<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number: 0-26190
US Oncology, Inc.
(Exact name of registrant as specified in its charter)
Delaware 84-1213501
(State or other jurisdiction of incorporation or (I.R.S. Employer
organization) Identification No.)
16825 Northchase Drive, Suite 1300
Houston, Texas
77060
(Address of principal executive offices)
(Zip Code)
(281) 873-2674
(Registrant's telephone number, including area code)
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 09, 1999, 85,879,035 shares of the Registrant's Common Stock
were outstanding. In addition, as of November 09, 1999, the Registrant had
agreed to deliver 14,915,492 shares of its Common Stock on certain future dates
for no additional consideration.
<PAGE>
US ONCOLOGY, INC.
FORM 10-Q
SEPTEMBER 30, 1999
Table of Contents
<TABLE>
<CAPTION>
Page No.
--------
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheet 3
Condensed Consolidated Statement of Operations
and Comprehensive Income 4
Condensed Consolidated Statement of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About
Market Risks 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Changes in Securities 15
Item 6. Exhibits and Reports on Form 8-K 16
SIGNATURES 17
</TABLE>
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<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands, except par value)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
-------------------- ----------------------
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash and equivalents.................................................... $ 2,070 $ 13,691
Accounts receivable..................................................... 302,624 243,390
Prepaids and other current assets....................................... 76,421 42,581
Due from affiliated physician groups.................................... 13,126 22,354
---------- -----------
Total current assets............................................... 394,241 322,016
Property and equipment, net.............................................. 253,274 220,944
Management service agreements, net....................................... 526,357 467,214
Other assets............................................................. 25,269 23,354
---------- -----------
$1,199,141 $1,033,528
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term indebtedness.......................... $ 20,246 $ 22,426
Accounts payable...................................................... 73,253 80,729
Due to affiliated physician groups.................................... 13,933 6,606
Accrued compensation costs............................................ 7,009 10,118
Income taxes payable.................................................. 11,222 4,066
Other accrued liabilities............................................. 28,769 19,809
---------- ----------
Total current liabilities............................................. 154,432 143,754
Deferred income taxes.................................................... 23,060 23,537
Long-term indebtedness................................................... 331,410 234,474
---------- ----------
Total liabilities..................................................... 508,902 401,765
---------- ----------
Minority interest........................................................ 2,307 1,965
Stockholders' equity:
Preferred Stock, $.01 par value, 1,500 shares authorized, none
issued and outstanding..............................................
Series A Preferred Stock, $.01 par value, 500 shares authorized and
reserved, none issued and outstanding...............................
Common Stock, $.01 par value, 250,000 shares authorized, 85,539 and
81,205 issued and 85,539 and 80,830 outstanding........................ 855 812
Additional paid-in capital.............................................. 414,379 404,749
Common Stock to be issued, approximately 14,978 and 16,947 shares....... 102,244 89,142
Treasury Stock, 0 and 375 shares....................................... (3,696)
Accumulated other comprehensive income................................. 1,648 269
Retained earnings....................................................... 168,806 138,522
---------- ----------
Total stockholders' equity............................................ 687,932 629,798
---------- ----------
$1,199,141 $1,033,528
========== ==========
</TABLE>
The accompanying notes are an integral part of this statement.
-3-
<PAGE>
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------- ---------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenue...................................................... $277,789 $216,916 $793,415 $609,297
Operating expenses:
Pharmaceuticals and supplies............................ 134,773 92,916 373,502 256,307
Practice compensation and benefits...................... 54,464 44,169 156,043 126,375
Other practice costs.................................... 33,435 28,172 95,787 80,524
General and administrative.............................. 10,062 10,303 27,867 28,769
Merger and integration costs............................ 2,747 27,238
Depreciation and amortization........................... 15,317 13,458 45,573 34,708
-------- -------- -------- --------
250,798 189,018 726,010 526,683
-------- -------- -------- --------
Income from operations....................................... 26,991 27,898 67,405 82,614
Interest expense, net........................................ (6,016) (3,804) (15,949) (11,877)
-------- -------- -------- --------
Income before income taxes................................... 20,975 24,094 51,456 70,737
Income taxes................................................. 5,992 9,049 21,172 26,599
-------- -------- -------- --------
Net income................................................... 14,983 15,045 30,284 44,138
-------- -------- -------- --------
Other comprehensive income (loss), net of tax................ 1,499 124 1,379 (134)
-------- -------- -------- --------
Comprehensive income......................................... $ 16,482 $ 15,169 $ 31,663 $ 44,004
======== ======== ======== ========
Net income per share - basic................................. $0.15 $0.15 $0.30 $0.45
======== ======== ======== ========
Shares used in per share calculations - basic................ 100,493 98,331 100,018 97,550
======== ======== ======== ========
Net income per share - diluted............................... $ 0.15 $ 0.15 $ 0.30 $ 0.44
======== ======== ======== ========
Shares used in per share calculations - diluted.............. 102,184 100,308 101,600 100,120
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of this statement.
