<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30, 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 November 13, 2000, 73,774,235 shares of the Registrant's Common
Stock were outstanding.
<PAGE> 2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 2000 (unaudited) and December 31, 1999
(All amounts are expressed in thousands)
<TABLE>
<CAPTION>
ASSETS 2000 1999
----- ----------- -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents - unrestricted $ 6,117 $ 31,093
Cash and cash equivalents - restricted 40,213 29,619
Accounts receivable, net 12,196 230,513
Inventories 192 11,384
Prepaid expenses and other current assets 25,810 53,002
Assets held for sale, net 184,643 101,988
----------- -----------
Total current assets 269,171 457,599
Property and equipment, net 17,993 156,091
Intangible assets, net 118,413 522,742
Other assets 34,934 58,493
----------- -----------
Total assets $ 440,511 $ 1,194,925
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
----------------------------------------------
Current liabilities:
Current installments of long-term debt $ 175,704 $ 3,424
Current installments of obligations under capital leases 266 3,746
Accounts payable 14,583 34,963
Due to physician groups 155 30,142
Purchase price payable 5,900 20,711
Salaries and benefits payable 8,126 25,544
Incurred but not reported claims payable 29,675 45,124
Current portion of accrued restructuring reserves 21,492 7,316
Other accrued expenses and current liabilities 25,997 92,843
----------- -----------
Total current liabilities 281,898 263,813
Long-term debt, excluding current installments 2,662 247,861
Obligations under capital leases, excluding current installments 256 1,540
Accrued restructuring reserves, excluding current portion 16,847 679
Deferred credits and other liabilities 5,024 29,858
Convertible subordinated notes payable to physician groups 1,848 6,839
Convertible subordinated notes and debentures 303,813 298,750
----------- -----------
Total liabilities 612,348 849,340
Minority interest in earnings of consolidated partnerships 1,550 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 73,774 shares in 2000 and 73,479 shares in 1999 834,158 834,276
Accumulated deficit (1,007,545) (490,773)
----------- -----------
Total shareholders' equity (deficit) (173,387) 343,503
----------- -----------
Total liabilities and shareholders' equity (deficit) $ 440,511 $ 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 nine months ended September 30, 2000 and 1999
(All amounts are expressed in thousands, except for loss per share)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- -------------------------
2000 1999 2000 1999
--------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Net revenue $ 211,976 $ 371,193 $ 779,482 $ 1,181,225
Operating expenses
Cost of provider services 56,358 48,548 174,292 155,160
Salaries, wages and benefits 60,145 122,288 240,593 382,303
Supplies 24,668 54,511 100,504 173,105
Purchased medical services 3,494 8,858 15,781 28,183
Other expenses 43,589 56,636 137,699 174,679
General corporate expenses 4,026 7,086 18,978 22,739
Rents and lease expense 12,874 29,150 54,153 92,455
Depreciation and amortization 9,505 23,634 42,559 72,522
Provision for asset revaluation, restructuring and
refinancing 54,158 393,358 485,243 417,246
--------- --------- ----------- -----------
Net operating expenses 268,817 744,069 1,269,802 1,518,392
--------- --------- ----------- -----------
Loss from operations (56,841) (372,876) (490,320) (337,167)
Other (income) expense:
Interest income (1,874) (1,133) (5,083) (3,235)
Interest expense 8,071 10,211 28,049 30,198
--------- --------- ----------- -----------
Loss before income taxes, minority
interest and extraordinary item (63,038) (381,954) (513,286) (364,130)
Income tax expense 322 51,955 957 57,746
Minority interest in earnings of consolidated partnerships 1,015 2,801 2,529 11,123
--------- --------- ----------- -----------
Loss before extraordinary item (64,375) (436,710) (516,772) (432,999)
Extraordinary item - gain from extinguishment
of convertible subordinated debentures -- 1,018 -- 1,018
--------- --------- ----------- -----------
Net loss $ (64,375) $(435,692) $ (516,772) $ (431,981)
========= ========= =========== ===========
Loss per share:
Basic - Continuing operations $ (0.87) $ (5.76) $ (7.02) $ (5.70)
Extraordinary item -- 0.01 -- 0.01
--------- --------- ----------- -----------
$ (0.87) $ (5.75) $ (7.02) $ (5.69)
========= ========= =========== ===========
Diluted - Continuing operations $ (0.87) $ (5.76) $ (7.02) $ (5.70)
Extraordinary item -- 0.01 -- 0.01
--------- --------- ----------- -----------
$ (0.87) $ (5.75) $ (7.02) $ (5.69)
========= ========= =========== ===========
Weighted average number of shared and dilutive
share equivalents outstanding:
Basic 73,841 75,722 73,623 75,916
Diluted 73,841 75,722 73,623 75,916
========= ========= =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three months and nine months ended September 30, 2000 and 1999
(All amounts are expressed in thousands)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
2000 1999 2000 1999
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss $(64,375) $(435,692) $(516,772) $(431,981)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 9,505 23,634 42,559 72,522
Minority interests 1,015 2,801 2,529 11,123
Provision for asset revaluation, restructuring and refinancing 54,158 393,358 485,243 417,246
Accretion of convertible subordinated debentures 1,688 563 5,063 563
Increase (decrease) in cash, net of effects of acquisitions
and dispositions, due to changes in:
Accounts receivable 10,456 9,246 27,124 14,224
Inventories 97 (1,170) 80 (433)
Prepaid expenses and other current assets 6,162 1,116 8,046 (16,462)
Accounts payable 2,049 (987) (2,226) 7,244
Due to physician groups (3,418) (8,876) (5,261) (5,827)
Incurred but not reported claims payable 8,595 (6,718) 16,988 (11,310)
Accrued restructuring reserves (8,369) (2,504) (20,834) (9,889)
Other accrued expenses and current liabilities (14,183) 59,916 (29,101) 59,148
-------- --------- --------- ---------
Net cash provided by operating activities 3,380 34,687 13,438 106,168
-------- --------- --------- ---------
Cash flows from investing activities:
Dispositions (acquisitions), net 60,439 38,428 99,220 2,928
Purchase of property and equipment (2,052) (13,426) (18,561) (37,262)
Proceeds (payments) for other assets 2,722 (3,993) 1,551 (8,946)
-------- --------- --------- ---------
Net cash provided (used) by investing activities 61,109 21,009 82,210 (43,280)
-------- --------- --------- ---------
Cash flows from financing activities:
Net proceeds from issuance of convertible notes -- 94,496 -- 94,496
Net proceeds from issuance of common stock 7 343 (125) 1,613
Repurchase of common stock -- (9,027) -- (9,027)
Repayment of long-term borrowings (72,084) (125,338) (98,848) (121,368)
Repayment of obligations under capital leases (675) (1,332) (2,713) (5,145)
Distributions of minority interests (619) (3,391) (3,379) (11,019)
Loan costs incurred (2,872) (4) (4,965) (789)
-------- --------- --------- ---------
Net cash used by financing activities (76,243) (44,253) (110,030) (51,239)
-------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents (11,754) 11,443 (14,382) 11,649
Cash and cash equivalents - beginning of period 58,084 74,520 60,712 74,314
-------- --------- --------- ---------
Cash and cash equivalents - end of period $ 46,330 $ 85,963 $ 46,330 $ 85,963
======== ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
PHYCOR, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Three months and nine months ended September 30, 2000 and 1999
(All amounts are expressed in thousands)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
2000 1999 2000 1999
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
SUPPLEMENTAL SCHEDULE OF INVESTING ACTIVITIES:
Effects of acquisitions and dispositions, net:
Assets acquired (disposed), net of cash $ 108 $ 7,885 $ (1,161) $ (25,703)
Liabilities paid (assumed), including deferred purchase
price payments (451) (2,805) (7,229) (12,225)
Cancellation of convertible subordinated notes payable -- (7,000) -- (7,000)
Cancellation of common stock and warrants -- (3,716) -- (4,076)
Cash received from disposition of clinic assets, net 60,782 44,064 107,610 51,932
-------- --------- --------- ---------
Dispositions (acquisitions), net $ 60,439 $ 38,428 $ 99,220 $ 2,928
======== ========= ========= =========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Notes receivable received from disposition of
clinic assets $ 4,875 $ 10,722 $ 23,770 $ 15,532
======== ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Three months and nine months ended September 30, 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. The Company's clinics do not directly enter capitated
contracts. Through calculation of its service fees, the Company shares
indirectly in any capitation risk assumed by its affiliated physician
groups.
