<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, 2000
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)
(832) 601-8766
(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 9, 2000, 91,798,084 shares of the Registrant's Common Stock
were outstanding. In addition, as of November 9, 2000, the Registrant had
agreed to deliver 10,730,955 shares of its Common Stock on certain future dates
for no additional consideration.
<PAGE>
US ONCOLOGY, INC.
FORM 10-Q
SEPTEMBER 30, 2000
Table of Contents
<TABLE>
<CAPTION>
Page No.
------------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements----------------------- 3
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----------------------------- 10
Item 3. Quantitative and Qualitative Disclosures about Market Risks------- 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings------------------------------------------------- 18
Item 2. Changes in Securities--------------------------------------------- 19
Item 6. Exhibits and Reports on Form 8-K---------------------------------- 20
SIGNATURES 21
</TABLE>
2
<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,
2000 1999
----------- -----------
ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and equivalents....................................................... $ 14,043 $ 11,381
Investment in common stock................................................. -- 27,258
Accounts receivable........................................................ 342,002 331,361
Prepaid expenses and other current assets.................................. 60,249 42,655
Inventories................................................................ 14,481 24,692
Due from affiliated physician groups....................................... 28,727 38,894
--------- ----------
Total current assets................................................... 459,502 476,241
Property and equipment, net................................................. 270,679 254,289
Management service agreements, net.......................................... 546,164 537,130
Other assets................................................................ 31,197 30,817
---------- ----------
$1,307,542 1,298,477
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term indebtedness.............................. $ 26,395 $ 26,693
Accounts payable.......................................................... 124,759 107,937
Due to affiliated physician groups........................................ 8,524 2,584
Income taxes payable...................................................... 8,954 9,322
Other accrued liabilities................................................. 57,100 48,912
---------- ----------
Total current liabilities.............................................. 225,732 195,448
Deferred income taxes....................................................... 37,134 33,224
Long-term indebtedness...................................................... 292,835 360,191
---------- ----------
Total liabilities...................................................... 555,701 588,863
Minority interest........................................................... 2,962 2,450
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, 94,407 and 87,253
issued, 91,957 and 87,253 outstanding................................... 920 873
Additional paid-in capital................................................ 442,676 428,533
Common Stock to be issued, approximately 10,305 and 13,982 shares......... 79,868 91,330
Treasury Stock, 2,450 and 0 shares........................................ (11,712) --
Retained earnings......................................................... 237,127 186,428
---------- ----------
Total stockholders' equity............................................. 748,879 707,164
---------- ----------
$1,307,542 $1,298,477
========== ==========
</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,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue.......................................... $337,310 $277,789 $968,318 $793,415
Operating expenses
Pharmaceuticals and supplies............... 169,249 134,773 480,164 373,502
Practice compensation and benefits......... 69,680 54,464 201,206 156,043
Other practice costs....................... 40,351 33,435 114,151 95,787
General and administrative................. 13,426 10,062 38,900 27,867
Depreciation and amortization.............. 18,272 15,317 55,804 45,573
Contract separation and investigation
related costs............................. 206 -- 3,372 --
Merger and integration costs............... -- 2,747 -- 27,238
-------- -------- -------- --------
311,184 250,798 893,597 726,010
-------- -------- -------- --------
Income from operations........................... 26,126 26,991 74,721 67,405
Interest expense, net............................ (7,404) (6,016) (20,515) (15,949)
Gain on investment in common stock............... -- -- 27,566 --
-------- -------- -------- --------
Income before income taxes....................... 18,722 20,975 81,772 51,456
Income taxes..................................... 7,114 5,992 31,073 21,172
-------- -------- -------- --------
Net income....................................... 11,608 14,983 50,699 30,284
-------- -------- -------- --------
Other comprehensive income, net of tax........... -- 1,499 -- 1,379
-------- -------- -------- --------
Comprehensive income............................. $ 11,608 $ 16,482 $ 50,699 $ 31,663
======== ======== ======== ========
Net income per share - basic..................... $ 0.12 $ 0.15 $ 0.50 $ 0.30
======== ======== ======== ========
Shares used in per share calculations - basic.... 99,984 100,493 101,262 100,018
======== ======== ======== ========
Net income per share - diluted................... $ 0.12 $ 0.15 $ 0.50 $ 0.30
======== ======== ======== ========
Shares used in per share calculations - diluted.. 100,146 102,184 101,408 101,600
======== ======== ======== ========
</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,
-------------------------------
2000 1999
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income........................................................... $ 50,699 $ 30,284
Non cash adjustments:
Contract separation and investigation related costs.................. 1,514 --
Realized gain on investment in common stock.......................... (27,566) --
Depreciation and amortization........................................ 55,804 45,573
Deferred income taxes................................................ 3,910 (477)
