998 was .375% to
1.00% above the applicable eurodollar rate. At December 31, 1998, an aggregate
of $19.1 million was drawn under the synthetic lease facility. In March 1999,
the Company amended its synthetic lease facility to $60 million and total drawn
cost is now .50% to 1.25% above the applicable eurodollar rate. Of the $60
million available under the synthetic lease facility, $21.6 million has been
committed to lease properties associated with two of PhyCor's affiliated
clinics. The synthetic lease facility, as amended in March 1999, is not project
specific but is expected to be used for, among other projects, the construction
or acquisition of medical office buildings related to the Company's operations.
The Company's bank credit facility and the 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.
The Company has two stock option plans and two stock purchase plans.
Compensation expense calculated in determining pro forma earnings per share in
accordance with FAS 123, Earnings per Share, increased diluted loss per share
$0.27 in 1998 and decreased diluted earnings per share $0.27 and $0.11 in 1997
and 1996, respectively. Pro forma diluted earnings per share will likely
continue to be significantly below diluted earnings per share because the
Company plans to continue to grant stock options in future periods.
In August 1998, the Company adopted a stock option exchange program
available to all option holders, excluding the Company's executive officers and
its board of directors. Such holders were given the opportunity to exchange
options granted after October 1994 for new options with renewed four-year
vesting schedules representing fewer shares at an exercise price of $7.91 per
share. Options to purchase an aggregate of 3,964,000 shares were issued as a
result of the exchange of previously issued options to purchase 8,575,000
shares, which constitute 91% of the options eligible for exchange.
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<PAGE> 34
Market Risks Associated with Financial Instruments
The Company's interest expense is sensitive to changes in the general
level of interest rates. To mitigate the impact of fluctuations in interest
rates, the Company generally maintains a portion of its debt as fixed rate in
nature either by borrowing on a long-term basis or entering into interest rate
swap transactions. The interest rate swap agreements are contracts to
periodically exchange fixed and floating interest rate payments over the life of
the agreements. The floating-rate payments are based on LIBOR and fixed-rate
payments are dependent upon market levels at the time the swap agreement was
consummated. The interest rate swap agreements do not constitute positions
independent of the underlying exposures. The Company does not hold or issue
derivative instruments for trading purposes and is not a party to any
instruments with leverage features. Certain swap agreements allow the
counterparty the option to terminate at the end of the initial term. The Company
is exposed to credit losses in the event of nonperformance by the counterparties
to its financial instruments. The counterparties are creditworthy financial
institutions, and the Company anticipates that the counterparties will be able
to fully satisfy their obligations under the contracts. For the years ended
December 31, 1998 and 1997, the Company received a weighted average rate of
5.52% and 5.75% and paid a weighted average rate on its interest rate swap
agreements of 5.68% and 5.85% respectively.
The table below presents information about the Company's
market-sensitive financial instruments, including long-term debt and interest
rate swaps as of December 31, 1998. For debt obligations, the table presents
principal cash flows and related weighted-average interest rates by expected
maturity dates. For interest rate swap agreements, the table presents notional
amounts by expected maturity date (assuming the options to cancel are not
exercised) and weighted average interest rates based on rates in effect at
December 31, 1998. The fair values of long-term debt and interest rate swaps
were determined based on quoted market prices at December 1998 for the same or
similar debt issues.
<TABLE>
<CAPTION>
EXPECTED MATURITY DATE
-----------------------------------------------------------------------------------------------------
Fair
1999 2000 2001 2002 2003 Thereafter Total Value
---------- --------- --------- -------- ---------- ---------- ---------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liabilities
Long-term debt:
Fixed rate $ 16,472 11,393 10,407 3,036 201,756 3,297 246,361 164,116
Average interest rate(1) 8.58% 8.75% 7.79% 7.62% 4.52% 7.47% 5.21%
Variable rate 2,583 2,250 1,250 -- 377,000 23,295 406,378 389,102
Average interest rate(1) 6.12% 6.14% 6.25% -- 6.19% 5.87% 6.16%
Interest rate swaps:
Pay variable/ receive -- -- -- -- 200,000 26,000 226,000 (7,256)
fixed notional amounts
Average pay rate -- -- -- -- 5.46% 5.31% 5.45%
Average receive rate -- -- -- -- 5.03% 5.03% 5.03%
</TABLE>
- -------------------------
(1) Average interest rates exclude deferred loan costs and debt offering costs.
34
<PAGE> 35
Summary
At February 28, 1999, the Company had cash and cash equivalents of
approximately $78.7 million and at March 24, 1999, approximately $55.3 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 other
transactions, operations and asset dispositions, should be sufficient to meet
the Company's current planned acquisition, expansion, capital expenditure and
working capital needs through 1999. 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.
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 has 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
35
<PAGE> 36
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 who 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 of the Year 2000 issue. As
of February 28, 1999, management believed approximately 70% 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 October 1999.
The Company is in the process of 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 February 28, 1999, substantially all of
the Company's subsidiaries had completed the inventory and assessment phase, and
those facilities had completed approximately 70% 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 October 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 HCFA. HCFA paid
to the Company Medicare claims that comprised approximately 19% of the Company's
net revenue in fiscal 1998. In most cases, these third party relationships
originate and are managed at the local clinic level. The Company estimates that
information concerning the Year 2000 readiness of the most significant third
parties will be received and analyzed by the Company by October 1999. 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. As of April 5, 1999,
HCFA will require 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
which 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 in 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 develop
contingency plans for business critical IT
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<PAGE> 37
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
October 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 $16.0
million on the development and implementation of its Year 2000 compliance plan.
In addition, the Company believes that it will need to spend a total of
approximately $28 million to complete all phases of its plan, which amounts
will be funded from cash flows from operations and, if necessary, with
borrowings under the Company's primary credit facility. Of those costs, an
estimated $24 million is expected to be 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.
RISK FACTORS
Our disclosure and analysis in this report contain some forward-looking
statements. Forward-looking statements give our current expectations or
forecasts of future events. You can identify these statements by the fact that
they do not relate strictly to historical or current facts. From time to time,
we also may provide oral or written forward-looking statements in other
materials we release to the public.
Any of our forward-looking statements in this report and in any other
public statements we make may turn out to be incorrect. These statements can be
affected by inaccurate assumptions we might make or by known or unknown risks
and uncertainties. Many factors mentioned in the discussion - for example,
PhyCor's ability to successfully restructure its relationships with certain of
its affiliated physician groups, IPAs and their payors, PhyCor's ability to
consolidate clinics and IPAs and operate them profitably, competition in the
healthcare industry, regulatory developments and changes, the nature of
capitated fee arrangements and other methods of payment for medical services,
the risk of professional liability claims, PhyCor's dependence on the revenue
generated by its affiliated clinics, the outcome of pending litigation and the
risks associated with
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<PAGE> 38
Year 2000 related failure- will be important in determining future results.
Consequently, no forward-looking statement can be guaranteed. Actual future
results may vary materially.
We undertake no obligation to publicly update any forward-looking
statements, whether as a result of new information, future events or otherwise.
You are advised, however, to consult any further disclosures we make on related
subjects in our 10-Q, 8-K and 10-K reports to the SEC. In addition, we include
the following discussion of cautions, risks and uncertainties relevant to our
businesses.
CERTAIN CLINIC RELATIONSHIPS MAY BE TERMINATED OR RESTRUCTURED.
Because of a variety of circumstances, we have terminated or
renegotiated the service agreements with some of our clinics and recorded
significant asset revaluation charges in 1998. Currently, we are exploring
changes to our relationships with several affiliated multi-specialty medical
groups, and as a result may seek to restructure such operations or terminate our
service agreements with some of these groups. The outcome of these discussions
may result in additional charges to earnings to provide for restructuring costs
and for revaluing assets to reflect lower expected future cash flows from
operations or the disposition of the related assets. There can be no assurance
as to the outcome of any of these discussions.
Certain negative characteristics have contributed to instability at
some of our affiliated clinic relationships, including the clinic's market
position and demographics, physician relations, departure rates, declining
physician incomes, physician productivity, operating results and ongoing
viability of the existing medical group. These factors have been caused or may
be exacerbated by weak economic conditions in some markets, declining government
and managed care payments, poor financial performance and other factors, many of
which are outside of our control. There can be no assurance that these negative
influences will not contribute to additional restructurings or terminations of
relationships with some of our affiliated physician groups. As a result, we
could incur additional asset revaluation charges that may have a material
adverse effect on our financial condition and results of operations.
WE ARE DEPENDENT ON OUR AFFILIATED PHYSICIANS.
A significant majority of our revenue is derived from the service or
management agreements with our affiliated clinics. If certain of these
agreements were terminated, or declared unenforceable, our revenues would be
materially adversely affected because of lost revenues and funds advanced to the
clinics. Additionally, physicians in certain clinics have challenged the
enforceability of the non-competition provisions contained in their employment
agreements with their clinics. If these provisions were declared unenforceable,
our revenues at those clinics could be materially adversely affected because the
service fees are typically based on a percentage of the affiliated clinic's
operating income plus reimbursement of clinic expenses. Accordingly, if the
operating results of the affiliated clinics are adversely affected because of,
for example, physicians leaving the physician group and new physicians were not
added to replace them, our business and financial results could be materially
adversely affected.
THERE MAY BE CONSTRAINTS ON OUR ABILITY TO GROW.
Our growth is primarily dependent on our ability to (1) consolidate
multi-specialty medical clinics, (2) sustain or increase the profitability of
those clinics and (3) develop and manage IPAs. It is a lengthy and complex
process to negotiate successfully the affiliation with a physician group or to
develop a physician network. Further, clinic and physician network operations
require intensive management in a changing marketplace subject to constant
pressure to control costs. Additionally, pursuant to our bank credit facility,
the lenders must consent to borrowings that relate to the acquisition of certain
assets above certain purchase price thresholds. Although we continue to pursue
the acquisition of the assets of additional clinics and other medical network
management companies, there can be no assurance that we will be able to
consummate such acquisitions in the future.
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Our success in managing and developing IPAs is dependent on our ability
to: (1) form networks of physicians, (2) obtain favorable payor contracts and
(3) manage and control costs. Many of the physicians in PhyCor-managed IPAs did
not enter into exclusive arrangements. Therefore, they could join competing
networks or terminate their relationships with the IPAs. We may not be able to
establish new physician networks or maintain our physician networks in the
future.
WE MAY HAVE ADDITIONAL FINANCING NEEDS.
Our clinic acquisition and expansion program and our IPA development
and management plans require substantial capital resources. Clinic operations
require recurring capital expenditures for renovation, expansion, and the
purchase of costly medical equipment and technology. We will need capital to
develop new IPAs and to expand and manage existing IPAs. It is possible that our
capital needs in the next several years will exceed the capital generated from
our operations. Thus, we may incur additional debt or issue additional debt or
equity securities from time to time. This may include the issuance of common
stock or convertible notes in connection with acquisitions. We may be unable to
obtain sufficient financing on terms satisfactory to us or at all.
THERE MAY BE DECLINES IN OUR COMMON STOCK VALUE.
Our common stock is traded on the Nasdaq Stock Market. The market price
of our stock has declined significantly in the past year. Developments that
could cause the market price of the stock to be volatile include quarterly
operating results below analysts' expectations, changes in the health care
service and medical network management industries and changes in general
conditions in the economy or financial markets. We have considered in the past
and continue to consider a number of strategic financial alternatives that may
benefit our shareholders, bondholders, clinics, IPAs and other affiliates in the
long term. We cannot give assurance that our stock price will maintain its
current levels or improve or that we will pursue or consummate any strategic
alternative.
INDUSTRY COMPETITION MAY INCREASE.
Managing physician organizations is a competitive business. We compete
with many businesses to acquire medical clinics, manage these clinics, employ
physicians and provide services to IPAs. These competitors include:
- other medical network management companies;
- hospitals and health systems;
- multi-specialty clinics;
- single-specialty clinics;
- health care service companies; and
- insurance companies and HMOs.
Some of our competitors have longer operating histories and greater
financial resources. We may not be able to compete successfully with existing or
new competitors. Additional competition may make it more difficult for us to
acquire assets of clinics on beneficial terms.
FIXED FEE PATIENT ARRANGEMENTS MAY NOT BE PROFITABLE.
Many of the PhyCor-managed IPA contracts with third party payors are
based on fixed or capitated fee arrangements. Under these capitated
arrangements, health care providers receive a fixed fee per person covered under
the payor plan per month and bear the risk, subject to certain loss limits, that
the total costs of providing medical services to the insured persons will exceed
the fixed
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<PAGE> 40
fee. Because capitated payments are made on a "per member" basis, the total
payments paid to the IPA can vary from month to month as patients move into or
out of payor plans. The IPAs' management fees are based, in part, upon a share
of the remaining portion, if any, of the fixed fees. Some agreements with payors
also contain "shared risk" provisions under which we and the IPA can share
additional compensation, or can share in losses, based on the utilization of
services by unsecured persons. Any such losses could have a material adverse
effect on our business.
The health care providers' ability to efficiently manage the patient's
use of medical services and the costs of such services determine the
profitability of the capitated fee arrangement. The management fees are also
based upon a percentage of revenue collected by the IPA. Any loss of revenue by
an IPA because of the loss of affiliated physicians, the termination of third
party payor contracts or otherwise may decrease our management fees. We, like
other managed care providers and management entities, are often subject to
liability claims arising from activities such as utilization management and
compensation arrangements designed to control costs by reducing services. A
successful claim on this basis against us, an affiliated clinic or IPA could
have a material adverse effect on our business and financial results.
YEAR 2000 PROBLEMS MAY ADVERSELY AFFECT OPERATIONS.
As described in the "Year 2000" section, we are working to address
"Year 2000" problems. If we should fail to identify or fix all such problems in
our own operations, or if we are affected by the inability of a supplier or
major customer to continue operations due to such a problem, our business and
financial results could be materially adversely affected.