IPA management revenue is equal to the difference between the amount of
capitation and risk pool payments 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 September 30, 2000,
the Company had underwritten letters of credit totaling $3.5 million
for the benefit of certain managed care payors to help ensure payment
of the 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
has settled outstanding matters with substantially all such contracts.
(Continued)
6
<PAGE> 7
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
The following table represents amounts included in the determination of
net revenue (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------------
2000 1999 2000 1999
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Gross physician group, hospital and other revenue $377,402 $821,213 $1,561,727 $2,607,694
Less:
Provisions for doubtful accounts
and contractual adjustments 180,927 359,429 715,403 1,120,656
-------- -------- ---------- ----------
Net physician group, hospital and other revenue 196,475 461,784 846,324 1,487,038
IPA revenue 229,123 270,538 751,072 819,479
-------- -------- ---------- ----------
Net physician group, hospital, IPA
and other revenue 425,598 732,322 1,597,396 2,306,517
Less amounts retained by physician groups
and IPAs:
Physician groups 65,776 155,554 279,635 511,870
Clinical technical employee compensation 9,488 21,137 38,841 66,582
IPAs 138,358 184,438 499,438 546,840
-------- -------- ---------- ----------
Net revenue $211,976 $371,193 $ 779,482 $1,181,225
======== ======== ========== ==========
</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 has 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Multi-specialty clinics:
Net revenue $ 108,179 $ 271,776 $ 486,278 $ 868,668
Operating expenses(1) 108,599 249,007 451,266 789,243
Interest income (1,699) (707) (4,787) (1,812)
Interest expense 8,369 19,301 31,730 60,218
Earnings (loss) before taxes and minority interest(1) (7,090) 4,175 8,069 21,019
Depreciation and amortization 3,097 17,951 24,655 55,569
Segment assets 189,240 861,179 189,240 861,179
IPAs:
Net revenue 90,765 86,100 251,634 272,639
Operating expenses(1) 87,013 80,719 268,871 248,212
Interest income (798) (654) (2,239) (1,899)
Interest expense 3,281 2,744 9,236 8,260
Earnings (loss) before taxes and minority interest(1) 1,269 3,291 (25,234) 18,066
Depreciation and amortization 3,419 3,429 10,588 10,427
Segment assets 172,595 298,803 172,595 298,803
Corporate and other(2):
Net revenue 13,032 13,317 41,570 39,918
Operating expenses(1) 19,047 20,985 63,422 63,691
Interest income (3,579) (11,834) (12,917) (38,280)
Interest expense 623 228 1,943 476
Earnings (loss) before taxes and minority interest(1) (3,059) 3,938 (10,878) 14,031
Depreciation and amortization 2,989 2,254 7,316 6,526
Segment assets 78,676 136,569 78,676 136,569
</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, Inc. 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 third quarter of 2000, the Company recorded an asset revaluation
and restructuring charge of approximately $54.2 million. This charge
included a net pre-tax asset revaluation charge of approximately $43.7
million, which was comprised of a $47.0 million asset revaluation
charge less recovery of $3.3 million of certain asset impairment
charges recorded in prior quarters and a $10.5 million restructuring
charge. 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 revaluation of certain assets associated with six clinics
held for sale, the impairment of long-lived assets related to debt
refinancing and the Company's decision to cease operations and exit
certain IPA markets.
At September 30, 2000, net assets held for sale and expected to be sold
during the next 12 months totaled approximately $184.6 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 September 30, 2000 were $31.9 million and $(3.4) million
for the three months ended September 30, 2000, and $209.1 million and
$(13.3) million for the nine months ended September 30, 2000,
respectively, compared to $185.2 million and $2.2 million for the three
months ended September 30, 1999, and $632.3 million and $16.5 million
for the nine months ended September 30, 1999, respectively. Net revenue
and pre-tax income (losses) from the operations held for sale at
September 30, 2000 were $118.0 million and $(7.5) million for the three
months ended September 30, 2000, and $376.5 million and $(7.0) million
for the nine months ended September 30, 2000, respectively, compared to
$116.0 million and $3.5 million for the three months ended September
30, 1999, and $343.6 million and $13.1 million for the nine months
ended September 30, 1999, respectively.
The Company completed the disposition of the assets of ten clinics
during the third quarter of 2000 and received consideration consisting
of $60.8 million in cash and $4.9 million in notes receivable, in
addition to certain liabilities assumed by the purchasers. The Company
recorded a net additional charge related to these sales of
approximately $1.6 million in the third quarter of 2000, which included
asset impairment recoveries of $3.3 million on asset impairment charges
taken in prior quarters.
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 operation, the Company's
decision to cease operations and exit an IPA market which was still in
the development stages, the expected sale of its CareWise, Inc.
subsidiary ("CareWise") and the consolidation of the Company's
administrative office space.
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.
9
<PAGE> 10
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.
The Company adopted and implemented restructuring plans and recorded
pre-tax restructuring charges of approximately $10.5 million in the
third quarter of 2000 with respect to operations that are being sold or
closed. These restructuring plans include the involuntary termination
of 199 clinic, IPA management, business office and corporate personnel.
These terminations are expected to be completed over the next six
months. At September 30, 2000, accrued restructuring reserves totaled
approximately $38.3 million. The Company estimates that approximately
$21.5 million of the restructuring reserves at September 30, 2000 will
be paid during the next 12 months. The remaining $16.8 million relates
primarily to long term lease commitments. The following table
summarizes the restructuring accrual and payment activity for the first
nine months of 2000 (in thousands):
<TABLE>
<CAPTION>
FACILITY
AND LEASE SEVERANCE OTHER
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
Third quarter 2000 charges 1,390 4,983 4,097 10,470
Payments (2,301) (3,569) (2,499) (8,369)
Other re-allocations (60) -- 60 --
-------- -------- ------- --------
Balances at September 30, 2000 $ 23,797 $ 7,773 $ 6,769 $ 38,339
======== ======== ======= ========
</TABLE>
(Continued)
10
<PAGE> 11
PHYCOR, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(5) REFINANCING COSTS
The Company recorded a refinancing charge of approximately $2.2 million
in the third quarter of 2000 related to the amendment and restatement
of its bank credit facility in August 2000. This charge represented
unamortized costs that were expensed as a result of the reduced
commitment amounts and the acceleration of the maturity date of the
bank credit facility. The amended bank credit facility converted
substantially all of the outstanding balances under the previous
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.
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 the reduced
commitment amounts and an earlier termination date of the bank credit
facility.
(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 level. 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. The state court actions were
consolidated in Davidson County, Tennessee. The Plaintiffs' original
consolidated class action compliant 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 Section 11 and 12 of the Securities
Act of 1933 for alleged misleading statements in a prospectus released
in connection with the CareWise acquisition. The amended complaint also
added KPMG, LLP (KPMG), the Company's independent public auditors. KPMG
removed this case to federal court and its motion to dismiss has been
denied. The Company, the individual defendants and KPMG have all filed
an answer. On October 20, 2000, this case was consolidated with the
original federal consolidated action and a consolidated complaint is to
be filed by December 1, 2000. The Company anticipates the state and
federal actions will be tried separately. The discovery process
continues. The trial of all the consolidated cases is set for November
6, 2001. 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
11
<PAGE> 12
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
established 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 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
it 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 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. On October 4, 2000, the court granted the Company's
summary judgment motions with respect to all of plaintiff's remaining
claims, granted the Company's summary judgment with respect to the
Company's $5 million indemnity counter claim against the plaintiffs
and granted the Company's summary judgment trespass counter claim
against Dr. Reddy, leaving for trial only a determination of the
extent of damages on the trespass counter claim. That trial date has
not been set pending settlement discussions by the parties ordered by
the court. Plaintiffs will likely appeal the court's determinations.
