<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended June 30, 2000.
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition period from _____________ to
_____________.
COMMISSION FILE NUMBER: 0-19786
PHYCOR, INC.
------------
(Exact Name of Registrant as Specified in Its Charter)
TENNESSEE 62-1344801
------------------------------ ---------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
30 BURTON HILLS BLVD., SUITE 400
NASHVILLE, TENNESSEE 37215
-------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (615) 665-9066
--------------
NOT APPLICABLE
--------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
As of August 11, 2000, 73,776,411 shares of the Registrant's Common
Stock were outstanding.
<PAGE> 2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
June 30, 2000 (unaudited) and December 31, 1999
(All amounts are expressed in thousands)
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
ASSETS
------
Current assets:
Cash and cash equivalents - unrestricted $ 27,873 $ 31,093
Cash and cash equivalents - restricted 30,211 29,619
Accounts receivable, net 85,947 230,513
Inventories 3,244 11,384
Prepaid expenses and other current assets 37,225 53,002
Assets held for sale, net 169,292 101,988
--------- -----------
Total current assets 353,792 457,599
Property and equipment, net 62,343 156,091
Intangible assets, net 141,148 522,742
Other assets 60,145 58,493
--------- -----------
Total assets $ 617,428 $ 1,194,925
========= ===========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
------------------------------------
Current liabilities:
Current installments of long-term debt $ 222,223 $ 3,424
Current installments of obligations under capital leases 1,255 3,746
Accounts payable 18,114 34,963
Due to physician groups 7,303 30,142
Purchase price payable 9,938 20,711
Salaries and benefits payable 13,763 25,544
Incurred but not reported claims payable 23,782 45,124
Current portion of accrued restructuring reserves 17,715 7,316
Other accrued expenses and current liabilities 53,736 92,843
--------- -----------
Total current liabilities 367,829 263,813
Long-term debt, excluding current installments 5,564 247,861
Obligations under capital leases, excluding current installments 477 1,540
Accrued restructuring reserves 18,523 679
Deferred credits and other liabilities 28,940 29,858
Convertible subordinated notes payable to physician groups 2,148 6,839
Convertible subordinated notes and debentures 302,125 298,750
--------- -----------
Total liabilities 725,606 849,340
Minority interest in earnings of consolidated partnerships 836 2,082
Shareholders' equity (deficit):
Preferred stock, no par value; 10,000 shares authorized: -- --
Common stock, no par value; 250,000 shares authorized; issued
and outstanding 73,769 shares in 2000 and 73,479 shares in 1999 834,156 834,276
Accumulated deficit (943,170) (490,773)
--------- -----------
Total shareholders' equity (deficit) (109,014) 343,503
--------- -----------
Total liabilities and shareholders' equity (deficit) $ 617,428 $ 1,194,925
========= ===========
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE> 3
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three months and six months ended June 30, 2000 and 1999
(All amounts are expressed in thousands, except for earnings per share)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenue $ 258,010 $ 393,488 $ 567,506 $ 810,032
Operating expenses:
Cost of provider services 57,098 49,520 117,934 106,612
Salaries, wages and benefits 82,830 126,927 180,448 260,015
Supplies 35,023 57,994 75,836 118,594
Purchased medical services 4,990 9,084 12,287 19,325
Other expenses 47,779 59,811 94,110 118,043
General corporate expenses 7,368 7,010 14,952 15,653
Rents and lease expense 18,234 30,591 41,279 63,305
Depreciation and amortization 15,756 24,118 33,054 48,888
Provision for asset revaluation,
restructuring and refinancing 407,308 14,375 431,085 23,888
--------- --------- --------- ---------
Net operating expenses 676,386 379,430 1,000,985 774,323
--------- --------- --------- ---------
Earnings (loss) from operations (418,376) 14,058 (433,479) 35,709
Other (income) expense:
Interest income (1,749) (1,089) (3,209) (2,102)
Interest expense 9,912 10,122 19,978 19,987
--------- --------- --------- ---------
Earnings (loss) before income taxes and
minority interest (426,539) 5,025 (450,248) 17,824
Income tax expense 307 554 635 5,791
Minority interest in earnings (losses) of
consolidated partnerships (22) 3,548 1,514 8,322
--------- --------- --------- ---------
Net earnings (loss) $(426,824) $ 923 $(452,397) $ 3,711
========= ========= ========= =========
Earnings (loss) per share:
Basic $ (5.80) $ .01 $ (6.15) $ .05
========= ========= ========= =========
Diluted (5.80) .01 (6.15) .05
========= ========= ========= =========
Weighted average number of shares and dilutive
share equivalents outstanding:
Basic 73,548 76,034 73,513 75,989
Diluted 73,548 77,457 73,513 77,509
========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three months and six months ended June 30, 2000 and 1999
(All amounts are expressed in thousands)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) $(426,824) $ 923 $(452,397) $ 3,711
Adjustments to reconcile net earnings (loss) to net cash
provided by operating activities:
Depreciation and amortization 15,756 24,118 33,054 48,888
Minority interests (22) 3,548 1,514 8,322
Provision for asset revaluation, restructuring
and refinancing 407,308 14,375 431,085 23,888
Accretion of convertible subordinated notes 1,688 -- 3,375 --
Increase (decrease) in cash, net of effects
of acquisitions and dispositions, due to changes in:
Accounts receivable 13,824 22,631 16,668 4,978
Inventories 188 522 (17) 737
Prepaid expenses and other current assets 6,384 (5,133) 1,884 (17,578)
Accounts payable (3,088) 1,410 (4,275) 8,231
Due to physician groups (4,681) (6,158) (1,843) 3,049
Incurred but not reported claims payable 3,135 (6,786) 8,393 (4,592)
Accrued restructuring reserves (3,421) (4,710) (7,634) (7,385)
Other accrued expenses and current liabilities (1,927) (3,129) (19,748) (768)
--------- -------- --------- --------
Net cash provided by operating activities 8,320 41,611 10,059 71,481
--------- -------- --------- --------
Cash flows from investing activities:
Dispositions (acquisitions), net 23,078 (4,607) 38,781 (35,500)
Purchase of property and equipment (7,624) (9,487) (16,509) (23,836)
Payments for other assets (2,484) (1,860) (1,171) (4,953)
--------- -------- --------- --------
Net cash provided (used) by investing activities 12,970 (15,954) 21,101 (64,289)
--------- -------- --------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock (193) 400 (132) 1,270
Proceeds from long-term borrowings -- -- -- 26,000
Repayment of long-term borrowings (33,103) (18,799) (26,764) (22,030)
Repayment of obligations under capital leases (1,210) (1,667) (2,038) (3,813)
Payments from (distributions of) minority interests 108 (4,613) (2,760) (7,628)
Loan costs incurred (127) (14) (2,093) (785)
--------- -------- --------- --------
Net cash used by financing activities (34,525) (24,693) (33,787) (6,986)
--------- -------- --------- --------
Net increase (decrease) in cash and cash equivalents (13,235) 964 (2,627) 206
Cash and cash equivalents - beginning of period 71,319 73,556 60,711 74,314
--------- -------- --------- --------
Cash and cash equivalents - end of period $ 58,084 $ 74,520 $ 58,084 $ 74,520
========= ======== ========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Three months and six months ended June 30, 2000 and 1999
(All amounts are expressed in thousands)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
SUPPLEMENTAL SCHEDULE OF INVESTING ACTIVITIES:
Effects of acquisitions and dispositions, net:
Assets acquired, net of cash $ (374) $(24,533) $ (1,269) $(33,588)
Liabilities paid (assumed), including
deferred purchase price payments (2,108) 12,058 (6,778) (9,420)
Cancellation of common stock -- -- -- (360)
Cash received from disposition of assets 25,560 7,868 46,828 7,868
-------- -------- -------- --------
Dispositions (acquisitions), net $ 23,078 $ (4,607) $ 38,781 $(35,500)
======== ======== ======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Notes receivable received from disposition
of clinic assets $ 8,500 $ -- $ 18,895 $ 4,810
======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Three months and six months ended June 30, 2000 and 1999
(1) BASIS OF PRESENTATION
---------------------
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial reporting and in accordance with Rule 10-01 of Regulation S-X.
In the opinion of management, the unaudited interim financial statements
contained in this report reflect all adjustments, consisting of only
normal recurring accruals, that are necessary for a fair presentation of
the financial position and the results of operations for the interim
periods presented. The results of operations for any interim period are
not necessarily indicative of results for the full year.
These financial statements, footnote disclosures and other information
should be read in conjunction with the financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1999.
(2) NET REVENUE
-----------
Net revenue of the Company is comprised of clinic service agreement
revenue, independent practice association (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
is recorded at established rates reduced by provisions for doubtful
accounts and contractual adjustments. Contractual adjustments arise as a
result of the terms of certain reimbursement and managed care contracts.
Such adjustments represent the difference between charges at established
rates and estimated recoverable amounts and are recognized in the period
the services are rendered. Any differences between estimated contractual
adjustments and actual final settlements under reimbursement contracts
are recognized as contractual adjustments in the year final settlements
are determined. With the exception of certain clinics acquired as a 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)
6
<PAGE> 7
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
IPA management revenue is equal to the difference between the amount of
capitation and risk pool payments payable to the IPAs managed by the
Company less amounts retained by the IPAs. The Company has not
historically been a party to capitated contracts entered into by the
IPAs, but is exposed to losses to the extent of its share of deficits, if
any, of the capitated revenue of the IPAs. At June 30, 2000, the Company
had underwritten letters of credit totaling $3.3 million for the benefit
of certain managed care payors to help ensure payment of costs for which
the Company's affiliated IPAs are responsible. The Company is exposed to
losses if a letter of credit is drawn upon and the Company is unable to
obtain reimbursement from the IPA. Through the PrimeCare International,
Inc. (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 Company had terminated all
payor contracts relating to MHG and commenced closing its MHG operations
by April 30, 1999. The Company expects to complete the closure of MHG by
the end of 2000.
The following table represents amounts included in the determination of
net revenue (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ --------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross physician group, hospital and other revenue $543,284 $876,812 $1,184,325 $1,786,481
Less:
Provisions for doubtful accounts
and contractual adjustments 249,573 377,633 534,476 761,227
-------- -------- ---------- ----------
Net physician group, hospital
and other revenue 293,711 499,179 649,849 1,025,254
IPA revenue 252,265 279,781 521,949 548,941
-------- -------- ---------- ----------
Net physician group, hospital, IPA
and other revenue 545,976 778,960 1,171,798 1,574,195
Less amounts retained by physician groups
and IPAs:
Physician groups 95,923 173,692 213,859 356,316
Clinic technical employee compensation 13,750 22,155 29,353 45,445
IPAs 178,293 189,625 361,080 362,402
-------- -------- ---------- ----------
Net revenue $258,010 $393,488 $ 567,506 $ 810,032
======== ======== ========== ==========
</TABLE>
(Continued)
7
<PAGE> 8
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(3) BUSINESS SEGMENTS
-----------------
The Company has two reportable segments based on the way management has
organized its operations: multi-specialty clinics and IPAs. 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 that do
not meet the quantitative thresholds for reportable segments and
therefore have been aggregated within the corporate and other category.
The Company evaluates performance based on earnings from operations
before asset revaluation, restructuring and refinancing charges, minority
interest and income taxes. The following is a financial summary by
business segment for the periods indicated (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- -------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Multi-specialty clinics:
Net revenue $ 170,841 $ 289,897 $ 378,099 $ 596,892
Operating expenses(1) 155,466 262,246 342,667 540,236
Interest income (1,637) (629) (3,088) (1,105)
Interest expense 10,804 20,457 23,361 40,917
Earnings before taxes and minority interest(1) 6,208 7,823 15,159 16,844
Depreciation and amortization 9,586 17,949 21,558 37,618
Segment assets 384,769 1,356,450 384,769 1,356,450
IPAs:
Net revenue 73,972 90,156 160,869 186,539
Operating expenses(1) 91,479 82,314 182,858 167,493
Interest income (805) (601) (1,441) (1,245)
Interest expense 3,696 2,795 5,955 5,516
Earnings (loss) before taxes and minority interest(1) (20,398) 5,648 (26,503) 14,775
Depreciation and amortization 3,588 4,025 7,169 6,998
Segment assets 207,043 333,204 207,043 333,204
Corporate and other(2):
Net revenue 13,197 13,435 28,538 26,601
Operating expenses(1) 22,133 20,495 44,375 42,706
Interest income (4,588) (13,130) (9,338) (26,446)
Interest expense 693 141 1,320 248
Earnings (loss) before taxes and minority interest(1) (5,041) 5,929 (7,819) 10,093
Depreciation and amortization 2,582 2,144 4,327 4,272
Segment assets 25,616 132,266 25,616 132,266
</TABLE>
----------------------------
(1) Amounts exclude provision for asset revaluation, restructuring and
refinancing.
(2) This segment includes all corporate costs and real estate holdings
as well as the results for CareWise and the hospitals managed by
the Company.
