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, 1998
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from to
******************************
Commission File Number 0-26260
SHERIDAN HEALTHCARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3252967
(State or other jurisdiction of (IRS Employer ID Number)
incorporation or organization)
4651 Sheridan Street, Suite 400, Hollywood, Florida 33021
(Address of principal executive offices, including zip code)
954/987-5822
(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
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of outstanding shares of the issuer's classes of common
stock as of the latest practicable date.
As of November 1, 1998, there were 7,766,580 shares of the Registrant's voting
Common Stock, $.01 par value, outstanding and 296,638 shares of the Registrant's
non-voting Class A Common Stock, $.01 par value, outstanding.
<PAGE>
Part I: Financial Information
Item 1: Financial Statements
<TABLE>
<CAPTION>
SHERIDAN HEALTHCARE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
September 30, December 31,
1998 1997
------------- -------------
(unaudited)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents..................................................... $ 154 $ 427
Accounts receivable, net of allowances........................................ 26,628 21,588
Income tax refunds receivable................................................. 772 1,280
Deferred income taxes......................................................... --- 1,417
Other current assets.......................................................... 2,958 2,814
------------- -------------
Total current assets ...................................................... 30,512 27,526
Property and equipment, net of accumulated depreciation.......................... 3,813 3,538
Intangible assets net of accumulated amortization................................ 95,603 54,168
Other intangible assets, net of accumulated amortization......................... 1,599 1,803
Other assets..................................................................... 3,773 ---
------------- -------------
Total assets.............................................................. $ 135,300 $ 87,035
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................................. $ 506 $ 591
Amounts due for acquisitions.................................................. 543 527
Accrued salaries and benefits................................................. 2,083 2,686
Self-insurance accruals....................................................... 4,627 3,973
Refunds payable............................................................... 3,520 2,674
Accrued physician incentives.................................................. 645 744
Other accrued expenses........................................................ 2,668 2,235
Current portion of long-term debt............................................. 448 446
------------- -------------
Total current liabilities................................................... 15,040 13,876
Long-term debt, net of current portion........................................... 53,005 29,833
Amounts due for acquisitions..................................................... 1,358 1,976
Deferred income taxes............................................................ 1,031 ---
Stockholders' equity:
Preferred stock, par value $.01; 5,000 shares authorized, none issued......... --- ---
Common stock, par value $.01; 21,000 shares authorized:
Voting; 7,767 and 6,509 shares issued and outstanding....................... 78 66
Class A non-voting; 297 shares issued and outstanding...................... 3 3
Additional paid-in capital.................................................... 72,621 53,811
Accumulated deficit........................................................... (7,836) (12,530)
------------- -------------
Total stockholders' equity ................................................. 64,866 41,350
------------- -------------
Total liabilities and stockholders' equity................................ $ 135,300 $ 87,035
============= =============
</TABLE>
See accompanying notes.
2
<PAGE>
<TABLE>
<CAPTION>
SHERIDAN HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended
September 30,
-----------------------------
1998 1997
------------- -------------
Revenue:
<S> <C> <C>
Patient service revenue....................................................... $ 27,564 $ 24,185
Management fees............................................................... 861 811
------------- -------------
Total net revenue........................................................... 28,425 24,996
------------- -------------
Operating expenses:
Direct facility expenses...................................................... 19,475 17,624
Provision for bad debts....................................................... 1,417 975
Salaries and benefits......................................................... 1,913 1,821
General and administrative.................................................... 998 1,246
Amortization.................................................................. 943 494
Depreciation.................................................................. 192 150
------------- -------------
Total operating expenses.................................................... 24,938 22,310
------------- -------------
Operating income................................................................. 3,487 2,686
Other (income) expense:
Interest expense.............................................................. 1,058 595
Other income.................................................................. (549) ---
------------- -------------
Total other expense......................................................... 509 595
------------- -------------
Income before income taxes....................................................... 2,978 2,091
Income tax expense............................................................... 1,311 757
------------- -------------
Net income....................................................................... $ 1,667 $ 1,334
============= =============
Net income per share
Basic......................................................................... $ .20 $ .20
Diluted....................................................................... .20 .19
Weighted average shares of common stock and
common stock equivalents outstanding
Basic......................................................................... 8,162 6,715
Diluted....................................................................... 8,376 7,114
</TABLE>
See accompanying notes.