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. The judge assigned to this case is the same
judge presiding over the other Reddy matter discussed above. The
Company filed a motion to dismiss this new action. The court will not
render a decision on the Company's motion to dismiss until the parties
have completed their court ordered settlement discussions. Although the
Company intends to defend itself vigorously against Dr. Reddy's 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. In connection with this matter, the
court issued a preliminary injunction against Dr. Reddy and his
brother-in-law prohibiting them from acting in violation of their
existing noncompete agreements with the Company.
In September 2000, PrimeMed Pharmacy Services, Inc., a company in which
Dr. Reddy owns a controlling interest filed suit against PrimeCare
International, Inc. and nine affiliated medical groups alleging failure
to pay invoices for certain prescription drugs of approximately
$95,000. In addition, Desert Valley Medical, Inc., another company
controlled by Dr. Reddy, filed suit against PrimeCare Medical Group
Network and certain affiliated entities alleging failure to pay for
certain medical supplies and durable medical equipment totalling
approximately $1,800,000. All the actions were filed in the Superior
Court of the State of California for the County of Riverside. The
Company intends to vigorously defend these actions. There can be no
assurance, however that an adverse outcome in these actions would not
have a material adverse effect on the Company.
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. Court ordered mediation has
been delayed until December 2000 pending settlement discussions by the
parties. 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. Although the Company is vigorously defending this suit,
there can be no assurance that this suit will not have a material
adverse effect on the Company.
12
<PAGE> 13
In November 2000, the Company and Murfreesboro Medical Clinic dismissed
with prejudice all claims pending against each other in connection with
the sale of assets by the Company to the Murfreesboro Medical Clinic.
In November 2000, the Company and South Texas Medical Clinics dismissed
with prejudice all claims pending against each other in connection with
the sale of assets by the Company to the South Texas Medical Clinics.
In September 1999, three relators brought a claim in the United States
District Court for the District of Hawaii under the False Claims Act
against Straub Clinic and Hospital, Inc., the Company and one of the
Company's subsidiaries. This matter had been under seal until September
2000. On September 20, 2000, the United States government elected to
decline to intervene in the matter. It is uncertain if this action
will proceed. There can be no assurance that if this action proceeds
and ultimately is determined in favor of the plaintiffs, the adverse
determination 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 judgement on July 13, 2000. The
Company recorded as other operating expenses this judgement of $4.6
million in the second quarter of 2000. PrimeCare is appealing the
verdict, and a retrial of the Medicare fraud claims will not occur
until there is a ruling on PrimeCare's appeal. Plaintiff filed a
judgment lien against PrimeCare on August 31, 2000. PrimeCare has not
posted a bond in this matter. 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 judgement against
PrimeCare would not have a material adverse effect on PrimeCare. In
September 2000, Dr. Reddy filed an action in Delaware Chancery Court
seeking from PrimeCare advancement of expenses for a bond in the Benz
matter. On October 20, 2000, the court granted PrimeCare's motion for
summary judgment to dismiss this action.
The U.S. Department of Labor (the "Department") has concluded its
investigation of the administration of the Phycor, Inc. Savings and
Profit Sharing Plan. The Department has notified the Company that it
will take no further action against the Company in connection with the
investigation. The Company is required to periodically review its
performance on the timing of participant contributions. The Company
intends to fully cooperate with the Department's requests.
13
<PAGE> 14
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. 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. During
2000, the Company resolved its outstanding IRS examination for the
years 1996 through 1998. The IRS examination resulted in an adjustment
to the 1998 loss carryback and accordingly the Company repaid
approximately $1.2 million plus interest, as a result of revisions in
the alternative minimum tax calculation. The tax years 1988 through
1998 have been closed with respect to all issues without a material
financial impact. 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. As of December 31, 1999, the Company had
approximately $350.2 million in net operating loss carryforwards;
accordingly, the Company does not expect to pay current federal income
taxes for the foreseeable future.
As a result of the Company's determination to exit its IPA market in
Houston, Texas, a number of providers in the market have brought
actions naming several parties, including the Company and an
IPA-management subsidiary of the Company, alleging breach of contract,
among other matters. There can be no assurance that additional actions
will not be brought against the Company and its subsidiaries as a
result of the Company's determination to exit this market. There can be
no assurance that if these matters are determined adversely to the
Company that such determinations would not have a material adverse
effect on the Company.
Certain litigation is pending against the physician groups affiliated
with the Company and IPAs managed by the Company. The Company has not
assumed any liability in connection with such litigation. Claims
against the physician groups and IPAs could result in substantial
damage awards to the claimants which may exceed applicable insurance
coverage limits. While there can be no assurance that the physician
groups and IPAs will be successful in any such litigation, the Company
does not believe any such litigation will have a material adverse
effect on the Company. Certain other litigation is pending against the
Company and certain subsidiaries of the Company, none of which
management believes would have a material adverse effect on the
Company's financial position or results of operations on a consolidated
basis.
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<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 develops and manages independent practice associations
("IPAs"), provides contract management services to physician networks owned by
health systems and manages multi-specialty medical clinics and other medical
organizations. 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 two health maintenance organizations ("HMOs").
At September 30, 2000, the Company managed IPAs with approximately
18,000 physicians in 17 markets and managed 17 clinics with 1,145 physicians in
11 states. All of the clinics were held for sale. On such date, the Company's
affiliated physicians provided medical services under capitated contracts to
approximately 1.1 million patients, including approximately 200,000
Medicare/Medicaid eligible patients. As described below, the Company is in
discussions with all of its clinics to restructure or terminate its service
agreements. The Company has also determined to cease operations in two IPA
markets and has recorded asset revaluation and restructuring charges related to
those markets. The Company also provided health care decision-support services
to approximately 3.3 million individuals through its CareWise subsidiary. The
Company is seeking to sell a minority interest in CareWise, although, as of the
date hereof, no agreement regarding a transaction has been reached.
The assets of all of the Company's clinic subsidiaries, including the
two HMOs and one hospital owned by the Company are held for sale. The Company is
negotiating with 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 most 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
anticipates that these restructuring efforts and substantially all of the asset
sales should be completed during the first quarter of 2001. The Company is
obligated to use substantially all of the cash proceeds from the asset sales to
meet its financial obligations under its bank credit facility until such
obligations are satisfied in full. 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, including interest payments on its
convertible subordinated debentures. Such difficulty could cause a material
adverse effect on the Company and cause the Company to seek relief under United
States bankruptcy laws. 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 third quarter of 2000, the Company recorded an asset revaluation
and restructuring charge of approximately $54.2 million. This charge was
comprised of a $47.0 million asset revaluation charge less recovery of $3.3
million of certain asset impairment charges recorded in prior quarters and $10.5
million of restructuring charges. The asset revaluation charge consisted of
approximately $29.0 million related to assets held for sale, $12.5 million
related to assets sold or disposed of during the third quarter and $2.2 million
related to the write-down of deferred loan costs. The asset revaluation and
restructuring charge primarily resulted from the decision to exit two IPA
markets and to mark-to-market certain real estate holdings and clinic assets
held for sale.