Non cash merger and integration costs................................ -- 2,300
Gain on contract termination......................................... -- (3,152)
Earnings in joint ventures........................................... 512 --
Changes in operating assets and liabilities:......................... 16,445 (67,347)
--------- --------
Net cash provided by operating activities..................... 101,318 7,181
--------- --------
Cash flows from investing activities:
Acquisition of property and equipment................................ (47,428) (60,978)
Net payments in medical practice transactions........................ (11,767) (36,182)
Proceeds from sale of investment in common stock..................... 54,824 --
Other................................................................ -- 342
--------- --------
Net cash used by investing activities......................... (4,371) (96,818)
--------- --------
Cash flows from financing activities:
Proceeds from Credit Facility........................................ 262,000 83,000
Repayment of Credit Facility......................................... (326,000) (9,621)
Repayment of other indebtedness...................................... (15,731) --
Purchase of Treasury Stock........................................... (15,532) --
Proceeds from exercise of options.................................... 978 4,637
--------- --------
Net cash provided (used) by financing activities............. (94,285) 78,016
--------- --------
Increase (decrease) in cash and equivalents............................. 2,662 (11,621)
Cash and equivalents:
Beginning of period.................................................. 11,381 13,691
--------- --------
End of period........................................................ $ 14,043 $ 2,070
========= ========
Interest Paid........................................................... $ 19,159 $ 14,045
Taxes Paid.............................................................. $ 31,441 $ 14,016
Non cash transactions:
Value of Common Stock to be issued in medical practice transactions.. $ 5,570 $ 21,834
Delivery of Common Stock to be issued in medical practice
transactions........................................................ 17,034 8,733
Debt issued in medical practice transactions......................... 9,976 20,642
Debt assumed in medical practice transactions........................ 900 86
Debt issued to finance insurance premiums............................ 1,315 649
</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
10-K filed with the Securities and Exchange Commission on March 30, 2000.
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 2000 and
1999, 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 the presentation and accounting standards of the two
companies.
NOTE 3 - REVENUE
Revenue recorded by the Company is the difference between medical service
revenue and amounts retained by affiliated physician groups. 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.
Amounts retained by the affiliated physician groups for physician compensation
are primarily derived under two management service agreement models. Under the
first model (the Net Revenue Model), amounts retained by physician groups are
based upon a specified amount (typically 23% of net revenue) and, if certain
financial criteria are satisfied, an incremental performance-based amount.
Under the second model (the EBIT Model), amounts retained by physician groups
are based upon a percentage (typically 65% - 75%) of the difference between net
revenues less direct expenses, excluding interest expense and taxes.
6
<PAGE>
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-continued
(UNAUDITED)
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,
-------------------------- ----------------------------
2000 1999 2000 1999
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Medical service revenue........................... $441,301 $361,716 $1,266,566 $1,033,519
Amounts retained by affiliated physician groups... 103,991 83,927 298,248 240,104
-------- -------- ---------- ----------
Revenue........................................... $337,310 $277,789 $ 968,318 $ 793,415
======== ======== ========== ==========
</TABLE>
The Company's most significant management services agreement, which is the only
management services agreement to provide more than 10% of revenues to the
Company, is with Texas Oncology, P.A. (TOPA). TOPA accounted for approximately
24.9% and 24.8% of the Company's total revenue for the three months ended
September 30, 2000 and 1999, respectively, and 24.9% and 25.2% for the nine
months ended September 30, 2000 and 1999, respectively.
NOTE 4 - GAIN ON SALE OF INVESTMENT IN COMMON STOCK
In March 2000, the Company sold its equity investment in ILEX Oncology, Inc. in
a private sale transaction and realized proceeds of $54.8 million, or $38.8
million net of tax. Included in other income for the first nine months of 2000
is $27.6 million related to a gain on disposal of this stock. A previous gain
of $14.4 million was recognized during the fourth quarter of 1999 as a result of
the Company's reclassification of the ILEX stock as a trading security.
NOTE 5 - CAPITALIZATION
In March 2000, the Board of Directors of the Company authorized the repurchase
of up to 10,000,000 shares of the Company's Common Stock in public or private
transactions. From May 2000 through September 2000, the Company repurchased
3,291,786 shares of Common Stock at an average price of $4.72 per share. The
Company issued 841,849 shares from Treasury Stock to affiliated physicians in
satisfaction of the Company's obligation to issue Common Stock in connection
with medical practice transactions.
NOTE 6 - CREDIT FACILITY AND MASTER LEASE
Credit Facility
Effective 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 consisted of a $175 million
five-year revolving credit facility (Revolver) and a $100 million 364-day
revolving credit facility. The Company allowed the $100 million 364-day
revolving credit facility to terminate at its maturity in June 2000, as the
Company did not anticipate requiring any borrowings under such facility for the
remainder of 2000. 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, 2000,
the Company had an outstanding balance of $110 million under the $175 million
Credit Facility. The Company has classified borrowings under the Credit
Facility as long-term indebtedness due to its ability and intent to maintain the
borrowings beyond the next twelve months.