3
<PAGE>
<TABLE>
<CAPTION>
SHERIDAN HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Nine Months Ended
September 30,
-----------------------------
1998 1997
------------- -------------
Revenue:
<S> <C> <C>
Patient service revenue....................................................... $ 81,368 $ 69,871
Management fees............................................................... 2,549 2,357
------------- -------------
Total net revenue........................................................... 83,917 72,228
------------- -------------
Operating expenses:
Direct facility expenses...................................................... 57,011 50,707
Provision for bad debts....................................................... 4,127 2,850
Salaries and benefits......................................................... 5,673 5,544
General and administrative.................................................... 3,074 3,655
Amortization.................................................................. 2,553 1,406
Depreciation.................................................................. 581 446
------------- -------------
Total operating expenses.................................................... 73,019 64,608
------------- -------------
Operating income................................................................. 10,898 7,620
Other (income) expense:
Interest expense.............................................................. 2,968 1,779
Other income.................................................................. (549) ---
------------- -------------
Total other expense......................................................... 2,419 1,779
------------- -------------
Income before income taxes....................................................... 8,479 5,841
Income tax expense............................................................... 3,785 2,087
------------- -------------
Net income....................................................................... $ 4,694 $ 3,754
============= =============
Net income per share
Basic......................................................................... $ .59 $ .56
Diluted....................................................................... .57 .54
Weighted average shares of common stock and
common stock equivalents outstanding
Basic......................................................................... 7,939 6,715
Diluted....................................................................... 8,298 6,969
</TABLE>
See accompanying notes
4
<PAGE>
<TABLE>
<CAPTION>
SHERIDAN HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
September 30,
-----------------------------
1998 1997
------------- -------------
Cash flows from operating activities:
<S> <C> <C>
Net income.................................................................... $ 4,694 $ 3,754
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization................................................................ 2,553 1,406
Depreciation................................................................ 581 446
Provision for bad debts..................................................... 4,127 2,850
Deferred income taxes....................................................... 2,448 (621)
Changes in operating assets and liabilities:
Accounts receivable......................................................... (8,792) (6,654)
Other current assets........................................................ (230) (902)
Other assets................................................................ 72 (469)
Accounts payable............................................................ (165) (12)
Other accrued expenses...................................................... 183 267
------------- ------------
Net cash provided by operating activities................................. 5,471 65
------------- ------------
Cash flows from investing activities:
Investment in management agreements and
acquisitions of physician practices......................................... (26,193) (8,992)
Sale of physician practices................................................... 38 3,282
Capital expenditures.......................................................... (848) (573)
------------- ------------
Net cash (used) in investing activities................................... (27,003) (6,283)
------------- ------------
Cash flows from financing activities:
Borrowings on long-term debt.................................................. 23,501 7,605
Payments on long-term debt.................................................... (410) (1,101)
Treasury stock purchases...................................................... (1,898) ---
Exercise of employee stock options............................................ 66 ---
------------- ------------
Net cash provided by financing activities................................. 21,259 6,504
------------- ------------
Increase (decrease) in cash and cash equivalents................................. (273) 286
Cash and cash equivalents:
Beginning of period........................................................... 427 ---
------------- ------------
End of period................................................................. $ 154 $ 286
============= ============
</TABLE>
See accompanying notes.
5
<PAGE>
SHERIDAN HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(unaudited)
(1) Basis of presentation
---------------------
The interim consolidated financial statements have been prepared without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission
("SEC"). Certain information and footnote disclosures, normally included in
financial statements prepared in accordance with generally accepted accounting
principles, have been condensed or omitted pursuant to SEC rules and
regulations; nevertheless, management believes that the disclosures herein are
adequate to make the information presented not misleading. These consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 1997. In the opinion of management,
all adjustments, consisting only of normal recurring adjustments, necessary to
fairly present the consolidated financial position of the Company at September
30, 1998, and the consolidated results of its operations and its consolidated
cash flows for the periods shown in the interim consolidated financial
statements, have been included herein. The results of operations for the interim
periods are not necessarily indicative of the results for the full years.
(2) Principles of consolidation
---------------------------
The consolidated financial statements include the accounts of the Company and
its majority owned subsidiaries and other entities in which the Company has a
controlling financial interest.
In November 1997, the Emerging Issues Task Force ("EITF") reached a consensus on
when a physician practice management company ("PPM") has established a
controlling financial interest in a physician practice through a contractual
management service agreement ("MSA"). A controlling financial interest must
exist in order for a PPM to consolidate the operations of an affiliated
physician practice. The consensus is addressed in EITF Issue 97-2, "Application
of FASB Statement No. 94 and APB Opinion No. 16 to Physician Practice Management
Entities".
The Company is following the controlling financial interest provisions of EITF
Issue 97-2 in its determination of whether the operations of an affiliated
physician practice qualify for consolidation. The Company's controlling
financial interest is demonstrated by means other than direct record ownership
of voting stock based on the provisions of its purchase agreements, voting trust
agreements or management agreements with these entities.
In accordance with EITF Issue 97-2, the Company's consolidated financial
statements include three practices that are affiliates of the Company, (the
"Affiliates"), Sheridan Medical Healthcorp, P.C., Sheridan Healthcare of Texas,
P.A. and Sheridan Children's Healthcare Services of Pennsylvania, P.C. Each of
these affiliates is owned by Gilbert Drozdow, as a nominee shareholder, who is
an executive officer and stockholder of the Company. These entities have
long-term management agreements with the Company whose terms demonstrate a
controlling financial interest by the Company. The practices provide
hospital-based physician services to four hospitals and have been included in
the Company's consolidated financial statements since the date of their
inception.