THE OUTCOME OF SHAREHOLDER LITIGATION MAY ADVERSELY AFFECT OUR BUSINESS AND
FINANCIAL RESULTS.
Claims have been brought against us and our executive officers and
directors alleging various violations of the securities laws. The ultimate
disposition of these matters could have a material adverse effect on our
financial condition or cash flows and results of operations, as described in the
discussions of such matters in "Legal Proceedings" in Item 3 in this report.
THERE ARE NUMEROUS REGULATORY RISKS ASSOCIATED WITH OUR BUSINESS AND INDUSTRY.
The state and federal governments highly regulate the health care
industry and physicians' medical practices. All states restrict the unlicensed
practice of medicine. In addition, many states prohibit physicians from
splitting or sharing fees with nonphysician entities and do not enforce
noncompetition agreements against physicians. Most of the states only prohibit
the sharing of fees if a physician shares fees with a referral source. Because
we do not refer business to our managed groups, the fee-splitting laws in most
states should not restrict the physician groups from paying our management fee.
If courts determined that we violated the corporate practice of medicine or
fee-splitting statutes, the physicians' licenses could be revoked or suspended,
lowering our revenue. Courts could also hold the contracts between us and our
managed physicians invalid.
In Florida, however, the Florida Board of Medicine recently interpreted
the Florida fee-splitting law very broadly. This interpretation may prohibit the
payment of any percentage-based management fee, even to a management company
that does not refer patients to the managed groups. We manage four of our six
affiliated physician groups in Florida under service agreements for which we are
paid a percentage-based fee. The Florida Board of Medicine stayed its own
decision pending judicial interpretation of its decision. The Florida courts and
regulatory authorities may make a determination that could adversely affect our
financial condition and operating results.
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Many states also prohibit the "corporate practice of medicine" by an
unlicensed corporation or other nonphysician entity that employs physicians.
Except in the states of Florida and Georgia, we do not employ physicians but
instead manage the physician groups. The physicians are employed at the group
level by professional associations or corporations, which are authorized to
employ physicians under most states' laws. In Georgia and Florida, physicians
can be employed by corporations and other entities.
Federal law prohibits offering, paying, soliciting or receiving payment
for referrals, or arranging for referrals of, Medicare or other federal or state
health program patients or patient care opportunities. It also prohibits
payments in return for the purchase, lease or order of items or services that
are covered by Medicare or other federal or state health programs. The
government has adopted or proposed several different exceptions or safe harbors
for arrangements that will not be deemed to violate the Anti-Kickback law. In
1998, the federal government released advisory opinion 98-4, which states that a
percentage-based management fee does not fit within any safe harbor and that
such a fee could implicate the Anti-Kickback law if any part of the management
fee is intended to compensate the manager for its efforts in arranging for
referrals to its managed group. The management fee structure of most of our
service agreements does not fit within a safe harbor because they are calculated
in part on a percentage basis. Accordingly, there can be no assurance that the
fee structure will not be successfully challenged.
In addition, physicians with certain financial relationships with
health care providers cannot refer certain types of Medicare or Medicaid
reimbursed "designated health services" unless the referral fits within an
exception to the law. The most often used exception requires that the physician
groups be included within a definition of "group practice" to be permitted to
make referrals within the group. Federal antitrust law also prohibits conduct
that may result in price fixing or other anticompetitive conduct.
All of our physician groups are structured so they fit within the
definition of "group practice," and all referrals from those physicians are
structured to fit within an exception to federal law. In addition, we do not
make or arrange referrals to our physicians, and we are not compensated based on
referral levels between the physicians. Nevertheless, because of the structure
of our relationships with our physician groups and managed IPAs, courts or
regulatory authorities may determine our arrangements violate federal law which
could adversely affect our financial condition and results of operations. Also,
the health care regulatory environment may change in a way that would restrict
our existing operations or limit the expansion of our business or otherwise
adversely affect us. If we violate the Medicare or Medicaid statutes, civil and
criminal penalties could be assessed, and we could be excluded from further
participation in Medicare or state health care programs.
There is increasing scrutiny of arrangements between health care
providers and potential referral sources by (1) law enforcement authorities, (2)
the office of Inspector General or the Department of Health and Human Services,
(3) the courts and (4) the Congress. Investigators are demonstrating a
willingness to look beyond the business transaction documents to determine if
the purpose of these arrangements is really the payment for referrals and
opportunities. Enforcement actions are increasing. Although we are not aware of
any investigations of us that would negatively affect our business, we may be
investigated in the future.
In addition, Congress and many state legislatures routinely consider
proposals to control health care spending. Government efforts to reduce health
care expenses through the use of managed care or the reduction of Medicare and
Medicaid reimbursement may adversely affect our cost of doing business and our
contractual relationships. For example, recent developments that affect our
business include: (1) federal legislation requiring a health plan to continue
coverage for individuals who are no longer eligible for group health benefits
and prohibiting the use of "pre-existing condition" exclusions that limited the
scope of coverage; (2) a Health Care Financing Administration policy prohibiting
restrictions in Medicare risk HMO plans on a physician's
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recommendation of other health plans and treatment options to patients; and (3)
regulations imposing restrictions on physician incentive provisions in physician
provider agreements. These types of legislation, programs and other regulatory
changes may have a material adverse effect on our business.
Our profitability may be adversely affected by Medicare and Medicaid
regulations, decisions of third party payors and other payment factors which are
out of our control. The federal Medicare program has undergone significant
legislative and regulatory changes in the reimbursement and fraud and abuse
areas. These changes may have a negative impact on our revenue. Efforts to
control health care costs are increasing. Many of our physician groups are
affiliating with provider networks, managed care organizations and other
organized health care systems to provide fixed fee schedules or capitation
arrangements that are lower than standard charges. Our profitability in this
changing health care environment is likely to be affected significantly by
management of health care costs, pricing of services and agreements with payors.
Because we derive our revenue from the revenues generated by our clinics, any
reductions in the payments to physicians or changes in payment for health care
services may reduce our profitability.
INSURANCE REGULATIONS MAY ADVERSELY AFFECT OUR BUSINESS.
Our managed IPAs enter into contracts and joint ventures with licensed
insurance companies such as HMOs. Under these contracts, the IPAs may be paid on
a capitated fee basis. Under capitation arrangements, health care providers bear
the risk, subject to certain loss limits, that the total costs of providing
medical services to members will exceed the premiums received. The IPAs may be
deemed to be in the business of insurance if they subcontract with physicians or
other providers to provide services on a fee-for-service basis. Thus, the IPAs
may be subject to a variety of regulatory and licensing requirements applicable
to insurance companies and HMOs. These requirements could increase the managed
IPAs cost and lower our revenue.
From time to time, we acquire HMOs that are affiliated with
multi-specialty medical clinics. The HMO industry is highly regulated at the
state level and is highly competitive. Further, the HMO industry has been
subject to numerous legislative initiatives during the last few years. One
initiative creates additional liabilities for HMOs for patient malpractice. This
increases HMO costs and lowers our revenue. These developments may have an
adverse effect on our wholly-owned HMOs or on other HMOs with which we are
financially involved. In addition, PrimeCare Medical Network, Inc., a subsidiary
of PrimeCare, holds a Knox-Keene license from the California Department of
Corporations. Knox-Keene licenses are subject to extensive regulation on the
state level, and our operations in California could come under increased
governmental scrutiny.
THERE ARE RISKS ASSOCIATED WITH HOSPITAL OWNERSHIP.
In January 1997, we consummated our merger with Straub, an integrated
health care system with a 152-physician multi-specialty clinic and 159-bed acute
care hospital located in Honolulu, Hawaii. In connection with the transaction
with Straub, we agreed to provide certain management services to both a
physician group practice and a hospital owned by the group. In May 1998, we
consummated a merger with PrimeCare, a management company that manages several
IPAs and physician practices in California and also owns and operates a hospital
and other ancillary providers in California. Because hospitals are subject to
extensive regulation on both the federal and state levels and because hospital
management companies have, in some instances, been viewed as referral sources by
federal regulatory agencies, the relationship between us and the physician group
could come under increased scrutiny under the Medicare fraud and abuse law.
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THERE IS A RISK OF TAX AUDIT ADJUSTMENTS.
The IRS audited us for the years 1988 through 1993. It proposed that we
make adjustments relating to the timing of recognition of certain revenue and
deductions. The revenue and deductions relate to uncollectible accounts and our
relationship with affiliated physician groups. We disagree with the IRS
position, including any recharacterization, and are vigorously contesting the
proposed adjustments. The IRS National Office has agreed with our position on
the major issue, but the IRS Appeals Office has raised a potential alternative
position with respect to our accounting for accounts receivable and
uncollectible accounts. It is unclear whether the IRS will pursue this
alternative position. If such alternative position is pursued by the IRS, we
will vigorously contest any proposed adjustment. We believe any adjustments that
result will not affect our reported net earnings, but will defer tax benefits
and change levels of current and deferred tax assets and liabilities. Any
adjustments for the years under the audit, and potentially for subsequent years,
could result in our making material cash payments. Any successful adjustment by
the IRS would cause an interest expense to be incurred. We do not believe that
this matter will materially adversely affect us, but we can not make any
assurances.
OUR INVOLVEMENT IN THE MEDICAL SERVICES BUSINESS EXPOSES US TO RISK OF
PROFESSIONAL LIABILITY CLAIMS.
As a result of the fact that our affiliated physician groups deliver
medical services to the public, there is a risk of professional liability claims
against us. Claims of this nature, if successful, could result in an award of
damages that exceeds the limits of insurance coverage. Insurance against losses
of this type can be expensive and varies from state to state. In the substantial
majority of our markets, we do not control our affiliated physicians and
physician groups' practice of medicine or compliance with regulatory
requirements. Successful malpractice claims brought against the physician
groups, the managed IPAs and physician members could have a material adverse
effect on us. In certain of our Florida clinics and Georgia clinics, we directly
employ physicians. These employment relationships increase the risk of
malpractice liability and increase scrutiny under health care regulations and
laws.
ANTI-TAKEOVER PROVISIONS COULD PREVENT AN ACQUISITION OF OUR COMPANY.
We are authorized to issue up to 10,000,000 shares of preferred stock.
The Board of Directors determines the rights of the preferred stock. In February
1994, the Board of Directors approved the adoption of a Shareholder Rights Plan.
The Shareholder Rights Plan is meant to encourage potential acquirers of PhyCor
to negotiate with the Board of Directors instead of making coercive,
discriminatory and unfair proposals. Our stock incentive plans allow the
acceleration of the vesting of options if there is a change of control. Our
Charter classifies our Board of Directors into three classes. Each class of
directors serves staggered terms of three years. The executive officers'
employment agreements provide that they are compensated after termination, in
some cases for 24 months, following a change in control. Most of the physician
groups can terminate their service agreements if there is a change of control
that was not approved by the Board. A change of control without the bank's
consent also is a default under the bank credit facility. All of these factors
may discourage or make it more difficult for there to be a change of control.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7. "Management's Discussion and Analysis of Results of
Operations and Financial Condition. Liquidity and Capital Resources - Market
Risks Associated With Financial Instruments."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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PHYCOR, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
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PHYCOR, INC. AND SUBSIDIARIES
Index to Financial Statements
PAGE
Independent Auditors' Report 46
Consolidated Balance Sheets 47
Consolidated Statements of Operations 48
Consolidated Statements of Shareholders' Equity 49
Consolidated Statements of Cash Flows 50
Notes to Consolidated Financial Statements 51
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INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
PhyCor, Inc.:
We have audited the consolidated balance sheets of PhyCor, Inc. and subsidiaries
as of December 31, 1998 and 1997 and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1998. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of PhyCor, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ KPMG LLP
Nashville, Tennessee
February 23, 1999, except for
Notes 10 and 17, which are as of
March 17, 1999
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and 1997
(All amounts are expressed in thousands)
<TABLE>
<CAPTION>
1998 1997
----------- ---------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 74,314 38,160
Accounts receivable, less allowances of $230,785 in 1998
and $208,534 in 1997 378,732 391,668
Inventories 19,852 18,578
Prepaid expenses and other current assets 55,988 44,921
Assets held for sale 41,225 3,237
----------- ---------
Total current assets 570,111 496,564
Property and equipment, net 241,824 235,685
Intangible assets, net 981,537 807,726
Other assets 53,067 22,801
----------- ---------
Total assets $ 1,846,539 1,562,776
=========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt $ 4,810 1,144
Current installments of obligations under capital leases 5,687 3,564
Accounts payable 50,972 34,622
Due to physician groups 51,941 50,676
Purchase price payable 73,736 114,971
Salaries and benefits payable 37,077 37,141
Incurred but not reported claims payable 59,333 12,832
Other accrued expenses and current liabilities 98,701 38,313
----------- ---------
Total current liabilities 382,257 293,263
Long-term debt, excluding current installments 388,644 210,893
Obligations under capital leases, excluding current installments 6,018 5,093
Purchase price payable 8,967 23,545
Deferred tax credits and other liabilities 8,663 57,918
Convertible subordinated notes payable to physician groups 47,580 61,576
Convertible subordinated debentures 200,000 200,000
----------- ---------
Total liabilities 1,042,129 852,288
----------- ---------
Shareholders' equity:
Preferred stock, no par value, 10,000 shares authorized -- --
Common stock, no par value; 250,000 shares authorized; issued and
outstanding 75,824 shares in 1998 and 64,530 shares in 1997 850,657 645,288
Retained earnings (deficit) (46,247) 65,200
----------- ---------
Total shareholders' equity 804,410 710,488
----------- ---------
Commitments, contingencies and subsequent event
Total liabilities and shareholders' equity $ 1,846,539 1,562,776
=========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
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PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1998, 1997 and 1996
(All amounts are expressed in thousands, except for earnings per share)
<TABLE>
<CAPTION>
1998 1997 1996
----------- ---------- --------
<S> <C> <C> <C>
Net revenue $ 1,512,499 1,119,594 766,325
Operating expenses:
Cost of provider services 134,302 -- --
Salaries, wages and benefits 513,646 421,716 291,361
Supplies 227,440 181,565 119,081
Purchased medical services 37,774 31,171 21,330
Other expenses 218,359 171,480 125,947
General corporate expenses 29,698 26,360 21,115
Rents and lease expense 126,453 100,170 65,577
Depreciation and amortization 90,238 62,522 40,182
Provision for asset revaluation and clinic
restructuring 224,900 83,445 --
Merger expenses 14,196 -- --
----------- ---------- --------
Net operating expenses 1,617,006 1,078,429 684,593
----------- ---------- --------
Earnings (loss) from operations (104,507) 41,165 81,732
Other (income) expense:
Interest income (3,032) (3,323) (3,867)
Interest expense 36,266 23,507 15,981
----------- ---------- --------
Earnings (loss) before income taxes and
minority interest (137,741) 20,981 69,618
Income tax expense (benefit) (39,890) 6,098 22,775
Minority interest in earnings of consolidated partnerships 13,596 11,674 10,463
----------- ---------- --------
Net earnings (loss) $ (111,447) 3,209 36,380
=========== ========== ========
Earnings (loss) per share:
Basic $ (1.55) 0.05 0.67
Diluted (1.55) 0.05 0.60
=========== ========== ========
Weighted average number of shares and dilutive share
equivalents outstanding:
Basic 71,822 62,899 54,608
Diluted 71,822 66,934 61,096
=========== ========== ========
</TABLE>
See accompanying notes to consolidated financial statements.