(Continued)
8
<PAGE> 9
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(4) ASSET REVALUATION AND RESTRUCTURING
-----------------------------------
In the second quarter of 2000, the Company recorded a pre-tax asset
revaluation charge of approximately $370.2 million. This charge related
to the revaluation of certain assets associated with the completed sales
and expected sales of certain assets of the Company's clinic operations
at amounts less than book value, the impairment of long-lived assets of
certain of its ongoing operating units, the anticipated sale of the
Company's Kentucky HMO operation, substantial operating losses in the
Company's Houston IPA operations the Company's decision to cease
operations and exit an IPA market which was still in the development
stages, the expected sale of CareWise and the consolidation of the
Company's administrative office space.
At June 30, 2000, net assets held for sale and expected to be sold during
the next 12 months totaled approximately $169.3 million after taking into
account the charges relating to clinics with which the Company intends to
terminate or restructure its affiliation and the revaluation of certain
other assets. These net assets consisted of current assets, property and
equipment, intangible assets and other assets less liabilities which are
expected to be assumed by the purchasers.
Net revenue and pre-tax income (losses) from operations disposed of or
closed through June 30, 2000 were $16.7 million and $900,000 for the
three months ended June 30, 2000, and $63.0 million and $800,000 for the
six months ended June 30, 2000, respectively, compared to $146.9 million
and $(600,000) for the three months ended June 30, 1999, and $321.8
million and $1.9 million for the six months ended June 30, 1999,
respectively. Net revenue and pre-tax income (losses) from the operations
held for sale at June 30, 2000 were $124.5 million and $(700,000) for the
three months ended June 30, 2000, and $257.0 million and $2.3 million for
the six months ended June 30, 2000, respectively, compared to $115.0
million and $6.0 million for the three months ended June 30, 1999, and
$227.9 million and $11.5 million for the six months ended June 30, 1999,
respectively.
The Company completed the disposition of the assets of six clinics and
certain real estate during the second quarter of 2000 and received
consideration consisting of $25.6 million in cash and $8.5 million in
notes receivable, in addition to certain liabilities assumed by the
purchasers. The Company recorded an additional charge related to these
sales of approximately $19.7 million in the second quarter of 2000, which
is included in the pre-tax asset revaluation charge described above.
In the first quarter of 2000, the Company recorded a net pre-tax asset
revaluation charge of approximately $19.0 million, which was comprised of
a $26.0 million charge less the reversal of certain asset revaluation
charges recorded in the third quarter of 1999. The first quarter 2000
charge related to the revaluation of certain assets associated with one
clinic held for sale, the completed sales of the operating assets of five
clinics for less than book value and the exiting of an IPA market.
The Company completed the disposition of the assets of six clinics,
certain satellite operations of another clinic and certain real estate
during the first quarter of 2000 and received consideration consisting of
$21.3 million in cash and $10.4 million in notes receivable, in addition
to certain liabilities being assumed by the purchasers. The asset sales
of one of these clinics resulted in the reversal of revaluation charges
recorded in the third quarter of 1999 of approximately $6.1 million.
(Continued)
9
<PAGE> 10
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
The Company adopted and implemented restructuring plans and recorded
pre-tax restructuring charges of approximately $37.1 million in the
second quarter of 2000 with respect to operations that are being sold or
closed. These restructuring plans include the involuntary termination of
512 clinic, IPA management, business office and corporate personnel.
These terminations are expected to be completed over the next six months.
At June 30, 2000, accrued restructuring reserves totaled approximately
$36.2 million. The Company estimates that approximately $17.7 million of
the restructuring reserves at June 30, 2000 will be paid during the next
12 months. The remaining $18.5 million relates primarily to long term
lease commitments. The following table summarizes the restructuring
accrual and payment activity for the first six months of 2000 (in
thousands):
<TABLE>
<CAPTION>
FACILITY AND SEVERANCE OTHER
LEASE TERMINATION AND RELATED EXIT
COSTS COSTS COSTS TOTAL
----- ----- ----- -----
<S> <C> <C> <C> <C>
Balances at December 31, 1999 $ 2,644 $ 2,381 $ 2,970 $ 7,995
First quarter 2000 charges 1,886 774 979 3,639
Payments (617) (1,121) (2,481) (4,219)
Other re-allocations (211) (217) 428 --
-------- -------- ------- --------
Balances at March 31, 2000 3,702 1,817 1,896 7,415
Second quarter 2000 charges 21,488 11,364 4,217 37,069
Payments (404) (6,861) (981) (8,246)
Other re-allocations (18) 39 (21) --
-------- -------- ------- --------
Balances at June 30, 2000 $ 24,768 $ 6,359 $ 5,111 $ 36,238
======== ======== ======= ========
</TABLE>
(5) REFINANCING COSTS
-----------------
The Company recorded a refinancing charge of approximately $1.2 million
in the first quarter of 2000 related to the amendment and restatement of
the bank credit facility in January 2000. This charge represented
unamortized costs that were expensed as a result of lower commitment
amounts and an earlier termination date of the bank credit facility. The
Company is in the process of negotiating modifications to its bank credit
facility. The bank group extended its waiver of existing defaults under
the bank credit facility and the synthetic lease facility until August
25, 2000 by which date the Company anticipates that it will have executed
a restated bank credit facility. Management expects that the bank credit
facility, as amended, will provide for the conversion of outstanding
balances under the existing revolving credit and synthetic lease
facilities and outstanding letters of credit to a term loan and a $25
million revolving loan with a maturity of June 30, 2001. As a result, the
Company anticipates a refinancing charge related to unamortized loan
costs of approximately $2.2 million will be recorded in the third quarter
of 2000. There can be no assurance, however, that the Company and the
bank group will reach agreement on the restated facility or that, if an
agreement is reached, such agreement will be on the terms currently
contemplated by the Company.
(Continued)
10
<PAGE> 11
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(6) COMMITMENTS AND CONTINGENCIES
-----------------------------
The Company and certain of its current and former officers and directors,
Joseph C. Hutts, Derril W. Reeves, Thompson S. Dent, Richard D. Wright
and John K. Crawford (only Mr. Dent remains employed by the Company while
he and Mr. Hutts serve as directors) have been named defendants in 10
securities fraud class actions filed in state and federal courts in
Tennessee between September 8, 1998 and June 24, 1999. The factual
allegations of the complaints in all 10 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 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 was denied and the case is now in the discovery stage
of the litigation. Defendants' unopposed motion to set a new trial date
was granted on April 19, 2000, and the court has set the trial date for
June 4, 2001. The state court actions were consolidated in Davidson
County, Tennessee. The Plaintiffs' original consolidated class action
complaint in state court was dismissed for failure to state a claim.
Plaintiffs, however, were granted leave to file an amended complaint. The
amended complaint filed by Plaintiffs asserted, in addition to the
original Tennessee Securities Act claims, that Defendants had also
violated Sections 11 and 12 of the Securities Act of 1933 for alleged
misleading statements in a prospectus released in connection with the
CareWise acquisition. Defendants removed this case to federal court and
have filed an answer. The amended complaint also added KPMG, LLP (KPMG),
the Company's independent public auditors. KPMG removed this case to
federal court. The Company and the individual defendants filed an answer.
KPMG's motion to dismiss is still pending before the Court. This case has
been consolidated with the original federal consolidated action for
discovery purposes only. The Company anticipates the state and federal
actions will be tried separately. The discovery process continues. The
Company believes that it has meritorious defenses to all of the claims,
and is vigorously defending 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 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 the 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
(Continued)
11
<PAGE> 12
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
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. On
June 5, 2000, the court granted in full the Company's motion for partial
summary judgment, which eliminated the plaintiff's allegations of fraud
and violations of federal and state securities laws. As a result of the
court's rulings, the plaintiff is no longer entitled to rescission of the
merger agreement, return of the proceeds from the operations of
PrimeCare, or punitive damages. In addition, on August 7, 2000, at the
pretrial conference the court ruled in favor of the Company on
substantially all of the Company's motions in limine and, on August 8,
2000, the court set a new pre-trial conference for October 23, 2000, and
invited the parties to file by September 7, 2000 motions for summary
judgment based on the court's rulings on the motions in limine. The
Company intends to file Motions for Summary Judgment by such date.
Although the Company believes it has meritorious defenses to all of the
remaining claims and is vigorously defending this suit, there can be no
assurance that it will not have a material adverse effect on the Company.
On July 26, 2000, Prem Reddy filed a new action captioned Prem Reddy,
M.D. v. Harry Lifschutz, M.D., PhyCor, Inc. and Does 1 through 50, in
Superior Court of the State of California, County of San Bernardino. Dr.
Reddy alleges claims for unfair business practices and alleged fraudulent
conveyances in connection with the Company's efforts to sell Company
assets located in California and other locations. The plaintiff seeks to
enjoin these asset sales or to impose a constructive trust on any
completed sales. In response, the Company, on July 27, 2000, removed the
action to the United States District Court, Central District of
California and, by order of the Court on August 9, 2000, the case was
reassigned to the United States District Court, Western District of
California. The judge assigned to this case is the same judge presiding
over the other Reddy matter discussed above. The Company intends to file
a motion to dismiss this new action in the very near future. Although the
Company intends to defend itself vigorously against these claims if the
court does not dismiss this matter, there can be no assurance that an
adverse decision in this matter would not have a material adverse effect
on the Company.
Three clinics are challenging the enforceability of their service
agreements with the Company's subsidiaries in court. In August 1999,
Medical Arts Clinic Association (Medical Arts) filed suit against the
Company in the District Court of Navarro County, Texas, which complaint
has been subsequently amended. The Company removed this case to Federal
District Court for the Northern District of Texas. Medical Arts is
seeking damages for breach of contract and rescission of the service
agreement and declaratory relief regarding the enforceability of the
service agreement alleging it is null and void on several grounds,
including but not limited to, the violation of state law provisions as to
the corporate practice of medicine and fee splitting. On April 28, 2000,
Medical Arts filed a Motion for Partial Summary Judgement seeking a
determination that the Service Agreement constituted the corporate
practice of medicine in violation of Texas law. On May 31, 2000, the
Company filed a Cross-Motion for Partial Summary Judgement on the same
issue. On August 8, 2000, the Court denied both parties' Motions for
Partial Summary Judgement, ordered mediation by the parties within 60
days of the Court's order, and stayed all discovery pending mediation. On
April 24, 2000, the Texas District Court of Navarro County, Texas,
ordered the appointment of a receiver to rehabilitate Medical Arts. On
May 10, 2000, the same state court granted Medical Arts a temporary
restraining order against the Company and set for hearing the matters set
forth in the order. On May 12, 2000, the Company, in response to the
foregoing, filed its notice of removal of the above matters to the
federal court. This removal stays any action of the state court. In
December, 1999 the Company filed suit in Davidson County, Tennessee which
currently seeks declaratory relief that the service agreement with
Murfreesboro Medical Clinic, P.A. (Murfreesboro Medical) is enforceable
or alternatively seeking damages for breach by Murfreesboro Medical under
the service agreement and related asset
(Continued)
12
<PAGE> 13
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
purchase agreement. Murfreesboro Medical then filed a motion to dismiss
our suit which was denied. Simultaneously, Murfreesboro Medical filed
suit in Circuit Court in Rutherford County, Tennessee, claiming breach of
the service agreement by the Company and seeking a declaratory judgment
that the service agreement was unenforceable. Pursuant to a motion by the
Company, the Rutherford County lawsuit has been dismissed. The Davidson
County suit is still pending. In January 2000, South Texas Medical
Clinics, P.A. (South Texas) filed suit against PhyCor of Wharton, L.P. in
the State District Court in Fort Bend County, Texas. South Texas is
seeking a declaratory judgment that the service agreement is
unenforceable as a matter of law because it violates the Texas Health and
Safety Code relating to the corporate practice of medicine and fee
splitting. In the alternative, South Texas seeks to have the agreements
declared void alleging, among other things, fraud in the inducement and
breach of contract by the Company. The Company has filed a motion to
remove this case to Federal District Court for the Southern District of
Texas.. On April 18, 2000, the court entered an Agreed Order whereby
South Texas, among other matters, agreed to pay over to the Company cash
proceeds from certain accounts receivable and pay into the registry of
the court proceeds from certain other accounts receivable during the
pendancy of this matter. 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. Although
the Company is vigorously defending the enforceability of the structure
of its management fee and service agreements against these suits, there
can be no assurance that these suits will not have a material adverse
effect on the Company.
The Company is aware of a qui tam lawsuit filed under seal which names as
defendants the Company, a subsidiary of the Company, and a clinic
affiliated with the Company, and alleges violations of the False Claims
Act and the Whistle Blower's Act, breach of contract and employee
discrimination. It is too early to determine whether this action will
proceed or if any governmental agencies will participate in the action.
If the action proceeds, the Company will vigorously defend this action
and believes it will have meritorious defenses to these claims. There can
be no assurance, however, that this suit, if ultimately determined in
favor of the plaintiffs, would not have a material adverse effect on the
Company.
On April 18, 2000, a jury in the case of United States of America ex rel.