In addition, the Company's consolidated financial statements also include eleven
office-based practices and one hospital-based practice with which the Company
has long-term management agreements and purchase option agreements whose terms
also demonstrate a controlling financial interest, (the "Consolidating
Practices"). These agreements, entered into during 1997 and 1998, have been
accounted for in the Company's consolidated financial statements in accordance
with EITF 97-2 and have been included in the Company's consolidated financial
statements since the date of their acquisition.
6
<PAGE>
SHERIDAN HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The Company provides management services to a neonatology practice and a pain
management practice which entered into long-term management agreements with the
Company in December 1997 and February 1998, respectively. The Company also
provided management services to a primary care practice whose agreement was
terminated in December 1997 and to a primary care practice whose agreement was
terminated in April 1998. The Company does not have a controlling financial
interest in these practices. These management agreements are included in the
Company's consolidated financial statements only to the extent of management
fees earned and expenses incurred by the Company.
The table below sets forth the components of the Company's net revenue:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------- -------------------------------------
1998 1997 1998 1997
----------------- ------------------ ---------------- -----------------
Total % Total % Total % Total %
<S> <C> <C> <C> <C> <C> <C> <C> <C>
The Company................. $ 17,787 62.6% $ 19,168 76.7% $ 55,331 65.9% $ 57,152 79.1%
Affiliates.................. 3,141 11.1 3,058 12.3 9,287 11.1 9,073 12.6
Consolidating Practices..... 6,636 23.3 1,959 7.8 16,750 20.0 3,646 5.0
--------- ------- --------- -------- -------- -------- --------- -------
Patient service revenue.. 27,564 97.0 24,185 96.8 81,368 97.0 69,871 96.7
--------- ------- --------- -------- -------- -------- --------- -------
Management fees............. 861 3.0 811 3.2 2,549 3.0 2,357 3.3
--------- ------- --------- -------- -------- -------- --------- -------
Total.................. $ 28,425 100.0% $ 24,996 100.0% $ 83,917 100.0% $ 72,228 100.0%
========= ======= ========= ======== ======== ======== ========= =======
</TABLE>
(3) Intangible Assets
-----------------
The Company acquires or affiliates with physician practices through the
acquisition of their net assets, the acquisition of their stock or the
acquisition of an option to acquire their stock concurrent with the execution of
a long-term management services agreement. In each of these transactions the
Company allocates the purchase price to the tangible assets acquired and
liabilities assumed. The excess of the purchase price over the fair value of
assets acquired and liabilities assumed is allocated to intangible assets as
goodwill when the Company acquires the net assets or outstanding stock of a
physician practice and to intangible assets as the cost of obtaining the
management services agreement when the Company enters into a long-term
management services agreement and purchases the option to acquire the
outstanding stock of a physician practice.
Approximately $28.0 million of the total amount of intangible assets, net of
accumulated amortization, at September 30, 1998, is related to the Company's
acquisition of Sheridan Healthcorp, Inc. (the "Predecessor") in November 1994.
Such goodwill represents the Company's market position and reputation, its
relationships with its customers and affiliated physicians, the relationships
between its affiliated physicians and their patients, and other similar
intangible assets and is being amortized on a straight-line basis over 40 years.
Approximately $16.8 million of the total amount of intangible assets is
goodwill, net of accumulated amortization, at September 30, 1998, related to
several acquisitions of physician practices by the Company and its Predecessor.
Such goodwill represents the general reputation of the practices in the
communities they serve, the collective experience of the management and other
employees of the practices, contracts with health maintenance organizations,
relationships between the physicians and their patients, patient lists, and
other similar intangible assets. The Company evaluates the underlying facts and
circumstances related to each acquisition and establishes an appropriate
amortization period for the related goodwill. The goodwill related to these
physician practice acquisitions is being amortized on a straight-line basis over
periods ranging from 20 to 25 years.
7
<PAGE>
SHERIDAN HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Approximately $50.8 million of the total amount of intangible assets represents
the cost of obtaining management services agreements, net of accumulated
amortization, at September 30, 1998. The cost of obtaining management services
agreements with practices is related to the general reputation of the practices
in the communities they serve, contracts with third-party payors, relationships
between the physicians and their patients, patient lists, the Company's ability
to integrate the practice into its existing network of hospital-based and
office-based practices and the term and enforceability of the management
services agreement. The Company evaluates the underlying facts and circumstances
related to each agreement and establishes an appropriate amortization period
related to the cost of obtaining the agreement. The cost of obtaining management
services agreements is being amortized over the shorter of the term of the
agreement or 25 years.
The Components of the Company's intangible assets segregated by amortization
period are as follows:
Physician Practice Acquisitions and Affiliations:
<TABLE>
<CAPTION>
Amortization Original Balance
Period Amount September 30, 1998
------------ ---------------- ------------------
<S> <C> <C>
20 years 3,016 2,290
25 years 66,878 65,320
---------------- ----------------
Sub-Total 69,894 67,610
Predecessor Acquisition:
40 years 30,960 27,993
---------------- ----------------
Total $ 100,854 $ 95,603
================ ================
</TABLE>
The weighted average amortization period of the Company's intangible assets is
approximately 25 years, excluding the goodwill which arose from the acquisition
of the Predecessor by the Company, and approximately 31 years for all intangible
assets of the Company.