The continued sales of the Company's assets related to its affiliated
multi-specialty clinics and termination of the related service agreements will
result in a significant reduction in the Company's revenues. As of November 13,
2000, the Company had completed the disposition of six clinics and certain real
estate during the fourth quarter of 2000 and received proceeds totaling $56.7
million in cash in addition to certain liabilities being assumed by the
purchasers. After the anticipated clinic asset sales and termination of the
related service agreements, the Company believes that
15
<PAGE> 16
it will derive only a small percentage of its revenues from the provision of
management services to clinics. The Company believes that it will maintain
management agreements with no more than five of its affiliated clinics after the
consummation of the anticipated sales. The Company expects revenue from these
contracts to be less than $5 million on an annual basis. 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. The Company determined in the third quarter of 2000 to cease operations
in Houston, Dallas and two other IPA markets. Two IPA markets were closed during
the third quarter of 2000 for which asset revaluation and restructuring charges
were recorded in the fourth quarter of 1999. Closure of the Houston and Dallas
operations is expected to be completed during the fourth quarter of 2000. These
closure decisions may negatively impact a number of the Company's payor
relationships and, if so, the Company may be materially adversely affected. The
Company classified the net assets of its Kentucky HMO and CareWise as held for
sale in the second quarter of 2000. The Kentucky HMO was placed voluntarily in
rehabilitation with the State of Kentucky in November 2000 because of its
inability to meet the net worth requirements under state insurance laws. It is
expected to be placed in voluntary receivership in 60 days. Kentucky insurance
regulators have assumed responsibility for the HMO's operations.
Despite the recent losses in certain IPA markets, the Company believes
that the Company's IPA management division's revenues will comprise a
substantial majority of the Company's total revenue in 2001 and beyond primarily
because of the sale of the clinic assets and termination of the related service
agreements. A majority of the Company's IPA management revenue is derived from
its operations in California through its PrimeCare International, Inc.,
("PrimeCare"), subsidiary. The success of the IPA management division in future
periods is in large part dependent on the performance of PrimeCare Medical
Network, Inc. ("PCMN"), a subsidiary of PrimeCare, PCMN's contracting IPAs and
the managed care environment in California. The Company has suffered losses in
PrimeCare to date in 2000, in part because of unfavorable hospital and payor
contract renegotiations and expenses relating to litigation which arose prior to
its acquisition by PhyCor. In addition, the State of California's Department of
Managed Health Care, which regulates health plans in the State of California,
and the Company have reached an agreement regarding the funding of certain cash
reserve requirements for claims payment. The Company would be adversely affected
if the Company failed to maintain compliance with that agreement and California
regulators took corrective action.
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 and to further develop physician relationships. 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 its affiliated 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
and The Morgan Health Group, Inc. ("MHG") acquisitions, the Company became a
party to certain managed care contracts and, accordingly is 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 and has
settled the outstanding matters relating to substantially all such contracts. In
addition, at September 30, 2000, the Company had underwritten letters of credit
totaling $3.5 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 classified the net assets of its health care decision
support services division, CareWise, as held for sale in the second quarter of
2000. The Company is seeking to sell a minority interest in CareWise. As of the
date hereof no agreement regarding a transaction has been reached. There can be
no assurance that the Company will reach an agreement regarding a CareWise
transaction. In the event the Company does not reach an agreement, the Company
may incur additional charges to earnings.
As discussed above, in the first nine months of 2000, the Company sold
the assets of many of its affiliated multi-specialty clinics and anticipates
selling the assets of substantially all of its remaining clinics by the end of
the first quarter of 2001. The Company believes that its revenues will
significantly decline in the year 2001 and beyond compared to the revenues for
2000. The Company further believes management arrangements with clinics will
constitute only a small percentage of its revenues and that its IPA management
division's revenues will constitute the substantial majority of its revenues in
the future. The success of the IPA management services division, and therefore
the Company, is contingent in large part on the financial success of the
Company's PrimeCare
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<PAGE> 17
subsidiary. In the event the IPA management division is unprofitable, there can
be no assurance that the Company will be able to continue its operations or
return to profitability.
RESULTS OF OPERATIONS
The following table shows the percentage of net revenue represented by
various expenses and other income items reflected in the Company's Consolidated
Statements of Operations:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
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 ........... 26.6 13.1 22.4 13.2
Salaries, wages and benefits ........ 28.4 32.9 30.9 32.4
Supplies ............................ 11.6 14.7 12.9 14.6
Purchased medical services .......... 1.6 2.4 2.0 2.4
Other expenses ...................... 20.6 15.3 17.7 14.8
General corporate expenses .......... 1.9 1.9 2.4 1.9
Rents and lease expense ............. 6.1 7.8 6.9 7.8
Depreciation and amortization ....... 4.5 6.4 5.5 6.1
Provision for asset revaluation
and clinic restructuring ......... 25.5 106.0 62.2 35.3
------ ------ ------ ------
Net operating expenses .................. 126.8 200.5 162.9 128.5
------ ------ ------ ------
Loss from operations ............. (26.8) (100.5) (62.9) (28.5)
Interest income ......................... (0.9) (0.3) (0.6) (0.3)
Interest expenses ....................... 3.8 2.7 3.6 2.6
------ ------ ------ ------
Loss before income taxes, minority
interest and extraordinary item (29.7) (102.9) (65.9) (30.8)
Income tax expense ...................... 0.2 14.0 0.1 4.9
Minority interest ....................... 0.5 0.8 0.3 1.0
------ ------ ------ ------
Loss before extraordinary item ... (30.4) (117.7) (66.3) (36.7)
Extraordinary item ...................... -- 0.3 -- 0.1
------ ------ ------ ------
Net loss ......................... (30.4)% (117.4)% (66.3)% (36.6)%
====== ====== ====== ======
</TABLE>
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<PAGE> 18
2000 Compared to 1999
Net revenue decreased $159.2 million, or 42.9%, from $371.2 million for
the third quarter of 1999 to $212.0 million for the third quarter of 2000, and
$401.7 million, or 34.0%, from $1.2 billion for the first nine months of 1999 to
$779.5 million for the first nine months of 2000. Net revenue from
multi-specialty clinics ("Clinic Net Revenue") decreased in the third quarter of
2000 from the third quarter of 1999 by $163.6 million. The decrease was
comprised of (i) a $132.5 million decrease in service fees for reimbursement of
clinic expenses incurred by the Company and (ii) a $31.1 million decrease in the
Company's fees from clinic operating income and net physician group revenue.
Decreases in Clinic Net Revenue for the quarter included reductions of $11.6
million from clinics whose assets were held for sale at September 30, 2000
and reductions of $153.6 million as a result of clinic operations disposed of
in 1999 and 2000. Increases in Clinic Net Revenue for the quarter included $1.6
million in fees from management contracts 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 43.5% for the third quarter of 1999 to 47.6% for the third quarter of
2000.
Clinic Net Revenue decreased in the first nine months of 2000 from the
first nine months of 1999 by $382.4 million. The decrease was comprised of (i) a
$320.8 million decrease in service fees for reimbursement of clinic expenses
incurred by the Company and (ii) a $61.6 million decrease in the Company's fees
from clinic operating income and net physician group revenue. Net decreases in
Clinic Net Revenue for the first nine months included decreases of $7.4 million
from clinics whose assets were held for sale at September 30, 2000 and decreases
of $379.9 million from clinic operations disposed of in 1999 and 2000. Clinic
Net Revenue for the first nine months of 2000 included $4.9 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 the result of 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 43.0% for the nine months ended September 30, 1999
to 45.7% for the nine months ended September 30, 2000.