48
<PAGE> 49
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Years ended December 31, 1998, 1997 and 1996
(All amounts are expressed in thousands)
<TABLE>
<CAPTION>
COMMON STOCK RETAINED
SHARES AMOUNT EARNINGS TOTAL
------- --------- -------- --------
<S> <C> <C> <C> <C>
Balances at December 31, 1995 53,399 $ 363,211 25,611 388,822
Issuance of common stock and warrants, net of
placement commissions and offering
expenses totaling $192 261 10,312 -- 10,312
Conversion of subordinated notes payable
to common stock 859 11,450 -- 11,450
Stock options exercised and related tax benefits 312 4,739 -- 4,739
Net earnings
-- -- 36,380 36,380
------- --------- -------- --------
Balances at December 31, 1996 54,831 389,712 61,991 451,703
Issuance of common stock and warrants, net of
placement commissions and offering
expenses totaling $8,957 8,109 232,422 -- 232,422
Conversion of subordinated notes payable
to common stock 1,046 14,816 -- 14,816
Stock options exercised and related tax benefits 544 8,338 -- 8,338
Net earnings
-- -- 3,209 3,209
------- --------- -------- --------
Balances at December 31, 1997 64,530 645,288 65,200 710,488
Issuance of common stock and warrants, net of
placement commissions and offering
expenses totaling $140 12,663 204,286 -- 204,286
Repurchase of common stock (2,628) (12,590) -- (12,590)
Conversion of subordinated notes payable
to common stock 209 2,000 -- 2,000
Stock options exercised and related tax benefits 1,050 11,673 -- 11,673
Net loss
-- -- (111,447) (111,447)
------- --------- -------- --------
Balances at December 31, 1998 75,824 $ 850,657 (46,247) 804,410
======= ========= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
49
<PAGE> 50
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1998, 1997 and 1996
(All amounts are expressed in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) $(111,447) 3,209 36,380
Adjustments to reconcile net earnings (loss) to
net cash provided by operating activities:
Depreciation and amortization 90,238 62,522 40,182
Deferred income taxes (43,011) (9,677) 9,616
Minority interests 13,596 11,674 10,463
Provision for asset revaluation and clinic restructuring 224,900 83,445 --
Merger expenses 14,196 -- --
Increase (decrease) in cash, net of effects of acquisitions, due to
changes in:
Accounts receivable, net (777) (28,920) (36,376)
Inventories (865) (1,929) (1,880)
Prepaid expenses and other current assets (9,620) 137 (16,481)
Accounts payable (2,356) 2,211 (3,291)
Due to physician groups (1,365) 10,396 13,489
Incurred but not reported claims payable (535) 1,448 1,785
Other accrued expenses and current liabilities (11,766) (18,468) 21,221
--------- -------- --------
Net cash provided by operating activities 161,188 116,048 75,108
--------- -------- --------
Cash flows from investing activities:
Payments for acquisitions, net (185,743) (299,191) (252,270)
Purchase of property and equipment (67,612) (66,486) (50,053)
Payments to acquire other assets (17,914) (12,711) (4,719)
--------- -------- --------
Net cash used by investing activities (271,269) (378,388) (307,042)
--------- -------- --------
Cash flows from financing activities:
Net proceeds from issuance of stock and warrants 18,591 226,458 4,975
Net proceeds from issuance of convertible debentures -- -- 194,395
Repurchase of common stock (12,590) -- --
Proceeds from long-term borrowings 173,000 295,000 161,000
Repayment of long-term borrowings (16,156) (235,972) (104,546)
Repayment of obligations under capital leases (6,139) (4,088) (1,811)
Distributions of minority interests (10,130) (11,107) (10,291)
Loan costs incurred (341) (321) (85)
--------- -------- --------
Net cash provided by financing activities 146,235 269,970 243,637
--------- -------- --------
Net increase in cash and cash equivalents 36,154 7,630 11,703
Cash and cash equivalents - beginning of year 38,160 30,530 18,827
--------- -------- --------
Cash and cash equivalents - end of year $ 74,314 38,160 30,530
========= ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid (received) during the year for:
Interest $ 34,792 23,005 13,745
Income taxes, net of refunds (14,510) 18,314 13,991
========= ======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Effects of acquisitions, net:
Assets acquired, net of cash $ 377,649 450,872 384,807
Liabilities paid (assumed), net of deferred purchase price payments 25,583 (131,681) (89,326)
Issuance of convertible subordinated notes payable (8,317) (11,286) (36,084)
Issuance of common stock and warrants (193,057) (8,714) (7,127)
Cash received from disposition of clinic assets (16,115) -- --
--------- -------- --------
Payments for acquisitions, net $ 185,743 299,191 252,270
========= ======== ========
Capital lease obligations incurred to acquire equipment $ 808 555 471
Conversion of subordinated notes payable to common stock 2,000 14,816 11,450
========= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
50
<PAGE> 51
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(a) DESCRIPTION OF BUSINESS
PhyCor, Inc. (the Company) is a medical network management company
that operates multi-specialty medical clinics, develops and
manages independent practice associations (IPAs) 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 our multi-specialty clinic operations, the Company
manages and operates two hospitals and four HMOs. PhyCor's
strategy is to organize physicians into professionally managed
networks that assist physicians in assuming increased
responsibility for delivering cost-effective medical care while
attaining high-quality clinical outcomes and patient satisfaction.
The Company, through wholly-owned subsidiaries, acquires certain
assets of and operates clinics under long-term service agreements
with affiliated physician groups that practice exclusively through
such clinics. The Company provides administrative and technical
support for professional services rendered by the physician groups
under service agreements. Under most service agreements, the
Company is reimbursed for all clinic expenses, as defined in the
agreement, and participates at varying levels in the excess of net
clinic revenue over clinic expenses. As of December 31, 1998, the
Company operated 56 clinics with 3,693 physicians in 27 states.
The Company also manages IPAs which are networks of independent
physicians. Fees earned from managing the IPAs are based upon a
percentage of revenue collected by the IPAs and also upon a share
of surplus, if any, of capitated revenue of the IPAs. At December
31, 1998, these IPAs included approximately 22,900 physicians in
35 markets. Our affiliated physicians provided capitated medical
services to approximately 1,643,000 members, including
approximately 304,000 Medicare and Medicaid members. The Company
provides health care decision-support services to approximately
2.2 million individuals within the United States and 500,000
additional individuals under foreign country license arrangements.
(b) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its majority owned subsidiaries, partnerships and
other entities in which the Company has more than a 50% ownership
interest or exercises control. All significant intercompany
balances and transactions are eliminated in consolidation. The
Company does not consolidate the physician practices it manages as
it does not have operating control as defined in EITF 97-2,
"Application of APB Opinion No. 16 and FASB Statement No. 94 to
Physician Practice Entities." Physician practices which are owned
and operated by the Company are consolidated.
(Continued)
51
<PAGE> 52
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(c) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a
maturity of three months or less when purchased to be cash
equivalents. Cash and cash equivalents as of December 31, 1998
include approximately $22,480,000 of consolidated partnership
cash. These balances may only be used for the operations of the
respective partnerships.
(d) ACCOUNTS RECEIVABLE
Accounts receivable principally represent receivables from
patients and third-party payors for medical services provided by
physician groups. Terms of the service agreements require the
Company to purchase receivables generated by the physician groups
on a monthly basis. Such amounts are recorded net of contractual
allowances and estimated bad debts. Accounts receivable are a
function of net clinic revenue rather than net revenue of the
Company (See note 2).
(e) INVENTORIES
Inventories are comprised primarily of medical supplies,
medications and other materials used in the delivery of health
care services by the physician groups at the Company's clinics and
hospitals. The Company values inventories at the lower of cost or
market with cost determined using the first-in, first-out (FIFO)
method.
(f) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Equipment held under
capital leases is stated at the present value of minimum lease
payments at the inception of the related leases. Depreciation of
property and equipment is calculated using the straight-line
method over the estimated useful lives of the assets. Equipment
held under capital leases and leasehold improvements are amortized
on a straight line basis over the shorter of the lease term or
estimated useful life of the assets.
(g) INTANGIBLE ASSETS
CLINIC SERVICE AGREEMENTS
Costs of obtaining clinic service agreements are amortized using
the straight-line method over the periods during which the
agreements are effective, up to a maximum of twenty-five years.
Clinic service agreements represent the exclusive right to operate
the Company's clinics in affiliation with the related physician
groups during the term of the agreements. In the event of
termination of a service agreement, the related physician group is
obligated to purchase all clinic assets, including the unamortized
portion of intangible assets, generally at the current net book
value.
(Continued)
52
<PAGE> 53
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
EXCESS OF COST OF ACQUIRED ASSETS OVER FAIR VALUE
Excess of cost of acquired assets over fair value (goodwill) is
amortized using the straight-line method over a period not to
exceed twenty-five years.
OTHER INTANGIBLE ASSETS
Other intangible assets include costs associated with obtaining
long-term financing which are being amortized systematically over
the terms of the related debt agreements and franchise rights
which are being amortized over fifteen years.
AMORTIZATION AND RECOVERABILITY
Effective April 1, 1998, the Company changed its policy with
respect to amortization of intangible assets. All existing and
future intangible assets will be amortized over a period not to
exceed 25 years from the inception of the respective intangible
assets. Had the Company adopted this policy at the beginning of
1997, amortization expense would have increased and diluted
earnings per share would have decreased by approximately $11.2
million and $0.10, respectively, for the year. On the same basis,
for the first quarter of 1998, amortization expense would have
increased by approximately $3.3 million, resulting in a decrease
in diluted earnings per share of $0.03. Amortization of
intangibles amounted to $38,034,000, $23,865,000, and $15,150,000
for 1998, 1997 and 1996, respectively.
The Company periodically reviews its intangible assets to assess
whether recoverability and impairments would be recognized in the
statement of operations if a permanent impairment were determined
to have occurred. Recoverability of intangibles is determined
based on undiscounted future operating cash flows from the related
business unit or activity. The amount of impairment, if any, is
measured based on discounted future operating cash flows using a
discount rate reflecting the Company's average cost of funds or
based on the fair value of the related business unit or activity.
The assessment of the recoverability of intangible assets will be
impacted if estimated future operating cash flows are not
achieved.
(h) IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used
is measured by a comparison of the carrying amount of an asset to
future net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount
of the assets exceeded the fair value of the assets.
(Continued)
53
<PAGE> 54
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(i) INCOME TAXES
Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in the tax rates
is recognized in income in the period that includes the enactment
date.
(j) FINANCIAL INSTRUMENTS
In 1997, the Company entered into an interest rate swap agreement
to reduce the exposure to fluctuating interest rates with respect
to $100,000,000 of its bank credit facility. During 1998, the
Company amended the previous interest rate swap agreement and
entered into additional swap agreements. At December 31, 1998,
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 an
additional $100 million beginning October 2000. These agreements
are accounted for on the accrual method. Gains and losses
resulting from these instruments are recognized in the same period
as the related interest expense. Gains and losses are included in
interest expense. The Company does not use interest rate swap
agreements or other derivative financial instruments for
speculative or trading purposes.
The FASB has issued Statement of Financial Accounting Standards
(SFAS) No. 133., Accounting for Derivative Instruments and Hedging
Activities, which the Company will be required to adopt in the
first quarter of 2000. Adoption of SFAS No. 133 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. Had the Company adopted SFAS No. 133 as of December
31, 1998, the Company estimates it would have recorded a non-cash
charge to earnings of 7.3 million.
(k) STOCK OPTION PLANS
The Company accounts for its compensation and stock option plans
in accordance with the provisions of Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees,
and related interpretations. As such, compensation expense would
be recorded on the date of grant only if the current market price
of the underlying stock exceeded the exercise price. In accordance
with SFAS No. 123, Accounting for Stock-Based Compensation (SFAS
No. 123), the Company provides pro forma net income and pro forma
earnings per share disclosures for employee stock option grants
made in 1995 and subsequent years as if the fair-value-based
method defined in SFAS No. 123 had been applied.
(Continued)
54
<PAGE> 55
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(l) EARNINGS PER SHARE
Basic earnings per share is computed based on weighted average
shares outstanding and excludes any potential dilution. Diluted
earnings per share reflects the potential dilution from the
exercise or conversion of all dilutive securities into common
stock based on the average market price of common shares
outstanding during the period.