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)
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
7
<PAGE>
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-continued
(UNAUDITED)
interest on LIBOR related loans is due at the end of each applicable interest
period or quarterly, if earlier. As of September 30, 2000, the weighted average
interest rate on all outstanding draws under the Credit Facility was 7.74%.
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.
Senior Secured Notes
In November 1999, the Company issued $100 million in senior secured notes to a
select group of institutional investors. The notes bear interest at 8.42%,
mature in installments from 2002 through 2006 and rank equal in right of payment
with all current and future senior indebtedness of the Company. The senior
secured notes contain restrictive financial and operational covenants and are
secured by the same collateral as the Credit Facility.
Master Lease
Effective 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, 2000 were $58.9 million.
NOTE 7 - 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.
8
<PAGE>
US ONCOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-continued
(UNAUDITED)
The table below summarizes the determination of shares used in per share
calculations (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Outstanding at end of period:
Common Stock............................................ 91,957 85,539 91,957 85,539
Common Stock to be issued............................... 10,305 14,978 10,305 14,978
------- ------- ------- -------
102,262 100,517 102,262 100,517
Effect of weighting..................................... (2,278) (24) (1,000) (499)
------- ------- ------- -------
Shares used in per share calculations-basic.................. 99,984 100,493 101,262 100,018
Effect of weighting and assumed share equivalents for grants
of stock options at less than the weighted average price
and subordinated convertible promissory notes.............. 162 1,691 146 1,582
------- ------- ------- -------
Shares used in per share calculations-diluted................ 100,146 102,184 101,408 101,600
======= ======= ======= =======
Anti-dilutive stock options not included above.............. 6,740 3,921 7,027 5,737
======= ======= ======= =======
</TABLE>
NOTE 8 - 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 as of and for 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. In 1999, FASB issued Statement No. 137 which delayed
the required implementation date for FAS 133 until the Company's year ended
December 31, 2001. Management expects to implement FAS 133 for the year ended
December 31, 2001 and is still evaluating the potential impact but currently
does not expect such implementation to have a material effect on the Company's
operations.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB
101) which provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements. Implementation of this guidance is required no
later than the fourth quarter of fiscal year 2000 giving retroactive effect to
January 1, 2000. The Company is still evaluating the potential impact of SAB
101.
9
<PAGE>
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
US Oncology, Inc. (the "Company" or "US Oncology") is a cancer management
company that 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, which include reimbursement of all medical
practice operating costs for which the Company is contractually responsible.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
The following statements are or may constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995: (i)
certain statements, including possible or assumed future results of operations
of US Oncology, contained in "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and including any statements contained
herein regarding the prospects for any of the Company's services; (ii) any
statements preceded by, followed by or that include the words "believes",
"expects", "anticipates", "intends", "estimates", "plans" or similar
expressions; and (iii) other statements contained herein regarding matters that
are not historical facts.
US Oncology's business and results of operations are subject to risks and
uncertainties, many of which are beyond the Company's ability to control or
predict. Because of these risks and uncertainties, actual results may differ
materially from those expressed or implied by such forward-looking statements,
and US Oncology stockholders are cautioned not to place undue reliance on such
statements, which speak only as of the date thereof. Factors that could cause
actual results to differ materially include, but are not limited to, government
regulation and enforcement, reimbursement for healthcare services, particularly
including reimbursement for pharmaceuticals, integration of formerly separate
operations in connection with the AOR/PRN merger, changes in cancer therapy or
the manner in which cancer care is delivered, drug utilization, and the
operations of the Company's affiliated physician groups. Please refer to the
Company's Annual Report on Form 10-K for the year ended December 31, 1999,
particularly the section entitled "Risk Factors," for a more detailed discussion
of certain of these risks and uncertainties.
The cautionary statements contained or referred to herein should be considered
in connection with any written or oral forward-looking statements that may be
issued by US Oncology or persons acting on its behalf. US Oncology does not
undertake any obligation to release any revisions to or to update publicly any
forward-looking statements to reflect events or circumstances after date thereof
or to reflect the occurrence of unanticipated events.
In addition to the risk factors cited above, investors should consider the
following:
There is a continued risk of declining reimbursement for pharmaceuticals used by
the Company's affiliated physician groups.