-4-
<PAGE>
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
1999 1998
------------------ ------------------
<S> <C> <C>
Cash flows from operating activities:
Net income............................................................. $ 30,284 $ 44,138
Noncash adjustments:
Depreciation and amortization......................................... 45,573 34,708
Deferred income taxes................................................. (477) 8,413
Non cash merger and integration costs................................. 2,300
Gain on contract termination.......................................... (3,152)
Changes in operating assets and liabilities............................ (67,347) (37,969)
-------- --------
Net cash provided by operating activities........................... 7,181 49,290
Cash flows from investing activities:
Acquisition of property and equipment.................................. (60,978) (34,713)
Net payments in medical practice transactions.......................... (36,182) (22,539)
Other.................................................................. 342 (585)
-------- --------
Net cash used in investing activities............................... (96,818) (57,837)
Cash flows from financing activities:
Net proceeds from credit facilities.................................... 83,000 39,000
Repayment of other indebtedness........................................ (9,621) (27,381)
Purchase of Treasury Stock............................................. (9,562)
Proceeds from exercise of options...................................... 4,637 3,350
-------- --------
Net cash provided by financing activities........................... 78,016 5,407
Decrease in cash and equivalents........................................ (11,621) (3,140)
Cash and equivalents:
Beginning of period.................................................... 13,691 7,772
-------- --------
End of period.......................................................... $ 2,070 $ 4,632
======== ========
Noncash transactions:
Value of Common Stock to be issued in medical
practice transactions................................................ $ 21,834 $ 8,403
Debt issued in medical practice transactions........................... 20,642 14,696
Debt assumed in medical practice transactions.......................... 86
Tax benefit from exercise of non-qualified stock options............... 4,301
Debt issued to finance insurance premiums.............................. 649
</TABLE>
The accompanying notes are an integral part of this statement.
-5-
<PAGE>
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial reporting and in accordance with Form 10-Q and Rule 10.01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the unaudited condensed
consolidated financial statements contained in this report reflect all
adjustments that are normal and recurring in nature and considered necessary for
a fair presentation of the financial position and the results of operations for
the interim periods presented. The preparation of the Company's financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses, as well as disclosures on contingent
assets and liabilities. Because of inherent uncertainties in this process,
actual future results could differ from those expected at the reporting date.
These unaudited condensed consolidated financial statements, footnote
disclosures and other information should be read in conjunction with the
financial statements and the notes thereto included in US Oncology, Inc.'s Form
8-K/A-2 filed with the Securities and Exchange Commission on August 16, 1999.
Operating segments
During 1998, the Company adopted Financial Accounting Standards Board (FASB)
Statement No. 131, "Disclosures About Segments of an Enterprise and Related
Information" (FAS 131), which requires reporting of summarized financial results
for the operating segments as well as establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Company's sole business is providing comprehensive management services,
facilities and equipment, administrative and technical support and ancillary
services necessary for physicians to establish and maintain a fully integrated
network of outpatient cancer care. The physicians affiliated with the Company
provide all aspects of care related to the diagnosis and outpatient treatment of
cancer, including comprehensive oncology services (including primarily medical,
radiation, and gynecological services), diagnostic radiology services, retail
pharmacy services and clinical research. For the first nine months of 1999 and
1998, oncology related services was the only product line that exceeded the
reporting thresholds of FAS 131. The Company, therefore, has used the
aggregation criteria of FAS 131 and reports a single segment.
NOTE 2 - Business Combination
On June 15, 1999, the Company, formerly American Oncology Resources, Inc. (AOR),
consummated a merger transaction pursuant to which Physician Reliance Network,
Inc. (PRN) became a wholly owned subsidiary of the Company and each outstanding
share of PRN's common stock was converted into .94 shares of the Company's
common stock (the Merger). At the time of the Merger, the Company changed its
name to US Oncology, Inc. The transaction was accounted for as a pooling of
interests and accordingly the financial statements presented herein have been
restated to conform to the presentation and accounting standards of the two
companies. The Company has recognized merger and integration costs for the nine
months and three months ended September 30, 1999 of approximately $27.2 million
and $2.7 million respectively. Merger and integration costs for the nine months
ended September 30, 1999 are comprised of transaction costs of approximately
$17.2 million for professional fees, costs of due diligence, severance costs and
other out of pocket expenses; restructuring costs of approximately $5.0 for
leasehold and software abandonment; and, integration costs of approximately $5.0
million for integration consulting fees, communications, and Merger related
Company meetings.
Note 3 - Revenue
Medical service revenue for services to patients by the physician groups
affiliated with the Company is recorded when services are rendered based on
established or negotiated charges reduced by contractual adjustments and
allowances for doubtful accounts. Differences between estimated contractual
adjustments and final settlements are reported in the period when final
settlements are determined. Medical service revenue of the affiliated physician
groups is reduced by amounts retained by the physician groups under the
Company's management services agreements to arrive at the Company's management
fee revenue.