The SEC has recently provided guidance in regards to the appropriate
amortization periods to be used in connection with the amortization of
intangible assets within the physician practice management industry. The
guidance provided has caused several companies within the industry that were
amortizing intangible assets over periods in excess of 25 years to prospectively
change the amortization period of their intangible assets to 25 years. This
change in estimate has resulted in an increase in the amortization expense
reported by those companies. The Company has entered into discussions with the
SEC regarding the amortization periods of its intangible assets. A significant
change in the estimated useful lives of certain intangible assets of the Company
could have an adverse impact on its future net income and reported earnings per
share. Such an accounting change, if made, would have no impact on the Company's
cash flow or operations nor would it reflect a change in management's estimate
of the value and expected duration of such intangible assets.
8
<PAGE>
SHERIDAN HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(4) Other intangible assets
-----------------------
Other intangible assets consist primarily of the physician employee workforce,
non-physician employee workforce, management team and computer software acquired
in the Company's acquisition of the Predecessor, identified intangible assets
acquired concurrent with transactions with physician practices and deferred loan
costs. These other intangible assets are being amortized over the lives of the
underlying assets or agreements, which range from three to seven years.
(5) Other assets
------------
Other assets consist primarily of notes receivable entered into in connection
with the sale of certain physician practices during 1997 and 1998. The notes
receivable have maturity dates ranging from December 1999 to April 2003 and bear
interest at annual rates that range from 7.5% to 9.0%.
(6) Amounts due for acquisitions
----------------------------
Amounts due for acquisitions include obligations to the former stockholders of
certain physician practices acquired by the Company. The obligations to former
stockholders arose at the time of acquisition as a result of negotiation between
the Company and the former stockholders who desired ongoing compensation in
excess of a reasonable market rate for their physician services. These payments
are being made to former stockholders who are employed by the Company over the
terms of their employment agreements with the Company which range from three to
five years. These payments cease upon termination of the physician's employment
with the Company. Amounts due for acquisitions also includes termination
benefits payable to the former stockholders of an acquired practice, which are
payable beginning in 2001 or upon termination of their employment by the
Company, whichever is later. These termination benefits were an obligation of
the practice prior to acquisition by the Company and were included as part of
the purchase price allocation at the time of acquisition.
(7) Acquisitions and divestitures
-----------------------------
During the period from March 1997 to December 1997, the Company purchased
options to acquire five office-based physician practices and one hospital-based
physician practice for an aggregate of $10.8 million in cash and approximately
14,000 shares of the Company's common stock which had a value of approximately
$170,000 on the date of acquisition. During the period from January 1998 to
September 1998 the Company completed thirteen transactions with physician
practices for aggregate consideration of approximately $46.0 million of which
approximately $25.3 million was paid in cash and approximately $20.7 million was
paid through the issuance of approximately 1,428,000 shares of the Company's
common stock. The table below summarizes the components of consideration paid in
connection with the transactions completed in 1998 (in thousands):
<TABLE>
<CAPTION>
Cash Shares Value of Total
Date Paid Issued Shares Consideration
-------------------- --------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C>
January 1998 $ 5,750 173 $ 2,525 $ 8,275
February 1998 5,936 287 3,878 9,814
March 1998 1,650 39 566 2,216
March 1998 4,195 885 13,167 17,362
May-June 1998 3,175 44 519 3,694
July-September 1998 4,600 --- --- 4,600
--------------- --------------- ---------------- ---------------
$ 25,306 1,428 $ 20,655 $ 45,961
=============== =============== ================ ===============
</TABLE>
9
<PAGE>
SHERIDAN HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Each of these transactions was completed as an acquisition of a practice's net
assets, an acquisition of a practice's stock or through the acquisition of an
option to acquire the practice's stock for a nominal amount concurrent with the
execution of a long-term management services agreement. Acquisitions and
transactions with practices in which the Company established a controlling
financial interest are accounted for as purchases and accordingly, the
operations of each acquired or managed practice are included in the Company's
consolidated financial statements beginning on each respective date of
acquisition, or the effective date of the management agreement, as applicable.
The operations under management agreements entered into with the practices in
which the Company does not have a controlling financial interest are included in
the Company's consolidated financial statements beginning on the date of each
agreement. In each transaction, the consideration was allocated to the net
assets acquired based on their estimated fair market values. As a result of
these allocations, $40.9 million of the aggregate consideration was allocated to
the cost of management services agreements which is being amortized over 25
years and $5.2 million was allocated to goodwill which is also being amortized
over 25 years.
The value of the Company's common stock issued in connection with each
transaction is based on the closing market price for the Company's common stock
on the date each transaction is completed. In connection with the issuance of
the Company's common stock as consideration for the acquisition of certain
physician practices, the Company is obligated to make additional payments to the
sellers of the practices which are contingent on the market price of the
Company's common stock upon a specified date following the date of the
transaction. In most cases, the Company has the option to satisfy the contingent
obligation by either making an additional cash payment or by the issuance of
additional shares of the Company's common stock. If required, additional
payments would be accounted for as additional purchase price and increase
recorded goodwill or intangible assets. Such shares have been excluded from the
calculation of diluted earnings per share because of management's ability to
fund the additional purchase price, if any, through cash payments rather than
the issuance of additional shares.