William R. Benz v. PrimeCare International, Inc. and Prem Reddy, in the
United States District Court, Central District of California, returned a
verdict in favor of the plaintiff as follows: $500,000 against PrimeCare
on plaintiff's breach of contract claims; $900,000 in compensatory
damages and $3 million in punitive damages jointly and severally against
PrimeCare and Prem Reddy on plaintiff's claims for wrongful termination
and intentional infliction of emotional distress; and $200,000 against
PrimeCare on plaintiff's claim for violations of state labor codes. The
jury returned a verdict in defendants' favor on plaintiff's claim for
retaliatory termination under the False Claims Act. The jury was unable
to reach a verdict on plaintiff's Medicare fraud claims. The court
entered a final judgment on July 13, 2000. The Company has recorded as
other operating expenses this judgment of $4.6 million in the second
quarter of 2000. A new trial on the Medicare fraud claims has been set
for September 12, 2000. The defendants filed post-trial motions with the
court on July 17, 2000 seeking to dismiss the Medicare fraud, the
wrongful termination and intentional infliction of emotion distress
claims and, in the alternative, to obtain a new trial on all claims. All
of the claims in this matter arose from events occurring prior to
PhyCor's acquisition of PrimeCare and relate to the termination of Mr.
Benz, a former officer of PrimeCare. The Company believes that it is
entitled to seek indemnification from Prem Reddy for any damages incurred
by PrimeCare as a result of this matter and intends to seek such
indemnification. There can be no assurance that plaintiff's enforcement
of his judgment against PrimeCare would not have a material adverse
effect on PrimeCare.
(Continued)
13
<PAGE> 14
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
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 Plan is currently negotiating with
the Department to end the investigation with no required payments by the
Plan subject to certain on-going outside reviews of the timing of
participant contributions. The Company intends to fully cooperate with
the Department's requests.
The Company is currently under examination by the Internal Revenue
Service ("IRS") for the years 1996 through 1998 and the IRS has proposed
an adjustment to the carryback that will result in the Company owing
approximately $1.2 million plus interest. Additionally, two subsidiaries
are currently under examination for the 1995 and 1996 tax years. The
Company acquired the stock of these subsidiaries during 1996. For the
years under audit, and potentially, for subsequent years, any such
adjustments could result in material cash payments by the Company. The
Company cannot determine at this time the resolution of these matters,
however, it does not believe the resolution of these matters will have a
material adverse effect on its financial condition, although there can be
no assurance as to the outcome of these matters.
Certain litigation is pending against the physician groups affiliated
with the Company and IPAs managed by the Company. The Company has not
assumed any liability in connection with such litigation. Claims against
the physician groups and IPAs could result in substantial damage awards
to the claimants which may exceed applicable insurance coverage limits.
While there can be no assurance that the physician groups and IPAs will
be successful in any such litigation, the Company does not believe any
such litigation will have a material adverse effect on the Company.
Certain other litigation is pending against the Company and certain
subsidiaries of the Company, none of which management believes would have
a material adverse effect on the Company's financial position or results
of operations on a consolidated basis.
14
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
OVERVIEW
PhyCor, Inc. ("PhyCor" or the "Company") is a medical network
management company that provides contract management services to physician
networks owned by health systems, manages multi-specialty medical clinics and
other medical organizations and develops and manages independent practice
associations ("IPAs"). The Company also 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 its physician network operations, the Company
manages and operates two hospitals and four health maintenance organizations
("HMOs").
At June 30, 2000, the Company managed 26 clinics with 1,630 physicians
in 18 states, of which 13 clinics with 925 physicians were held for sale, and
managed IPAs with approximately 22,000 physicians in 21 markets. On such date,
the Company's affiliated physicians provided medical services under capitated
contracts to approximately 1.2 million patients, including approximately 300,000
Medicare/Medicaid eligible patients. As described below, the Company is in
discussions with substantially all of its clinics to restructure or terminate
its service agreements. The Company has also determined to cease operations in
one IPA market which was still in the development stage and has recorded asset
revaluation and restructuring charges for that market. The Company has also
recorded asset revaluation charges for the Houston IPA market, which has
experienced substantial operating losses. The Company also provided health care
decision-support services to approximately 3.5 million individuals through its
CareWise subsidiary. The Company intends to sell CareWise, although no agreement
regarding the sale has been reached.
In the quarter ended June 30, 2000, the Company contacted most of its
affiliated multi-specialty clinics to discuss the repurchase of clinic assets
from the Company by the respective physician groups. The Company is negotiating
with substantially all of its multi-specialty clinics to restructure or
terminate its existing service agreements and to reduce the Company's investment
in the assets of these clinics. As a result of its ongoing discussions,
management believes that a majority of the clinics intend to repurchase all or a
portion of the related assets. Management intends to negotiate with the clinics
for the sale and repurchase of the assets on mutually agreeable terms. The
Company expects to use a significant portion of the cash proceeds from the asset
sales to meet its financial obligations under its bank credit facility. In the
event the proceeds from the asset sales are less than anticipated or are not
received when anticipated, the Company may experience difficulty meeting its
obligations under the bank credit facility and other debt obligations. Such
difficulty could cause a material adverse effect on the Company. There can be no
assurance that the clinics will repurchase the assets, that the repurchases will
be on terms agreeable to the Company or that additional charges to earnings will
not be necessary as a result of the final terms of the assets sales.
In the second quarter of 2000, the Company recorded asset revaluation
and restructuring charges of approximately $407.3 million. These charges were
comprised of $370.2 million of asset revaluation charges relating to assets at
the Company's operating units and corporate office and $37.1 million of
restructuring charges. The asset revaluation charges consisted of approximately
$198.6 million related to assets held for sale, $19.7 million related to assets
sold during the second quarter and $151.9 million related to asset impairments.
As further described herein, the asset revaluation and restructuring charges
primarily resulted from the anticipated restructuring or termination of
substantially all of the Company's clinic service agreements, the
classification of the net assets of its Kentucky HMO and CareWise as held for
sale, the exit from one IPA market and substantial operating losses in its
Houston IPA market. The Company currently anticipates recording additional
restructuring charges as the Company ceases operations in certain additional
markets or further restructures its operations.
The continued sales of the Company's assets related to the
multi-specialty clinics and termination of the related service agreements will
result in a significant reduction in the Company's revenues. After the
completion of the anticipated asset sales, the Company intends to focus on its
IPA management division and to continue to provide physician management services
to health systems and independent physician organizations along with providing
management services to certain affiliated medical groups. The Company
anticipates that the revenues from the IPA management division will comprise a
substantial majority of the Company's revenues in 2001 and beyond. This change
is primarily the result of the continued sales of existing clinic operations.
There can be no assurance that the Company's continuing business operations will
be successful or that the Company will return to profitability.
15
<PAGE> 16
After the anticipated clinic asset sales and termination of the related
service agreements, the Company believes that it will continue to derive a
significant percentage of its revenues from the provision of management services
to physician organizations. The Company expects to remain a party to service
agreements with those clinics that do not repurchase their assets. In addition,
the Company anticipates that pursuant to management agreements, it will provide
management services to certain clinics that repurchase their assets. The Company
will continue to pursue management affiliations with multi-specialty clinics and
assist the physician networks of health systems. The Company believes that it
can assist these clinics and systems in improving the operations of their
physician networks by offering the organizations a range of services to address
their needs. Under these arrangements, the Company will not acquire the assets
or employ the personnel of the physician organization, except certain key
personnel, and will not have an obligation to provide capital to the physician
organization.
The Company's IPA management division has experienced losses in certain
markets, including but not limited to, one development market which it decided
to cease operations in the second quarter of 2000 and its Houston market. The
Houston IPA market's losses were approximately $11.2 million for the six-month
period ended June 30, 2000. The Company has determined not to make further
capital investments in the Houston market. As a result, it is unlikely that the
Company can sustain its IPA operations in Houston beyond the short term. If the
Company ceases its IPA operations in the Houston market, the Company's
relationships with payors and providers in other IPA markets may be materially
adversely affected. As of June 30, 2000, the IPAs managed in Houston included
approximately 1,600 physicians and 215,000 covered lives. If the operating
results of the Company's IPA management division do not improve, or if a
significant number of the Company's payor relationships are impacted adversely
because of the operating difficulties in the Houston market, the Company will be
materially adversely affected.
The Company believes that this division's revenues will comprise a
substantial majority of the Company's total revenue in 2001 and beyond. The
Company has increased its focus on managing and developing its existing IPAs to
enable the Company to provide services to a broader range of physician
organizations, to enhance the operating performance of remaining 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 a share of surplus, if any, of
capitated revenue of the IPAs. The Company has not historically been a party to
the capitated contracts entered into by the IPAs, but through the calculation of
its service fees is exposed to indirect losses based on the capitated risk
assumed by the IPA, if any, resulting from the capitated contracts of the IPAs.
Through the PrimeCare International, Inc. ("PrimeCare") and The Morgan Health
Group, Inc. ("MHG") acquisitions, the Company became a party to certain managed
care contracts and, accordingly will be exposed to direct losses, if any,
resulting from the PrimeCare capitated contracts. The Company had terminated all
managed care contracts of MHG by April 30, 1999. In addition, at June 30, 2000,
the Company had underwritten letters of credit totaling $3.3 million for the
benefit of certain managed care payors to help ensure payment of costs for which
its affiliated IPAs are responsible. The Company would seek reimbursement from
an IPA if there were a draw on a letter of credit. The Company is exposed to
losses if a letter of credit is drawn upon and the Company is unable to obtain
reimbursement from the IPA.
The Company is seeking to sell its health care decision-support
services division, CareWise. At present, the Company is considering several
offers but has not reached any agreement regarding the ultimate sale of this
division. There can be no assurance that the Company will be successful in its
attempt to sell CareWise or to sell it on favorable terms. In the event the
Company does not sell CareWise or it is sold for less than the recorded book
value, the Company may incur additional charges to earnings.
16
<PAGE> 17
RESULTS OF OPERATIONS
The following table shows the percentage of net revenue represented by
various expenses and other income items reflected in the Company's Consolidated
Statements of Operations:
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenue......................................... 100.0% 100.0% 100.0% 100.0%
Operating expenses
Cost of provider services.................... 22.1 12.6 20.8 13.2
Salaries, wages and benefits................. 32.1 32.3 31.8 32.1
Supplies..................................... 13.6 14.7 13.3 14.6
Purchased medical services................... 1.9 2.3 2.2 2.4
Other expenses............................... 18.5 15.2 16.6 14.6
General corporate expenses................... 2.9 1.8 2.6 1.9
Rents and lease expense...................... 7.1 7.8 7.3 7.8
Depreciation and amortization................ 6.1 6.1 5.8 6.0
Provision for asset revaluation,
restructuring and refinancing........... 157.9 3.6 76.0 3.0
----- ----- ------ -----
Net operating expenses.............................. 262.2 (A) 96.4 (A) 176.4 (A) 95.6 (A)
----- ---- ----- ----
Earnings (loss) from operations......... (162.2) (A) 3.6 (A) (76.4) (A) 4.4 (A)
Interest income..................................... (0.7) (0.3) (0.6) (0.3)
Interest expense.................................... 3.8 2.6 3.5 2.5
----- ----- ----- -----
Earnings (loss) before income taxes
and minority interest............. (165.3) (A) 1.3 (A) (79.3) (A) 2.2 (A)
Income tax expense.................................. 0.1 (A) 0.2 (A) 0.1 (A) 0.7 (A)
Minority interest................................... 0.0 0.9 0.3 1.0
----- ----- ----- -----
Net earnings (loss)..................... (165.4)%(A) 0.2%(A) (79.7)%(A) 0.5% (A)
======= ===== ======= =====
</TABLE>
----------------------------
(A) Excluding the effect of the provision for asset revaluation, restructuring
and refinancing in 2000 and 1999, net operating expenses, earnings (loss) from
operations, earnings (loss) before income taxes and minority interest, income
tax expense and net earnings (loss), as a percentage of net revenue, would have
been 104.3%, (4.3)%, (7.5)%, 0.1% and (7.6)%, respectively, for the three months
ended June 30, 2000, 100.4%, (0.4)%, (3.4)%, 0.1% and (3.8)%, respectively, for
the six months ended June 30, 2000, 92.8%, 7.2%, 4.9%, 1.5% and 2.5%,
respectively, for the three months ended June 30, 1999, and 92.6%, 7.4%, 5.2%,
1.6% and 2.6%, respectively, for the six months ended June 30, 1999.
17
<PAGE> 18
2000 Compared to 1999
Net revenue decreased $135.5 million, or 34.4%, from $393.5 million for
the second quarter of 1999 to $258.0 million for the second quarter of 2000, and
$242.5 million, or 29.9%, from $810.0 million for the first six months of 1999
to $567.5 million for the first six months of 2000. Net revenue from
multi-specialty clinics ("Clinic Net Revenue") decreased in the second quarter
of 2000 from the second quarter of 1999 by $119.1 million. The decrease was
comprised of (i) a $101.9 million decrease in service fees for reimbursement of
clinic expenses incurred by the Company and (ii) a $17.2 million decrease in the
Company's fees from clinic operating income and net physician group revenue.