(m) COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive
Income. Comprehensive income generally includes all changes in
equity during a period except those resulting from investments by
shareholders and distributions to shareholders. Net income was the
same as comprehensive income for 1998, 1997 and 1996.
(n) USE OF ESTIMATES
Management of the Company has made certain estimates and
assumptions relating to the reporting of assets and liabilities
and the disclosure of contingent assets and liabilities to prepare
these consolidated financial statements in conformity with
generally accepted accounting principles. Actual results could
differ from those estimates.
(o) RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to
the 1998 presentation.
(2) NET REVENUE
Net revenue of the Company is comprised of net clinic service agreement
revenue, IPA management revenue, net hospital revenues 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 and net hospital revenue
are 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 reimbursements contracts
are recognized as contractual adjustments in the year final settlements
are determined. With the exception of the Company's wholly-owned
subsidiary, PrimeCare International, Inc. (PrimeCare) and certain clinics
acquired as part of the First Physician Care, Inc. ("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)
55
<PAGE> 56
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
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 The
Morgan Health Group, Inc. (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 following represent amounts included in the determination of net
revenue (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---------- --------- ---------
<S> <C> <C> <C>
Gross physician group, hospital and other revenue $3,498,668 2,849,646 1,928,045
Less:
Provisions for doubtful accounts and
contractual adjustments 1,415,933 1,090,329 699,186
---------- --------- ---------
Net physician group, hospital and other
revenue 2,082,735 1,759,317 1,228,859
IPA revenue 773,089 411,912 255,181
---------- --------- ---------
Net physician group, hospital and IPA
revenue 2,855,824 2,171,229 1,484,040
Less amounts retained by physician groups and IPAs:
Physician groups 714,081 634,983 459,179
Clinic technical employee compensation 94,906 74,715 50,395
IPAs 534,338 341,937 208,141
---------- --------- ---------
Net revenue $1,512,499 1,119,594 766,325
========== ========= =========
</TABLE>
The Company derives most of its net revenue from 56 physician groups
located in 27 states with which it has service agreements at December 31,
1998. The Company's affiliated physician groups derived approximately
26%, 27% and 24% of their net revenues from services provided under the
Medicare program for the years ended December 31, 1998, 1997 and 1996,
respectively. Other than the Medicare program, the physician groups have
no customers which represent more than 10% of aggregate net clinic
revenue for the years ended December 31, 1998, 1997 and 1996 or 5% of
accounts receivables at December 31, 1998 and 1997.
(Continued)
56
<PAGE> 57
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(3) ACQUISITIONS
(a) MULTI-SPECIALTY MEDICAL CLINICS
During 1998, 1997 and 1996, the Company, through wholly-owned
subsidiaries, acquired certain operating assets of the following
clinics:
<TABLE>
<CAPTION>
CLINIC EFFECTIVE DATE LOCATION
------ -------------- ---------
<S> <C> <C>
1998:
Grove Hill Medical Center March 1, 1998 New Britain, Connecticut
Huntington Medical Group October 1, 1998 Huntington, New York
1997:
Vancouver Clinic January 1, 1997 Vancouver, Washington
First Physicians Medical Group February 1, 1997 Palm Springs, California
St. Petersburg-Suncoast
Medical Group February 28, 1997 St. Petersburg, Florida
Greater Chesapeake Medical Group (i) May 1, 1997 Annapolis, Maryland
Welborn Clinic June 1, 1997 Evansville, Indiana
White-Wilson Medical Center July 1, 1997 Ft. Walton Beach, Florida
Maui Medical Group September 1, 1997 Maui, Hawaii
Murfreesboro Medical Clinic October 1, 1997 Murfreesboro, Tennessee
West Florida Medical Center Clinic October 1, 1997 Pensacola, Florida
Northern California Medical
Association December 1, 1997 Santa Rosa, California
Lakeview Medical Center (ii) December 1, 1997 Suffolk, Virginia
</TABLE>
(Continued)
57
<PAGE> 58
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
<TABLE>
<S> <C> <C>
1996:
Arizona Physicians Center (iii) January 1, 1996 Phoenix, Arizona
Clinics of North Texas March 1, 1996 Wichita Falls, Texas
Carolina Primary Care (iv) May 1, 1996 Columbia, South Carolina
Harbin Clinic May 1, 1996 Rome, Georgia
Focus Health Services July 1, 1996 Denver, Colorado
Clark-Holder Clinic July 1, 1996 LaGrange, Georgia
Medical Arts Clinic August 1, 1996 Minot, North Dakota
Wilmington Health Associates August 1, 1996 Wilmington, North Carolina
Gulf Coast Medical Group (v) August 1, 1996 Galveston, Texas
Hattiesburg Clinic October 1, 1996 Hattiesburg, Mississippi
Straub Clinic & Hospital (vi) October 1, 1996 Honolulu, Hawaii
Toledo Clinic November 1, 1996 Toledo, Ohio
Lewis-Gale Clinic November 1, 1996 Roanoke, Virginia
</TABLE>
(i) Certain assets associated with Greater Chesapeake Medical
Group were disposed of in the fourth quarter of 1998.
(ii) Lakeview Medical Center was operated under a management
agreement during December 1997. Effective January 1, 1998,
the Company completed the purchase of certain clinic
operating assets and entered into a long-term service
agreement with the affiliated physician group.
(iii) Certain assets associated with Arizona Physicians Center
were disposed of in the second quarter of 1998.
(iv) Certain assets associated with Carolina Primary Care were
disposed of in the third quarter of 1998.
(v) Certain assets associated with Gulf Cost Medical Group were
disposed of in the first quarter of 1999.
(vi) Straub Clinic & Hospital (Straub) was operated under an
administrative service agreement effective October 1, 1996.
The Company completed its merger and entered into a
long-term service agreement with Straub effective January
17, 1997.
In addition, the Company acquired certain operating assets of
various individual physician practices and single specialty groups
which were merged into clinics already operated by the Company.
(Continued)
58
<PAGE> 59
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
The Company acquires operating assets and liabilities in exchange
for cash, convertible debentures, common stock or a combination
thereof. Such consideration for the above clinic acquisitions and
single specialty mergers was $152,344,000 for 1998, $430,757,000
for 1997, and $357,458,000 for 1996. The acquisitions were
accounted for as purchases, and the accompanying consolidated
financial statements include the results of their operations from
the dates of their respective acquisitions. Simultaneous with each
acquisition, the Company entered into a long-term service
agreement with the related clinic physician group. In conjunction
with certain acquisitions, the Company is obligated at December
31, 1998 to make deferred payments to physician groups of which
$73,736,000 are due on demand or within one year and $7,863,000,
$841,000, and $263,000 are due in 2000, 2001, and 2002,
respectively. Such payments are included in purchase price payable
in the accompanying consolidated balance sheets.
(b) INDEPENDENT PRACTICE ASSOCIATIONS (IPAS)
Effective January 1, 1995, the Company completed its merger with
North American Medical Management, Inc. (NAMM), an operator and
manager of IPAs. The Company made additional payments for the NAMM
acquisition pursuant to an earn-out formula during 1996 and 1997
totaling $35.0 million. A final payment of $35 million was made in
April 1998, of which $13.0 million was paid in shares of the
Company's common stock. In July 1998, the Company acquired MHG, an
Atlanta-based IPA, for approximately 500,000 shares of common
stock and assumed liabilities for an aggregate purchase price of
approximately $33.1 million (See note 13).
(c) PHYCOR MANAGEMENT CORPORATION (PMC)
In June 1995, the Company purchased a minority interest of
approximately 9% in PMC and managed PMC pursuant to a 10-year
administrative services agreement. PMC developed and managed IPAs
and provided other services to physician organizations. The
Company acquired the remaining interests of PMC on March 31, 1998
for an aggregate purchase price of approximately $21.0 million
paid in shares of the Company's common stock and integrated the
operations of PMC into NAMM.
(d) PRIMECARE
In May 1998, the Company acquired PrimeCare, a medical network
management company serving southern California's Inland Empire
area, in a purchase business combination for approximately 4.0
million shares of common stock, assumed liabilities and cash for
an aggregate purchase price of approximately $170.0 million.
PrimeCare's delivery network is comprised of an integrated campus,
including the Desert Valley Medical Group, Desert Valley Hospital
and Apple Valley Surgery Center, as well as the Inland Empire area
IPA network.
(Continued)
59
<PAGE> 60
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(e) CAREWISE, INC. (CAREWISE)
In July 1998, the Company acquired Seattle-based CareWise, a
nationally recognized leader in the health care decision-support
industry for approximately 3.1 million shares of common stock and
assumed liabilities for an aggregate purchase price of
approximately $67.5 million. The acquisition was accounted for as
a purchase.
(f) FIRST PHYSICIAN CARE, INC. (FPC)
In July 1998, the Company acquired Atlanta-based FPC, a
privately-held physician practice management company that operated
in six markets in Texas, Florida, Illinois, New York and Georgia,
and provided practice management services to approximately 140
physicians. The acquisition was made for approximately 2.9 million
shares of common stock and assumed liabilities for an aggregate
purchase price of approximately $60.4 million, and was accounted
for as a purchase. During the fourth quarter of 1998, the Company
disposed of the assets associated with the New York market (See
Note 13).
(g) PRO FORMA INFORMATION
The unaudited consolidated pro forma net revenue, net loss and per
share amounts of the Company assuming the PrimeCare, MHG, CareWise
and FPC acquisitions had been consummated on January 1, 1997 are
as follows (in thousands, except for loss per share):
<TABLE>
<CAPTION>
1998 1997
---------- ------------
<S> <C> <C>
Net revenue $ 1,577,792 1,286,509
Net Loss (116,099) (12,261)
Loss per share:
Basic (1.51) (.17)
Diluted (1.51) (.17)
</TABLE>
The consolidated statements of operations include the results of
the above businesses from the dates of their respective
acquisitions.
(Continued)
60
<PAGE> 61
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(4) BUSINESS SEGMENTS
The Company has two reportable segments: 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 2). In addition the Company provides health care
decision-support services and operates two hospitals which do not meet
the quantitative thresholds for reportable segments.
The accounting policies of the segments are the same as those described
in the summary of significant accounting polices. 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>
1998 1997 1996
----------- ---------- --------
<S> <C> <C> <C>
Multi-specialty clinics:
Net revenue $ 1,139,616 933,081 636,183
Operating expenses(1) 1,021,811 818,328 560,172
Interest income (1,282) (1,534) (1,920)
Interest expense 73,451 58,693 30,302
Earnings before taxes and
minority interest(1) 45,636 57,594 47,570
Depreciation and amortization 71,073 49,542 31,059
Segment Assets 1,347,843 1,240,954 860,240
Group formation clinics:
Net revenue 98,377 122,429 83,102
Operating expenses(1) 89,277 111,186 75,484
Interest (income) expense (198) 37 (8)
Interest expense 11,915 12,163 6,665
Earnings (loss) before taxes and
minority interest(1) (2,617) (957) 961
Depreciation and amortization 6,645 7,587 5,246
Segment Assets 66,316 160,493 159,063
IPAs:
Net revenue 242,812 63,638 47,040
Operating expenses(1) 209,625 40,048 29,438
Interest income (1,729) (1,378) (791)
Interest expense 9,362 4,434 2,697
Earnings before taxes and
minority interest(1) 11,958 8,860 5,233
Depreciation and amortization 8,963 3,021 1,929
Segment Assets 299,641 92,527 61,685
Corporate and other(2):
Net revenue 31,694 446 0
Operating expenses(1) 57,197 25,422 19,479
Interest (income) expense 177 (448) (1,148)
Interest expense (income) (58,462) (51,783) (23,683)
Earnings before taxes and
minority interest(1) 32,782 27,255 5,391
Depreciation and amortization 3,557 2,372 1,948
Segment Assets 132,739 68,802 37,593
</TABLE>
(Continued)
61
<PAGE> 62
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(1) Amounts exclude provision for asset revaluation and clinic
restructuring and merger expenses.
(2) This segment includes all real estate holdings as well as the
results for CareWise and the hospitals managed by the Company.
(5) PROPERTY AND EQUIPMENT
Property and equipment at December 31, consists of the following (in
thousands):
<TABLE>
<CAPTION>
1998 1997
-------- -------
<S> <C> <C>
Land and improvements $ 6,661 6,018
Buildings and leasehold improvements 81,902 70,558
Equipment 270,092 232,039
Construction in progress 7,134 13,318
-------- -------
365,789 321,933
Less accumulated depreciation and amortization 123,965 86,248
-------- -------
Property and equipment, net $241,824 235,685
======== =======
</TABLE>
At December 31, 1998 and 1997, equipment with a cost of approximately
$17,523,000 and $20,080,000, and accumulated depreciation of
approximately $8,039,000 and $8,215,000, respectively, was held under
capital leases.
(6) INTANGIBLE ASSETS
Intangible assets at December 31, net of accumulated amortization,
consist of the following (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- -------
<S> <C> <C>
Clinic service agreements $671,486 732,848
Excess of cost of acquired assets over fair value 302,698 67,384
Franchise rights 2,174 2,078
Loan issuance costs 5,179 5,416
-------- -------
Intangible assets, net $981,537 807,726
======== =======
</TABLE>
(Continued)
62
<PAGE> 63
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(7) FAIR VALUE OF FINANCIAL INSTRUMENTS
As of December 31, 1998 and 1997, the fair value of the Company's cash
and cash equivalents, accounts receivable, accounts payable, purchase
price payable due to physician groups, and accrued expenses approximated
their carrying value because of the short maturities of those financial
instruments. The fair value of the Company's long-term debt also
approximates its carrying value since the related notes bear interest at
current market rates.