The following table summarizes the pro forma consolidated results of operations
of the Company as though the transactions with physician practices that were
accounted for as purchases, as discussed above, had occurred at the beginning of
the period presented. The pro forma consolidated results of operations shown
below do not necessarily represent what the consolidated results of operations
of the Company would have been if these acquisitions had actually occurred at
the beginning of the period presented, nor do they represent a forecast of the
consolidated results of operations of the Company for any future period.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- --------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(in thousands, except per share data)
Pro Forma Results of Operations:
<S> <C> <C> <C> <C>
Net revenue of the Company................ $ 29,099 $ 30,746 $ 90,151 $ 92,240
Income before income taxes................ 3,015 3,056 9,199 8,918
Net income................................ 1,681 1,860 5,077 5,411
Net income per share - basic.............. 0.21 0.24 0.62 0.69
Net income per share - diluted............ 0.20 0.23 0.59 0.67
</TABLE>
During the period from February 1997 through December 1997 the Company sold two
primary care office locations and two rheumatology practices. Effective April 1,
1998 the Company completed the sale of a primary care practice with two office
locations. The office-based practices sold during 1997 and 1998 generated
approximately $1.9 million and $7.8 million in net revenue for the nine months
ended September 30, 1998 and 1997, respectively and $2.2 million for the three
months ended September 30, 1997. The practices sold did not generate significant
operating income for those periods.
10
<PAGE>
SHERIDAN HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(8) Long-term debt
--------------
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
----------- -----------
<S> <C> <C>
Revolving credit facility, maturing in April 2001,
secured by substantially all assets of the Company.................... $ 52,500 $ 29,000
Capital lease obligations payable in various monthly
installments, maturing at various dates through 2001.................. 953 1,279
----------- -----------
Total................................................................ 53,453 30,279
Less current portion.................................................... (448) (446)
----------- -----------
Long-term debt...................................................... $ 53,005 $ 29,833
=========== ===========
</TABLE>
On March 12, 1997, the Company established a new $35 million revolving credit
facility, which was used to pay the outstanding balance under the previous
credit facility. On December 17, 1997 the Company amended its existing revolving
credit facility which increased the amount available from $35 million to $50
million. On April 30, 1998 the Company further amended its revolving credit
facility which increased the amount available from $50 million to $75 million.
This amendment included the syndication of the credit facility with a group of
banks led by NationsBank, N.A. There are no principal payments due under the new
credit facility until the maturity date of April 30, 2001. The new revolving
credit facility contains various restrictive covenants that include, among other
requirements, the maintenance of certain financial ratios, various restrictions
regarding acquisitions, sales of assets, liens and dividends, and limitations
regarding investments, additional indebtedness and guarantees. The Company was
in compliance with the loan covenants in the new credit facility as of September
30, 1998. The additional amount that could be borrowed under the credit facility
is potentially restricted by a leverage ratio defined in the credit agreement.
Based on the value of this leverage ratio at September 30, 1998, the Company had
the ability to borrow the entire unused portion of the credit facility, which
was $22.5 million at September 30, 1998.
(9) Income taxes
------------
The Company's income tax expense was reduced by a loss carryforward from the
prior year for the three months and nine months ended September 30, 1997.
Without the loss carryforward, income tax expense for the three months and nine
months ended September 30, 1997 would have been approximately $970,000 and $2.7
million, respectively. The Company had an unused loss carryforward of
approximately $550,000 for book purposes as of September 30, 1997. The tax
effect of the loss carryforward from 1996 was allocated evenly among all four
quarters in the year ending December 31, 1997. The Company had net deferred tax
liabilities at September 30, 1998, which represent the tax effect of differences
between the tax basis and the financial reporting basis of assets and
liabilities on the Company's balance sheet.
(10) Litigation
----------
In October 1996, the Company and certain of its directors, officers and legal
advisors were named as defendants in a lawsuit filed in the Circuit Court of the
Seventeenth Judicial Circuit in and for Broward County, Florida by certain
former physician stockholders of the predecessor, which was formerly named
Southeastern Anesthesia Management Associates, Inc. The claim alleges that the
defendants engaged in a conspiracy of fraud and deception for personal gain in
connection with inducing the plaintiffs to sell their stock in the predecessor
to the Company, as well as legal malpractice and violations of Florida
securities laws. The claim seeks damages of at least $10 million and the
imposition of a constructive trust and disgorgement of stock and options held by
certain members of the Company's management. The litigants are presently engaged
in the course of discovery. The Company intends to continue to vigorously defend
against the lawsuit and also believes the lawsuit's ultimate resolution and
ongoing fees incurred as defense costs will not have a material adverse impact
on the financial position, operations and cash flow of the Company.