Excluding same clinic revenue increases discussed below, decreases in Clinic Net
Revenue for the quarter included reductions of $3.1 million from clinics whose
assets were held for sale at June 30, 2000 and reductions of $123.2 million as a
result of clinic operations disposed of in 1999 and 2000. Increases in Clinic
Net Revenue for the quarter included $1.7 million in fees from contract
management service agreements that were entered into in the fourth quarter of
1999. The decrease in Clinic Net Revenue was also impacted by declining
reimbursement for services rendered by the physician groups. Specifically, the
provision for doubtful accounts and contractual adjustments as a percentage of
gross physician group, hospital and other revenue increased from 43.1% for the
second quarter of 1999 to 45.9% for the second quarter of 2000. Net revenue from
the service agreements (excluding clinics held for sale) in effect for both
quarters increased by $5.5 million, or 13.6%, for the second quarter of 2000,
compared with the second quarter of 1999. The growth in same market Clinic Net
Revenue resulted from the addition of new physicians, the expansion of ancillary
services and increases in patient volume and fees.
Clinic Net Revenue decreased in the first six months of 2000 from the
first six months of 1999 by $218.8 million. The decrease was comprised of (i) a
$188.2 million decrease in service fees for reimbursement of clinic expenses
incurred by the Company and (ii) a $30.6 million decrease in the Company's fees
from clinic operating income and net physician group revenue. Excluding same
clinic revenue increases discussed below, net decreases in Clinic Net Revenue
for the first six months included increases of $3.4 million from clinics whose
assets were held for sale at June 30, 2000 and reductions of $235.8 million from
clinic operations disposed of in 1999 and 2000. Clinic Net Revenue for the first
six months of 2000 included $3.4 million in fees from contract management
service agreements that were entered into in the fourth quarter of 1999 and
first quarter of 2000. The decrease in Clinic Net Revenue was also impacted by
declining reimbursement for services rendered by the physician groups.
Specifically, the provision for doubtful accounts and contractual adjustments as
a percentage of gross physician group, hospital and other revenue increased from
42.6% for the six months ended June 30, 1999 to 45.1% for the six months ended
June 30, 2000. Net revenue from the service agreements (excluding clinics held
for sale) in effect for both quarters increased by $10.2 million, or 12.9%, for
the first six months of 2000, compared with the first six months of 1999. The
growth in same market Clinic Net Revenue resulted from the addition of new
physicians, the expansion of ancillary services and increases in patient volume
and fees.
Net revenue from IPAs ("IPA Net Revenue") decreased $16.2 million, or
18.0%, from $90.2 million for the second quarter of 1999 to $74.0 million for
the second quarter of 2000 and $25.6 million, or 13.8%, from $186.5 million for
the first six months of 1999 to $160.9 million for the first six months of 2000.
The closing of MHG in 1999 caused a decrease in IPA Net Revenue of approximately
$4.8 million during the second quarter of 2000 and $18.0 million in the first
six months of 2000. The Company had terminated all payor contracts relating to
MHG and commenced closing MHG operations by April 30, 1999. The Company expects
to complete the closure of MHG by the end of 2000. Decreases of approximately
$5.4 million during the second quarter of 2000 and $9.6 million in the first six
months of 2000 resulted from the closing or restructuring of several smaller IPA
markets. IPA Net Revenues during the second quarter and first six months of 2000
included an increase of approximately $400,000 and $1.4 million, respectively,
in net revenues from an IPA market and a management agreement entered into
subsequent to the second quarter of 1999. Additionally, IPA Net Revenues
increased $13.3 million during the second quarter of 2000 and $26.5 million for
the first six months of 2000 due to the Company's acquisition of the remaining
interest in an HMO in 1999. IPA Net Revenue from the IPA markets in effect for
the second quarters of both 2000 and 1999 decreased by $19.7 million, or 26.7%,
of which $11.8 million related to the Company's IPA operations in Houston, and
$25.9 million, or 17.8%, of which $19.0 million related to the Company's IPA
operations in Houston, for the first six months of 2000 compared to the same
period in 1999. Same
18
<PAGE> 19
market IPA decreases resulted primarily from a combination of higher bed days
and per diem rates and increased utilization of physician services by capitated
patients in the Houston market and unfavorable hospital and payor contract
renegotiations in another market.
During the second quarter and first six months of 2000, most categories
of operating expenses were relatively stable as a percentage of net revenue when
compared to the same period in 1999. During the first six months of 2000, cost
of provider services expense increased as a result of the Company acquiring the
remaining 50% interest in an HMO in late 1999. Supplies expense had more than a
marginal decrease as a percentage of net revenue over the same period in 1999
because the Company divested certain clinics in 1999 whose supply costs as a
percentage of net revenue were higher than that of the current base of clinics.
Other expenses increased as a result of the Company incurring costs associated
with information systems and software conversions in its IPA markets during the
fourth quarter of 1999 and the first quarter of 2000 and a $4.6 million judgment
recorded in the second quarter of 2000. The increase in interest expense as a
percentage of net revenue in the first six months of 2000 compared to the same
period in 1999 is primarily due to amendments to the Company's bank credit
facility that increased interest rates.
The Company's managed IPAs and affiliated physician groups enter into
contracts with third party payors, many of which 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 the Company, 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. Through calculation of its
service fees, the Company also shares indirectly in capitation risk assumed by
its affiliated physician groups. In addition, the Company manages and operates
four HMOs. Incurred but not reported claims payable ("IBNR claims payable")
represents the estimated liability for covered services that have been performed
by physicians for enrollees of various medical plans. The IBNR claims payable is
based on the Company's historical claims data, current enrollment, health
service utilization statistics and other related information. There were no
material adjustments in 2000 to prior years' IBNR claims payable.
On behalf of certain of the Company's affiliated IPAs, the Company has
underwritten letters of credit to managed care payors to help ensure payment of
health care costs for which the affiliated IPAs have assumed responsibility. At
June 30, 2000, letters of credit aggregating $3.3 million were outstanding under
the bank credit facility for the benefit of managed care payors. While no draws
on any of these letters of credit have occurred to date, there can be no
assurance that draws will not occur in the future. The Company would seek
reimbursement from an IPA if there were a draw on a letter of credit. The
Company is exposed to losses if a letter of credit is drawn upon and the Company
is unable to obtain reimbursement from the IPA.
In the second quarter of 2000, the Company recorded approximately
$407.3 million in asset revaluation and restructuring charges. These charges
included approximately $370.2 million of asset revaluation charges related to
the impairment of long-lived assets of certain of its ongoing operating units
and at its corporate office. This asset revaluation charge consisted of
approximately $198.6 million related to assets held for sale, $19.7 million
related to assets sold during the quarter and $151.9 million related to asset
impairments. These charges also included approximately $37.1 million of
restructuring charges related to the Company's adoption and implementation of
its restructuring plans in the second quarter of 2000. These charges were
comprised of approximately $26.5 million related to the operations of clinics
that were sold, closed or restructured, $700,000 related to management's plans
to cease operations and exit an IPA market, and $9.9 million related to
reductions in personnel and office space at the corporate office. See discussion
of these charges in "Asset Revaluation and Restructuring" below.
The Company recorded a refinancing charge of approximately $1.2 million
in the first quarter of 2000 related to the amendment and restatement of the
bank credit facility in January 2000. This charge represented unamortized costs
that were expensed as a result of lower commitment amounts and an earlier
termination date of the bank credit facility. See
19
<PAGE> 20
additional discussion of the bank credit facility amendment in "Liquidity and
Capital Resources." The Company is currently in the process of negotiating
modifications to its bank credit facility. The bank group extended its waiver of
existing defaults under the bank credit facility and under the synthetic lease
facility until August 25, 2000 by which date the Company anticipates that it
will have executed a restated bank credit facility. Management expects that the
bank credit facility, as amended, will provide for the conversion of outstanding
balances under the existing revolving credit and synthetic lease facilities and
outstanding letters of credit to a term loan and a $25 million revolving loan.
As a result, the Company anticipates a refinancing charge related to unamortized
loan costs of approximately $2.2 million will be recorded in the third quarter
of 2000. There can be no assurance, however, that the Company and the bank group
will reach agreement on the restated facility or that, if an agreement is
reached, such agreement will be on the terms currently contemplated by the
Company. The Company's failure to reach agreement on the restated bank credit
facility could have a material adverse effect on the Company.
The Company will incur no federal income tax expense and make no
federal income tax payments in the foreseeable future as a result of available
net operating loss carryforwards. Tax expense incurred for the first six months
of 2000 represented state income tax expense.
ASSET REVALUATION AND RESTRUCTURING
General
As a result of many rapid changes in the health care industry that have
negatively affected the Company's relationships with its physician groups, since
early 1998, the Company has sold clinic operating assets and terminated the
related service agreements. After unsuccessful attempts in late 1999 and the
first quarter of 2000 to restructure most of its service agreements in an effort
to create a base of stable clinics that would be able to grow and was committed
to the mutual success of the Company, the Company contacted most of its clinics
in the second quarter of 2000 to discuss the repurchase of the respective clinic
assets in connection with the restructuring of or termination of their related
service agreements. As a result of its ongoing discussions, management believes
that the majority of the clinics intend to repurchase all or a portion of the
related assets. Management intends to negotiate with the clinics for the sale
and repurchase of the assets on mutually agreeable terms. There can be no
assurance, however, that the asset sales will be consummated or consummated on
the terms currently contemplated or that additional charges to earnings will not
be necessary as a result of the final terms of the asset sales. The Company
expects to remain a party to service agreements with those clinics that do not
repurchase their assets. In addition, the Company anticipates that pursuant to
management agreements, it will provide management services to certain clinics
that repurchase their assets. For additional discussion of the changes in these
relationships, see "Overview" and "Liquidity and Capital Resources."
The Company has experienced losses in certain IPA markets. The Company
determined in the second quarter to cease operations in one IPA market which was
still in the development stages and recorded asset revaluation and restructuring
charges for that market. The Company also recorded asset revaluation charges for
the Houston IPA market, which has experienced substantial operating losses. The
Company also classified the net assets of its Kentucky HMO and CareWise as held
for sale in the second quarter of 2000.
In the second quarter of 2000, the Company recorded approximately
$407.3 million in asset revaluation and restructuring charges. These charges
were comprised of approximately $370.2 million of asset revaluation charges
related to the impairment of long-lived assets of certain of its ongoing
operating units and at its corporate office. The asset revaluation charge
consisted of approximately $198.6 million related to assets held for sale, $19.7
million related to assets sold during the second quarter and $151.9 million
related to asset impairments. The total charges also included approximately
$37.1 million of restructuring charges related to the Company's adoption and
implementation of its restructuring plans in the second quarter of 2000. The
restructuring charges were comprised of approximately $26.5 million related to
the operations of clinics that were sold, closed or restructured, $700,000
related to management's plans to cease operations in an IPA market, and $9.9
million related to reductions in personnel and office space at the corporate
office. The Company currently anticipates recording additional restructuring
charges as the Company ceases operations in additional markets or further
restructures its operations.
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Assets Held for Sale
At June 30, 2000, net assets held for sale primarily consisted of the
net assets of 16 clinics, the Company's Kentucky HMO operations and CareWise,
which totaled approximately $169.3 million, including $5.1 million of real
estate. These net assets consisted of current assets, property and equipment,
intangible assets and other assets less liabilities which are expected to be
assumed by the purchasers. The Company expects to recover these amounts during
the next 12 months as the asset sales occur; however, there can be no assurance
that the Company will recover this entire amount. The Company's failure to
recover these amounts could cause a material adverse effect on the Company. As
of August 11, 2000, the Company had completed the disposition of two clinics and
the sale of certain assets of another clinic in the third quarter of 2000 and
received proceeds totaling $15.6 million in cash and $4.0 million in notes
receivable, in addition to certain liabilities assumed by the purchasers, which
approximated the net carrying value of these clinic assets. The Company expects
to complete the sale by September 30, 2000 of several of the remaining 14
clinics' assets held for sale, two of which, Hattiesburg Clinic and Harbin
Clinic, individually accounted for more than 10% of the Company's earnings
before interest, taxes, depreciation and amortization ("EBITDA") for the six
months ended June 30, 2000 and several more of the remaining 14 clinics in the
fourth quarter of 2000, including Arnett Clinic which also accounted for more
than 10% of the Company's EBITDA for the six months ended June 30, 2000. The
Company expects to recover in excess of tangible book value of the assets of
these clinics, however, there can be no assurance it will do so. The sale of
these clinics will negatively impact the Company's future revenues and the
failure to consummate the sales on the anticipated terms would negatively impact
the Company's cash flows.
In the second quarter of 2000, the Company recorded approximately
$198.6 million of asset revaluation charges for the impairment of long-lived
assets of certain of its ongoing operating units and at its corporate office
related to assets held for sale and $19.7 million related to assets sold during
the quarter. The second quarter asset revaluation charge related to assets held
for sale included current assets, property and equipment, other assets and
intangible assets of $14.5 million, $12.5 million, $3.9 million and $167.7
million, respectively. During the second quarter of 2000, the Company classified
as held for sale ten additional clinics, one of which was included in the asset
impairment charge taken in the third quarter of 1999. The Company's decision to
classify the assets as held for sale was based upon correspondence received from
or discussions with the respective medical groups in the second quarter of 2000
or the decline in the specific group's stability and economic situation. In
addition, the Company classified as held for sale its Kentucky HMO
operations and CareWise.