Currently Medicare and most Medicaid programs reimburse providers for oncology
drugs based on the Average Wholesale Price (AWP) of the drugs. AWP is
determined by third-party information services using data furnished by
pharmaceutical companies. In May 2000, the U.S. Department of Health and Human
Services announced its intention to publish instructions to the Health Care
Financing Administration (HCFA), the agency that administers the Medicare
program, that would require a new source for AWP for calculating the amount that
health care providers would receive from Medicare for certain pharmaceuticals
used in cancer treatment. The proposed change would have resulted in radically
lowered reimbursement from federal government programs for chemotherapy agents
and other pharmaceutical agents used by oncologists, without any adjustment in
reimbursement for services and other costs related to chemotherapy infusion that
10
<PAGE>
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONT.
are currently undercompensated, resulting in oncologists' incurring losses for
the administration of many chemotherapy treatments. In September 2000, HCFA
stated that reimbursement for pharmaceuticals used to treat cancer would not be
reduced at that time. At the same time, however, HCFA announced its belief that
there is a need to modify its reimbursement scheme for pharmaceuticals, and that
HCFA would therefore commence a comprehensive initiative to develop a more
accurate reimbursement methodology for outpatient cancer therapy services. In
addition, currently published AWPs remain under scrutiny. It is not possible to
assess the likely outcome of reimbursement for oncology services, particularly
reimbursement of pharmaceuticals, whether through HCFA initiatives or through
the calculation of AWP from information supplied by pharmaceutical companies,
but it is possible that changes in reimbursement that are ultimately adopted or
implemented may have a materially adverse effect on the Company's and its
affiliated physician practices' operations and financial condition.
Many of the management fee arrangements with physician groups subject the
Company to disproportionate economic risk.
Currently, the economic arrangements in the Company's management agreements with
affiliated physician groups fall into two principal categories. In all of the
agreements, the Company's management fee includes reimbursement for all practice
costs (primarily, pharmaceuticals and supplies, practice compensation and
benefits, other practice costs and financing costs) and an additional fee. Some
of the Company's agreements, known as the "EBIT Model" agreements, provide that
this additional fee is a percentage of the practice's earnings before income
taxes and interest. In others, known as "Net Revenue Model" agreements, the
additional fee is comprised of a fixed fee, a percentage fee (in most states)
and, if certain financial and performance criteria are met, a performance fee.
Where the Company's management agreement follows the Net Revenue Model, the
physician group is entitled to retain a fixed portion of net revenue before any
management fee (other than practice costs) is paid. Under these agreements,
therefore, the Company bears disproportionately the economic impact of
increasing or declining margins. The Company's costs of operations have
increased, primarily due to an increase of expensive single source drugs and
practice compensation and benefits, which has resulted in a disproportionate
decline in the Company's operating margin. Because of this, the Company is
considering alternatives to the Net Revenue Model and evaluating the
appropriateness of a change on a market-by-market basis. Although the Company
is encouraged by initial feedback from some of its affiliated physician groups
regarding management fee alternatives, there can be no assurance that the
Company will be successful in implementing favorable alternative arrangements.
In the event it is not successful, continuing to manage physician practices
under the Net Revenue Model agreements could have a material and adverse effect
on the Company.
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.
As of September 30, 2000, the Company is affiliated with the following number of
physicians by specialty:
<TABLE>
<S> <C>
Medical oncology.................................. 660
Radiation oncology................................ 116
Other............................................. 88
---
864
===
</TABLE>
11
<PAGE>
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONT.
The following table sets forth the sources for growth in the number of
physicians affiliated with the Company:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
----------------------
2000 1999
---- ----
<S> <C> <C>
Affiliated physicians, beginning of period........ 806 719
Physician practice affiliations................... 24 41
Recruited physicians.............................. 51 51
Retiring/Other.................................... (17) (12)
---- ----
Affiliated physicians, end of period.............. 864 799
==== ====
</TABLE>
Additionally, the Company either owned or leased 68 and 60 cancer centers as of
September 30, 2000 and 1999, respectively.
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,
2000 1999 2000 1999
----- ----- ----- -----
<S> <C> <C> <C> <C>
Revenue........................................... 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Pharmaceuticals and supplies..................... 50.2 48.5 49.6 47.1
Practice compensation and benefits............... 20.6 19.6 20.8 19.7
Other practice costs............................. 12.0 12.0 11.8 12.1
Contract separation and investigation related
costs........................................... 0.1 -- 0.3 --
General and administrative....................... 4.0 3.6 4.0 3.5
Merger and integration costs..................... -- 1.0 -- 3.4
Depreciation and amortization.................... 5.4 5.5 5.8 5.7
Other income..................................... -- -- (2.8) --
Net interest expense............................. 2.2 2.2 2.1 2.0
----- ----- ----- -----
Income before income taxes........................ 5.5 7.6 8.4 6.5
Income taxes...................................... 2.1 2.2 3.2 2.7
----- ----- ----- -----
Net income........................................ 3.4% 5.4% 5.2% 3.8%
===== ===== ===== =====
</TABLE>
2000 COMPARED TO 1999
Overall, the Company experienced a decrease in operating margins from the first
nine months of 1999 to the first nine months of 2000, with earnings before
taxes, interest, depreciation, amortization and other income ("EBITDA"), as a
percentage of revenue, declining from 14.2% to 13.5%. EBITDA as a percentage of
revenue decreased from 15.2% for the third quarter of 1999 to 13.2% for the
third quarter of 2000. A number of factors contributed to the decrease in
operating margins, including: (i) increases in the acquisition cost of
pharmaceuticals, (ii) shifts in the mix of pharmaceuticals to lower margin
products, (iii) increase in practice personnel costs due to increasing labor
rates and numerous network-wide initiatives, (iv) contract separation and
12
<PAGE>
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONT.