The following presents the amounts included in the determination of the
Company's revenue (in thousands):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------------------- ---------------------------------
1999 1998 1999 1998
--------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C>
Medical service revenue........................... $351,127 $275,952 $1,008,897 $780,456
Amounts retained by affiliated physician groups... 83,297 68,152 240,104 193,003
-------- -------- ---------- --------
Management fee revenue............................ 267,830 207,800 768,793 587,453
Other revenue..................................... 9,959 9,116 24,622 21,844
-------- -------- ---------- --------
Revenue........................................... $277,789 $216,916 $ 793,415 $609,297
======== ======== ========== ========
</TABLE>
The Company's most significant and only management service agreement to provide
more than 10% of revenues to the Company is with Texas Oncology, P.A. (TOPA).
TOPA accounted for approximately 29.5% and 25.2% for the nine months ended
September 30, 1998 and 1999 of the Company's total revenue, and 28.9% and 24.8%
for the three months ended September 30, 1998 and 1999.
-6-
<PAGE>
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS CONTINUED
(unaudited)
NOTE 4 - Credit Facility and Master Lease
Credit Facility
On June 15, 1999, in connection with the Merger, the Company executed a $275
million revolving credit facility (Credit Facility) with First Union National
Bank (First Union), individually and as Administrative Agent for eight
additional lenders ("Lenders"). The Credit Facility consists of a $175 million
five-year revolving credit facility and a $100 million 364-day revolving credit
facility. Initial proceeds under the Revolver were used to refinance existing
debt and to pay certain transaction fees and expenses in connection with the
Credit Facility and the Merger. Proceeds of loans under the Credit Facility may
be used to finance medical practice transactions, to provide working capital and
for other general corporate uses. As of September 30, 1999, the Company had an
outstanding balance of $239 million under the Credit Facility. The Company has
classified the Credit Facility as long-term indebtedness due to its ability and
intent to maintain the borrowings beyond the next twelve months. Costs incurred
in connection with the extinguishment of the Company's previous credit
facilities were expensed in the second quarter as merger and integration costs.
Borrowings under the Credit Facility are secured by all capital stock of the
Company's subsidiaries, all of the Company's management services agreements and
all accounts receivable of the Company. At the Company's option, funds may be
borrowed at the Base interest rate or the London Interbank Offered Rate (LIBOR)
up to LIBOR plus an amount determined under a defined formula. The Base rate is
selected by First Union and is defined as their prime rate or Federal Funds Rate
plus 1/2%. Interest on amounts outstanding under Base rate loans is due
quarterly while interest on LIBOR related loans is due at the end of each
applicable interest period or quarterly, if earlier. As of September 30, 1999,
the weighted average interest rate on all outstanding draws under the Credit
Facility was 6.7%.
The Company is subject to restrictive covenants under the Credit Facility,
including the maintenance of certain financial ratios. The agreement limits
certain activities such as incurrence of additional indebtedness, sales of
assets, investments, capital expenditures, mergers and consolidations and the
payment of dividends. Under certain circumstances, additional medical practice
transactions may require First Union's and the Lenders' consent.
Master Lease
On June 15, 1999, the Company amended its $75 million master lease agreement
related to integrated cancer centers to extend the construction and acquisition
period through December 2000. Under the agreement, the lessor purchases and has
title to the properties, pays for the construction costs and thereafter leases
the facilities to the Company. The initial term of the lease is for five years
and can be renewed in one year increments if approved by the lessor. The lease
provides for substantial residual value guarantees and includes purchase options
at original cost on each option. Advances under the master lease agreement as
of September 30, 1999 were $42 million.
-7-
<PAGE>
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS CONTINUED
(unaudited)
NOTE 5 - Earnings Per Share
The Company computes earnings per share in accordance with the provisions of
FASB Statement No. 128, "Earnings Per Share", which requires the Company to
disclose "basic" and "diluted" earnings per share (EPS).
The computation of basic EPS is based on a weighted average number of
outstanding shares of Common Stock and Common Stock to be issued during the
periods. The Company includes Common Stock to be issued in both basic and
diluted EPS as there are no foreseeable circumstances that would relieve the
Company of its obligation to issue these shares. The computation of the diluted
EPS is based on a weighted average number of outstanding shares of Common Stock
and Common Stock to be issued during the periods as well as all dilutive
potential Common Stock calculated under the treasury stock method.