In the first quarter of 2000, the Company recorded a net pre-tax asset
revaluation charge of approximately $19.0 million, which was comprised of a
$26.0 million charge less recovery of certain asset revaluation charges recorded
in the third quarter of 1999. This net charge consisted of approximately $12.9
million related to assets held for sale, $6.0 million related to assets sold
during the quarter and $100,000 related to asset impairments (see discussion
below). The net charge related to the revaluation of certain assets associated
with one clinic, the completed sales of the operating assets of five clinics and
the exit from an IPA market. The first quarter 2000 asset revaluation charge
related to assets held for sale including current assets, property and
equipment, other assets and intangible assets of $2.3 million, $5.7 million,
$2.5 million and $2.4 million, respectively. During the first quarter of 2000,
the Company classified as held for sale four additional clinics, one of which
was included in the asset impairment charge taken in the third quarter of 1999.
This determination was based upon correspondence received from or discussions
with the respective medical groups in the first quarter and the decline in the
specific group's stability and economic situation. The Company therefore
determined to sell the clinic operating assets and terminate the related service
agreements. As a result of calculating the estimated net realizable values of
the assets of these clinics, one clinic's assets were written down approximately
$1.2 million, which resulting charge was offset by the recovery of certain asset
impairment charges recorded in the third quarter of 1999. The Company disposed
of one of these clinics in the second quarter of 2000, receiving consideration
consisting of $6.2 million in cash and certain liabilities assumed by the
purchasers. Net revenue and pre-tax income from the clinic sold were
approximately $2.4 million and $200,000, respectively, for the quarter ended
June 30, 2000 and $6.1 million and $600,000, respectively, for the six months
ended June 30, 2000. Net revenue and pre-tax income from the clinic sold were
approximately $3.4 million and
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$300,000, respectively, for the quarter ended June 30, 1999 and $7.0 million and
$600,000, respectively, for the six months ended June 30, 1999. The net assets
held for sale for the remaining three clinics in this group at June 30, 2000
were approximately $15.9 million and consisted primarily of accounts receivable,
property and equipment and intangible assets less certain current liabilities.
During the first quarter of 2000, the assets of a clinic were sold with
recoveries of approximately $6.1 million of an impairment charge taken in the
third quarter of 1999. Net revenue and pre-tax income from the clinic sold were
$1.1 million and $400,000, respectively, for the six months ended June 30, 2000.
Net revenue and pre-tax income from the clinic sold were approximately $900,000
and $300,000, respectively, for the quarter ended June 30, 1999 and $1.8 million
and $500,000, respectively, for the six months ended June 30, 1999.
In the fourth quarter of 1999, the Company recorded a net pre-tax asset
revaluation charge of approximately $5.2 million, which was comprised of a $9.3
million charge less recovery of certain asset revaluation charges recorded in
the fourth quarter of 1998 and third quarter of 1999. This net charge was
comprised of approximately $4.5 million related to assets held for sale,
$300,000 related to assets sold during the quarter and $400,000 related to asset
impairments (see discussion below). This net charge related to the revaluation
of certain assets associated with one clinic, the completed sale of another
clinic's operating assets and the exiting and centralization of certain IPA
markets in Florida. The fourth quarter 1999 asset revaluation charge related to
assets held for sale included current assets, property and equipment, other
assets and intangible assets of $1.0 million, $2.8 million, $300,000 and
$700,000, respectively. During the fourth quarter of 1999, the Company
classified as held for sale two clinics that were included in the asset
impairment charge taken in the third quarter of 1999. This determination was
based upon correspondence received from the respective medical groups in the
fourth quarter and the decline in each group's stability and economic situation.
The Company therefore decided to sell the clinic operating assets and terminate
the service agreements related to these clinics. As a result of calculating the
estimated net realizable values of the assets of these clinics, an additional
net asset revaluation charge was taken with respect to one clinic of
approximately $4.5 million, comprised of a $6.5 million charge less recovery of
certain asset impairment charges recorded in the fourth quarter of 1998. The
Company disposed of one of these clinics in the first quarter of 2000 and the
other clinic in the second quarter of 2000, receiving consideration consisting
of $13.9 million in cash and $2.5 million in notes receivable, in addition to
certain liabilities assumed by the purchasers. Net revenue and pre-tax income
(losses) from these two clinics were $15.0 million and $(700,000), respectively,
for the six months ended June 30, 2000. Net revenue and pre-tax income (losses)
from these two clinics were approximately $22.1 million and $400,000,
respectively, for the quarter ended June 30, 1999 and $43.8 million and $1.0
million, respectively, for the six months ended June 30, 1999.
In the third quarter of 1999, the Company recorded a pre-tax asset
revaluation charge of approximately $390.3 million, consisting of $195.6 million
related to assets held for sale, $2.2 million related to assets sold during the
quarter and $192.5 million related to asset impairments (see discussion below)
in conjunction with its initial decision to downsize. The Company recorded
$195.6 million of asset revaluation charges related to 17 clinics whose net
assets the Company had classified as held for sale. The third quarter 1999 asset
revaluation charge related to assets held for sale included current assets,
property and equipment, other assets and intangible assets of $9.2 million,
$19.8 million, $13.3 million and $153.3 million, respectively.
Three of the 17 clinics held for sale as of September 30, 1999
represented all of the Company's then remaining operations considered to be
"group formation clinics." Group formation clinics represented the Company's
attempt to create multi-specialty groups by combining the operations of several
small physician groups or individual physician practices. The Company was unable
to successfully consolidate the operations of these clinics as a result of a
variety of factors including lack of medical group governance or leadership,
inability to agree on income distribution plans, separate information systems,
redundant overhead structures and lack of group cohesiveness. The Company
therefore determined to sell the clinic operating assets and terminate the
agreements related to these clinics. The asset revaluation charge related to
these clinics in the third quarter of 1999 was $13.8 million. The Company
completed the sale of these clinics in the fourth quarter of 1999 and received
proceeds totaling approximately $17.5 million in cash and $1.7 million in notes
receivable, in addition to certain
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liabilities being assumed by the purchaser. Net revenue and pre-tax income from
these group formation clinics sold in 1999 were approximately $10.7 million and
$100,000, respectively, for the quarter ended June 30, 1999 and $21.7 million
and $300,000, respectively, for the six months ended June 30, 1999.
The remaining 14 clinics held for sale as of September 30, 1999 were
multi-specialty clinics that the Company determined to sell because of a variety
of negative operating and market issues, including those related to declining
reimbursement for Medicare and commercial patient services, market position and
clinic demographics, physician relations, physician turnover rates, declining
physician incomes, physician productivity, operating results and ongoing
viability of the existing medical group. The combined effect of these factors on
the operations at those clinics lead to the Company's decision to sell the
clinic operating assets and terminate the related service agreements. The asset
revaluation charge related to these clinics in the third quarter of 1999 was
$181.8 million. The Company completed the sale of the assets of five of these
clinics during the fourth quarter of 1999, receiving consideration consisting of
approximately $32.6 million in cash and $22.0 million in notes receivable, in
addition to certain liabilities being assumed by the purchasers. The Company
disposed of the assets of six additional clinics during the first six months of
2000, receiving consideration consisting of approximately $16.0 million in cash
and $10.4 million in notes receivable, in addition to certain liabilities being
assumed by the purchasers. Included in these 14 clinics were the net assets of
the clinics operating in Lexington, Kentucky and Sayre, Pennsylvania. In the
second quarter of 1999, the Company disclosed that it did not expect to extend
the interim management agreement with the Guthrie Clinic in Sayre, Pennsylvania,
beyond November 1999 and discussed certain risks associated with the Lexington
Clinic operation. In the third quarter of 1999, the Company reached agreements
on the sales of these assets to the respective physician groups. The Company
completed the sales of these assets in the fourth quarter and recorded a net
asset impairment charge of approximately $300,000, comprised of a $2.2 million
charge less recovery of certain asset impairment charges recorded in the third
quarter of 1999. At June 30, 2000, the net assets held for sale for the
remaining three clinics were approximately $9.2 million and consisted primarily
of accounts receivable and property and equipment less certain current
liabilities. Net revenue and pre-tax income from the 11 clinics disposed as of
June 30, 2000 were approximately $5.1 million and $800,000, respectively, for
the quarter ended June 30, 2000 and $20.9 million and $300,000, respectively,
for the six months ended June 30, 2000. Net revenue and pre-tax income from the
11 clinics disposed as of June 30, 2000 were approximately $74.2 million and
$400,000, respectively, for the quarter ended June 30, 1999 and $148.8 million
and $1.9 million, respectively, for the six months ended June 30, 1999. The
Company completed the sale of certain assets of one of these clinics during the
third quarter of 2000 and had received consideration of approximately $1.8
million in cash, in addition to certain liabilities being assumed by the
purchasers.
In the second quarter of 1999, the Company recorded a pre-tax asset
revaluation charge of $13.7 million related to the sale of one clinic's
operating assets and pending sale of two clinics' operating assets and the
termination of the related service agreements. This asset revaluation charge
included current assets, property and equipment, and intangible assets of $2.0
million, $1.5 million and $10.2 million, respectively. At June 30, 1999 the
Company was also in negotiations relating to the sale of the assets of three
additional clinics, including the Holt-Krock Clinic. The factors impacting the
decision to sell these assets and terminate the agreements with the affiliated
physician groups were consistent with the factors described in the discussion of
the third quarter of 1999 asset revaluation charge above. The Company completed
the sale of the assets of one of these clinics during the second quarter of 1999
and the assets of four of these clinics during the third quarter of 1999. The
assets of the remaining clinic was sold during the first quarter of 2000 and is
included with the 14 clinics discussed above. With respect to the Holt-Krock
sale, certain proceeds were being held in escrow pending resolution of certain
disputed matters. These matters were resolved in the third quarter of 1999 and
the Company recorded an additional asset revaluation charge of $2.2 million in
the third quarter. Total consideration received from these terminations in 1999
consisted of approximately $45.5 million in cash and $3.3 million in notes
receivable, in addition to certain liabilities being assumed by the purchasers.
Net revenue and pre-tax losses from the five clinics that were sold in 1999 were
approximately $16.2 million and $(1.5) million, respectively, for the quarter
ended June 30, 1999 and $36.5 million and $(2.4) million, respectively, for the
six months ended June 30, 1999.
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In summary, net revenue and pre-tax income (losses) from operations
disposed of or closed as of June 30, 2000 were $16.7 million and $900,000 for
the three months ended June 30, 2000, and $63.0 million and $800,000 for the six
months ended June 30, 2000, respectively, compared to $146.9 million and
$(600,000) for the three months ended June 30, 1999, and $321.8 million and $1.9
million for the six months ended June 30, 1999, respectively. Net revenue and
pre-tax income (losses) from the operations held for sale at June 30, 2000 were
$124.5 million and $(700,000) for the three months ended June 30, 2000, and
$257.0 million and $2.3 million for the six months ended June 30, 2000,
respectively, compared to $115.0 million and $6.0 million for the three months
ended June 30, 1999, and $227.9 million and $11.5 million for the six months
ended June 30, 1999, respectively.
The Company expects that a majority of its remaining service agreements
will terminate upon repurchase by the clinics of their respective assets. As a
result, the Company anticipates that its revenues will be significantly reduced
in the next few quarters and thereafter as the majority of service agreements
terminate. The Company anticipates the proceeds generated from the sales of the
Company's assets related to its multi-specialty clinics will approximate the
adjusted carrying value of the assets. There can be no assurance, however, that
the Company will consummate the anticipated asset sales, or consummate the sales
on the anticipated terms or that additional clinics will not terminate their
relationships with the Company. The Company may incur additional charges to
earnings if the asset sales are not consummated, are consummated on less
favorable terms or if more service agreements are terminated than expected. Such
events could have a material adverse effect on the Company.
Asset Impairments
In the second quarter of 2000, the Company recorded approximately
$151.9 million of asset revaluation charges related to the impairment of
long-lived assets of certain of its ongoing operating units and at its corporate
office. Approximately $65.3 million of these asset revaluation charges related
to the Company's IPA operations in Houston, $80.4 million related to clinic
operations and $6.2 million related to the impairment of certain long-lived
assets at the Company's corporate office.
The asset revaluation charge related to the Houston IPA operations of
$65.3 million was primarily attributable to its disappointing financial
performance. Net revenue and pre-tax income (losses) for these operations were
$3.7 million and $(11.2) million for the six months ended June 30, 2000,
respectively, compared to $22.8 million and $8.8 million for the six months
ended June 30, 1999. Cash flows provided (used) by operations were $(18.9)
million for the six months ended June 30, 2000 and $7.0 million for the six
months ended June 30, 1999. The deterioration in the financial results for this
market is primarily attributable to higher bed days and per diem rates and
increased utilization of physician services by capitated patients. The Company's
analysis of future cash flows for the Houston IPA operations resulted in this
asset revaluation charge.
The asset revaluation charge related to clinic operations of $80.4
million was based on the Company's decision to restructure its service
agreements and to reduce its investment in the assets of the clinics. In
connection with this decision, the Company recorded charges in the second
quarter of 2000 to reduce to net realizable value the related assets associated
with these operations. Approximately $6.2 million of these charges relate to the
impairment of certain long-lived assets at the Company's corporate office due to
the consolidation of space of its administrative offices and the expected
disposition of certain long-lived assets.