The estimated fair value of the convertible subordinated notes payable to
physician groups was approximately $27,119,000 and $65,218,000 as of
December 31, 1998 and 1997, respectively. The carrying value of these
notes was approximately $47,580,000 and $61,576,000 at December 31, 1998
and 1997, respectively. The estimated fair value of these convertible
securities is based on the greater of their yield to maturity and quoted
market prices for similar debt issues or the closing market value of the
common shares into which they could have been converted at the respective
balance sheet date. The estimated fair value of the Company's convertible
subordinated debentures was $120,940,000 and $195,000,000 as of December
31, 1998 and 1997, respectively, compared to a carrying value of
$200,000,000 in both periods. The estimated fair value of these
convertible debentures is based on quoted market prices at these dates.
(8) CONVERTIBLE SUBORDINATED NOTES PAYABLE TO PHYSICIAN GROUPS
At December 31, 1998 and 1997, the Company had outstanding subordinated
convertible notes payable to affiliated physician groups in the aggregate
principal amount of approximately $47,580,000 and $61,576,000,
respectively. These notes bear interest at rates of 5.86% to 7.0% and are
convertible into shares of the Company's common stock at conversion
prices ranging from $26.35 to $57.78 per share. A convertible
subordinated note of $33,295,000 issued in connection with the Guthrie
Clinic transaction will be convertible into approximately 903,000 shares
of common stock upon the Company's acquisition of the clinic's assets
prior to November 17, 2005. If the then current price of the common stock
is less than the conversion price, PhyCor will pay the clinic the
principal amount of the note. The remaining convertible notes may be
converted into approximately 732,000 shares of common stock, with 162,000
shares convertible at December 31, 1998 and 570,000 shares convertible
commencing on varying dates in 1999 through 2004 at the option of the
holders.
(9) CONVERTIBLE SUBORDINATED DEBENTURES
During February 1996, the Company completed a public offering of
$200,000,000 convertible subordinated debentures, which mature in 2003.
Net proceeds from the offering were $194,395,000. The debentures were
priced at par with a coupon rate of 4.5% and are convertible into the
Company's common stock at $38.67 per share. From February 15, 1999 to
maturity, the bonds may be redeemed at prices decreasing from 102.572% of
face value to 100% of face value.
(Continued)
63
<PAGE> 64
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(10) LONG-TERM DEBT
Long-term debt at December 31, consists of the following (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- -------
<S> <C> <C>
Bank credit facility, bearing interest at a weighted
average rate of 6.18% at December 31, 1998 $377,000 204,000
Mortgages payable, bearing interest at rates ranging from
8.25% to 10.5%, secured by land, building, and
certain equipment 8,537 3,704
Other notes payable 7,917 4,333
-------- -------
Total long-term debt 393,454 212,037
Less current installments 4,810 1,144
-------- -------
Long-term debt, excluding current installments $388,644 210,893
======== =======
</TABLE>
The Company modified its bank credit facility (Bank Credit Facility) in
April and September 1998 and March 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 Bank Credit Facility during 1998
was either (i) the applicable eurodollar rate plus .50% to 1.25% or (ii)
the agent's base rate plus .25% to .575% per annum. The total weighted
average drawn cost of outstanding borrowings at December 31, 1998 was
6.18%. After amending the Bank Credit Facility March 15, 1999, total
drawn cost is now either (i) the applicable eurodollar rate plus .625% to
1.50% or (ii) the agent's base rate plus .40% to .65% per annum.
On October 17, 1997, the Company entered into an interest rate swap
agreement to fix the interest rate on $100 million of debt at 5.85%
relative to the three month floating LIBOR. This interest rate swap
agreement was amended, effective October 17, 1998, to a fixed rate of
5.78% and a maturity date of July 2003 with the lender's option to
terminate beginning October 2000. Effective September 9, 1998, the
Company entered into an interest rate swap agreement to fix the interest
rate on an additional $100 million of debt at 5.14% relative to the three
month floating LIBOR. This swap agreement matures September 2003 with the
lender's option to terminate beginning September 2000. Effective
September 14, 1998, the Company entered into an interest rate swap
agreement to fix the interest rate on up to $21 million of debt under the
Company's synthetic lease facility through April 2000, of which
approximately $5.2 million was outstanding at December 31, 1998, at 5.28%
relative to the one month floating LIBOR. This swap agreement matures
April 2005. Effective December 1, 1998, the Company entered into an
interest rate swap agreement to fix the interest rate on $5 million of
debt at 5.2425% relative to the one month floating LIBOR. This swap
agreement matures April 2005. At December 31, 1998, notional amounts
under interest rate swap agreements totaled approximately $210.2 million.
(Continued)
64
<PAGE> 65
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
The Company also entered into a $100 million synthetic lease facility
(Synthetic Lease Facility) in April 1998. The Synthetic Lease Facility
provides off balance sheet financing with an option to purchase the
leased facilities at the end of the lease term and 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 total
drawn cost under the Synthetic Lease Facility during 1998 was .375% to
1.00% above the applicable eurodollar rate. At December 31, 1998, an
aggregate of $19.1 million had been utilized under the Synthetic Lease
Facility. In March 1999, the Company amended its Synthetic Lease Facility
to $60 million and total drawn cost is now .50% to 1.25% above the
applicable eurodollar rate.
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, and
(iii) the payment of cash dividends on, and the redemption or repurchase
of, securities of the Company, (iv) investments and (v) acquisitions. The
Company is required to obtain bank consent for an acquisition with a
purchase price of $25.0 million or more or purchases aggregating $150
million in any 12-month period.
The aggregate maturities of long-term debt at December 31, 1998, are as
follows (in thousands):
<TABLE>
<S> <C>
1999 $ 4,810
2000 4,562
2001 2,307
2002 923
2003 377,883
Thereafter 2,969
---------
$ 393,454
=========
</TABLE>
(11) LEASES
The Company has entered into operating leases for commercial property and
equipment with affiliated physician groups and third parties. Commercial
properties under operating leases include clinic buildings, satellite
operations, and administrative facilities. Capital leases relating to
equipment expire at various dates during the next five years.
(Continued)
65
<PAGE> 66
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
The future minimum lease payments under noncancelable operating leases
net of sublease income and capital leases at December 31, 1998, are as
follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL NET OPERATING
LEASES LEASES
------- ------
<S> <C> <C>
1999 $ 6,650 11,845
2000 3,965 8,655
2001 1,488 7,407
2002 663 6,908
2003 174 5,591
Thereafter 12 6,470
------- ------
Total minimum lease payments 12,952 46,876
======
Less amount representing interest (at rates ranging from
10% to 13%) 1,247
-------
Present value of net minimum capital lease payments 11,705
Less current installments of obligations under capital
leases 5,687
-------
Obligations under capital leases, excluding current
installments $ 6,018
=======
</TABLE>
Net payments under operating leases at December 31, 1998, include total
commitments of $1,867,359,000 reduced by amounts to be reimbursed under
clinic service agreements of $1,820,483,000. Payments due under operating
leases include $1,417,889,000 payable to physician groups and their
affiliates. Generally, in the event of a service agreement termination,
any related lease obligations are also terminated.
(12) SHAREHOLDERS' EQUITY
(a) COMMON STOCK
In the first quarter of 1997, the Company completed a public
offering of 7,295,000 shares of its common stock. Net proceeds
from the offering were approximately $210.0 million.
On May 17, 1996, the Company declared a three-for-two stock split
to shareholders of record on May 31, 1996. All common share and
per share data included in the accompanying consolidated financial
statements and footnotes thereto have been restated to reflect the
stock split.
(Continued)
66
<PAGE> 67
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
In September 1998, the Company adopted a common stock repurchase
program whereby the Company may repurchase up to $50.0 million of
its common stock. In October 1998, the Company announced the
expansion of its common stock repurchase program into a securities
repurchase program to include the Company's 4.5% convertible
subordinated debentures and other securities, the economic terms
of which are derived from the common stock and/or debentures. In
conjunction with the securities repurchase program, the Company
has repurchased approximately 2,628,000 shares of common stock for
approximately $12,590,000.
(b) PREFERRED STOCK
The Company has 10,000,000 shares of authorized but unissued
preferred stock. The Company has reserved for issuance 500,000
shares of Series A Junior Participating Preferred Stock issuable
in the event of certain change-in-control events.
(c) WARRANTS
The following represents a summary of all warrants outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
EXERCISABLE
EXPIRATION NUMBER EXERCISE AT DECEMBER 31,
GRANT DATE DATE OF SHARES PRICE 1998
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
February 1992 2002 2,188 $ 4.74 2,188
June 1995 2005 348,001 15.40 348,001
November 1995 2003 387,967 25.78 --
July 1996 2002 67,835 44.23 67,835
February 1997 2007 250,000 31.13 --
May 1997 2007 250,000 27.75 --
August 1997 2002 40,000 33.16 --
--------- -------
1,345,991 418,024
========= =======
</TABLE>
(Continued)
67
<PAGE> 68
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(d) 1988 STOCK INCENTIVE PLAN AND DIRECTORS' STOCK PLAN
The Company has two stock option plans. Under the Amended 1988
Incentive Stock Plan ("Incentive Plan"), the Company has reserved
17,000,000 shares of its common stock for issuance pursuant to
option and stock grants to employees and directors. Under the
Amended 1992 Directors Stock Plan ("Directors Plan"), 337,500
shares of common stock are reserved. Under both plans, stock
options are granted with an exercise price equal to the estimated
fair market value of the Company's common stock on the date of
grant. Most options under the Incentive Plan have a term of ten
years and become exercisable in installments over periods ranging
up to five years. Options under the Directors Plan have a term of
ten years and are exercisable when granted.
In August 1998, the Company adopted an option exchange program
available to all option holders, excluding the executive officers
and the Board of Directors. Such eligible holders were given the
opportunity to exchange options granted after October 1994 for new
options with a renewed four year vesting schedule representing
fewer shares at an exercise price of $7.91 per share. Options to
purchase an aggregate of 3,964,000 shares were issued as a result
of the exchange of 8,575,000 previously issued options, (91% of
eligible options.)
At December 31, 1998, there were approximately 2,005,000 and
87,000 additional shares available for grant under the Incentive
Plan and the Directors Plan, respectively.
The per share weighted-average fair value of stock options granted
during 1998, 1997 and 1996 was $8.24, $15.18, and $16.97 on the
date of grant using the Black Scholes option-pricing model with
the following assumptions: an expected dividend yield of 0.0% for
all years, expected volatility of 105% in 1998, and 56% in 1997
and 1996, risk-free interest rate ranging from 4.25% to 5.75% in
1998, 5.88% to 6.33% in 1997 and 5.25% to 6.63% in 1996, and an
expected life of two to five years for 1998 and five years for
1997 and 1996.
The Company applies APB Opinion No. 25 in accounting for its Plans
and, accordingly, no compensation cost has been recognized for its
stock options in the consolidated financial statements. Had the
Company determined compensation cost based on the fair value at
the grant date for its stock options under SFAS No. 123, the
Company's net earnings (loss) and per share amounts would have
been reduced to the pro forma amounts indicated below (in
thousands except for earnings per share):
<TABLE>
<CAPTION>
1998 1997 1996
---------- -------- -------
<S> <C> <C> <C> <C>
Net earnings (loss) As reported $ (111,447) 3,209 36,380
Pro forma (130,579) (13,806) 30,133
Basic earnings (loss) per share As reported (1.55) 0.05 0.67
Pro forma (1.82) (0.22) 0.55
Diluted earnings (loss) per share As reported (1.55) 0.05 0.60
Pro forma (1.82) (0.22) 0.49
</TABLE>
(Continued)
68
<PAGE> 69
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
Pro forma net earnings (loss) reflects only options granted
beginning in 1995. Therefore, the full impact of calculating
compensation cost for stock options under SFAS No. 123 is not
reflected in the pro forma net earnings (loss) amounts presented
above because compensation cost is reflected over the options'
vesting period and compensation cost for options granted prior to
January 1, 1995 is not considered.
Stock option activity during the periods indicated is as follows
(shares in thousands):
<TABLE>
<CAPTION>
WEIGHTED-
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
------ --------------
<S> <C> <C>
Balance at December 31, 1995 7,554 $ 11.93
Granted 3,164 30.55
Exercised (297) 5.25
Forfeited (134) 19.49
------- ---------
Balance at December 31, 1996 10,287 17.84
Granted 3,542 27.81
Exercised (544) 6.14
Forfeited (302) 22.91
------- ---------
Balance at December 31, 1997 12,983 20.99
Granted 8,742 12.68
Assumed in connection with acquisitions 776 6.77
Exercised (1,050) 6.64
Forfeited (3,426) 21.49
Exchanged (4,611) 18.64
------- ---------
Balance at December 31, 1998 13,414 $ 10.27
======= =========
</TABLE>
At December 31, 1998, the range of exercise prices and
weighted-average remaining contractual life of outstanding options
was $0.75 - $30.75 and 8.06 years, respectively.
At December 31, 1998, 1997 and 1996, the number of options
exercisable was 6,366,000, 2,268,000, and 1,392,000, respectively,
and the weighted-average exercise price of those options was
$13.87, $7.02, and $5.23, respectively.
(Continued)
69
<PAGE> 70
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(e) STOCK PURCHASE PLANS
The Company has reserved 843,750 common shares for issuance
pursuant to its employee stock purchase plan. During 1998 and
1997, approximately 163,000 and 82,000 shares, respectively, were
issued relative to the employee stock purchase plan. Shares issued
under the employee stock purchase plan will generally be priced at
the lower of 85% of the fair market value of the Company's common
stock on the first or the last trading days of the plan year.
The Company also established the 1996 Affiliate Stock Purchase
Plan and has reserved 2,250,000 common shares for this plan.
Eligible participants generally include physicians and other
employees of medical clinics with which the Company has a
management or service agreement and employees of limited liability
companies and partnerships in which the Company has an equity
interest of at least 50%. Shares issued under the plan to
employees of limited liability companies and partnerships in which
the Company has an equity interest of at least 50% are priced
using a method similar to that of the employee stock purchase
plan. Shares issued under the plan to other participants are
priced equal to 95% of the market price on the purchase date.
During 1998 and 1997, approximately 760,000 and 343,000 shares,
respectively, were issued under this plan.