investigation related costs, and (v) increased operating costs without the
proportionate effect on physician compensation.
Revenue. Revenue increased from $793.4 million for the first nine months of
1999 to $968.3 million for the first nine months of 2000, an increase of $174.9
million, or 22%. Revenue increased from $277.8 million for the third quarter
of 1999 to $337.3 million for the third quarter of 2000, an increase of $59.5
million, or 21%. The growth in revenue is attributable to the growth in
affiliated practices' medical service revenue offset by amounts retained by
physician groups. The following presents the amounts included in determination
of the Company's revenue (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -----------------------------
2000 1999 2000 1999
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Medical service revenue........................... $441,301 $361,716 $1,266,566 $1,033,519
Amounts retained by affiliated physician groups... 103,991 83,927 298,248 240,104
-------- -------- ---------- ----------
Revenue........................................... $337,310 $277,789 $ 968,318 $ 793,415
======== ======== ========== ==========
</TABLE>
Medical service revenue growth is attributable to an increase in: (i) medical
oncology services, (ii) anticancer pharmaceuticals and (iii) radiation and
diagnostic revenue. The increase in medical oncology services is attributable
to an increase in medical oncology visits of existing affiliated physicians,
combined with the addition of 65 physicians in the nine months ended September
30, 2000. The increase in anticancer pharmaceuticals revenue is attributable to
the growth in medical oncology services, coupled with a continued increase in
utilization of more expensive, lower margin drugs, principally single-source
drugs. The increase in radiation and diagnostic revenue is attributable to an
increase of daily radiation treatments by existing affiliated physicians by 7%,
combined with the opening of six additional cancer centers during the nine
months ended September 30, 2000.
Amounts retained by physician groups increased from $240.1 million for the first
nine months of 1999 to $298.2 million for the first nine months of 2000, an
increase of $58.1 million, or 24.2%. Amounts retained by physician groups
increased from $83.9 million for the third quarter of 1999 to $104.0 million for
the third quarter of 2000, an increase of $20.1 million, or 23.9%. Such
increases in amounts retained by physician groups are directly attributable to
the growth in medical service revenue combined with the increase in
profitability of affiliated practices. The following is the medical service
revenue attributed to the Company's two principal management fee models--the
EBIT Model and the Net Revenue Model (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- ----------------------------
2000 1999 2000 1999
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Net Revenue Model................................. $256,540 $210,960 $ 735,030 $ 593,656
EBIT Model ...................................... 181,485 146,316 523,284 422,266
Other............................................. 3,276 4,440 8,252 17,597
-------- -------- ---------- ----------
$441,301 $361,716 $1,266,566 $1,033,519
======== ======== ========== ==========
</TABLE>
Amounts retained by physician groups increased from 23.2% of medical service
revenue for the first nine months of 1999 to 23.5% for the first nine months of
2000 and from 23.2% for the third quarter of 1999 to 23.6% for the third quarter
of 2000. 58.0% of medical service revenue for the first nine months of 2000 is
derived from Net Revenue Model management agreements, with 40.9% being derived
from EBIT Model management agreements. The lack of proportionate decline in
physician compensation, when compared to increasing operating costs as a
percentage of medical service revenue, results in physician groups' compensation
under the Net Revenue Model not being proportionately impacted by increasing
operating costs.
13
<PAGE>
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONT.
Pharmaceuticals and Supplies. Pharmaceuticals and supplies expense, which
includes drugs, medications and other supplies used by the affiliated physician
groups, increased from $373.5 million for the first nine months of 1999 to
$480.2 million for the first nine months of 2000, an increase of $106.7 million,
or 28.6%. Pharmaceuticals and supplies expense increased from $134.8 million in
the third quarter of 1999 to $169.2 million in the third quarter of 2000, an
increase of $34.5 million, or 25.6%. As a percentage of revenue,
pharmaceuticals and supplies increased from 47.1% for the first nine months of
1999 to 49.6% for the comparable period of 2000 and from 48.5% in the third
quarter of 1999 to 50.2% in the third quarter of 2000. This increase was
primarily due to: (i) a shift in the revenue mix to a higher percentage of
revenue from drugs, (ii) increases in acquisition prices of drugs, (iii) a shift
to lower margin drugs and (iv) with respect to practices operating under the Net
Revenue Model, the Company's disproportionately bearing the impact of increasing
operating costs. Management expects that third-party payors, particularly
government payors, will continue to negotiate or mandate 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.