11
<PAGE>
SHERIDAN HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(11) Recent accounting developments
------------------------------
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income", ("SFAS
No. 130"), which was adopted in the first quarter of fiscal 1998. This statement
established standards for the reporting and display of comprehensive income and
its components in a full set of general-purpose financial statements. This
statement requires that an enterprise (a) classify items of other comprehensive
income by their nature in financial statements and (b) display the accumulated
balance of other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of statements of financial
position. Comprehensive income is defined as the change in equity during the
financial reporting period of a business enterprise resulting from non-owner
sources. The Company currently does not have other comprehensive income and
therefore the adoption of SFAS No. 130 did not have a significant impact on its
financial statement presentation as comprehensive income is equal to net income.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information", ("SFAS No. 131"), which is required to be
adopted in fiscal 1998. This statement requires that a public business
enterprise report financial and descriptive information about its reportable
operating segments including, among other things, a measure of segment profit or
loss, certain specific revenue and expense items, and segment assets. The
Company does not believe the adoption of SFAS No. 131 will have a significant
impact on its financial statement presentation.
In February 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No.132, "Employers' Disclosures about Pensions
and Other Postretirement Benefits", ("SFAS No. 132") which is effective for
fiscal years ending after December 15, 1997. SFAS No. 132 revises employers'
disclosures about pension and other postretirement obligations of those plans.
The Company does not believe the adoption of SFAS No. 132 will have a
significant impact on its financial statement disclosures.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-5 ("SOP 98-5"). SOP 98-5 requires all
non-governmental entities to expense costs of start-up activities, including
pre-operating, pre-opening and organization activities, as those costs are
incurred. The Company does not believe the adoption of SOP 98-5 will have a
significant impact on the Consolidated Statements of Operations.
(12) Earnings per share
------------------
Reconciliation of Basic EPS Factors to Diluted EPS Factors:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- --------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(in thousands)
Weighted average common shares
outstanding for basic earnings per
<S> <C> <C> <C> <C>
share .................................. 8,162 6,715 7,939 6,715
Impact of dilutive employee stock
options................................. 214 399 359 254
----------- ----------- ----------- -----------
Weighted average of shares of
common stock equivalents for
diluted earnings per share.............. 8,376 7,114 8,298 6,969
=========== =========== =========== ===========
</TABLE>
12
<PAGE>
SHERIDAN HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(13) Stock options
-------------
The Company adopted Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," ("SFAS No. 123") in 1996. The Company
has elected to continue using Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," in accounting for employee stock
options. Each stock option has an exercise price equal to the market price on
the date of grant and, accordingly, no compensation expense has been recorded
for any stock option grants.
Stock option activity during the nine months ended September 30, 1998 was as
follows:
<TABLE>
<CAPTION>
Weighted
Average
Number Exercise
of Shares Price
<S> <C> <C>
Balance, December 31, 1997................................................. 937,084 $ 7.91
Exercised.................................................................. (18,247) 3.59
Granted during period...................................................... 523,050 14.80
Forfeited during period.................................................... (14,300) 7.72
-----------
Balance, September 30, 1998................................................ 1,427,587 $ 9.90
===========
</TABLE>
13
<PAGE>
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS
This form 10-Q contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. All forward-looking statements included in this document are based on
information available to the Company on the date hereof, and the Company assumes
no obligation to update any such forward-looking statements. The Company's
actual results could differ materially from those set forth in the
forward-looking statements. Certain factors, in addition to other information
set forth herein and identified in the Company's Form 10-K for fiscal 1997 under
"Business" and elsewhere therein, that might cause such a difference include the
following: fluctuation in the volume of services delivered by the Company's
affiliated physicians, changes in reimbursement rates for those services from
third party payors including government sponsored healthcare programs,
uncertainty about the ability to collect the appropriate fees for those
services, the loss of significant hospital or third-party payer relationships,
the ability to recruit and retain qualified physicians, changes in the number of
patients using the Company's physician services and legislated changes to the
Company's structural relationships with its physicians and practices.
GENERAL
The Company provides physician services to hospitals, ambulatory surgical
facilities and in office-based settings in a variety of medical specialties
including anesthesia, emergency medicine, general surgery, gynecology,
infertility, neonatology, obstetrics, pediatrics, perinatology and primary care.
The Company also provides management services to physician practices that employ
physicians practicing in generally the same medical specialties as the Company's
physicians. The Company derives its revenue from the medical services provided
by the physicians who are employed by the Company and from management fees
earned from the managed practices. For the nine months ended September 30, 1998,
approximately 97% of the Company's net revenue was derived from physician
services and approximately 3% of the Company's net revenue was generated under
management services agreements. References to physician services provided by the
Company include services performed by physicians employed by the Company and
services provided by physicians in whose practices the Company has a controlling
financial interest (the "Consolidated Practices"). The financial results of the
Consolidated Practices are presented on a consolidated basis with those of the
Company because the Company has a controlling financial interest in these
practices based on the provisions of its purchase agreements, voting trust
agreements or management agreements with these entities.
Three of the Consolidated Practices are affiliates of the Company, Sheridan
Medical Healthcorp, P.C. ("Sheridan NY"), Sheridan Healthcare of Texas, P.A.