In the first quarter of 2000, the Company recorded approximately
$100,000 of asset revaluation charges related to the impairment of certain
long-lived assets in an IPA market. The Company determined to cease operations
in one market in the state of Tennessee as a result of insufficient enrollment
volume. Accordingly, the Company recorded a charge in the first quarter of 2000
primarily to reduce to net realizable value its investments in equipment
associated with the market.
In the fourth quarter of 1999, the Company recorded approximately
$400,000 of asset revaluation charges related to the impairment of certain
long-lived assets in three IPA markets in Florida. The Company determined to
cease operations in certain markets in the state of Florida and centralize the
remaining operations as a result of a variety of factors, including mounting
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deficits and strained relations with payors. Accordingly, the Company recorded
a charge primarily to reduce to net realizable value its investments in
software licenses associated with three markets.
In the third quarter of 1999, events such as the anticipated downsizing
of certain clinics, changes in the Company's expectations relative to efforts to
change business mix and improve margins within certain markets, the failure of
certain joint venture or ancillary consolidation opportunities, and ongoing
local market economic pressure, impacted the Company's estimate of future cash
flows for certain long-lived assets and, in some cases, caused the Company to
change the estimated remaining useful life for certain long-lived assets. The
change in the Company's view on recovery of certain long-lived assets was also
evidenced by the recognition in the third quarter of 1999 of the need to change
its overall business model for its relationship with medical groups to decrease
cash flows to the Company and therefore increase cash flow to the medical group.
Fair value for the long-lived assets was determined by utilizing the results of
both a discounted cash flows analysis and an EBITDA sales multiple analysis
based on the Company's actual past experience with asset dispositions in similar
market conditions.
In the third quarter of 1999, the Company recorded approximately $192.5
million of asset revaluation charges related to the impairment of long-lived
assets of certain of its ongoing operating units. Approximately $172.5 million
of these charges related to certain clinic operations with the remainder related
to the operations of PhyCor Management Corporation ("PMC"), an IPA management
company acquired in the first quarter of 1998. The Company determined to exit
the most significant PMC market as a result of a variety of factors, including
the loss of relationships with physicians in that market in the third quarter of
1999. An additional PMC market was closed in the fourth quarter of 1999 and the
other markets in which PMC operates are not expected to generate significant
cash flows and are expected to be closed during 2000. These events reduced the
estimated future cash flows from the PMC acquisition and resulted in an asset
impairment charge of approximately $20.0 million. In the fourth quarter of 1999,
the Company classified as held for sale two clinics included in the third
quarter 1999 asset impairment charge. In the first quarter of 2000, the Company
classified as held for sale one clinic included in the third quarter 1999 asset
impairment charge and completed the sale of two clinics included in the third
quarter 1999 asset impairment charge. In the second quarter of 2000, the Company
classified as held for sale one clinic included in the third quarter 1999 asset
impairment charge and completed the sale of two clinics included in the third
quarter 1999 asset impairment charge.
Restructuring Charges
In the second quarter of 2000, the Company adopted and implemented
restructuring plans and recorded pre-tax restructuring charges of approximately
$37.1 million. These charges were comprised of approximately $26.5 million
related to the operations of clinics that were sold, closed or restructured,
$700,000 related to management's plans to cease operations and exit an IPA
market, and $9.9 million related to reductions in personnel and office space at
the corporate office. These charges were comprised of approximately $11.4
million in severance costs, $21.5 million in facility and lease termination
costs and $4.2 million in other exit costs. These restructuring plans included
the involuntary termination of 512 clinic, IPA management, business office and
corporate personnel. During the second quarter of 2000, the Company paid
approximately $6.3 million in severance costs, $200,000 in facility and lease
termination costs and $400,000 in other exit costs related to the second quarter
2000 charge.
In the first quarter of 2000, the Company adopted and implemented
restructuring plans and recorded pre-tax restructuring charges of approximately
$3.6 million with respect to operations that were sold or were to be closed.
These charges were comprised of approximately $1.9 million in facility and lease
termination costs, $700,000 in severance costs and $1.0 million in other exit
costs. These restructuring plans included the involuntary termination of 218
local clinic and IPA management and business office personnel. During the second
quarter and first six months of 2000, the Company paid approximately $100,000
and $300,000, respectively, in facility and lease termination costs, $300,000
and $700,000, respectively, in severance costs and $300,000 and $800,000,
respectively, in other exit costs related to the first quarter of 2000 charge.
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In 1999, the Company adopted and implemented restructuring plans and
recorded net pre-tax restructuring charges of approximately $21.8 million with
respect to operations that were being sold or closed, of which approximately
$9.5 million was recorded in the first quarter, $675,000 was recorded in the
second quarter, a net $3.1 million was recorded in the third quarter and $8.5
million was recorded in the fourth quarter. The net third quarter charge of $3.1
million was comprised of a $4.2 million charge less recovery of certain asset
revaluation charges recorded in the third quarter of 1998 due to sales proceeds
exceeding carrying value. These net charges were comprised of approximately $4.4
million in facility and lease termination costs, $5.1 million in severance costs
and $12.3 million in other exit costs. These restructuring plans included the
involuntary termination of 382 local clinic and IPA management and business
office personnel. During the second quarter and first six months of 2000, the
Company paid approximately $100,000 and $500,000, respectively, in facility and
lease termination costs, $300,000 and $1.0 million, respectively, in severance
costs and $200,000 and $2.2 million, respectively, in other exit costs related
to the 1999 charges. During 1999, the Company paid approximately $1.4 million in
facility and lease termination costs, $3.1 million in severance costs and $10.6
million in other exit costs related to the 1999 charges.
The fourth quarter of 1999 charge primarily related to IPA operations
where management adopted plans in the fourth quarter of 1999 to cease operations
and exit the related markets. Of these IPA charges, approximately $8.1 million
related to certain Florida markets and were comprised of approximately $400,000
in facility and lease termination costs, $100,000 in severance costs and $7.6
million in other exit costs. Due to mounting deficits and strained relations
with payors in several Florida IPA markets, the Company adopted and implemented
restructuring plans in the fourth quarter of 1999 to terminate the agreements
with these payors and exit the related markets and centralize the remaining
Florida IPA operations. In conjunction with terminating the payor relationships,
the Company agreed to pay final settlements of approximately $7.4 million to
obtain full release from future claims. These restructuring plans included the
involuntary termination of 21 local management and business office personnel.
During the first six months of 2000, the Company paid approximately $100,000 in
facility and lease termination costs and $1.6 million in other exit costs
related to the fourth quarter 1999 Florida IPA charge. During 1999, the Company
paid approximately $100,000 in severance costs and $5.9 million in other exit
costs related to the fourth quarter 1999 Florida IPA charge.
In summary, during the second quarter and first six months of 2000, the
Company paid approximately $400,000 and $1.0 million, respectively, in facility
and lease termination costs, $6.9 million and $8.0 million respectively, in
severance costs and $900,000 and $3.4 million, respectively, in other exit costs
related to 1998, 1999 and 2000 charges. At June 30, 2000, accrued restructuring
reserves totaled approximately $36.2 million and consisted of approximately
$24.8 million in facility and lease termination costs, $6.3 million in severance
costs and $5.1 million in other exit costs. The Company estimates that
approximately $17.7 million of the remaining restructuring reserves at June 30,
2000 will be paid during the next 12 months. The remaining $18.5 million relates
primarily to long term lease commitments.
The Company anticipates recording additional restructuring charges as
it ceases operations in certain markets or further restructures its operations.
There can be no assurance that the payment of liabilities relating to
restructuring charges will not have a material adverse effect on the Company.
LIQUIDITY AND CAPITAL RESOURCES
General
At June 30, 2000, current liabilities exceeded current assets of the
Company by $14.0 million, compared to $193.8 million of working capital at
December 31, 1999 primarily as a result of the restated bank credit facility
being classified as a current liability as of June 30, 2000. At June 30, 2000,
the Company had $30.2 million in restricted cash and cash equivalents, compared
to $29.6 million at December 31, 1999. Restricted cash and cash equivalents
include amounts held by IPA partnerships and HMOs whose use is restricted to
operations of the IPA partnerships or to meet regulatory deposit requirements.
At June 30, 2000, net accounts receivable of $85.9 million amounted to 54 days
of net clinic revenue compared to $230.5 million and 55 days at the end of 1999.
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The Company generated $8.3 million of cash flows from operations for
the second quarter of 2000 compared to $41.6 million for the second quarter of
1999 and $10.1 million for the first six months of 2000 compared to $71.5
million for the same period in 1999. Cash flows from operations of clinics that
were disposed of or closed at June 30, 2000 resulted in a decrease of $22.7
million for the quarter ended June 30, 2000 compared to the quarter ended June
30, 1999 and $21.8 million for the first six months of 2000 compared to the
first six months of 1999. The Company's IPA management division has experienced
losses in certain markets. The Company ceased operations in an IPA market in the
development stage in the second quarter of 2000, recorded revaluation charges
related to the Houston IPA market and expects that it may cease operations in
certain additional IPA markets. Cash flows from operations were also negatively
impacted by a reduction in net earnings related to the Company's IPA operations
of $23.4 million, of which $13.6 million relates to the Company's IPA operations
in Houston, in the second quarter of 2000 compared to the second quarter of 1999
and of $34.5 million, of which $25.9 million relates to the Company's IPA
operations in Houston, in the first six months of 2000 compared to the first six
months of 1999. If the Company records restructuring charges in the third
quarter of 2000, the Company's cash flows may be negatively impacted.
Capital expenditures during the first six months of 2000 totaled $16.5
million. The Company is responsible for capital expenditures at its affiliated
clinics under the terms of its service agreements. The Company expects to make
approximately $3.0 million in additional capital expenditures during the
remainder of 2000. The Company anticipates capital expenditures will be funded
primarily from operating cash flows.
Deferred acquisition payments are payable to certain physician groups
in the event such physician groups attain predetermined financial targets during
established periods of time following the acquisitions. If each group satisfied
its applicable financial targets for the periods covered, the Company would be
required to pay an aggregate of approximately $13.1 million of additional
consideration over the next four years, of which a maximum of approximately
$11.4 million would be payable during the next 12 months. As a result of its
ongoing discussions to restructure or terminate the service agreements with its
multi-specialty clinics, the Company does not anticipate making any of these
payments.
During 1999, the Company favorably resolved its outstanding Internal
Revenue Service ("IRS") examinations for the years 1988 through 1995. The IRS
had proposed adjustments relating to the timing of recognition for tax purposes
of certain revenue and deductions related to accounts receivable, the Company's
relationship with affiliated physician groups, and various other timing
differences. The tax years 1988 through 1995 have been closed with respect to
all issues without a material financial impact. The Company is currently under
examination by the IRS for the years 1996 through 1998 and the IRS has proposed
an adjustment to the carryback that will result in the Company owing
approximately $1.2 million plus interest. Additionally, two subsidiaries are
currently under examination for the 1995 and 1996 tax years. The Company
acquired the stock of these subsidiaries during 1996. For the years under audit,
and potentially, for subsequent years, any such adjustments could result in
material cash payments by the Company. The Company cannot determine at this time
the resolution of these matters, however, it does not believe the resolution of
these matters will have a material adverse effect on its financial condition,
although there can be no assurance as to the outcome of these matters. In August
1999, the Company received a $13.7 million tax refund as a result of applying
the 1998 loss carryback to recover taxes paid in 1996 and 1997. As of December
31, 1999, the Company had approximately $297.0 million in net operating loss
carryforwards; accordingly, the Company does not expect to pay current federal
income taxes for the foreseeable future.
Capital Resources
The Company modified its bank credit facility in January and June 2000
and its synthetic lease facility in January 2000. The Company is in the process
of negotiating additional modifications to its bank credit facility. The bank
group extended its waiver of existing defaults under the bank credit facility
and the synthetic lease facility until August 25, 2000 by which date the Company
anticipates that it will have executed a restated bank credit facility.
Management expects that the bank credit facility, as amended, will provide for
the conversion of outstanding balances under the existing revolving credit and
synthetic lease facilities and outstanding letters of credit to a term loan
("Term Loan") and a $25 million revolving loan ("Revolving Loan"). Amounts will
be available under this Revolving Loan only to the extent repayments have been
made from excess cash flows of the Company. The Company anticipates that it will
have limited access to the Revolving Loan which could have a material adverse
impact on the Company's ability to meet its operating obligations. The
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Company also expects that the restated credit facility will also include a
senior secured revolving loan of up to $15 million ("New Revolving Loan"). Under
the proposed terms of this amended bank credit facility, net cash proceeds from
asset sales will be required to be prepaid against outstanding borrowings under
the Term Loan, the Revolving Loan and the New Revolving Loan. Irrespective of
asset sales, management expects the aggregate balance of the Term Loan and
Revolving Loan to be reduced each month end until maturity on June 30, 2001.
There can be no assurance that the Company and the bank group will reach
agreement on the restated credit facility or that, if an agreement is reached,
such agreement will be on the terms currently contemplated by the Company.
Failure to reach agreement would have a material adverse effect on the Company.