Pro forma compensation expense included in the pro forma
calculation above is recognized for the fair value of each stock
purchase right estimated on the date of grant using the Black
Scholes pricing model. The following assumptions were used for
stock purchases: an expected dividend yield of 0.0% for all years,
expected volatility of 105% in 1998 and 56% in 1997 and 1996,
risk-free interest rate of 5.5% in 1998, 6.0% in 1997 and 6.25%
in 1996, and an expected life of one year for all years.
(f) RECONCILIATION OF EARNINGS PER SHARE CALCULATION
The following is a reconciliation of the numerators and
denominators of the basic and diluted earnings per share
computations for net earnings (loss):
<TABLE>
<CAPTION>
INCOME (LOSS) SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
<S> <C> <C> <C>
FOR THE YEAR ENDED DECEMBER 31, 1998
------------------------------------
BASIC EPS
Loss attributable to common shareholders $(111,447) 71,822 $ (1.55)
========
EFFECT OF DILUTIVE SECURITIES
Options -- --
Warrants -- --
Convertible Notes -- --
--------- ------
DILUTED EPS
Loss attributable to common shareholders $(111,447) 71,822 $ (1.55)
========= ====== ========
</TABLE>
(Continued)
70
<PAGE> 71
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
<S> <C> <C> <C>
FOR THE YEAR ENDED DECEMBER 31, 1997
------------------------------------
BASIC EPS
Income available to common shareholders $ 3,209 62,899 $ 0.05
========
EFFECT OF DILUTIVE SECURITIES
Options -- 2,353
Warrants -- 225
Convertible Notes -- 1,457
--------- ------
DILUTED EPS
Income available to common shareholders $ 3,209 66,934 $ 0.05
========= ====== ========
FOR THE YEAR ENDED DECEMBER 31, 1996
------------------------------------
BASIC EPS
Income available to common shareholders $ 36,380 54,608 $ 0.67
========
EFFECT OF DILUTIVE SECURITIES
-----------------------------
Options -- 4,520
Warrants -- 290
Convertible Notes -- 1,678
--------- ------
DILUTED EPS
Income available to common shareholders $ 36,380 61,096 $ 0.60
========= ====== ========
</TABLE>
Options and warrants to purchase 14,760,000 and 3,662,000 shares
of common stock were outstanding at December 31, 1998 and 1997,
respectively, but were not included in the computation of diluted
EPS because the options' and warrants' exercise prices were
greater than the average market price of the common shares and, in
1998, due to a loss for the year, resulting in the options and
warrants being antidilutive. Antidilutive securities at December
31, 1998 also included 212,000 shares of common stock to be issued
at future dates related to clinic acquisitions. Additionally,
subordinated notes payable convertible into 1,636,000 and
1,057,000 shares at December 31, 1998 and 1997, respectively, were
antidilutive. Interest paid on the convertible notes is offset by
service agreement fees received by the Company of an equal amount.
(Continued)
71
<PAGE> 72
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(13) ASSET REVALUATION AND CLINIC RESTRUCTURING
In the fourth quarter of 1997, the Company recorded a pre-tax charge to
earnings of $83.4 million related to the revaluation of assets of seven
of the Company's multi-specialty clinics. Included in the seven clinics
were three clinic operations the Company determined to dispose of because
of a variety of negative operating and market-specific issues. The
pre-tax charge to earnings included $29.2 million related to write down
of assets to be disposed of to fair value less costs to sell. The Company
completed the disposal of one of these clinics in March of 1998, a second
in April 1998 and the third in July 1998. Amounts received upon the
dispositions approximated the post-charge net carrying value of those
assets. Clinic net assets to be disposed of included current assets,
property and equipment, intangibles and other assets totaling $3,237,000
at December 31, 1997.
In addition, the Company reviewed certain of its clinics, consistent with
SFAS 121, when specific events occurred in the fourth quarter of 1997
that indicated that the four clinics included in the charge could be
impaired (i.e. physician group declared bankruptcy, notifications of
physician termination, etc.). The Company determined that an impairment
had occurred and wrote down the associated clinic assets and service
agreement intangibles to fair value determined by discounting future
operating cash flows of the related physician groups. The pre-tax charge
to earnings included $54.2 million related to the impairment of assets at
these four clinics.
Restructuring charges totaling $22.0 million were recorded in the first
quarter of 1998 with respect to clinics that were being sold or
restructured. These charges were comprised of facility and lease
termination costs, severance costs and other exit costs in the amounts of
$15,316,000, $4,611,000 and $2,073,000, respectively. During 1998, the
Company paid approximately $3,033,000 in costs associated with facility
and lease terminations, $2,690,000 in costs associated with severance and
$1,398,000 in other exit costs. At December 31, 1998, accrued expenses
payable included remaining reserves for clinics to be restructured and
exit costs for disposed clinic operations of approximately $4,105,000,
which included facility and lease termination costs, severance costs and
other exit costs in the amounts of $740,000, $1,713,000 and $1,652,000,
respectively. Remaining liabilities from the first quarter 1998
restructuring charge of approximately $10,774,000 were reversed against
the third quarter 1998 asset revaluation charge as the Company determined
to dispose of certain clinic operations that were originally anticipated
to be restructured.
(Continued)
72
<PAGE> 73
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
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 third quarter charge related
to deteriorating negative operating trends for three clinic operations
which were included in the fourth quarter 1997 asset revaluation charge,
and the corresponding decision to dispose of those assets. Amounts
received upon the dispositions of net assets approximated the post-charge
net carrying value. Additionally, this charge provided for the
disposition of assets of another clinic, completed in the third quarter,
not included in the fourth quarter 1997 asset revaluation charge, and the
revaluation of assets at two other clinics that were being disposed of or
restructured. The Company completed the disposal of one of these clinics
in the fourth quarter, and amounts received upon the disposition
approximated the post-charge net carrying value of those assets.
In the fourth quarter of 1998, the Company recorded a pre-tax asset
revaluation charge of $110.4 million. This charge related to adjustments
of the carrying value of the Company's assets at two clinics as a result
of agreements to sell certain assets associated with the related service
agreements that are expected to be terminated, and an adjustment to
recognize the decline in future cash flows from the acquired physician
practice management company, FPC, pursuant to SFAS 121. Additionally,
this charge provided for the write-off of goodwill recorded in connection
with the MHG acquisition and the write down of certain assets to net
realizable value and service agreement intangibles to fair value at
another clinic.
Clinic net assets to be disposed of totaled $41,225,000 at December 31,
1998, and consisted of current assets, property and equipment,
intangibles and other assets from three clinics associated with the
fourth quarter 1998 asset revaluation charge and one clinic included in
the fourth quarter 1997 and third quarter 1998 asset revaluation charges.
The Company expects to dispose of the assets and terminate the service
agreements related to such clinics in 1999. Net revenue and pre-tax
income (loss) from the clinics and IPA disposed of or to be disposed of
totaled $175,408,000 and $(2,064,000), respectively, in 1998 and
$186,296,000 and $1,507,000, respectively, in 1997.
(14) MERGER EXPENSES
The Company recorded a pre-tax charge to earnings 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 the
Company's share of investment banking, legal, travel, accounting and
other expenses incurred during the merger negotiation process.
(Continued)
73
<PAGE> 74
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(15) INCOME TAX EXPENSE
Income tax expense for the years ended December 31, 1998, 1997 and 1996,
consists of (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- ------
<S> <C> <C> <C>
Current:
Federal $ 300 12,724 10,935
State 2,821 3,051 2,224
Deferred:
Federal (42,124) (10,391) 9,354
State (887) 714 262
-------- ------- ------
$(39,890) 6,098 22,775
======== ======= ======
</TABLE>
For federal income tax purposes, the Company receives a deduction arising
from the exercise of non-qualified stock options equal to the difference
between the fair market value at date of exercise and the exercise price.
This tax benefit was recorded as a credit to common stock in the amount
of $4,686,000, $5,464,000, and $2,940,000 in 1998, 1997 and 1996,
respectively.
Total income tax expense (benefit) differed from the amount computed by
applying the U.S. federal income tax rate of 35 percent in 1998, 1997 and
1996 to earnings (loss) before income taxes as a result of the following
(in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------ -------
<S> <C> <C> <C>
Computed "expected" tax expense (benefit) $(52,968) 3,257 20,704
Increase (reduction) in income taxes resulting
from:
State income taxes, net of federal
income tax benefit 1,257 2,447 1,616
Amortization of nondeductible goodwill 4,103 791 499
Nondeductible goodwill written off 8,582 -- --
Other, net (864) (397) (44)
-------- ------ -------
Total income tax expense (benefit) $(39,890) 6,098 22,775
======== ====== =======
</TABLE>
(Continued)
74
<PAGE> 75
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31 are presented below (in thousands):
<TABLE>
<CAPTION>
1998 1997
--------- -------
<S> <C> <C>
Deferred tax assets:
Reserves (including incurred but not reported
self-insurance claims) $ 39,241 $ 9,289
Operating loss carryforwards 88,959 9,668
Cash to accrual adjustment 11,476 14,883
Other 6,717 2,406
--------- -------
Total gross deferred tax asset 146,393 36,246
Valuation allowance 43,519 12,315
--------- --------
Net deferred tax assets 102,874 23,931
--------- --------
Deferred tax liabilities:
Plant and equipment, principally due to differences
in depreciation 14,430 10,398
Capital leases 4,339 3,672
Clinic service agreements 41,626 24,971
Prepaid expenses 1,634 2,033
Income from partnerships 3,336 4,889
Accounts receivable 2,853 3,811
Other 1,910 1,397
--------- --------
Total gross deferred tax liabilities 70,128 51,171
--------- --------
Net deferred tax assets (liabilities) $ 32,746 $(27,240)
========= ========
</TABLE>
The significant components of the deferred tax expense as of December 31,
1998 and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
--------- -------
<S> <C> <C>
Change in net deferred tax assets (liabilities) $ (59,986) $ 9,966
Deferred taxes of acquired entities 16,975 (19,643)
--------- --------
Deferred tax benefit $ (43,011) $ (9,677)
========= ========
</TABLE>
(Continued)
75
<PAGE> 76
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
The net change in the total valuation allowance for the year ended
December 31, 1998, which primarily relates to federal and state net
operating loss carryforwards and expenses relating to the provision for
asset revaluation and restructuring charges not expected to be deductible
for state tax purposes, was an increase of $31,204,000. As of December
31, 1998, the Company had approximately 207,897,000 of federal and
$352,633,000 of state net operating loss carryforwards which begin to
expire in 2007. The utilization of these carryforwards is subject to the
future level of taxable income of the Company and its applicable
subsidiaries. However, the Company believes the full benefit of the
deferred tax assets (net of valuation allowance) will be obtained based
upon its evaluation of the Company's anticipated profitability over the
period of years the operating loss carryforwards are available for
utilization or that the other temporary differences are expected to
become tax deductions. Regardless of the Company's expectations, there
can be no assurance that the Company will generate any specific level of
continuing earnings. Refundable federal and state income taxes totaled
approximately $13,968,000 and $14,751,000 at December 31, 1998 and 1997,
respectively.
The Company has been the subject of an audit by the Internal Revenue
Service (IRS) covering the years 1988 through 1993. The IRS has proposed
adjustments relating to the timing of recognition for tax purposes of
deductions relating to uncollectible accounts. PhyCor disagrees with the
positions asserted by the IRS and is vigorously contesting these proposed
adjustments. Most of the issues originally raised by the IRS as to
revenues and deductions and the Company's relationship with affiliated
physician groups have been resolved by the National Office of the IRS in
favor of the Company and with respect to these issues, no additional
taxes, penalties or interest are owed by the Company related to such
claims. The IRS Appeals Office has raised another but similar issue
concerning the recognition of income with respect to accounts receivable
but it is unclear whether the IRS will pursue this similar issue. The
Company is prepared to continue to vigorously contest any proposed
adjustment on this similar issue. The Company believes that any
adjustments resulting from resolution of this disagreement would not
affect reported net earnings of PhyCor, but would defer tax benefits and
change the levels of current and deferred tax assets and liabilities. For
the years under audit, and potentially for subsequent years, any such
adjustments could result in material cash payments by the Company. Any
successful adjustment by the IRS would cause interest expense to be
incurred. PhyCor does not believe the resolution of this matter will have
a material adverse effect on its financial condition, although there can
be no assurance as to the outcome of this matter. In addition, the IRS is
in the process of examining the Company's 1994 and 1995 federal tax
returns.
(16) EMPLOYEE BENEFIT PLANS
As of January 1, 1989, the Company adopted the PhyCor, Inc. Savings and
Profit Sharing Plan. The Plan is a defined contribution plan covering
most employees. Company contributions are based on specified percentages
of employee compensation. The Company funds contributions as accrued. The
plan expense for 1998, 1997 and 1996 amounted to $14,012,000,
$10,245,000, and $7,803,000, respectively.
In connection with certain of the Company's acquisitions, the Company
adopted employee retirement plans previously sponsored solely by the
physician groups. The Company has recognized as expense its required
contributions to be made to the plans of approximately $7,632,000,
$4,789,000, and $3,174,000 relative to its employees for 1998, 1997 and
1996, respectively.
(Continued)
76
<PAGE> 77
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(17) COMMITMENTS AND CONTINGENCIES
(a) EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with certain of
its management employees, which include, among other terms,
non-compete provisions and salary and benefits continuation.
(b) COMMITMENTS TO PHYSICIAN GROUPS
Under terms of certain of its service agreements, the Company is
committed to provide capital for the improvement and expansion of
clinic facilities. The commitments vary depending on such factors
as total capital expenditures, the number of physicians practicing
at each clinic, and the cost of specific planned projects. All
projects funded under these commitments must be approved by the
Company before they commence.