Net revenue from IPAs ("IPA Net Revenue") increased $4.7 million, or
5.4%, from $86.1 million for the third quarter of 1999 to $90.8 million for the
third quarter of 2000 and decreased $21.0 million, or 7.7%, from $272.6 million
for the first nine months of 1999 to $251.6 million for the first nine months of
2000. The closing of MHG in 1999 caused a decrease in IPA Net Revenue of
approximately $18.0 million in the first nine 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. IPA Net Revenue decreased approximately $4.9 million during
the third quarter of 2000 and $33.5 million in the first nine months of 2000
primarily as a result of the decisions to restructure, and then in the third
quarter of 2000, to close the Houston, Dallas and two other IPA markets. IPA Net
Revenues during the third quarter and first nine months of 2000 included an
increase of approximately $400,000 and $1.8 million, respectively, in net
revenues from an IPA market and a management agreement entered into subsequent
to the third quarter of 1999. Additionally, IPA Net Revenues increased $13.7
million during the third quarter of 2000 and $40.2 million for the first nine
months of 2000 due to the Company's acquisition of the remaining interest in the
Kentucky HMO in late 1999. This HMO was placed voluntarily in rehabilitation
with the State of Kentucky in November 2000 as a result of minimum net worth
deficiencies under state insurance laws. It is expected to be placed in
voluntary receivership in 60 days. IPA Net Revenue from the IPA markets in
effect for the third quarters of both 2000 and 1999 decreased by $4.6 million,
or 7.3% and $11.5 million, or 6.2% for the first nine months of 2000 compared to
the same period in 1999 as a result of unfavorable hospital and payor contract
renegotiations for 2000 at PrimeCare.
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<PAGE> 19
During the first nine months of 2000, cost of provider services expense
increased as a result of the Company acquiring the remaining 50% interest in
the Kentucky HMO in late 1999. Other expenses increased as a result of costs
associated with information systems and software conversions in 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. In an effort to
obtain prepayment of several notes receivable, the Company negotiated discounts
totaling $3.8 million which were recorded as other expenses in the third
quarter of 2000. The increase in interest expense as percentage of net revenue
in the first nine 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 have entered
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 two HMOs. Incurred but not reported claims payable
("IBNR claims payable") represent 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.
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
September 30, 2000, letters of credit aggregating $3.5 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 third quarter of 2000, the Company recorded an asset revaluation
and restructuring charge of approximately $54.2 million. This charge was
comprised of a $47.0 million asset revaluation charge less recovery of $3.3
million of certain asset impairment charges recorded in prior quarters and a
$10.5 million restructuring charge. The net asset revaluation charge consisted
of approximately $29.0 million related to assets held for sale, $12.5 million
related to assets sold or disposed of during the third quarter and $2.2 million
related to the write-off of deferred financing costs. The asset revaluation and
restructuring charges primarily resulted from the decision to exit four IPA
markets and to mark-to-market certain real estate holdings and assets held for
sale. See discussion of these charges in "Asset Revaluation and Restructuring"
below.
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.
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The Company recorded a refinancing charge of approximately $2.2 million
in the third quarter of 2000 related to the amendment and restatement of the
bank credit facility in August 2000. This charge represented unamortized costs
that were expensed as a result of the lower commitment amounts and an earlier
termination date of the bank credit facility. The amended bank credit facility
converted substantially all of the outstanding balances under the previous
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.
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 the lower commitment amounts and an earlier
termination date of the bank credit facility.
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 nine months
of 2000 represented state income tax expense.
ASSET REVALUATION AND RESTRUCTURING
General
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 has contacted all its clinics 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 most clinics intend to repurchase
all or a portion of the related assets and has categorized all its clinic assets
as held for sale. Management intends to negotiate with the clinics for the sale
and repurchase of the assets at 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
believes that it will maintain service agreements with no more than five of its
affiliated clinics. 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. Two IPA
markets were closed during the third quarter of 2000. In addition, the Company
determined in the third quarter to cease operations in the Dallas and Houston
IPA markets and recorded asset revaluation and restructuring charges for those
markets. The Company classified the net assets of its Kentucky HMO and CareWise
as held for sale in the second quarter of 2000. The Kentucky HMO was placed
voluntarily in rehabilitation with the state of Kentucky in November 2000 due to
its inability to meet net worth requirements of the state insurance laws. It is
expected to be placed in voluntary receivership in 60 days. Kentucky insurance
regulators have assumed responsibility for the Kentucky HMO's operations.
In the third quarter of 2000, the Company recorded an asset revaluation
and restructuring charge of approximately $54.2 million. This charge included a
net pre-tax asset revaluation charge of approximately $43.7 million, which was
comprised of a $47.0 million asset revaluation charge less recovery of $3.3
million of certain asset impairment charges recorded in prior quarters and a
$10.5 million restructuring charge. The net asset revaluation charge consisted
of approximately $29.0 million related to assets held for sale, $12.5 million
related to assets sold or disposed of during the third quarter and $2.2 million
related to the write-off of deferred financing costs. The asset revaluation and
restructuring charge primarily resulted from the decision to exit four IPA
markets and to mark-to-market certain real estate holdings and assets held for
sale.
In the second quarter of 2000, the Company recorded an asset
revaluation and restructuring charge of approximately $407.3 million. The charge
was comprised of an asset revaluation charge of approximately $370.2 million
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 charge also included
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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 charge was 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
exit 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 exits additional
markets or restructures is operations.
Assets Held for Sale
At September 30, 2000, net assets held for sale primarily consisted of
the net assets of 18 clinics, the Company's Kentucky HMO operations, CareWise
and certain real estate holdings which totaled approximately $184.6 million,
including $39.6 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 November 13, 2000, the Company had
completed the disposition of six clinics and certain real estate in the fourth
quarter of 2000 and received proceeds totaling $56.7 million in cash 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 March 31, 2001 of the assets of substantially all of its remaining 12
clinics, one of which, Arnett Clinic, accounted for more than 10% of the
Company's earnings before interest, taxes, depreciation, amortization ("EBITDA")
and provision for asset revaluation and restructuring for the nine months ended
September 30, 2000. The Company expects to recover in excess of tangible book
value of the assets of these clinics held for sale, 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 third quarter of 2000, the Company recorded approximately $29.0
million of asset revaluation charges for the impairment of long-lived assets of
certain of its ongoing operating units related to assets held for sale and $12.5
million related to assets sold or disposed of during the quarter. The third
quarter asset revaluation charge related to assets held for sale including
current assets, property and equipment, and intangible assets of $1.4 million,
$17.4 million and $10.2 million, respectively. In the third quarter of 2000, the
Company classified as held for sale ten additional clinics, two of which were
included in the asset impairment charge taken in the third quarter of 1999 and
eight of which were included in the asset impairment charge taken in the second
quarter of 2000. The Company's decision to classify the assets as held for sale
was based upon management's decision to sell all remaining clinic assets back to
the respective physician groups irrespective of any ongoing management
relationship. In addition, the Company classified as held for sale certain real
estate holdings. The net assets held for sale for the operating units classified
as held for sale during the third quarter were approximately $60.7 million on
September 30, 2000, and consisted primarily of accounts receivable, property and
equipment and intangible assets less certain current liabilities.
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 including 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 these assets as held for sale was based upon correspondence received
from its 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. The Company disposed of six of these clinics in the third quarter
of 2000, receiving consideration consisting of $51.0 million in cash and $4.9
million in notes receivable and certain liabilities assumed by the purchasers.
Net revenue and pre-tax income from the clinics sold were approximately $12.7
million and $600,000 ,respectively, for the quarter ended September 30, 2000,
and $100.4 million and $4.5 million, respectively, for the nine months ended
September 30,
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2000. Net revenue and pre-tax income from the clinics sold were approximately
$39.5 million and $1.8 million, respectively, for the quarter ended September
30, 1999 and $117.1 million and $6.6 million, respectively, for the nine months
ended September 30, 1999. At September 30, 2000, the net assets held for sale
for the remaining four clinics, Kentucky HMO operations and CareWise were
approximately $67.2 million and consisted primarily of accounts receivable,
property and equipment and intangible assets less certain current liabilities.