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.
Practice Compensation and Benefits. Practice compensation and benefits, which
includes the salaries, wages and benefits of the affiliated physician groups'
employees (excluding affiliated physicians) and the Company's employees who are
located at the affiliated physician practice sites and business offices,
increased from $156.0 million for the first nine months of 1999 to $201.2
million for the first nine months of 2000, an increase of $45.2 million or
28.9%. Practice compensation and benefits increased from $54.5 million in the
third quarter of 1999 to $69.7 million in the third quarter of 2000, an increase
of $15.2 million, or 27.9%. As a percentage of revenue, practice compensation
and benefits increased from 19.7% in the first nine months of 1999 to 20.8% in
the first nine months of 2000 and from 19.6% in the third quarter of 1999 to
20.6% in the third quarter of 2000. The increase was primarily attributable to
salary increases due to low unemployment rates and additional labor to execute
numerous network-wide initiatives.
Other Practice Costs. Other practice costs, which consist of rent, utilities,
repairs and maintenance, insurance and other direct practice costs, increased
from $95.8 million for the first nine months of 1999 to $114.2 million for the
first nine months of 2000, an increase of $18.4 million or 19.2%. Other
practice costs increased from $33.4 million in the third quarter of 1999 to
$40.4 million in the third quarter of 2000, an increase of $6.9 million, or
20.7%. This increase in other practice costs is due to increased facilities and
activity levels. As a percentage of revenue, other practice costs decreased
from 12.1% in the first nine months of 1999 to 11.8% in the first nine months of
2000, and remained constant at 12% in each of the third quarters of 1999 and
2000.
Contract Separation and Investigation Related Costs. During the third quarter
and second quarter of 2000, the Company incurred costs of $206,000 and $1.7
million, respectively, in connection with the qui tam lawsuits described in Part
II, Item I, of this report, consisting primarily of auditing and legal fees and
related expenses. In addition, the Company incurred $1.5 million of costs in
the second quarter of 2000 consisting of intangible asset and receivable write-
downs as a result of terminating its affiliation with a sole practitioner and
with the physician group named in the qui tam lawsuits.
General and Administrative. General and administrative expenses increased
from $27.9 million in the first nine months of 1999 to $38.9 million of the
first nine months of 2000, an increase of $11.0 million or 39.6%. General and
administrative expenses increased from $10.1 million in the third quarter of
14
<PAGE>
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONT.
1999 to $13.4 million in the third quarter of 2000, an increase of $3.3
million, or 33.4%. As a percentage of revenue, general and administrative costs
increased from 3.5% in the first nine months of 1999 to 4.0% for the first nine
months of 2000 and from 3.6% in the third quarter of 1999 to 4.0% in the third
quarter of 2000. This increase was primarily attributable to additional
resources necessary for corporate operations support, as well as expansion of
systems and new business development.
Merger and Integration Costs. In the third quarter 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.
Interest. Net interest expense increased from $15.9 million in the first nine
months of 1999 to $20.5 million for the first nine months of 2000, an increase
of $4.6 million or 28.6%. Net interest expense increased from $6.0 million in
the third quarter of 1999 to $7.4 million in the third quarter of 2000, an
increase of $1.4 million, or 23.1%. As a percentage of revenue, net interest
expense was 2.0% and 2.1% for the first nine months of 1999 and 2000,
respectively, and remained constant at 2.2% for the third quarters of each of
1999 and 2000.
Other Income. Other income of $27.6 million in the first nine months of 2000
represents the recognition of the remaining gain on shares of common stock of
ILEX Oncology, Inc. owned by the Company. A previous gain of $14.4 million was
recognized during the fourth quarter of 1999 as a result of the Company's
reclassification of the ILEX stock as a trading security. The stock was sold by
the Company during the first quarter of 2000.
Income Taxes. For the first nine months of 2000, the Company recognized a tax
expense of $31.1 million resulting in an effective tax rate of 38.0%, down from
41.1% for the same prior year period. The decrease in rate is due to certain
non-deductible merger related costs in 1999.