The table summarizes the determination of shares used in per share calculations
(in thousands):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------------------- ------------------------------------
1999 1998 1999 1998
----------------- ------------- ----------------- ----------------
<S> <C> <C> <C> <C>
Outstanding at end of period:
Common Stock................................... 85,539 79,812 85,539 79,812
Common Stock to be issued...................... 14,978 17,905 14,978 17,905
------- ------- ------- -------
100,517 97,717 100,517 97,717
Effect of weighting............................ (24) 614 (499) (167)
------- ------- ------- -------
Shares used in per share calculations-basic.. 100,493 98,331 100,018 97,550
Effect of weighting and assumed share
equivalents for grants of stock options at
less than the weighted average price and
subordinated convertible promissory notes...... 1,691 1,977 1,582 2,570
------- ------- ------- -------
Shares used in per share calculations-diluted.. 102,184 100,308 101,600 100,120
======= ======= ======= =======
Anti-dilutive stock options not included above... 3,921 3,356 5,737 2,242
======= ======= ======= =======
</TABLE>
NOTE 6 - Recent Pronouncements
In June 1998, FASB issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities," (FAS 133) which is effective for the
Company's financial statements beginning with the first quarter of the year
ending December 31, 2000. FAS 133 requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and to measure those instruments at fair value. Management does not
expect such implementation to have a material effect on the Company's
operations.
-8-
<PAGE>
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Introduction
US Oncology, Inc. (the "Company") is a cancer management company which provides
comprehensive management services under long-term agreements to its affiliated
oncology practices, including operational and clinical research services and
data management, and furnishes personnel, facilities, supplies and equipment.
These affiliated practices provide a broad range of medical services to cancer
patients, integrating the specialties of medical and gynecological oncology,
hematology, radiation oncology, diagnostic radiology and stem cell
transplantation. Substantially all of the Company's revenue consists of
management fees and includes all medical practice operating costs for which the
Company is contractually responsible.
The Company believes that the coordinated delivery of comprehensive cancer care
in an outpatient setting offers high quality care that is more cost-effective
than traditional approaches and is increasingly preferred by patients, payors
and physicians. The Company believes that many oncology practices recognize the
need for outside managerial, financial and business expertise to more
efficiently manage the increasingly complex, burdensome and time-consuming
nonmedical aspects of their practices and that practices will increasingly elect
to enter into management relationships with entities such as the Company.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
The statements contained in this report, in addition to historical information,
are forward-looking statements based on the Company's current expectations, and
actual results may vary materially. Forward-looking statements often include
words like "believe", "plan", "expect", "intend" or "estimate". The Company's
business and financial results are subject to various risks and uncertainties,
including the Company's continued ability to enter into affiliations with new
physician practices and to successfully integrate such practices, the results of
operations of groups currently affiliated with the Company including results of
operations impacted by changes in cancer therapies or the manner in which cancer
care is delivered, the ability to construct integrated cancer centers and to
operate them profitably, competition, reductions in third-party reimbursement
for services rendered by physician groups affiliated with the Company, drug
utilization, health care regulation and other risks generally affecting the
health care industry. Please refer to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998 and the joint proxy statement and
prospectus distributed in connection with the Merger, each of which was filed
with the Securities and Exchange Commission (SEC), and the Company's subsequent
filings with the SEC for a more detailed discussion of such risks and
uncertainties. Many of these risks and uncertainties are beyond the Company's
ability to control or predict. These forward-looking statements are provided as
a framework for the Company's results of operations. The Company does not
intend to provide updated information other than as otherwise required by
applicable law.
RESULTS OF OPERATIONS
Medical service revenue for services to patients by the physician groups
affiliated with the Company is recorded when services are rendered based on
established or negotiated charges reduced by contractual adjustments and
allowances for doubtful accounts. Differences between estimated contractual
adjustments and final settlements are reported in the period when final
settlements are determined. Medical service revenue of the affiliated physician
groups is reduced by amounts retained by the physician groups under the
Company's management services agreements to arrive at the Company's management
fee revenue.
-9-
<PAGE>
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
The following presents the amounts included in the determination of the
Company's revenue (in thousands):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------------------- ----------------------------------
1999 1998 1999 1998
--------------- -------------- --------------- ----------------
<S> <C> <C> <C> <C>
Medical service revenue......................... $351,127 $275,952 $1,008,897 $780,456
Amounts retained by affiliated physician
groups........................................ 83,297 68,152 240,104 193,003
-------- -------- ---------- --------
Management fee revenue.......................... 267,830 207,800 768,793 587,453
Other revenue................................... 9,959 9,116 24,622 21,844
-------- -------- ---------- --------
Revenue......................................... $277,789 $216,916 $ 793,415 $609,297
======== ======== ========== ========
</TABLE>
The Company's most significant and only management service agreement to provide
more than 10% of revenues to the Company is with Texas Oncology, P.A. (TOPA).
TOPA accounted for approximately 29.5% and 25.2% for the nine months ended
September 30, 1998 and 1999 of the Company's total revenue, and 28.9% and 24.8%
for the three months ended September 30, 1998 and 1999.