During the second quarter of 2000, the assets of one clinic were sold
and the Company received 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 $6.1 million and $600,000, respectively,
for the nine months ended September 30, 2000. Net revenue and pre-tax income
from the clinic sold were approximately $3.4 million and $300,000, respectively,
for the quarter ended September 30, 1999 and $10.4 million and $900,000,
respectively, for the nine months ended September 30, 1999.
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 for $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 operating assets of the clinics 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 third quarter of 2000, receiving
consideration consisting of $2.1 million in cash and certain liabilities assumed
by the purchasers. Net revenue from the clinic sold was approximately $800,000
for the quarter ended September 30, 2000. Net revenue and pre-tax income from
the clinic sold were approximately $6.0 million and $300,000, respectively, for
the nine months ended September 30, 2000. Net revenue and pre-tax income from
the clinic sold were approximately $2.6 million and $100,000, respectively, for
the quarter ended September 30, 1999 and $8.1 million and $400,000,
respectively, for the nine months ended September 30, 1999. The net assets held
for sale for the remaining two clinics in this group at September 30, 2000 were
approximately $12.0 million and consisted primarily of accounts receivable,
property and equipment 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 nine months ended September 30,
2000. Net revenue and pre-tax income from the clinic sold were approximately
$800,000 and $200,000, respectively, for the quarter ended September 30, 1999
and $2.6 million and $700,000, respectively, the nine months ended September 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 $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
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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 nine months ended September 30, 2000. Net revenue and pre-tax income
(losses) from these two clinics were approximately $21.6 million and $(100,000),
respectively, for the quarter ended September 30, 1999 and $65.4 million and
$900,000, respectively, for the nine months ended September 30, 1999.
In summary, net revenue and pre-tax income (losses) from operations
disposed of or closed during the third quarter ended September 30, 2000 were
$31.9 million and $(3.4) million for the three months ended September 30, 2000,
and $209.1 million and $(13.3) million for the nine months ended September 30,
2000, respectively, compared to $185.2 million and $2.2 million for the three
months ended September 30, 1999, and $632.3 million and $16.5 million for the
nine months ended September 30, 1999, respectively. Net revenue and pre-tax
income (losses) from the operations held for sale at September 30, 2000 were
$118.0 million and $(7.5) million for the three months ended September 30, 2000,
and $376.5 million and $(7.0) million for the nine months ended September 30,
2000, respectively, compared to $116.0 million and $3.5 million for the three
months ended September 30, 1999, and $343.6 million and $13.1 million for the
nine months ended September 30, 1999, respectively.
The Company expects that most 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 year 2001 and thereafter compared to the revenues for 2000. The Company
anticipates the proceeds generated from the sales of 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. The
Company may incur additional charges to earnings if the asset sales are not
consummated, or are consummated on less favorable terms. Such events could have
a material adverse effect on the Company. There can be no assurance that the
Company will remain a viable entity or return to profitability.
Asset Impairments
In the second quarter of 2000, the Company recorded an asset
revaluation charge of approximately $151.9 million 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 this asset revaluation charge 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
$17.4 million and $(7.0) million for the nine months ended September 30, 2000,
respectively, compared to $32.3 million and $10.0 million for the nine months
ended September 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 it 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
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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 the IPA market. The Company determined to cease operations
in one market in 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.
Refinancing Costs
In the third quarter of 2000, the Company recorded approximately $2.2
million of asset revaluation charges related to the amendment and restatement of
the bank credit facility in August 2000. This charge represented unamortized
costs that were expensed as a result of the reduced commitment amounts and the
acceleration of the maturity date of the bank credit facility. The amended bank
credit facility converted substantially all of the outstanding balances under
the previous 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.
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 the reduced commitment amounts and an earlier
termination date of the bank credit facility.
Restructuring Charges
In the third quarter of 2000, the Company adopted and implemented
restructuring plans and recorded a pre-tax restructuring charge of approximately
$10.5 million. This charge was comprised of approximately $1.2 million related
to the operations of clinics that were closed, $7.9 million related to
management's plans to cease operations and exit the Dallas and Houston IPA
markets, and $1.4 million related to reductions in personnel at the corporate
office. This charge included approximately $5.0 million in severance costs, $1.4
million in facility and lease termination costs and $4.1 million in other exit
costs. These restructuring plans included the involuntary termination of 199
clinic, IPA management, business office and corporate personnel.
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 included 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.
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.
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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.
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 third quarter and first nine months of 2000, the Company
paid approximately $2.3 and $3.3 million, respectively, in facility and lease
termination costs, $3.6 million and $11.6 million respectively, in severance
costs and $2.5 million and $5.9 million, respectively, in other exit costs
related to 1998, 1999 and 2000 charges. At September 30, 2000, accrued
restructuring reserved totaled approximately $38.3 million and consisted of
approximately $23.8 million in facility and lease termination costs, $7.8
million in severance costs and $6.7 million in other exit costs. The Company
estimates that approximately $21.5 million of the remaining restructuring
reserves at September 30, 2000 will be paid during the next 12 months. The
remaining $16.8 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
The Company's primary business liquidity strategy in 2000 has been to
sell assets in its medical clinic business and to apply the proceeds to the
amounts outstanding under its bank credit facility. If the Company fails to meet
its principal and interest payment obligations under the bank credit facility or
its convertible subordinated debentures, it may not remain a viable business
entity and may be forced to seek relief under the United States bankruptcy laws.
At September 30, 2000, current liabilities exceeded current assets of the
Company by $12.7 million, compared to $193.8 million of working capital at
December 31, 1999 primarily as a result of the reclassification of the restated
bank credit facility obligation as a current liability beginning June 30, 2000.
At September 30, 2000, the Company had $46.3 million in cash and cash
equivalents, including $40.2 million of restricted cash and cash equivalents,
compared to $60.7 million and $29.6 million, respectively, at December 31, 1999.
Restricted cash and cash equivalents include amounts held by IPA partnerships
and HMOs, the use of which is restricted to operations of the IPA
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partnerships or to meet regulatory deposit requirements. At September 30, 2000,
net accounts receivable, including that held for sale, of $156.7 million
amounted to 53 days of net clinic revenue compared to $283.4 million and 55 days
at the end of 1999.
The Company generated $3.4 million of cash flows from operations for
the third quarter of 2000 compared to $34.7 million for the third quarter of
1999 and $13.4 million for the first nine months of 2000 compared to $106.2
million for the same period in 1999. Cash flows from operations of clinics that
were disposed of or closed at September 30, 2000 resulted in a decrease of $6.9
million for the quarter ended September 30, 2000 compared to the quarter ended
September 30, 1999 and $30.5 million for the first nine months of 2000 compared
to the first nine months of 1999. The Company's IPA management division has
experienced losses in certain markets. The Company ceased operations in a
development stage IPA market in the second quarter of 2000, two IPA markets in
the third quarter of 2000 and determined, in the third quarter of 2000, to exit
the Houston and Dallas IPA markets. Cash flows related to the Company's IPA
operations increased $4.2 million in the third quarter of 2000 compared to the
third quarter of 1999 and decreased $34.4 million, of which $30.4 million
related to the Company's IPA operations in Houston, in the first nine months of
2000 compared to the first nine months of 1999.
As of November 13, 2000, the Company had completed the disposition of
six clinics and certain real estate in the fourth quarter of 2000 and received
proceeds totaling $56.7 million in cash 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 March 31, 2001 of the
assets of substantially all of its remaining 12 clinics, one of which, Arnett
Clinic, accounted for more than 10% of the Company's earnings before interest,
taxes, depreciation, amortization ("EBITDA") and provision for asset revaluation
and restructuring for the nine months ended September 30, 2000. The Company
expects to recover in excess of tangible book value of the assets of these
clinics held for sale, 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.