The Company expects to use a significant portion of the cash proceeds
from the asset sales to meet its financial obligation under the restated bank
credit facility. In the event the proceeds from the asset sales are less than
anticipated or not received when anticipated, the Company may experience
difficulty meeting its obligations under the bank credit facility and other debt
obligations. Such difficulty could cause a material adverse effect on the
Company.
The total drawn cost under the bank credit facility at June 30, 2000
was either (i) the applicable eurodollar rate plus 2.75% per annum or (ii) the
agent's base rate plus .50% per annum. The total weighted average drawn cost of
outstanding borrowings at June 30, 2000 was 8.32%. As part of the proposed
amendment, management believes the total drawn cost for the Term Loan and
Revolving Loan will be higher than the cost under its current bank credit
facility.
The Company's synthetic lease facility, as amended in January, provided
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 at June 30, 2000 was 2.75% to 4.00% above the applicable eurodollar
rate. At August 14, 2000, an aggregate of $24.8 million was drawn under the
synthetic lease facility. The bank group has granted a waiver of defaults under
the synthetic lease facility until August 25, 2000, by which date the Company
anticipates that it will have executed a new amended and restated credit
facility. Under the proposed amendment, the Company expects that the amounts
outstanding under the synthetic lease facility will be converted to the Term
Loan and Revolving Loan discussed above. There can be no assurance that the
Company and the bank group will reach agreement regarding the terms of the
restated synthetic lease facility or that the synthetic lease facility will be
on the terms currently contemplated by the Company.
Outstanding borrowings under the bank credit facility and synthetic
lease facility are secured by the capital stock the Company holds in its
significant subsidiaries (as defined in the bank credit facility), certain real
property of the Company and the personal property held by the significant
subsidiaries. Both facilities contain covenants which, among other things,
require the Company to maintain minimum financial ratios and impose 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.
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
June 30, 2000, notional amounts under interest rate swap agreements totaled
$230.0 million. Fixed interest rates ranged from 5.14% to 5.78% relative to the
one month or three month floating LIBOR. The Company terminated the swap
agreements in July 2000 and received payments totaling $2.2 million. The FASB
has issued Statement of Financial Accounting Standards (SFAS) No. 133,
Accounting for Derivative Instruments and Hedging Activities, which the Company
is required to adopt in the first quarter of 2001. 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 June 30, 2000, the Company estimates it
would have recorded pre-tax non-cash earnings of approximately $2.4 million for
the six months ended June 30, 2000. 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.
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During the second quarter of 1999, the Company announced a definitive
agreement allowing for a strategic investment in the Company of up to $200.0
million by funds managed by E.M. Warburg, Pincus and Co., LLC ("Warburg,
Pincus"). The agreement allowed for the issuance of two separate series of zero
coupon convertible subordinated notes. The first of these series ("Series A
Notes") was issued on September 3, 1999 and provided gross proceeds to PhyCor of
$100 million. The Company used the net proceeds of $92.5 million from the Series
A Notes to repay indebtedness outstanding under the Company's credit facility.
The Series A Notes are non-voting, have a 6.75% yield and are convertible at an
initial conversion price of $6.67 at the option of the holders into
approximately 15.0 million shares of PhyCor common stock. The Series A Notes
will accrete to a maturity value of approximately $266.4 million at the 15-year
maturity date and include an investor option to put the notes to PhyCor at the
end of ten years. In the second quarter of 2000, the Company mutually agreed
with Warburg, Pincus not to issue the second series of notes.
In conjunction with its securities repurchase program, the Company
repurchased approximately 2.6 million shares of common stock for approximately
$12.6 million in 1998 and approximately 2.9 million shares of common stock for
approximately $13.5 million in 1999. During the third quarter of 1999, the
Company repurchased $3.5 million of its convertible subordinated debentures for
a total consideration of approximately $2.5 million, resulting in an
extraordinary gain of approximately $1.0 million. The Company's amended bank
credit facility prohibits additional securities repurchases.
During the second quarter of 2000, the Nasdaq Stock Market, Inc.
("Nasdaq") informed the Company that the Company's common stock would be
delisted if its stock price did not increase to certain minimum levels. In
addition, as a result of the charges recorded by the Company in the second
quarter of 2000, the Company no longer satisfies the minimum net tangible asset
listing requirements of Nasdaq. Accordingly, the Company has been informed that
its common stock will be delisted as of August 25, 2000. The Company expects
that the common stock will immediately begin trading on the OTC Bulletin Board.
The Company's delisting may negatively impact its liquidity because it may
further hinder the Company's ability to raise necessary capital through equity
financing.
Asset Sales and Restructuring Costs
During 1998, 1999 and 2000, the Company sold clinic operating assets
and real estate and terminated the related service agreements with a majority of
the Company's affiliated clinics. For additional discussion related to these
clinics and the asset revaluation and restructuring charges associated with
these clinics, see "Asset Revaluation and Restructuring - Assets Held for Sale"
and "Asset Revaluation and Restructuring - Restructuring Charges". For the
quarter ended June 30, 2000, the Company received consideration which consisted
of approximately $25.6 million in cash and $8.5 million in notes receivable, in
addition to certain liabilities being assumed by the purchasers, related to the
sale of clinic assets and real estate. For the six months ended June 30, 2000,
the Company received consideration which consisted of approximately $46.8
million in cash and $18.9 million in notes receivable, in addition to certain
liabilities being assumed by the purchasers, related to the sale of clinic
assets and real estate. An additional asset impairment charge of $19.7 million
was recorded in the second quarter of 2000 and $25.7 million was recorded during
the first six months of 2000 related to completed clinic dispositions. For the
year ended December 31, 1999, the Company received consideration which consisted
of approximately $103.1 million in cash and $31.9 million in notes receivable,
in addition to certain liabilities assumed by the purchasers, related to the
sale of clinic assets. The amounts received upon disposition of the assets in
1999 approximated the post-charge net carrying value, with the exception of
Holt-Krock Clinic, for which an additional asset impairment charge of $2.2
million was recorded in the third quarter of 1999, a clinic for which an
additional net asset impairment charge of $300,000 was recorded in the fourth
quarter of 1999, and another clinic whose sales proceeds exceeded carrying value
and resulted in the recovery of $1.1 million against the third quarter 1999
restructuring charge. The Company intends to seek recovery of certain of its
remaining assets through litigation against several physicians formerly
affiliated with Holt-Krock who did not join Sparks Regional Medical Center.
During the second quarter and first six months of 2000, the Company received
payments on notes receivable of approximately $500,000 and $2.5 million,
respectively. During 1999, the Company received payments on notes receivable of
approximately $3.9 million.
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As of August 11, 2000, the Company had received consideration which
consisted of $15.6 million in cash and $4.0 million in notes receivable, in
addition to certain liabilities assumed by the purchasers, related to the sale
of clinic assets in the third quarter of 2000.
During 1999 and 2000, the Company has recorded restructuring charges
related to operations that are being sold or closed. These charges related to
facility and lease termination costs, severance costs, and other exit costs
incurred or expected to be incurred when these assets are sold or closed. For
additional discussion, see "Asset Revaluation and Restructuring - Restructuring
Charges." During the second quarter and first six months of 2000, the Company
paid approximately $400,000 and $1.0 million in facility and lease termination
costs, respectively, $6.9 million and $8.0 million in severance costs,
respectively, and $900,000 and $3.4 million in other exit costs, respectively.
During 1999, the Company paid approximately $1.8 million in facility and lease
termination costs, $4.9 million in severance costs and $12.3 million in other
exit costs. The Company estimates that approximately $17.7 million of the
remaining restructuring charges at June 30, 2000 will be paid during the next
twelve months. The Company currently anticipates recording additional
restructuring charges as the Company exits certain markets or restructures its
operations.
Summary
In the quarter ended June 30, 2000, the Company contacted most of its
affiliated multi-specialty clinics to discuss the repurchase of clinic assets
from the Company by the respective physician groups. The Company is negotiating
with substantially all of its multi-specialty clinics to restructure or
terminate its existing service agreements and to reduce the Company's investment
in the assets of these clinics. As a result of its ongoing discussions,
management believes that a majority of the clinics intend to repurchase all or a
portion of the related assets. Management intends to negotiate with the clinics
for the sale and repurchase of the assets at mutually agreeable terms. The
Company anticipates that these restructuring efforts and asset sales should be
completed during 2001. The ultimate impact of the changes to the service
agreements on pre-tax earnings and cash flows is expected to be determined
during 2001 and the Company expects that the changes will substantially reduce
the earnings of the Company in the future. There can be no assurance that the
clinics will repurchase any assets, that the repurchases will be on terms
agreeable to the Company or that additional charges to earnings will not be
necessary as a result of the final terms of the assets sales. In the event the
proceeds from the asset sales are less than anticipated or are not received when
anticipated the Company's liquidity may be materially adversely affected.
At June 30, 2000, the Company had cash and cash equivalents of
approximately $58.1 million, including $30.2 million of restricted cash and cash
equivalents, and at August 11, 2000, approximately $10.0 million available under
its bank credit facility. While the Company believes that the combination of
funds available under the Company's bank credit facility, together with cash
reserves, cash flows from operations and proceeds from asset dispositions,
should be sufficient to meet the Company's current capital expenditure and
working capital needs over the next 12 months, there can be no assurance that
cash needs will not exceed cash availability or that the restated bank credit
facility will provide for sufficient borrowing availability.
The Company has limited sources of capital. The bank credit facility
restricts the Company's ability to incur additional indebtedness. Further, the
restated bank credit facility is expected to mature on June 30, 2001. There can
be no assurance that any additional financing will be available on terms
acceptable to the Company. The Company's current stock price, impending
delisting from Nasdaq, and limited growth expectations will negatively impact
its ability to issue equity and other debt securities, which could increase the
Company's dependence on its bank credit facility as a source of capital. There
can be no assurance that the projected asset sales will be consummated or
consummated on the terms currently contemplated. The failure to consummate the
asset sales or to receive the proceeds projected therefrom may materially
adversely affect the Company and its liquidity. The outcome of certain pending
legal proceedings described in Part II, Item 1 hereof may have a negative impact
on the Company's liquidity and capital resources.
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FORWARD-LOOKING STATEMENTS
Forward-looking statements of PhyCor included herein or incorporated by
reference including, but not limited to, those regarding the possibility of
additional losses and charges to earnings resulting from the termination and
restructuring of clinic service agreements, repurchase of the assets of clinics
or continued poor performance of the IPA management services division, the
adequacy of PhyCor's capital resources, the future profitability of capitated
fee arrangements, the possibility of losses in excess of insurance coverage in
respect of pending legal proceedings and statements regarding trends relating to
various revenue and expense items, could be affected by a number of risks,
uncertainties, and other factors described herein under "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Legal
Proceedings" and in the Company's Annual Report on Form 10-K for the year ended
December 31, 1999, including those related to the termination of clinic
relationships, the restructuring of existing service agreements, the dependence
on affiliated physicians, the availability of additional capital, the Company's
growth strategy, the Company's affiliation model and fixed fee patient
arrangements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
During the six months ended June 30, 2000, there were no material
changes to the Company's quantitative and qualitative disclosures about the
market risks associated with financial instruments as described in the Company's
Annual Report on Form 10-K for the year ended December 31, 1999.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company and certain of its current and former officers and
directors, Joseph C. Hutts, Derril W. Reeves, Thompson S. Dent, Richard D.
Wright and John K. Crawford (only Mr. Dent remains employed by the Company while
he and Mr. Hutts serve as directors) have been named defendants in 10 securities
fraud class actions filed in state and federal courts in Tennessee between
September 8, 1998 and June 24, 1999. The factual allegations of the complaints
in all 10 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 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 was
denied and the case is now in the discovery stage of the litigation. Defendants'
unopposed motion to set a new trial date was granted on April 19, 2000, and the
court has set the trial date for June 4, 2001. The state court actions were
consolidated in Davidson County, Tennessee. The Plaintiffs' original
consolidated class action complaint in state court was dismissed for failure to
state a claim. Plaintiffs, however, were granted leave to file an amended
complaint. The amended complaint filed by Plaintiffs asserted, in addition to
the original Tennessee Securities Act claims, that Defendants had also violated
Sections 11 and 12 of the Securities Act of 1933 for alleged misleading
statements in a prospectus released in connection with the CareWise acquisition.
Defendants removed this case to federal court and have filed an answer. The
amended complaint also added KPMG, LLP ("KPMG"), the Company's independent
public auditors. KPMG removed this case to federal court. The Company and the
individual defendants filed an answer. KPMG's motion to dismiss is still pending
before the Court. This case has been consolidated with the original federal
consolidated action for discovery purposes only. The Company anticipates the
state and federal actions will be tried separately. The discovery process
continues. The Company believes that it has meritorious defenses to all of the
claims, and is vigorously defending 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)
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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 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 the 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. On June 5, 2000,
the court granted in full the Company's motion for partial summary judgment,
which eliminated the plaintiff's allegations of fraud and violations of federal
and state securities laws. As a result of the court's rulings, the plaintiff is
no longer entitled to rescission of the merger agreement, return of the proceeds
from the operations of PrimeCare, or punitive damages. In addition, on August 7,
2000, at the pretrial conference the court ruled in favor of the Company on
substantially all of the Company's motions in limine and, on August 8, 2000, the
court set a new pre-trial conference for October 23, 2000, and invited the
parties to file by September 7, 2000 motions for summary judgment based on the
court's rulings on the motions in limine. The Company intends to file Motions
for Summary Judgment by such date. Although the Company believes it has
meritorious defenses to all of the remaining claims and is vigorously defending
this suit, there can be no assurance that it will not have a material adverse
effect on the Company.