The following table sets forth the percentages of revenue represented by certain
items reflected in the Company's Statement of Operations and Comprehensive
Income. The information that follows should be read in conjunction with the
Company's unaudited condensed consolidated financial statements and notes
thereto included elsewhere herein.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------------- ----------------------------
1999 1998 1999 1998
------------- ------------- ------------- ------------
<S> <C> <C> <C> <C>
Revenue.............................................. 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Pharmaceuticals and supplies........................ 48.5 42.8 47.1 42.1
Practice compensation and benefits.................. 19.6 20.4 19.7 20.8
Other practice costs................................ 12.0 13.0 12.1 13.2
General and administrative.......................... 3.6 4.7 3.5 4.7
Merger and integration costs........................ 1.0 3.4
Depreciation and amortization....................... 5.5 6.2 5.7 5.7
Net interest expense................................ 2.2 1.8 2.0 1.9
----- ----- ----- -----
Income before income taxes........................... 7.6 11.1 6.5 11.6
----- ----- ----- -----
Income taxes......................................... 2.2 4.2 2.7 4.4
----- ----- ----- -----
Net income........................................... 5.4% 6.9% 3.8% 7.2%
===== ===== ===== =====
</TABLE>
-10-
<PAGE>
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
1999 COMPARED TO 1998
The Company entered into new affiliation agreements with fifteen oncology groups
in the first nine months of 1999 and twelve oncology groups in the first nine
months of 1998. The results of the new affiliated oncology practices are
included in the Company's operating results from the dates of affiliation.
Changes in results of operations for the first nine months of 1998 compared to
the first nine months of 1999 were caused, in part, by affiliations with these
oncology practices.
Revenue. Revenue increased from $609.3 million in the first nine months of
1998 to $793.4 million in 1999, an increase of $184.1 million, or 30.2%, and
from $216.9 million in the third quarter of 1998 to $277.8 million in the third
quarter of 1999, an increase of $60.9 million or 28.1%. Revenue for markets
under management in the first nine months of 1998 and 1999 increased $114.2
million or 18.7% over the same period from the prior year, and $50.5 million or
24.7% in the third quarter of 1999. This growth was the result of expansion of
services, increases in patient volume, and recruitment of or affiliation with
additional physicians.
Pharmaceuticals and Supplies. Pharmaceuticals and supplies expense, which
includes drugs, medications and other supplies used by the affiliated physician
groups, increased from $256.3 million for the first nine months of 1998 to
$373.5 million for the first nine months of 1999, an increase of $117.2 million,
or 45.7%, and from $92.9 million in the third quarter of 1998 to $134.7 million
in the third quarter of 1999, an increase of $41.2 million or 45.0%. As a
percentage of revenue, pharmaceuticals and supplies increased from 42.1% for the
first nine months of 1998 to 47.1% for the comparable period of 1999 and from
42.8% in the third quarter of 1998 to 48.5% in the third quarter of 1999. This
increase was primarily due to a shift in the revenue mix to a higher percentage
of revenue from drugs, the introduction of a number of new chemotherapy agents
and a shift to lower margin drugs. Management expects that third-party payors
will continue to negotiate the reimbursement rate for pharmaceuticals and
supplies, with the goal of lowering reimbursement rates, and that such lower
reimbursement rates as well as shifts in revenue mix may continue to adversely
impact the Company's margins with respect to such items.
Other Practice Costs. Other practice costs which consist of rent, utilities,
repairs and maintenance, insurance and other direct practice costs, increased
from $80.5 million for the first nine months of 1998 to $95.8 million for the
first nine months of 1999, an increase of $15.3 million or 19.0%, and from $28.2
million in the third quarter of 1998 to $33.5 million in the third quarter of
1999, an increase of $5.3 million or 18.8%. The increase was principally
attributable to the same factors that caused revenue to increase. As a
percentage of revenue other practice costs decreased from 13.2% in the first
nine months of 1998 to 12.1% in the first nine months of 1999 and from 13.0% in
the third quarter of 1998 to 12.0% in the third quarter of 1999. The decrease
was primarily attributable to economies of scale.
Merger and Integration Costs. In the first nine months of 1999 the Company
recognized merger and integration costs of approximately $27.2 million. Merger
and integration costs are comprised of transaction costs of approximately $17.2
million for professional fees, costs of due diligence, severance costs and other
out of pocket expenses; restructuring costs of approximately $5.0 million for
leasehold and software abandonment; and integration costs of approximately $5.0
million for integration consulting fees, communications and Merger related
Company meetings.
Income Taxes. Income tax expense increased from the prior year. For the first
nine months of 1999 the Company recognized a tax expense of $21.2 million
resulting in an effective tax rate of 41.1% compared to 37.6% for the same prior
year period. The increase in the effective tax rate is attributable to
non-deductible merger and integration charges.
Net Income. Net income decreased from $44.1 million in the first nine months
of 1998 to $30.3 million in the first nine months of 1999, a decrease of $13.8
million or 31.3%. Net income remained at $15.0 million for the third quarter of
1998 and 1999. Excluding the merger costs, net income for the first nine months
of 1999 was $49.2 million, which represents earnings per share of $.48, and for
the third quarter of 1999 net income would have been $14.8 million, which
represents earnings per share of $.15. Net income as a percentage of revenue
decreased from 7.2% for the nine months ended September 30, 1998 to 6.2% for the
nine months ended September 30, 1999 excluding merger and integration costs, and
decreased from 6.9% for the third quarter of 1998 to 5.3% for the third quarter
of 1999, excluding merger and integration costs. Such decreases are
attributable to the shift in the revenue mix to a higher percentage of drug
revenue as discussed above, an increase in the use of lower margin chemotherapy
agents and, for the nine months ended only, to a change in amortization period
for management services agreements from forty years to twenty-five years,
effective July 1, 1998.