("Sheridan TX"), and Sheridan Children's Healthcare Services of Pennsylvania,
P.C. ("Sheridan PA"). Each of these affiliates has entered into a long-term
management agreement with the Company and is owned by Gilbert Drozdow, M.D. who
is an executive officer and a stockholder of the Company. In addition, the
Consolidated Practices include twelve practices with which the Company executed
long-term management agreements and purchase option agreements from March 1997
through September 1998. One of these practices is located in Texas, the
remainder are located in Florida.
The Company generates revenue from its physician services by directly billing
third-party payors or patients on a fee-for-service or discounted
fee-for-service basis, through subsidies paid by hospitals to supplement billing
from third party payors and pursuant to capitation arrangements, which included
shared-risk capitation arrangements with managed care organizations until April
1, 1998. The Company generates management services revenue from managed
practices through a variety of reimbursement arrangements. Reimbursement terms
under management agreements in place with unconsolidated practices during 1998
required the practice to pay the Company a management fee that was either based
on a percentage of net revenues or based on expenses incurred by the Company
plus a flat fee that does not fluctuate based on performance. Management fees
that are based on a percentage of net revenue range from 35% to 65% and are not
subject to adjustment.
14
<PAGE>
In most of its arrangements with hospitals and ambulatory surgical facilities,
the Company is responsible for recruiting and employing physicians and other
healthcare professionals who provide healthcare services at the facility. In
addition, the Company provides a comprehensive range of support services,
including contracting with third-party payors, billing and collections,
malpractice risk management, quality assurance, and physician recruiting and
credentialling. By entering into a contract with the Company, a hospital
substantially reduces its responsibilities related to the contracted specialty,
and eliminates the administrative burdens related to providing physician
coverage, since the Company provides contracted services on a 24-hour a day,
365-day a year basis.
The Company provides management services to a neonatology practice and a pain
management practice which entered into long-term management agreements with the
Company in December 1997 and February 1998, respectively. The Company also
provided management services to a primary care practice whose agreement was
terminated in December 1997 and to a primary care practice whose agreement was
terminated in April 1998.
In connection with a management services agreement, the Company typically
manages all aspects of the practice other than the provision of medical
services, which is controlled by the practice. The Company typically is
responsible for all leases for office space and equipment, hires all
non-clinical office personnel and provides comprehensive management services,
including physician recruiting and credentialling, managed care contracting,
malpractice risk management, utilization review, billing and collections, and
management information systems. In exchange for these services, the practice
pays the Company a management fee.
Transactions with acquired physician practices are accounted for as purchases.
Transactions with managed physician practices whose agreements with the Company
have terms that demonstrate a controlling financial interest by the Company are
also accounted for as purchases. The operations of acquired and managed
practices whose transactions are accounted for as purchases are included in the
Company's financial statements beginning on each respective transaction date.
From January 1, 1997 to November 4, 1997 the Company entered into long-term
management agreements with, and purchased options to acquire, four obstetrical
practices and one general surgical practice at an aggregate cost of
approximately $11 million in cash and 14,000 shares of the Company's common
stock which had a value of approximately $170,000 on the date of closing.
In January 1998 and June 1998 the Company entered into long-term management
agreements with, and purchased options to acquire, a hospital-based anesthesia
practice and a neonatology practice, respectively, for approximately $6.9
million in cash and approximately 204,000 shares of the Company's common stock
which had a value on the date of closing of approximately $2.9 million. During
the period from January 6, 1998 through September 9, 1998 the Company completed
four acquisitions of obstetrical practices and entered into long-term management
agreements with and purchased options to acquire two obstetrical practices, a
perinatology practice, a gynecology-oncology practice, an infertility practice
and a general surgical practice at an aggregate cost of $12.5 million in cash
and 937,000 shares of the Company's common stock which had a value of
approximately $13.9 million on the date of closing. The Company's consolidated
financial statements include the operations of these practices from the date of
their respective transaction.
In December 1997, the Company entered into a twenty-year management agreement
with a hospital-based neonatology practice at a cost of $435,000. In addition,
in February 1998 the Company executed a forty-year management agreement with a
pain management practice at a cost of $5.9 million in cash and approximately
287,000 shares of the Company's common stock which had a value on the date of
closing of approximately $3.9 million. The operations under management
agreements entered into with the practices in which the Company does not have a
controlling financial interest are included in the Company's consolidated
financial statements beginning on the date of each agreement.
On November 4, 1996, the Company announced a change in its strategic direction,
which was to place more emphasis on its hospital-based business and to reduce
its emphasis on the primary care business, and its intent to dispose of
non-strategic office-based physician practices. Due to this change in strategic
direction, the Company wrote down certain assets related to its office-based
operations to their estimated realizable values, and accrued certain liabilities
for commitments that no longer have value to the Company's future operations.
These adjustments resulted in a $17.4 million charge to earnings in 1996.