On July 26, 2000, Prem Reddy filed a new action captioned Prem Reddy,
M.D. v. Harry Lifschutz, M.D., PhyCor, Inc. and Does 1 through 50, in Superior
Court of the State of California, County of San Bernardino. Dr. Reddy alleges
claims for unfair business practices and alleged fraudulent conveyances in
connection with the Company's efforts to sell Company assets located in
California and other locations. The plaintiff seeks to enjoin these asset sales
or to impose a constructive trust on any completed sales. In response, the
Company, on July 27, 2000, removed the action to the United States District
Court, Central District of California and, by order of the Court on August 9,
2000, the case was reassigned to the United States District Court, Western
District of California. The judge assigned to this case is the same judge
presiding over the other Reddy matter discussed above. The Company intends to
file a motion to dismiss this new action. Although the Company intends to defend
itself vigorously against these claims if the court does not dismiss this
matter, there can be no assurance that an adverse decision in this matter would
not have a material adverse effect on the Company.
Three clinics are challenging the enforceability of their service
agreements with the Company's subsidiaries in court. In August 1999, Medical
Arts Clinic Association (Medical Arts) filed suit against the Company in the
District Court of Navarro County, Texas, which complaint has been subsequently
amended. The Company removed this case to Federal District Court for the
Northern District of Texas. Medical Arts is seeking damages for breach of
contract and rescission of the service agreement and declaratory relief
regarding the enforceability of the service agreement alleging it is null and
void on several grounds, including but not limited to, the violation of state
law provisions as to the corporate practice of medicine and fee splitting. On
April 28, 2000, Medical Arts filed a Motion for Partial Summary Judgement
seeking a determination that the Service Agreement constituted the corporate
practice of medicine in violation of Texas law. On May 31, 2000, the Company
filed a Cross-Motion for Partial Summary Judgement on the same issue. On August
8, 2000, the Court denied both parties' Motions for Partial Summary Judgement,
ordered mediation by the parties within 60 days of the Court's order, and stayed
all discovery pending mediation. On April 24, 2000, the Texas District Court of
Navarro County, Texas, ordered the appointment of a receiver to rehabilitate
Medical Arts. On May 10, 2000, the same state court granted Medical Arts a
temporary restraining order against the Company and set for hearing the matters
set forth in the order. On May 12, 2000, the Company, in response to the
foregoing, filed its notice of removal of the above matters to the federal
court. This removal stays any action of the state court. In December, 1999 the
Company filed suit in Davidson County, Tennessee which currently seeks
declaratory relief that the service agreement with Murfreesboro Medical Clinic,
P.A. (Murfreesboro Medical) is enforceable or alternatively seeking damages for
breach by Murfreesboro Medical under the service agreement and related asset
purchase agreement. Murfreesboro Medical then filed a motion to dismiss our suit
which was denied. Simultaneously, Murfreesboro Medical filed suit in Circuit
Court in Rutherford County, Tennessee,
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claiming breach of the service agreement by the Company and seeking a
declaratory judgment that the service agreement was unenforceable. Pursuant to a
motion by the Company, the Rutherford County lawsuit has been dismissed. The
Davidson County suit is still pending. In January 2000, South Texas Medical
Clinics, P.A. (South Texas) filed suit against PhyCor of Wharton, L.P. in the
State District Court in Fort Bend County, Texas. South Texas is seeking a
declaratory judgment that the service agreement is unenforceable as a matter of
law because it violates the Texas Health and Safety Code relating to the
corporate practice of medicine and fee splitting. In the alternative, South
Texas seeks to have the agreements declared void alleging, among other things,
fraud in the inducement and breach of contract by the Company. The Company has
filed a motion to remove this case to Federal District Court for the Southern
District of Texas On April 18, 2000, the court entered an Agreed Order whereby
South Texas, among other matters, agreed to pay over to the Company cash
proceeds from certain accounts receivable and pay into the registry of the court
proceeds from certain other accounts receivable during the pendancy of this
matter. 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. Although the Company is vigorously defending the
enforceability of the structure of its management fee and service agreements
against these suits, there can be no assurance that these suits will not have a
material adverse effect on the Company.
The Company is aware of a qui tam lawsuit filed under seal which names
as defendants the Company, a subsidiary of the Company, and a clinic affiliated
with the Company, and alleges violations of the False Claims Act and the Whistle
Blower's Act, breach of contract and employee discrimination. It is too early to
determine whether this action will proceed or if any governmental agencies will
participate in the action. If the action proceeds, the Company will vigorously
defend this action and believes it will have meritorious defenses to these
claims. There can be no assurance, however, that this suit, if ultimately
determined in favor of the plaintiffs, would not have a material adverse effect
on the Company.
On April 18, 2000, a jury in the case of United States of America ex
rel. William R. Benz v. PrimeCare International, Inc. and Prem Reddy, in the
United States District Court, Central District of California, returned a verdict
in favor of the plaintiff as follows: $500,000 against PrimeCare on plaintiff's
breach of contract claims; $900,000 in compensatory damages and $3 million in
punitive damages jointly and severally against PrimeCare and Prem Reddy on
plaintiff's claims for wrongful termination and intentional infliction of
emotional distress; and $200,000 against PrimeCare on plaintiff's claim for
violations of state labor codes. The jury returned a verdict in defendants'
favor on plaintiff's claim for retaliatory termination under the False Claims
Act. The jury was unable to reach a verdict on plaintiff's Medicare fraud
claims. The court entered a final judgment on July 13, 2000. The Company has
recorded this judgment of $4.6 million in the second quarter of 2000. A new
trial on the Medicare fraud claims has been set for September 12, 2000. The
defendants filed post-trial motions with the court on July 17, 2000 seeking to
dismiss the Medicare fraud, the wrongful termination and intentional infliction
of emotion distress claims and, in the alternative, to obtain a new trial on all
claims. All of the claims in this matter arose from events occurring prior to
PhyCor's acquisition of PrimeCare and relate to the termination of Mr. Benz, a
former officer of PrimeCare. The Company believes that it is entitled to seek
indemnification from Prem Reddy for any damages incurred by PrimeCare as a
result of this matter and intends to seek such indemnification. There can be no
assurance that plaintiff's enforcement of his judgment against PrimeCare would
not have a material adverse effect on PrimeCare.
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 Plan is currently negotiating with the Department
to end the investigation with no required payments by the Plan subject to
certain on-going outside reviews of the timing of participant contributions. The
Company intends to fully cooperate with the Department's requests.
The Company is currently under examination by the IRS for the years
1996 through 1998 and the IRS has proposed an adjustment to the carryback that
will result in the Company owing approximately $1.2 million plus interest.
Additionally, two subsidiaries are currently under examination for the 1995 and
1996 tax years. The Company acquired the stock of these subsidiaries during
1996. For the years under audit, and potentially, for subsequent years, any such
adjustments could result in material cash payments by the Company. The Company
cannot determine at this time the resolution of these matters, however, it does
not believe the resolution of these matters will have a material adverse effect
on its financial condition, although there can be no assurance as to the outcome
of these matters.
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
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believes would have a material adverse effect on the Company's financial
position or results of operations on a consolidated basis.
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.
The annual meeting of shareholders of the Company was held on
May 31, 2000. At this meeting, the following matters were voted upon by the
Company's shareholders:
(A) AMENDMENT TO THE COMPANY'S 1999 INCENTIVE STOCK PLAN
The shareholders of the Company approved the amendment to the Company's
2000 Incentive Stock Plan to increase from 4,500,000 to 7,700,000 the number of
shares of Common Stock authorized thereunder.
Votes Cast in Favor Votes Cast Against Abstentions
------------------- ------------------ -----------
50,489,034 6,861,055 228,102
(B) AMENDMENT TO THE COMPANY'S AMENDED 1992 NON-QUALIFIED STOCK OPTION
PLAN FOR NON-EMPLOYEE DIRECTORS
The shareholders of the Company approved the amendment to the Company's
Amended 1992 Non-Qualified Stock Option Plan to increase from 337,500 to 637,500
the number of shares of Common Stock authorized thereunder.
Votes Cast in Favor Votes Cast Against Abstentions
------------------- ------------------ -----------
51,792,212 5,561,331 224,647
(C) ELECTION OF CLASS III DIRECTORS
Ronald B. Ashworth, Joseph C. Hutts, Rodman W. Moorhead, III and Derril
W. Reeves were elected to serve as Class III directors of the Company.
The vote was as follows:
<TABLE>
<CAPTION>
Name Votes Cast in Favor Votes Cast Against or Withheld
---- ------------------- ------------------------------
<S> <C> <C>
Ronald B. Ashworth 54,279,334 3,298,856
Joseph C. Hutts 55,590,431 1,987,759
Rodman W. Moorhead, III 56,124,627 1,453,563
Derril W. Reeves 55,672,473 1,905,717
</TABLE>
34
<PAGE> 35
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------
<S> <C> <C>
3.1 -- Restated Charter of the Company (1)
3.2 -- Amendment to Restated Charter of the Company (2)
3.3 -- Amendment to Restated Charter of the Company (3)
3.4 -- Amended Bylaws of the Company (1)
4.1 -- Specimen of Common Stock Certificate (4)
4.2 -- Shareholder Rights Agreement, dated February 18, 1994, between the Company and First
Union National Bank of North Carolina (5)
10.1 -- PhyCor, Inc. 1999 Incentive Stock Plan (6)
10.2 -- Employment Agreement dated as of June 8, 2000 between the Company and Thompson S. Dent (7)
10.3 -- Amendment to Employment Agreement between the Company and Tarpley B. Jones dated June 15, 2000 (7)
10.4 -- Separation and Release Agreement between the Company and Joseph C. Hutts dated as of June 8, 2000 (7)
10.5 -- Separation and Release Agreement between the Company and Derril W. Reeves dated as of June 8, 2000 (7)
10.6 -- Amendment to and Termination of the PhyCor, Inc. Supplemental Executive Retirement Plan (7)
27.1 -- Financial Data Schedule (for SEC use only) (7)
</TABLE>
-------------
(1) Incorporated by reference to exhibits filed PhyCor's Annual Report on Form
10-K for the year ended December 31, 1994, Commission No. 0-19786.
(2) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-3, Registration No. 33-93018.
(3) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-3, Registration No. 33-98528.
(4) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-1, Registration No. 33-44123.
(5) Incorporated by reference to exhibits filed with PhyCor's Current Report on
Form 8-K dated February 18, 1994, Commission No. 0-19786.
(6) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-8, Registration No. 333-58709.
(7) Filed herewith.
(B) REPORTS ON FORM 8-K.
The Company's Current Report on Form 8-K as filed with the Commission
on June 9, 2000 relating to certain management changes.
35
<PAGE> 36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHYCOR, INC.
By: /s/ Tarpley B. Jones
----------------------------
Tarpley B. Jones
Executive Vice President and
Chief Financial Officer
Date: August 14, 2000
36
<PAGE> 37
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------
<S> <C> <C>
3.1 -- Restated Charter of the Company (1)
3.2 -- Amendment to Restated Charter of Company (2)
3.3 -- Amendment to Restated Charter of Company (3)
3.4 -- Amended Bylaws of the Company (1)
4.1 -- Specimen of Common Stock Certificate (4)
4.2 -- Shareholder Rights Agreement, dated February 18, 1994, between PhyCor and First Union National
Bank of North Carolina (5)
10.1 -- PhyCor, Inc. 1999 Incentive Stock Plan (6)
10.2 -- Employment Agreement dated as of June 8, 2000 between the Company and Thompson S. Dent (7)
10.3 -- Amendment to Employment Agreement between the Company and Tarpley B. Jones dated June 15, 2000 (7)
10.4 -- Separation and Release Agreement between the Company and Joseph C. Hutts dated as of June 8, 2000 (7)
10.5 -- Separation and Release Agreement between the Company and Derril W. Reeves dated as of June 8, 2000 (7)
10.6 -- Amendment to and Termination of the PhyCor, Inc. Supplemental Executive Retirement Plan (7)
27.1 -- Financial Data Schedule (for SEC use only) (7)
</TABLE>
-------------
(1) Incorporated by reference to exhibits filed with PhyCor's Annual Report on
Form 10-K for the year ended December 31, 1994, Commission No. 0-19786.
(2) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-3, Registration No. 33-93018.
(3) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-3, Registration No. 33-98528.
(4) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-1, Registration No. 33-44123.
(5) Incorporated by reference to exhibits filed with PhyCor's Current Report on
Form 8-K dated February 18, 1994, Commission No. 0-19786.
(6) Incorporated by reference to exhibits filed with PhyCor's Registration
Statement on Form S-8, Registration No. 333-58709.
(7) Filed herewith.