The Company is also committed to provide, under certain
circumstances, advances to physician groups to principally finance
the recruitment of new physicians. These advances will be repaid
out of the physician groups' share of future clinic revenue. At
December 31, 1998 and 1997, $2,883,000 and $4,038,000,
respectively, of such advances were outstanding.
(Continued)
77
<PAGE> 78
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(c) LITIGATION
The Company and certain of its current and former officers and
directors have been named defendants in nine securities fraud
class actions filed between September 8 and October 23, 1998. The
factual allegations of the complaints in all nine actions 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 nine actions, 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 actions 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 actions have been consolidated in the U.S.
District Court for the Middle District of Tennessee. Defendants'
motion to dismiss is pending before that court. The state court
actions have been consolidated in Davidson County, Tennessee. The
Company believes that it has meritorious defenses to all of the
claims, and intends to vigorously defend 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) under Section 48-18-304 of the Tennessee
Business Corporation Act.
On January 23, 1999, the Company and Holt-Krock entered into a
settlement agreement with Sparks to resolve their lawsuits and all
related claims between the parties and certain former Holt-Krock
physicians. As a result, Sparks is expected to acquire certain
assets from PhyCor, offer employment to a substantial number of
Holt-Krock physicians and enter into a long-term agreement whereby
PhyCor will provide key physician practice management resources to
Sparks. These transactions are expected to be completed on or
before May 31, 1999, upon execution of definitive agreements.
However, there can be no assurance that the transaction will be
completed or that it will be completed on the terms described
above.
(Continued)
78
<PAGE> 79
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
On February 2, 1999, the former majority shareholder in PrimeCare
filed suit against the Company and certain of its current and
former executive officers in United States District Court for the
Central District of California. The complaint asserts fraudulent
inducement relating to the PrimeCare acquisition 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 Company believes that it has meritorious defenses to
all of the class and intends to vigorously defend this suit,
however, there can be no assurance that such litigation, if the
Company is not successful, will not have a material adverse effect
on the Company.
On February 6, 1999, White-Wilson Medical Center filed suit
against 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 the Florida Board of Medicine opinion and
OIG Advisory Opinion 98-4. Additionally, on March 17, 1999, the
Clark-Holder Clinic filed suit against 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. The terms of the service agreements provide that the
agreements shall be modified if the laws are changed, modified or
interpreted in a way that requires a change in the agreements.
PhyCor intends to vigorously defend these suits, however, there
can be no assurance that such litigation, if the Company is not
successful, will not have a material adverse effect on the
Company.
Certain litigation is pending against the physician groups
affiliated with the Company and IPAs managed by the Company. The
Company has not assumed any liability in connection with such
litigation. Claims against the physician groups and IPAs could
result in substantial damage awards to the claimants which may
exceed applicable insurance coverage limits. While there can be no
assurance that the physician groups and IPAs will be successful in
any such litigation, the Company does not believe any such
litigation will have a material adverse effect on the Company.
Certain other litigation is pending against the Company and
certain subsidiaries of the Company, none of which management
believes would have a material adverse effect on the Company's
financial position or results of operations.
(d) INSURANCE
The Company and its affiliated physician groups are insured with
respect to medical malpractice risks on a claims-made basis. There
are known claims and incidents that may result in the assertion of
additional claims, as well as claims from unknown incidents that
may be asserted. Management is not aware of any claims against it
or its affiliated physician groups which might have a material
impact on the Company's financial position.
(Continued)
79
<PAGE> 80
PHYCOR, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(e) LETTERS OF CREDIT
On behalf of certain of the Company's affiliated IPAs, the Company
has been required to underwrite letters of credit to managed care
payors to help ensure payment of health care costs for which the
affiliated IPAs have assumed responsibility. As of December 31,
1998, letters of credit aggregating $7.0 million were outstanding
under the credit facility for the benefit of managed care payors.
The Company would ask reimbursement from an IPA if there was a
draw on a letter of credit. No draws on any of these letters of
credit have occurred to date.
(f) CONTINGENT CONSIDERATION
In connection with the acquisition of clinic operating assets, the
Company is contingently obligated to pay an estimated additional
$63,000,000 in future years, depending on the achievement of
certain financial and operational objectives by the related
physician groups. Such liability, if any, will be recorded in the
period in which the outcome of the contingencies become known. Any
payment made will be recorded to clinic service agreements and
will not immediately be charged to expense.
80
<PAGE> 81
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
81
<PAGE> 82
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to the executive officers of the Company is set forth
in the Company's Definitive Proxy Statement relating to the Annual Meeting of
Shareholders to be held on May 25, 1999 under the caption "Executive
Compensation Executive Officers of the Company" and is incorporated herein by
reference. Information with respect to the directors of the Company is set forth
in the Company's Definitive Proxy Statement relating to the Annual Meeting of
Shareholders to be held on May 25, 1999 under the caption "Election of
Directors" and is incorporated herein by reference. Information with respect to
compliance with Section 16(a) of the Securities Exchange Act of 1934 is set
forth in the Company's Definitive Proxy Statement relating to the Annual Meeting
of Shareholders to be held on May 25, 1999 under the caption "Compliance With
Reporting Requirements of the Exchange Act" and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is set forth in the Company's
Definitive Proxy Statement relating to the Annual Meeting of Shareholders to be
held on May 25, 1999 under the caption "Executive Compensation" and is
incorporated herein by reference, except that the Comparative Performance Graph
and the Compensation Committee Report on Executive Compensation included in the
Definitive Proxy Statement are expressly not incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to the security ownership of certain beneficial owners
and management is set forth in the Company's Definitive Proxy Statement relating
to the Annual Meeting of Shareholders to be held on May 25, 1999 under the
caption "Voting Securities and Principal Holders Thereof" and is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to certain relationships and related transactions is
set forth in the Company's Definitive Proxy Statement relating to the Annual
Meeting of Shareholders to be held on May 25, 1999 under the caption "Certain
Relationships and Related Transactions" and is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Index to Consolidated Financial Statements, Financial Statement
Schedules and Exhibits
(1) Financial Statements: See Item 8 herein.
(2) Financial Statement Schedules:
Independent Auditors' Report S-1
Schedule II - Valuation and Qualifying Accounts S-2
82
<PAGE> 83
All other schedules are omitted, because they are not applicable or not
required, or because the required information is included in the consolidated
financial statements or notes thereto.
(3) Exhibits:
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
3.1 -- Amended Bylaws of the Registrant (1)
3.2 -- Restated Charter of the Registrant (1)
3.3 -- Amendment to Restated Charter of the Registrant (2)
3.4 -- Amendment to Restated Charter of the Registrant (3)
4.1 -- Form of 4.5% Convertible Subordinated Debenture due
2003(4)
4.2 -- Form of Indenture by and between the Registrant and First
American National Bank, N.A. (4)
10.1 -- Form of Amended and Restated Employment Agreements dated
August 1, 1997 entered into by each of Messrs. Hutts,
Reeves, Dent and Wright (5)
10.2 -- Registrant's Amended 1988 Incentive Stock Plan (5)
10.3 -- Registrant's Amended 1992 Non-Qualified Stock Option Plan
for Non-Employee Directors (5)
10.4 -- Registrant's 1991 Amended Employee Stock Purchase Plan (6)
10.5 -- Registrant's Savings and Profit Sharing Plan (6)
10.6 -- $500,000,000 Second Amended and Restated Revolving Credit
Agreement dated as of April 2, 1998, among the Registrant,
the Banks named therein and Citibank, N.A. (5)
10.7 -- Amended and Restated Agreement of Merger, dated October 1,
1996, by and between the Registrant and Straub Clinic &
Hospital, Incorporated (7)
10.8 -- Service Agreement, dated as of January 17, 1997, by and
between PhyCor of Hawaii, Inc. and
Straub Clinic & Hospital, Inc. (8)
10.9 -- Supplemental Executive Retirement Plan (5)
21 -- List of subsidiaries of the Registrant (9)
23 -- Consent of KPMG LLP (9)
27 -- Financial Data Schedule for fiscal year ended December 31,
1998 (for SEC use only) (9)
- --------------------
(1) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1994,
Commission No. 0-19786.
(2) Incorporated by referenced to exhibits filed with the Registrant's
Registration Statement on Form S-3, Commission No. 33-93018.
(3) Incorporated by referenced to exhibits filed with the Registrant's
Registration Statement on Form S-3, Commission No. 33-98528.
(4) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-3, Registration No. 333-328.
(5) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1997,
Commission No. 0-19786.
(6) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1993,
Commission No. 0-19786.
(7) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-4, Commission No. 333-15459.
(8) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1991,
Commission No. 0-19786.
(9) Filed herewith.
83
<PAGE> 84
EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS
The following is a list of all executive compensation plans and arrangements
filed as exhibits to this Annual Report on Form 10-K:
(1) Form of Amended Employment Agreement, dated as of August 1,
1997, between the Registrant and each of Messrs. Hutts,
Reeves, Dent and Wright (filed as Exhibit 10.1)
(2) Registrant's Amended 1988 Incentive Stock Plan (filed as
Exhibit 10.2)
(3) Registrant's Amended 1992 Non-Qualified Stock Option Plan for
Non-Employee Directors (filed as Exhibit 10.3)
(4) Supplemental Executive Retirement Plan (filed as Exhibit
10.9)
(b) Reports on Form 8-K
Not applicable.
(c) Exhibits
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14(a)(3)
(d) Financial Statement Schedules
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14(a)(2).
84
<PAGE> 85
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Nashville,
State of Tennessee, on March 31, 1999.
PHYCOR, INC.
By: /s/ Joseph C. Hutts
-------------------------------------
Joseph C. Hutts
Chairman of the Board,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the date indicated.
<TABLE>
<S> <C> <C>
/s/ JOSEPH C. HUTTS Chairman of the Board, Chief Executive March 30, 1999
- ------------------------------------ Officer (Principal Executive Officer) and
Joseph C. Hutts Director
/s/ THOMPSON S. DENT President, Chief Operating Officer and March 30, 1999
- ------------------------------------ Director
Thompson S. Dent
/s/ DERRIL W. REEVES Vice Chairman, Executive Vice President, March 30, 1999
- ------------------------------------ and Director
Derril W. Reeves
/s/ JOHN K. CRAWFORD Executive Vice President, Chief Financial March 30, 1999
- ------------------------------------ Officer (Principal Financial and
John K. Crawford Accounting Officer) and Director
/s/ RONALD B. ASHWORTH Director March 30, 1999
- ------------------------------------
Ronald B. Ashworth
/s/ SAM A. BROOKS, JR. Director March 30, 1999
- ------------------------------------
Sam A. Brooks, Jr.
Director March , 1999
- ------------------------------------
Winfield Dunn
Director March , 1999
- ------------------------------------
C. Sage Givens
/s/ JOSEPH A. HILL, M.D. Director March 30, 1999
- ------------------------------------
Joseph A. Hill, M.D.
/s/ JAMES A. MONCRIEF, M.D. Director March 30, 1999
- ------------------------------------
James A. Moncrief, M.D.
/s/ KAY COLES JAMES Director March 30, 1999
- ------------------------------------
Kay Coles James
</TABLE>
85
<PAGE> 86
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
PhyCor, Inc.:
Under date of February 23, 1999, except as to notes 10 and 17 which are as of
March 17, 1999, we reported on the consolidated balance sheets of PhyCor, Inc.
and subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
years in the three-year period ended December 31, 1998, as contained in the 1998
annual report to shareholders. These consolidated financial statements and our
report thereon are included in the Annual Report on Form 10-K for the year 1998.
In connection with our audits of the aforementioned consolidated financial
statements, we also audited the related financial statement schedule. The
financial statement schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion on the financial statement schedule
based on our audits.
In our opinion, the financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly,
in all material respects, the information set forth therein.
/s/ KPMG LLP
Nashville, Tennessee
February 23, 1999
S-1
<PAGE> 87
PHYCOR, INC. AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BEGINNING ADDITIONS ENDING
BALANCE EXPENSE DEDUCTIONS OTHER(1) BALANCE
-------- --------- ---------- ------ -------
<S> <C> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND
CONTRACTUAL ADJUSTMENTS (IN THOUSANDS)
December 31, 1996 $ 82,205 699,186 (688,276) 41,441 134,556
======== ========= ========== ====== =======
December 31, 1997 $134,556 1,090,329 (1,050,164) 33,813 208,534
======== ========= ========== ====== =======
December 31, 1998 $208,534 1,419,501 (1,432,358) 35,108 230,785
======== ========= ========== ====== =======
</TABLE>
(1) represents allowances of acquisitions
See accompanying independent auditors' report.
S-2
<PAGE> 88
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
3.1 -- Amended Bylaws of the Registrant (1)
3.2 -- Restated Charter of the Registrant (1)
3.3 -- Amendment to Restated Charter of the Registrant (2)
3.4 -- Amendment to Restated Charter of the Registrant (3)
4.1 -- Form of 4.5% Convertible Subordinated Debenture due
2003(4)
4.2 -- Form of Indenture by and between the Registrant and First
American National Bank, N.A. (4)
10.1 -- Form of Amended and Restated Employment Agreements dated
August 1, 1997 entered into by each of Messrs. Hutts,
Reeves, Dent and Wright (5)
10.2 -- Registrant's Amended 1988 Incentive Stock Plan (5)
10.3 -- Registrant's Amended 1992 Non-Qualified Stock Option Plan
for Non-Employee Directors (5)
10.4 -- Registrant's 1991 Amended Employee Stock Purchase Plan (6)
10.5 -- Registrant's Savings and Profit Sharing Plan (6)
10.6 -- $500,000,000 Second Amended and Restated Revolving Credit
Agreement dated as of April 2, 1998, among the Registrant,
the Banks named therein and Citibank, N.A. (5)
10.7 -- Amended and Restated Agreement of Merger, dated October 1,
1996, by and between the Registrant and Straub Clinic &
Hospital, Incorporated (7)
10.8 -- Service Agreement, dated as of January 17, 1997, by and
between PhyCor of Hawaii, Inc. and Straub Clinic &
Hospital, Inc. (7)
10.9 -- Supplemental Executive Retirement Plan (5)
21 -- List of subsidiaries of the Registrant (9)
23 -- Consent of KPMG LLP (9)
27.1 -- Financial Data Schedule for fiscal year ended December 31,
1998 (for SEC use only) (9)
- --------------------
(1) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1994,
Commission No. 0-19786.