Net Income. Net income increased from $30.3 million in the first nine months
of 1999 to $50.7 million in the first nine months of 2000, an increase of $20.4
million or 67.4%. Net income decreased from $15.0 million in the third quarter
of 1999 to $11.6 million in the third quarter of 2000, a decrease of $3.4
million. Net income as a percentage of revenue changed from 3.8% for the first
nine months of 1999 to 5.2% for the first nine months of 2000 and from 5.4% in
the third quarter of 1999 to 3.4% in the third quarter of 2000. Included in net
income for the first nine months of 2000 is a $17.1 million after-tax gain
resulting from the sale of ILEX stock. Excluding the gain on ILEX stock and
contract separation and investigation related costs, net income for the nine
months ended September 30, 2000 would have been $26.5 million, which represents
earnings per share of $0.26. Included in net income for the three months and
nine months ended September 30, 1999 were merger and integration costs of $2.7
million and $27.2 million pre-tax, respectively. Excluding the merger costs,
net income for the first nine months of 1999 would have been $49.2 million,
which represents earnings per share of $0.48, and for the third quarter of 1999,
net income would have been $14.8 million, which represents earnings per share of
$0.15. The decrease in net income and earnings per share after excluding these
items is attributable to the factors described in the preceding paragraphs.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital primarily to finance affiliation transactions with,
and to purchase the nonmedical assets of, oncology practices and to develop
comprehensive cancer centers. During the first nine months of 2000, the Company
paid total consideration of $27.3 million in connection with affiliations with
nine physician groups, including cash and transaction costs of $11.8 million.
During the comparable period of the prior year, the Company paid total
consideration of $78.7 million for affiliations with fifteen physician groups,
including cash and transaction costs of $36.2 million.
15
<PAGE>
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONT.
In March 2000, the Company sold its equity investment in ILEX Oncology, Inc. in
a private sale transaction and realized proceeds of $54.8 million, or $38.8
million net of tax. These proceeds were used to reduce outstanding borrowings
under the Credit Facility. Also in March 2000, the Board of Directors of the
Company authorized the repurchase of up to 10,000,000 shares of the Company's
Common Stock in public or private transactions. This year, through November
9, 2000, the Company has purchased 5,055,500 shares of Common Stock at an
average price of $4.73 per share. This year, through November 9, 2000, the
Company has issued 1,516,157 shares from treasury stock to affiliated physicians
in satisfaction of the Company's obligation to issue Common Stock in connection
with medical practice transactions.
To fund its growth and development, the Company has satisfied its transaction
and working capital needs through debt and equity financings and borrowings
under a $175 million syndicated revolving credit facility ("Credit Facility")
with First Union National Bank ("First Union"), as a lender and as an agent for
various other lenders, which matures in 2004. In addition, in connection with
the Credit Facility the Company has available a $75 million leasing facility
used by the Company in connection with developing its integrated cancer centers.
In November 1999, the Company sold an aggregate of $100 million of Senior
Secured Notes to a group of institutional investors, the proceeds of which were
used to repay amounts outstanding under the Credit Facility. The Senior Secured
Notes rank equally in right of payment with the Credit Facility. The notes bear
interest at 8.42% per annum with a final maturity in 2006 and an average life of
five years.
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, Leasing Facility and Senior Secured Notes 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, Leasing Facility and Senior Secured Notes.
During the first nine months of 2000, the Company repaid $64.0 million, net,
under the Credit Facility from proceeds of the sale of ILEX stock and improved
accounts receivable management. The Company is currently in compliance with the
Credit Facility, Leasing Facility and Senior Secured Note covenants, with
additional capacity under the Credit Facility of $65.0 million and Leasing
Facility of approximately $16.1 million at September 30, 2000. The Company has
relied primarily on management fees received from its affiliated physician
groups to fund its operations.
Cash provided by operations was $101.3 million in the first nine months of 2000,
an increase of $94.1 million from the comparable period in 1999. The increase
was due primarily to improved cash flow from accounts receivable management and
an improved cash management program. Cash used by investing activities was $4.4
million for the first nine months of 2000, a decrease of $92.4 million from the
same period of 1999. Such decrease is due primarily to proceeds from the sale
of investment in common stock as well as less investment in property & equipment
and physician affiliations in the first nine months of 2000. Cash used by
financing activities was $94.3 million for the first nine months of 2000 as
compared to cash provided of $78.0 million in the comparable prior year period.
Such decrease is due to the use of proceeds from the sale of the equity
investment in common stock for the repayment of borrowings under the Credit
Facility and purchases of Treasury Stock in the first nine months of 2000.
As of September 30, 2000, the Company had net working capital of $233.8 million
and cash and cash equivalents of $14.0 million. The Company also had $225.7
million of current liabilities, including approximately $26.4 million of current
indebtedness maturing before September 30, 2001. The Company currently expects
that its principal use of funds in the near future will be in connection with
future transactions with oncology groups, the purchase of medical equipment,
investment in information systems and the acquisition or lease of real estate
for the development of integrated cancer centers and PET centers. It is likely
that the Company's capital needs in the next several years will exceed the cash
generated from operations.