The Company is required to make interest payments of $4.4 million to
holders of its convertible subordinated debentures on each of February 15 and
August 15, 2001. The Company's ability to make these payments is dependent on
two factors. First, the Company must have sufficient cash flow from operations
and second, the Company must have access to cash under the bank credit facility,
if necessary. The majority of the revenue earned by the IPA division is derived
from its operations in California, specifically PrimeCare. If these operations
do not generate sufficient cash flow, the Company may be unable to meet the
interest payment obligations on its convertible subordinated debentures. There
can be no assurance that the Company will have the positive cash flow or the
access to cash necessary to meet its interest payment obligations. The Company's
convertible subordinated debentures mature February 1, 2003 at the aggregate
redemption amount of $196.5 million. There can be no assurance that the Company
will be able to develop a strategy to successfully redeem or otherwise retire
the debentures.
Capital expenditures during the first nine months of 2000 totaled $18.6
million. The Company is responsible for capital expenditures at its affiliated
clinics under the terms of its service agreements. The Company expects to make
approximately $1.0 million in additional capital expenditures during the
reminder of 2000. The Company anticipates capital expenditures will be funded
primarily from operating cash flows. Capital expenditures in future years will
be significantly less than in 2000.
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 $5.6 million of additional
consideration over the next two years, of which a maximum of approximately
$600,000 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. 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. During 2000, the Company resolved its outstanding IRS examination for the
years 1996 through 1998. The IRS examination resulted in an adjustment to the
1998 loss carryback and accordingly the Company repaid approximately $1.2
million plus interest, as a result of revisions in the alternative minimum tax
calculation. The tax years 1988 through 1998 have been closed with respect to
all issues without a
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material financial impact. 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. As of December 31, 1999, the
Company had approximately $350.2 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, June and
August 2000 and its synthetic lease facility in January and August 2000. The
bank credit facility, as amended August 25, 2000, provided for the conversion of
outstanding balances under the previous 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 are 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 restated credit
facility also includes a senior secured revolving loan of up to $10 million
("New Revolving Loan"). Under the 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, the aggregate balance of the Term
Loan and Revolving Loan is required to be reduced each month end until maturity
on June 30, 2001. The Company was not in compliance with certain non-payment
related financial covenants as of September 30, 2000, and is in the process of
obtaining a waiver of such non-compliance. The Company believes that it will
obtain the necessary waiver by November 21, 2000. There can be no assurance that
the Company will obtain the expected waiver. Failure to obtain the waiver would
have material adverse effect on the Company.
The Company is obligated to use substantially all of the expected cash
proceeds from the asset sales to meet its financial obligation under the
restated bank credit facility until all such obligations are satisfied. 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, the convertible subordinated
debentures 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 September 30,
2000, was either (i) the applicable eurodollar rate plus 4.50% to 8.00% per
annum or (ii) the agent's base rate plus 1.00% per annum. The total weighted
average drawn cost of outstanding borrowings at September 30, 2000 was 11.15%.
Outstanding borrowings under the bank credit 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. The bank credit facility
contains covenants which, among other things, requires the Company to maintain
minimum financial ratios and imposes limitations or prohibitions on the Company
with respect to (i) the incurring of certain indebtedness, (ii) the creation of
security interests on the assets of the Company, (iii) the payment of cash
dividends on, and the redemption or repurchase of, securities of the Company,
(iv) investments and (v) acquisitions.
The Company'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 August 2000 amendment resulted in the conversion
of $19.3 million of amounts outstanding under the synthetic lease facility into
the term loan under the bank credit facility. The total drawn cost under the
synthetic lease facility at September 30, 2000 was 4.50% to 5.25% above the
applicable eurodollar rate. At September 30, 2000, an aggregate of $4.3 million
was outstanding under the synthetic lease facility. In November 2000, all such
amounts were repaid using asset sale proceeds and the synthetic lease facility
was terminated.
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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. 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 which were used to reduce amounts
outstanding under its bank credit facility. 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. If the Company had retained the swap agreements,
adoption of SFAS No. 133 would have required the Company to mark certain of its
interest rate swap agreements to market due to lender optionality features
included in those swap agreements The Company has historically not engaged in
trading activities in its interest rate swap agreements and does not intend to
so do in the future.
During the second quarter of 1999, the Company announced a definitive
agreement allowing for a strategic investment in the Company 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 shares 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.
In addition, as a result of the charges recorded by the Company in the
second quarter of 2000, the Company no longer satisfied the minimum net tangible
asset listing requirements of the NASDAQ Stock Market, Inc. ("NASDAQ"), and
accordingly, its common stock was delisted as of August 25, 2000. The Company's
common stock immediately began trading on the OTC Bulletin Board. The Company's
delisting will 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
its 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
September 30, 2000, the Company received consideration which consisted of
approximately $60.8 million in cash and $4.9 million in notes receivable, in
addition to certain liabilities being assumed by the purchasers, related to the
sale of clinic assets and real estate. For the nine months ended September 30,
2000, the Company received consideration which consisted of approximately $107.6
million in cash and $23.8 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 $12.5 million
was recorded in the third quarter of 2000 and $38.2 million was recorded during
the first nine 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 approximately the post-charge net carrying value, with the exception of
Holt-Krock Clinic, for which an
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additional asset impairment charge of $2.2 million was recorded in the third
quarter of 1999, a clinic for which an additional net 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. During the third
quarter and first nine months of 2000, the Company received payments on notes
receivable of approximately $1.2 million and $3.7 million, respectively. During
1999, the Company received payments on notes receivable of approximately $3.9
million.
As of November 13, 2000, the Company had received consideration which
consisted of $56.7 million in cash, in addition to certain liabilities assumed
by the purchasers, related to the sale of clinic assets and real estate in the
fourth quarter of 2000.
During 1999 and 2000, the Company 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 third quarter and first nine months of 2000, the Company
paid approximately $2.3 million and $3.3 million in facility and lease
termination costs, respectively, $3.6 million and $11.6 million in severance
costs, respectively, and $2.5 million and $5.9 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 $21.5
million of the remaining restructuring charges at September 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
The Company is negotiating with 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 most 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 substantially all
of the asset sales should be completed during the first quarter of 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 remaining 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 asset 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 September 30, 2000, the Company had cash and cash equivalents of
approximately $46.3 million, including $40.2 million of restricted cash and cash
equivalents, and at November 13, 2000, approximately $9.2 million available
under its bank credit facility.
The Company's ability to meet its financial obligations under its bank
credit facility is dependent upon the receipt of sufficient proceeds from the
asset sales. In addition, its ability to make the semi-annual interest payments
due on its convertible subordinated debentures in 2001 and beyond is dependent
upon having sufficient cash flow from operations and having access to cash under
the bank credit facility, if necessary. There can be no assurance that the
Company will be able to fund the principal or interest payments on the credit
facility or the debentures. Failure to meet its principal or interest payment
obligations would have a material adverse effect on the Company.
The Company has limited sources of capital. The bank credit facility
restricts the Company's ability to incur
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additional indebtedness. Further, the restated bank credit facility matures on
June 30, 2001. The Company does not currently anticipate any additional
borrowings will be available from the Company's banks after such maturity and it
will be required to seek additional sources of capital if cash flow from
operations is not sufficient to meet its obligations. There can be no assurance
that any additional financing will be available or available on terms acceptable
to the Company. In the event the Company is unable to obtain additional
financing on agreeable terms or to generate sufficient cash flows from its
operations, the Company may be forced to seek relief under United States
bankruptcy laws. The Company's current stock price, 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 in a timely manner 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 reserves.