(2) Incorporated by referenced to exhibits filed with the Registrant's
Registration Statement on Form S-3, Commission No. 33-93018.
(3) Incorporated by referenced to exhibits filed with the Registrant's
Registration Statement on Form S-3, Commission No. 33-98528.
(4) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-3, Registration No. 333-328.
(5) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1997,
Commission No. 0-19786.
(6) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1993,
Commission No. 0-19786.
(7) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-4, Commission No. 333-15459.
(8) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1991,
Commission No. 0-19786.
(9) Filed herewith.
<PAGE> 1
EXHIBIT 21
PHYCOR, INC.
SUBSIDIARIES/AFFILIATES
As of March 26, 1999
ALL ENTITIES ARE TENNESSEE DOMESTIC EXCEPT AS NOTED.
<TABLE>
<CAPTION>
NAME OF ENTITY FOREIGN QUALIFICATION(S)
- -------------- ------------------------
<S> <C>
PhyCor, Inc. Arkansas
Arnett Health Systems, Inc. (IN) None
-Arnett HMO, Inc. (IN) None
-Arnett TPA, Inc. (IN) (not on record)
CareWise, Inc. (DE) California
Montana
Washington
-Acamedica, Inc. (NJ) None
-Nurse On-Call (DE) None
Falcon Acquisition Sub, Inc. (DE) None
First Physician Care, Inc. (DE) Georgia, Missouri
-First Physician Care of Atlanta, Inc. (GA) None
-First Physician Care of Palm Beach, Inc. (DE) Florida
-First Physician Care of Riverbend, Inc. (DE) Illinois
-First Physician Care of South Florida, Inc.(FL) None
-First Physician Care of Tampa Bay, Inc. (FL) None
-FPC of New York, Inc. (DE) New York
-FPCNT, Inc. (TX) None
-FPCWT, Inc. (DE) Texas
-Manhattan Physicians IPA1, Inc. (NY) None
-Precept Healthcare Group, Inc. (DE) Georgia
(66.6% owned by FPC; 33.3% owned by US Surgical, Inc.)
-MSO Manhattan, LLC (NY) None
(50% owned by FPC; 50% owned by Eastside Physicians, PLLC)
Morgan Health Group (GA)
-PeachCare Health Plan, Inc. (GA)
North American Medical Management, Inc. None
-IPA Management Associates, L.P. Texas
-NAMM-Texas Investments, L.P. Texas
-Managed Care Management Associates, Inc. (TX) None
-Middle Tennessee Surgical Services, Inc. None
-North American Medical Management, Incorporated (CA None
-North American Medical Management - Alabama, Inc. Alabama
-North American Medical Management - Arizona, Inc. Arizona
-North American Medical Management - Kansas City, Inc.
-North American Medical Management - Kentucky, Inc. Kentucky
-Ohio Valley Medical Management, LLC Kentucky
-North American Medical Management - Illinois, Inc. (IL) None
-North American Medical Management - New Jersey, Inc. New Jersey,
Pennsylvania
-Morris-Somerset Management, LLC New Jersey
-North American Medical Management - New York, Inc. New York
-North American Medical Management - New York City, Inc. New York
-North American Medical Management - Nevada, Inc. Nevada
</TABLE>
1
<PAGE> 2
PHYCOR, INC.
SUBSIDIARIES/AFFILIATES
As of March 26, 1999
ALL ENTITIES ARE TENNESSEE DOMESTIC EXCEPT AS NOTED.
<TABLE>
<CAPTION>
NAME OF ENTITY FOREIGN QUALIFICATION(S)
- -------------- ------------------------
<S> <C>
-IPA Management Company - Nevada, LLC Nevada
-North American Medical Management - North Carolina, Inc. (NC) None
-North American Medical Management - Rhode Island, Inc. Rhode Island
-ProMedica Management, LLC (DE) Maryland,
Rhode Island
-North American Medical Management - South Carolina, Inc. South Carolina
-North American Medical Management - Southern
California, Inc.(CA) None
-North American Medical Management - Tennessee, Inc. None
-Physician Network Management, LLC None
-Tri County, LLC None
-Upper Cumberland, LLC None
-North American Medical Management - Virginia, Inc. Virginia
-IPA Management Company - Virginia, LLC Virginia
PhyCor Medical Management Company of Colorado, LLC
(Members are: PhyCor, Inc., PhyCor of Greeley, Inc., PhyCor
of Pueblo, Inc., PhyCor of Boulder, Inc. and PhyCor
of Denver, Inc.)
PhyCor - Lafayette, LLC Indiana
PhyCor/Lexington Real Estate, LLC Kentucky
PhyCor of Anne Arundel County, Inc. Maryland
PhyCor of Birmingham, Inc. Alabama
PhyCor of Boulder, Inc. Colorado
PhyCor of Charlotte, LLC (DE) North Carolina
PhyCor of Chickasha, Inc. Oklahoma
PhyCor of Coachella Valley, Inc. California
PhyCor of Columbia, Inc. South Carolina
PhyCor of Conroe, L.P. Texas
-PhyCor Investments, Inc. None
PhyCor of Corsicana, L.P. Texas
PhyCor of Dallas, L.P. Texas
PhyCor of Denver, Inc. Colorado
-FHS, Inc. (formerly Focus Health Services, L.P.) (CO) None
-Front Range Medical Management, Inc. (CO) None
-Focus Health Services, Professional LLC (CO) None
PhyCor of Dixon, Inc. Illinois
PhyCor of Evansville, LLC Indiana
PhyCor of Evansville HMO, Inc. (IN) None
PhyCor of Fort Smith, Inc. Arkansas,
Oklahoma
PhyCor of Ft. Walton Beach, Inc. Florida
PhyCor of Greeley, Inc. Colorado
</TABLE>
2
<PAGE> 3
PHYCOR, INC.
SUBSIDIARIES/AFFILIATES
As of March 26, 1999
ALL ENTITIES ARE TENNESSEE DOMESTIC EXCEPT AS NOTED.
<TABLE>
<CAPTION>
NAME OF ENTITY FOREIGN QUALIFICATION(S)
- -------------- ------------------------
<S> <C>
-Benchmark Worker Rehab Services, LLC None
PhyCor of Harlingen, L.P. Texas
PhyCor of Hattiesburg, Inc. Mississippi
PhyCor of Hawaii, Inc. Hawaii
-Straub Development Corp (HI) None
-Straub Development Corp. (Guam) None
-The Doctors' Clinic Development Company (Guam)
-The Doctors' Clinic (Guam) None
-Straub Health Plan Services, Inc. (HI) None
-Kapiolania-Straub Children's Center (HI) None
-Health Management Systems, Inc. (HI) None
PhyCor of Huntington, Inc. ???
PhyCor of Irving, L.P. Texas
PhyCor of Jacksonville, Inc. Florida
PhyCor of Kentucky HMO Management, LLC Kentucky
PhyCor of Kentucky, LLC Kentucky
PhyCor of Kingsport, Inc. Virginia
PhyCor of Laconia, Inc. New Hampshire
PhyCor of LaGrange, Inc. Alabama, Georgia
PhyCor of Lakeland, Inc. Florida
PhyCor of Lancaster, Inc. Pennsylvania
PhyCor of Maui, Inc. Hawaii
PhyCor of Mesa, Inc. Arizona
PhyCor of Minot, Inc. North Dakota
PhyCor of Murfreesboro, Inc. None
PhyCor of Nashville, Inc. None
PhyCor of New Britain, Inc. Connecticut
PhyCor of Newnan, Inc. Georgia
PhyCor of Northeast Arkansas, Inc. Arkansas
PhyCor of Northern California, Inc. California
PhyCor of Northern Michigan, Inc. Michigan
PhyCor of Northern Michigan Michigan
Medical Management, Inc.
PhyCor of Ogden, Inc. Utah
PhyCor of Olean, Inc. New York
PhyCor of Olympic Peninsula, Inc. Washington
PhyCor of Oregon, Inc. Oregon
PhyCor of Pensacola, Inc. Florida,Alabama
PhyCor of Phoenix, Inc. Arizona
PhyCor of Pueblo, Inc. Colorado
</TABLE>
3
<PAGE> 4
PHYCOR, INC.
SUBSIDIARIES/AFFILIATES
As of March 26, 1999
ALL ENTITIES ARE TENNESSEE DOMESTIC EXCEPT AS NOTED.
<TABLE>
<CAPTION>
NAME OF ENTITY FOREIGN QUALIFICATION(S)
- -------------- ------------------------
<S> <C>
PhyCor of Richmond, Inc. Virginia
PhyCor of Roanoke, Inc. Virginia
PhyCor of Rome, Inc. Alabama, Georgia
PhyCor of Ruston, LLC (DE) Louisiana
PhyCor of San Antonio, L.P. Texas
-PhyCor-S.A., Inc. (TX) None
(General Partner of PhyCor Texas Investments, L.P.)
-PhyCor-QCNINV, Inc. (TX) None
(Limited Partner of PhyCor Texas Investments, L.P.)
-PhyCor Texas Investments, L.P. (TX) None
(Limited Partner of Quality Network, Ltd.)
-Qualitycare Network, Ltd.(TX) None
PhyCor of Sayre, Inc. Pennsylvania,
New York
PhyCor of South Bend, LLC Indiana
PhyCor of St. Petersburg, Inc. Florida
PhyCor of Tidewater, Inc. Virginia
PhyCor of Toledo, Inc. Ohio
PhyCor of Vancouver, Inc. Washington
PhyCor of Vero Beach, Inc. (FL) None
PhyCor of Visalia, Inc. California
PhyCor of West Houston, L.P. Texas
PhyCor of Western Tidewater, Inc. Virginia
PhyCor of Wharton, L.P. Texas
PhyCor of Wichita Falls, L.P. Texas
PhyCor of Wilmington, LLC (DE) North Carolina
PhyCor of Winter Haven, Inc. Florida
PhyCor-Texas Gulf Coast, L.P. Texas
PhyCor-Texas Partnerships, Inc. None
PrimeCare International, Inc. (DE) California, Illinois
-Apple Valley Surgery Center Medical Corporation (CA) None
-Desert Valley Hospital, Inc. (CA) None
-Desert Valley Management Services, Inc. (CA) None
-Inland Valley Management Services, Inc. (CA) None
-Paragon Family Management Services, Inc. (CA) None
-PrimeCare Management Services of BBMV, Inc. (CA)
-PrimeCare Management Services of Coachella Valley, Inc. (CA)
-PrimeCare Management Services of Corona-Temecula, Inc. (CA)
-PrimeCare Management Services of Hemet Valley, Inc. (CA)
-PrimeCare Medical Network, Inc. (CA) None
-Redlands Management Services, Inc. (CA) None
-Southland Healthcare Medical Corporation (CA) None
</TABLE>
4
<PAGE> 5
PHYCOR, INC.
SUBSIDIARIES/AFFILIATES
As of March 26, 1999
ALL ENTITIES ARE TENNESSEE DOMESTIC EXCEPT AS NOTED.
<TABLE>
<CAPTION>
NAME OF ENTITY FOREIGN QUALIFICATION(S)
- -------------- ------------------------
<S> <C>
St. Petersburg Medical Clinic, Inc. (FL) None
The Member Corporation, Inc. Illinois
</TABLE>
5
<PAGE> 6
PHYCOR MANAGEMENT CORPORATION
SUBSIDIARIES/AFFILIATES
All entities are Tennessee corporations except as noted.
As of March 26, 1999
<TABLE>
<CAPTION>
NAME OF ENTITY STATE OF QUALIFICATION
- -------------- ----------------------
<S> <C>
PhyCor Management Corporation - Florida, Inc. Florida
PMC of Arizona, Inc. Arizona
PMC of Colorado, Inc. Colorado
PMC of Maryland, Inc. Maryland
PMC of Michigan, Inc. Michigan
</TABLE>
6
<PAGE> 1
EXHIBIT 23
The Board of Directors and Shareholders
PhyCor, Inc.
We consent to incorporation by reference in the registration statements of
PhyCor Inc. on Form S-3 (No. 33-98528), Form S-4 (Nos. 33-66210 and 33-98530)
and Form S-8 (Nos. 33-65228, 33-85726 and 333-58709) of our reports dated
February 23, 1999, except as to notes 10 and 17, which are as of March 17, 1999,
relating to the consolidated balance sheets of PhyCor, Inc. and subsidiaries as
of December 31, 1998 and 1997, and the related consolidated statements of
operation, shareholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1998, and related schedule, which reports
appear in the December 31, 1998 Annual Report on Form 10-K of PhyCor, Inc.
/s/ KPMG LLP
Nashville, Tennessee
March 30, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 74,314
<SECURITIES> 0
<RECEIVABLES> 609,517
<ALLOWANCES> 230,785
<INVENTORY> 19,852
<CURRENT-ASSETS> 570,111
<PP&E> 365,789
<DEPRECIATION> 123,965
<TOTAL-ASSETS> 1,846,539
<CURRENT-LIABILITIES> 382,257
<BONDS> 588,644
0
0
<COMMON> 850,657
<OTHER-SE> (46,247)
<TOTAL-LIABILITY-AND-EQUITY> 1,846,539
<SALES> 0
<TOTAL-REVENUES> 1,512,499
<CGS> 0
<TOTAL-COSTS> 1,617,006
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 33,234
<INCOME-PRETAX> (137,741)
<INCOME-TAX> (39,890)
<INCOME-CONTINUING> (111,447)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (111,447)
<EPS-PRIMARY> (1.55)
<EPS-DILUTED> (1.55)
</TABLE>