16
<PAGE>
US ONCOLOGY, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONT.
Thus, the Company may incur additional debt or issue additional debt or equity
securities from time to time. This may include the issuance of Common Stock or
notes in connection with physician affiliations. Capital available for health
care companies, whether raised through the issuance of debt or equity
securities, is quite limited. As a result, the Company may be unable to obtain
sufficient financing on terms satisfactory to management or at all.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
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 contain an element of market
risk from changes in interest rates. Historically, the Company has managed this
risk, in part, through the use of interest rate swaps; however, no such
agreements have been entered into in 2000. The Company does not enter into
interest rate swaps or hold other derivative financial instruments for
speculative purposes. The Company was not obligated under any interest rate
swap agreements during the nine-month period ended September 30, 2000.
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, 2000. The market values that result from these
computations are compared with the market values of these financial instruments
at September 30, 2000. 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.
17
<PAGE>
US ONCOLOGY, INC.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The provision of medical services by the Company's affiliated physicians entails
an inherent risk of professional liability claims. The Company does not control
the practice of medicine by physicians or the compliance with regulatory and
other requirements directly applicable to physicians and physician groups.
Because the Company's affiliated physician groups purchase and resell
pharmaceutical products, they face the risk of product liability claims. The
Company maintains insurance coverage that it believes to be adequate both as to
risks and amounts. In addition, pursuant to the management services agreements
with the affiliated physician groups, the affiliated practices and the Company
are required to maintain comprehensive professional liability insurance.
Successful malpractice claims asserted against the Company or one of the
affiliated physician groups could, however, have a material adverse effect on
the Company.
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. In addition to the government
bringing claims under the False Claims Act, qui tam, or "whistleblower," actions
may be brought by private individuals on behalf of the government. A violation
under the Federal False Claims Act occurs each time a claim is submitted to the
government or each time a false record is used to get a claim approved, when the
claim is false and the defendant acted knowingly. Under the False Claims Act,
defendants face exclusion from the Medicare/Medicaid programs and monetary
damages of $5,000 to $10,000 for each false claim, as well as treble damages.
The Company has been informed that the Company and certain affiliated physicians
are the subject of allegations that their billing practices may violate the
Federal False Claims Act. The allegations are the result of two qui tam
complaints filed under seal prior to the merger of PRN with a subsidiary of US
Oncology. The U.S. Department of Justice is currently 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 Sates does not intervene,
the plaintiffs may continue to pursue the claims individually. Because the
complaints are under seal, and because the Department of Justice is in the
process of investigating the claims, 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 Untied States were to prevail in these claims, the
resulting judgement could have a material adverse effect on the Company. In
addition, addressing the complaints and government investigation has required
and may continue to require the Company to devote significant financial and
other resources to the process, regardless of the ultimate outcome of the
claims. Because qui tam actions are filed under seal, there is a possibility
that the Company could be the subject of other qui tam actions of which it is
unaware.
In addition to the legal proceeding described in the prior paragraph, the
Company and its affiliated physicians are defendants in a number of lawsuits
involving employment disputes and breach of contract claims. Although the
Company believes the allegations are customary for the Company's size and scope
of operations, adverse judgements, individually or in the aggregate, could have
a material adverse effect on the Company.
18
<PAGE>
US ONCOLOGY, INC.
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.
During the first nine months of 2000, the Company affiliated with nine physician
groups consisting of 23 physicians. In conjunction with these transactions the
Company agreed to issue 1,594,015 shares of Common Stock and issued $10.0
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. All of the physicians involved in such transactions during
the first nine months of 2000 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.
19
<PAGE>
US ONCOLOGY, INC.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
3.1 Amended and Restated Certificate of Incorporation (filed as Exhibit
3.1 to the Company's Form 8-K/A filed June 17, 1999 and incorporated
herein by reference)
3.2 Amended and Restated By-Laws (filed as Exhibit 3.2 to the Company's
Form 8-K/A filed June 17, 1999 and incorporated herein by reference)
4.1 Rights Agreement between the Company and American Stock Transfer &
Trust Company (incorporated by reference from Form 8-A filed June 2,
1997)
4.2 Form of 8.42% Senior Secured Note due 2006 (filed as Exhibit 4.2 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1999 and incorporated herein by reference)
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 2000.
20
<PAGE>
US ONCOLOGY, INC.
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 13, 2000 US ONCOLOGY, INC.
By: /s/ R. DALE ROSS
--------------------------------------------
R. Dale Ross, Chief Executive Officer
(duly authorized signatory)
By: /s/ BRUCE D. BROUSSARD
--------------------------------------------
Bruce D. Broussard, Chief Financial Officer
(principal financial and accounting officer)
21