FORWARD-LOOKING STATEMENTS
Forward-looking statements of PhyCor included herein or incorporated by
reference including, but not limited to, those regarding the viability of the
Company, 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 affiliated
model and fixed fee patient arrangements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
During the nine months ended September 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 level. 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. The state
court actions were consolidated in Davidson County, Tennessee. The Plaintiffs'
original consolidated class action compliant in state court
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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 Section 11 and 12 of the Securities Act of 1933 for
alleged misleading statements in a prospectus released in connection with the
CareWise acquisition. The amended complaint also added KPMG, LLP (KPMG), the
Company's independent public auditors. KPMG removed this case to federal court
and its motion to dismiss has been denied. The Company, the individual
defendants and KPMG have all filed an answer. On October 20, 2000, this case was
consolidated with the original federal consolidated action and a consolidated
complaint is to be filed by December 1, 2000. The Company anticipates the state
and federal actions will be tried separately. The discovery process continues.
The trial of all the consolidated cases is set for November 6, 2001. 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 established 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
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 it 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 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. On October 4, 2000, the
court granted the Company summary judgment motions with respect to all of
plaintiff's remaining claims, granted the Company summary judgment with
respect to the Company $5 million indemnity counter claim against the
plaintiffs and granted the Company's summary judgment trespass counter claim
against Dr. Reddy, leaving for trial only a determination of the extent of
damages on the trespass counter claim. That trial date has not been set pending
settlement discussions by the parties ordered by the court. Plaintiffs will
likely appeal the court's determinations.
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. The judge assigned to this case is the
same judge presiding over the other Reddy matter discussed above. The Company
filed a motion to dismiss this new action. The court will not render a decision
on the Company's motion to dismiss until the parties have completed their court
ordered settlement discussions. Although the Company intends to defend itself
vigorously against Dr. Reddy's 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. In connection with this matter, the
court issued a preliminary injunction against Dr. Reddy and his brother-in-law
prohibiting them from acting in violation of their existing noncompete
agreements with the Company.
In September 2000, PrimeMed Pharmacy Services, Inc., a company in which
Dr. Reddy owns a controlling interest filed suit against PrimeCare
International, Inc. and nine affiliated medical groups alleging failure to pay
invoices for certain prescription drugs of approximately $95,000. In addition,
Desert Valley Medical, Inc., another company controlled by Dr. Reddy, filed suit
against PrimeCare Medical Group Network and certain affiliated entities alleging
failure to pay for certain medical supplies and durable medical equipment
totalling approximately $1,800,000. All the actions were filed in the Superior
Court of the State of California for the County of Riverside. The Company
intends to vigorously defend these actions. There can be no assurance, however
that an adverse outcome in these actions would not have a material adverse
effect on the Company.
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
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the Court's order, and stayed all discovery pending mediation. Court ordered
mediation has been delayed until December 2000 pending settlement discussions by
the parties. 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. Although the Company is vigorously defending this
suit, there can be no assurance that this suit will not have a material adverse
effect on the Company.
In November 2000, the Company and Murfreesboro Medical Clinic dismissed
with prejudice all claims pending against each other in connection with the sale
of assets by the Company to the Murfreesboro Medical Clinic. In November 2000,
the Company and South Texas Medical Clinics dismissed with prejudice all claims
pending against each other in connection with the sale of assets by the Company
to the South Texas Medical Clinics.
In September 1999, three relators brought a claim in the United States
District Court for the District of Hawaii under the False Claims Act against
Straub Clinic and Hospital, Inc., the Company and one of the Company's
subsidiaries. This matter had been under seal until September 2000. On September
20, 2000, the United States government elected to decline to intervene in the
matter. It is uncertain if this action will proceed. There can be no assurance
that if this action proceeds and ultimately is determined in favor of the
plaintiffs, the adverse determination 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 judgement on July 13, 2000. The Company has
recorded as other operating expenses this judgement of $4.6 million in the
second quarter of 2000. PrimeCare is appealing the verdict, and a retrial of the
Medicare fraud claims will not occur until there is a ruling on PrimeCare's
appeal. Plaintiff filed a judgment lien against PrimeCare on August 31, 2000.
PrimeCare has not posted a bond in this matter. 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 judgement against PrimeCare would not have a material adverse effect on
PrimeCare. In September 2000, Dr. Reddy filed an action in Delaware Chancery
Court seeking from PrimeCare advancement of expenses for a bond in the Benz
matter. On October 20, 2000, the court granted PrimeCare's motion for summary
judgment to dismiss this action.
The U.S. Department of Labor (the "Department") has concluded its
investigation of the administration of the Phycor, Inc. Savings and Profit
Sharing Plan. The Department has notified the Company that it will take no
further action against the Company in connection with the investigation. The
Company is required to periodically review its performance on the timing of
participant contributions. The Company intends to fully cooperate with the
Department's requests.
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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. 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. During 2000, the Company resolved its outstanding IRS examination for the
years 1996 through 1998. The IRS examination resulted in an adjustment to the
1998 loss carryback and accordingly the Company repaid approximately $1.2
million plus interest, as a result of revisions in the alternative minimum tax
calculation. The tax years 1988 through 1998 have been closed with respect to
all issues without a material financial impact. 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. As of
December 31, 1999, the Company had approximately $350.2 million in net operating
loss carryforwards; accordingly, the Company does not expect to pay current
federal income taxes for the foreseeable future.
As a result of the Company's determination to exit its IPA market in
Houston, Texas, a number of providers in the market have brought actions naming
several parties, including the Company and an IPA-management subsidiary of the
Company, alleging breach of contract, among other matters. There can be no
assurance that additional actions will not be brought against the Company and
its subsidiaries as a result of the Company's determination to exit this market.
There can be no assurance that if these matters are determined adversely to the
Company that such determinations would not have a material adverse effect on the
Company.
Certain litigation is pending against the physician groups affiliated
with the Company and IPAs managed by the Company. The Company has not assumed
any liability in connection with such litigation. Claims against the physician
groups and IPAs could result in substantial damage awards to the claimants which
may exceed applicable insurance coverage limits. While there can be no assurance
that the physician groups and IPAs will be successful in any such litigation,
the Company does not believe any such litigation will have a material adverse
effect on the Company. Certain other litigation is pending against the Company
and certain subsidiaries of the Company, none of which management believes would
have a material adverse effect on the Company's financial position or results of
operations on a consolidated basis.
The Company's forward-looking statements relating to the
above-described litigation reflect management's best judgement 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 3. DEFAULTS UPON SENIOR SECURITIES.
The Company is not currently in compliance with certain non-payment
related financial covenants under its bank credit facility. The Company is in
the process of obtaining a waiver of such non-compliance. The Company believes
that it will obtain the necessary waiver by November 21, 2000. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources."
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ITEM 5. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------ -----------------------
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 -- Fourth Amended and Restated Revolving Credit Agreement among
PhyCor, Inc., as Borrower, the Banks as named therein as
banks and Citicorp USA , Inc. as Administrative Agent and
Sole Book Runner ("Fourth Amended Facility") (7)
10.3 -- Amendment No. 1 to Fourth Amended Facility (8)
27.1 -- Financial Data Schedule (for SEC use only) (8)
----------------------------
(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) Incorporated by reference to exhibits filed with PhyCor's Current
Report on Form 8-K dated August 29, 2000 Commission No. 0-19786.
(8) Filed herewith.
(B) REPORTS ON FORM 8-K.
The Company's Current Report on Form 8-K as filed with the Commission
on August 29, 2000 relating to its amended bank credit facility.
34
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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: November 14, 2000
35
<PAGE> 36
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
IBIT
NUMBER DESCRIPTION OF EXHIBITS
------ -----------------------
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 -- Fourth Amended and Restated Revolving Credit Agreement among
PhyCor, Inc., as Borrower, the Banks as named therein as
banks and Citicorp USA, Inc. as Administrative Agent and
Sole Book Runner ("Fourth Amended Facility") (7)
10.3 -- Amendment No. 1 to Fourth Amended Facility (8)
27.1 -- Financial Data Schedule (for SEC use only) (8)
-------------
(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) Incorporated by reference to exhibits filed with PhyCor's Current
Report on Form 8-K dated August 29, 2000, Commission No. 0-19786.
(8) Filed herewith.
36