-11-
<PAGE>
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
In response to this decline in margin relating to certain pharmaceutical agents,
the Company has adopted several strategies. Most importantly, the Company has
formed a number of preferred pharmaceutical relationships and continues to
pursue others. In addition, the Company routinely considers and implements
measures to control other operating costs to enable it to achieve greater
economies of scale. Lastly, the Company seeks opportunities to expand its
business in areas that are less affected by lower pharmaceutical margins, such
as radiation oncology and diagnostic radiology. The Company believes that its
results of operations and financial condition have benefited from each of these
strategies.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital primarily to enter into management services
agreements with, and to purchase the nonmedical assets of, medical and radiation
oncology practices. During the first nine months of 1999, the Company paid
total consideration of $78.7 million in connection with affiliations with
fifteen physician groups, including cash and transaction costs of $36.2 million.
During the comparable period of the prior year, the Company paid total
consideration of $45.6 million for affiliations with twelve physician groups,
including cash and transaction costs of $22.5 million.
To fund its growth and development, the Company has satisfied its transaction
and working capital needs through borrowings under a $275 million syndicated
revolving credit facility ("Credit Facility") with First Union National Bank
("First Union"), as agent for the various lenders. In addition, the Company has
obtained a $75 million end-loaded leasing facility (Leasing Facility) for its
integrated cancer centers.
During the first nine months of 1999, the Company borrowed $83 million, net,
under the Credit Facility to fund medical practice transactions, pay merger
related expenses and the acquisition of property and equipment. Borrowings
under the Credit Facility bear interest at a rate equal to a rate based on prime
rate or the London Interbank Offered Rate, based on a defined formula. The
Credit Facility and Leasing Facility contain affirmative and negative covenants,
including the maintenance of certain financial ratios, restrictions on sales,
leases or other dispositions of property, restrictions on other indebtedness and
prohibitions on the payment of dividends. The Company's management services
agreements, the capital stock of the Company's subsidiaries and the Company's
accounts receivable are pledged as security under the Credit Facility and
Leasing Facility. The Company is currently in compliance with the Credit
Facility and Leasing Facility covenants, with additional capacity under the
Credit Facility of $36 million and Leasing Facility of approximately $33 million
at September 30, 1999. The Company has relied primarily on management fees
received from its affiliated physician groups to fund its operations.
Cash provided by operations was $7.2 million in the first nine months of 1999, a
decrease of $42.1 million from the comparable period in 1998. The decrease was
due primarily to Merger related expenditures of $21.5 million and the timing of
certain working capital payments. Excluding merger related expenditures, cash
provided from operations would have been $28.7 million. Cash used in investing
activities was $96.8 million for the first nine months of 1999, an increase of
$39.0 million from the same period of 1998. Such increase is due primarily to
greater activity in medical practice transactions in 1999 as well as increased
purchases of property and equipment. Cash provided by financing activities was
$78.0 million for the first nine months of 1999, an increase of $72.6 million
from the comparable prior year period. Such increase is due to borrowings to
pay merger and integration costs as well as fund medical practice transaction
costs. Incremental borrowings of $83 million under the Credit Facility were
incurred in the first nine months of 1999.
As of September 30, 1999, the Company had net working capital of $239.8 million
and cash and cash equivalents of $2.1 million. The Company's also had $154.4
million of current liabilities, including approximately $20.2 million of current
indebtedness maturing before September 30, 2000. The Company currently expects
that its principal use of funds in the near future will be in connection with
anticipated medical practice transactions, merger and integration expenses and
purchases of medical equipment.
-12-
<PAGE>
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
YEAR 2000 ISSUE
The "Year 2000 problem" describes computer programs that use two rather than
four digits to define the applicable year, and thus cannot distinguish between
the year 1900 and the year 2000. The Company's computer hardware and software,
building infrastructure components (e.g., alarm systems and HVAC systems) and
medical equipment (e.g., linear accelerators, which are used to provide
radiation therapy) that are date sensitive may contain programs with the Year
2000 problem. If uncorrected, the problem could result in computer system and
program failure or equipment malfunctions that could disrupt business
operations.
Project. The Company has divided its Year 2000 Project into six phases:
development, awareness, assessment, remediation, validation and implementation.
In connection with its Year 2000 Project, the Company is assessing information
technology software and hardware, medical equipment, third-party payors and
third-party suppliers. The Company's strategy also includes development of
contingency plans to address potential disruption of operations arising from the
Year 2000 problems.
Information Systems. The Company recognizes that investment in information
systems and state-of-the-art medical equipment is integral to its operations.
The majority of the Company's technology expenditures for 1998 and 1999 relate
to the development and implementation of a clinical information system. This
system provides an interactive electronic format for capturing the spectrum of
patient care and creates an electronic medical record. This system is believed
to be Year 2000 compliant. The costs of the clinical information system are
expected to be capitalized and amortized over the life of the asset.
In 1994, the Company began a project to replace the existing practice management
systems (billing and collection systems) with a common system to improve
efficiency and consistency among its affiliated practices of this common
practice management system. The common practice management system being
implemented is believed to be Year 2000 compliant. Any remaining practice
management systems not replaced by the new system have been modified with
vendor-supplied upgrades to make them Year 2000 compliant. Costs to upgrade the
practice management systems that are not converted to the common system would be
expensed; however, such costs are not expected to be material.
In 1996, the Company's management incorporated a business strategy to
accommodate the rapid growth of its operations. One component of this strategy
was the investment in developing an integrated financial system throughout its
network of affiliated physicians. This financial system is believed to be Year
2000 compliant and has been implemented in several locations. The Company
intends to complete the implementation of this financial system by the first
quarter of 2000. The costs incurred in developing this financial system have
been capitalized through the initial implementation date. Any legacy financial
systems not replaced before the end of 1999 are believed to be Year 2000
compliant.
Medical Equipment. The Company has reviewed the Year 2000 readiness of the
linear accelerators and associated equipment used in the affiliated radiation
oncology practices. The suppliers of the radiation oncology equipment have
certified that, with minor upgrades, these systems will be Year 2000 compliant
by the end of the fourth quarter. The Company has determined that all other
medical equipment is Year 2000 compliant. Costs incurred to upgrade medical
equipment have been expensed.
Third-Party Payors. The Company bills and collects for medical services from
numerous third party payors in operating its business. These third parties
include fiscal intermediaries on behalf of the Medicare program, as well as
insurance companies, HMOs and other private payors. As part of the Company's
Year 2000 strategy, a comprehensive survey has been sent to all significant
payors to assess their timeline for Year 2000 compliance and the impact to the
Company. The response rate for compliance is over 90% and non-respondants are
being contacted directly. All major payors who have responded to the Company's
requests have declared that they are or will be Year 2000 compliant by December
31, 1999.
-13-
<PAGE>
US ONCOLOGY, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
Third-Party Suppliers. The Company is currently evaluating third party
vendors of medical supplies and pharmaceuticals in order to determine whether
their services and products will be interrupted or malfunction due to the Year
2000 problem. The Company's pharmaceutical ordering system is a proprietary
system developed by a third party vendor and is utilized under the Company's
purchasing contract with such vendor. This relationship has been identified and
prioritized as the most critical in the vendor evaluation process. The third
party vendor has upgraded its pharmaceuticals purchase ordering system at no
cost to the Company. The upgraded system has been certified as Year 2000
compliant by the vendor and is scheduled for implementation by the fourth
quarter of 1999.
Risks. The failure to correct a material Year 2000 problem could result in an
interruption in, or failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of third-party payors and third-party
suppliers, the Company is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the Company's
results of operations, liquidity or financial condition. The Company has
received compliance certification from all major payors and its key third party
supplier of pharmaceutical agents which reduces the Company's level of
uncertainly considerably. The Company has also developed contingency plans to
use alternative business practices in the event of unexpected Year 2000 related
failures of third-party systems. However, there can be no assurance that
unexpected Year 2000 related failures will not occur or that such contingency
plans will be sufficient in the event of such failures. Any such failure
affecting the Company or any third party could have a material adverse effect on
the Company's results of operations, liquidity and financial condition.
Costs. The Company estimates that total costs to be incurred in the execution
of its Year 2000 Project are approximately $10.7 million, including
approximately $600,000 relating to laboratory and medical equipment upgrades and
replacements. The Company estimates that approximately $8.2 million of the
costs will be capitalized and amortized over the useful life of the assets as
they represent new applications and expanded capabilities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
In the normal course of business, the financial position of the Company is
routinely subjected to a variety of risks. Among these risks is the market risk
associated with interest rate movements on outstanding debt. The Company
regularly assesses these risks and has established policies and business
practices to protect against the adverse effects of these and other potential
exposures.
The Company's borrowings under the Credit Facility and subordinated notes due to
affiliated physicians contain an element of market risk from changes in interest
rates. The Company manages this risk, in part, through the use of interest rate
swaps. The Company does not enter into interest rate swaps or hold other
derivative financial instruments for speculative purposes. The Company is not
obligated under any interest rate swap agreements at September 30, 1999.
For purposes of specific risk analysis, the Company uses sensitivity analysis to
determine the impact that market risk exposures may have on the Company. The
financial instruments included in the sensitivity analysis consist of all of the
Company's cash and equivalents, long-term and short-term debt and all derivative
financial instruments
To perform sensitivity analysis, the Company assesses the risk of loss in fair
values from the impact of hypothetical changes in interest rates on market
sensitive instruments. The market values for interest rate risk are computed
based on the present value of future cash flows as impacted by the changes in
the rates attributable to the market risk being measured. The discount rates
used for the present value computations were selected based on market interest
rates in effect at September 30, 1999. The market values that result from these
computations are compared with the market values of these financial instruments
at September 30, 1999. The differences in this comparison are the hypothetical
gains or losses associated with each type of risk. A one percent increase or
decrease in the levels of interest rates on variable rate debt with all other
variables held constant would not result in a material change to the Company's
results of operations or financial position or the fair value of its financial
instruments.
-14-
<PAGE>
US ONCOLOGY, INC.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
A range of federal, civil and criminal laws target false claims and fraudulent
activities. One of the most significant is the Federal False Claims Act, which
prohibits the submission of a false claim or the making of a false record or
statement in order to secure reimbursement. The Federal False Claims Act carries
potential penalties of $5,000 to $10,000 for each false claim, as well as for
treble damages, and exclusion from the Medicare and Medicaid system. Claims
under these laws may be brought either by the government or by private
individuals on behalf of the government, through a "whistleblower" or "qui tam"
action. Because such actions are filed under seal and may remain secret for a
significant period of time, the Company may not be aware of the existence of any
such claim against it.
Earlier this month, the Company was informed that one of the Company's
subsidiaries and an affiliated physician group are the subject of allegations
that their billing practices may violate the Federal False Claims Act. It is our
understanding that the allegations are the result of two qui tam complaints
filed under seal prior to the Merger. The Company has been informed that the
Civil Division of the U.S. Department of Justice will be investigating the
allegations in order to determine if the United States will intervene and pursue
the claims on behalf of the plaintiffs. If the United States does not intervene,
the plaintiffs may continue to pursue the claims individually. Because the
complaints are under seal and very little information is available for the
Company to review, and because the Company is awaiting further information from
the Department of Justice (including its decision regarding intervention), the
Company is unable to fully assess at this point in time the nature or magnitude
of these allegations. If the plaintiffs and/or the United States were to prevail
in these claims, the resulting judgment could have a material adverse effect on
the Company.
ITEM 2. Changes in Securities
In connection with each affiliation transaction between the Company and a
physician group, the Company purchases the nonmedical assets of, and enters into
a long-term management services agreement with, that physician group. In
consideration for that arrangement, the Company typically pays cash, issues
subordinated promissory notes (in general, payable in equal installments on the
third through seventh anniversaries of the closing date at an annual interest
rate of seven percent) and unconditionally agrees to deliver shares of Common
Stock at future specified dates (in general, on each of the third through fifth
anniversaries of the closing date). The price per share is the lower of the
average of the closing price per share for the five days preceding the date of
the letter of intent or the closing date with respect to such affiliation
transaction.
For the first nine months of 1999 the Company affiliated with fifteen physician
groups consisting of forty-one physicians. In conjunction with these
transactions the Company agreed to issue 1,966,260 shares of Common Stock and
issued $17.8 million of subordinated promissory notes. Each sale was a private
placement made in connection with a physician transaction, as described in
general in the preceding paragraph. The overwhelming majority of the affiliated
physicians are accredited investors. No underwriter was involved in any such
sale, and no commission or similar fee was paid with respect thereto. Each sale
was not registered under the Securities Act of 1933 in reliance on Section 4(2)
of such Act and Rule 506 enacted thereunder.
-15-
<PAGE>
US ONCOLOGY, INC.
OTHER INFORMATION - CONTINUED
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
3.1 Amended and Restated Certificate of Incorporation (incorporated by
reference from the Company's Form 8-K/A, filed June 17, 1999)
3.2 Amended and Restated By-Laws (incorporated by reference from the
Company's Form 8-K/A filed June 17, 1999)
4.1 Rights Agreement between the Company and American Stock Transfer &
Trust Company (incorporated by reference from Form 8-A filed June 2,
1997)
10.1 Fourth Amended and Restated Loan Agreement dated May 11, 1999 among
First Union National Bank, various Lenders and the Company
(incorporated by reference from the Form 10-Q for the Second Quarter
of 1999)
10.2 Third Amendment to Certain Operative Agreements dated as of May 14,
1999 by and among the Company, various of its subsidiaries, First
Security Bank, National Association as owner trustee, various
Lenders and Holders (as defined herein) and First Union National
Bank, as Agent (incorporated by reference from the Form 10-Q for the
Second Quarter of 1999)
27 Financial Data Schedule
(b) Reports on Form 8-K
The Company did not file any current reports on Form 8-K during the Third
Quarter of 1999.
-16-
<PAGE>
US ONCOLOGY, INC.
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.
Date: November 11, 1999 US ONCOLOGY, INC.
By: /s/ L. FRED POUNDS
-------------------------------------------
L. Fred Pounds, Chief Financial Officer and
Treasurer (duly authorized signatory and
Principal Financial Officer)
-17-
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