15
<PAGE>
The Company sold one primary care office location in December 1996 and one in
February 1997, four rheumatology office locations in April 1997 and one primary
care location in December 1997. The Company consolidated the remaining practices
to be sold from five office locations into three office locations, which employ
five primary care physicians. Two of these primary care office locations were
sold in April 1998. In addition, as noted above, the Company has terminated two
long-term management agreements with primary care practices entered into during
1996 that included five office locations and four physicians. The office-based
practices which have been sold, and which the Company currently intends to sell,
include the four-facility practice acquired on September 1, 1994, two primary
care practices acquired in February 1995, a three-facility primary care practice
acquired in June 1995 and two rheumatology practices acquired in 1996. The
office-based practices sold during 1997 and 1998 generated approximately $ 1.9
million and $7.8 million in net revenue for the nine months ended September 30,
1998 and 1997, respectively and $2.2 million for the three months ended
September 30, 1997. The practices sold did not generate significant operating
income for those periods.
As a result of its change in strategic direction the Company has experienced a
shift in the composition of its patient service revenue away from capitation
arrangements. The primary care practices sold generated a substantial majority
of the Company's capitation revenue during 1997 and the nine months ended
September 30, 1998.
Revenue under shared-risk capitation arrangements accounted for approximately
2.3% and 8.7% for nine months ended September 30, 1998 and 1997, respectively,
of the Company's net revenue. Under shared-risk capitation the Company receives
a fixed monthly amount from a managed care organization in exchange for
providing, or arranging the provision of, substantially all of the health care
services required by members of the managed care organization. The Company
generally provides all of the primary care services required under such
arrangements, and refers its patients to unaffiliated specialist physicians,
hospitals, and other health care providers which deliver the remainder of the
required health care services. The Company's profitability under such
arrangements is dependent upon its ability to effectively manage the use of
specialist physician, hospital and other health care services by its patients.
In each of the above fiscal periods amounts received from managed care
organizations under shared-risk capitation arrangements exceeded the cost of
services provided to patients under such arrangements. However, the
profitability of the Company's shared-risk capitation arrangements had declined
each year as a result of a decline in patients enrolled with the managed care
organization and assigned to the Company's practices. The Company completed the
sale of a two facility primary care practice on April 1, 1998 which eliminated
all of the Company's shared-risk capitation revenue.
As a result of the 1994 Acquisition and several transactions with physician
practices completed by the Company and its Predecessor, intangible assets
constitute a substantial percentage of the total assets of the Company, and the
Company's results of operations include substantial expenses for amortization of
these intangible assets. Intangible assets are the excess of the purchase price
of acquired businesses or cost of management services agreements over the fair
value of the net assets acquired (which net assets include any other separately
identifiable intangible assets). As of September 30, 1998, the Company's total
assets were approximately $135.3 million, of which approximately $97.2 million,
or 71.8%, were intangible assets. Of the total intangible assets at September
30, 1998, $28.0 million is related to the 1994 Acquisition, and $69.2 million is
related to several transactions with physician practices completed by the
Predecessor and the Company.
The goodwill included in intangible assets that is related to the 1994
Acquisition represents the going concern value of the Company, which consists of
the Company's market position and reputation, its relationships with its
customers and affiliated physicians, the relationships between its affiliated
physicians and their patients, and other similar intangible assets. Since these
assets are believed by the Company to have useful lives of an indefinite length,
and the Company is not aware of any facts or circumstances that would limit the
useful lives of these assets, this goodwill is being amortized over 40 years.
The Company also acquired other intangible assets as part of the 1994
Acquisition, including the value of the Company's physician employee workforce,
management team, non-physician employee workforce and computer software. These
other intangible assets have been capitalized separately from goodwill and are
being amortized over their estimated useful lives, which range from five to
seven years.
16
<PAGE>
The goodwill included in intangible assets that is related to the acquisitions
of physician practices also represents the going concern value of those
practices. However, since the going concern value of an individual physician
practice, or a small group practice, is subject to a higher degree of risk than
the Company as a whole and may be more adversely affected by changes in the
health care industry, this goodwill is being amortized over shorter periods
ranging from 20 to 25 years.
The cost of long-term management services agreements included in intangible
assets that is related to the acquisition of options to acquire physician
practices and the simultaneous execution of management agreements with the
practices represents the going concern value of those management agreements. The
going concern value of these long-term management services agreements is related
to the general reputation of the practices in the communities they serve,
contracts with third-party payors, relationships between the physicians and
their patients, patient lists, the Company's ability to integrate the practice
into its existing network of hospital-based and office-based practices and the
term and enforceability of the management services agreement. The cost of
management services agreements is being amortized over the shorter of the term
of the management agreement or 25 years.
The Company continuously evaluates all components of goodwill and other
intangible assets to determine whether there has been any impairment of the
carrying value of goodwill or such other intangible assets or their useful
lives. The Company is not aware of any such impairment at the current time,
except for the impairment included in the $17.4 million write-down of
office-based net assets in 1996 discussed above, which resulted primarily from
the Company's change in strategic direction.
The Securities and Exchange Commission (the "SEC"), has recently provided
guidance in regards to the appropriate amortization periods to be used in
connection with the amortization of intangible assets within the physician
practice management industry. The guidance provided has caused several companies
within the industry that were amortizing intangible assets over periods in
excess of 25 years to prospectively change the amortization period of their
intangible assets to 25 years. This change in estimate has resulted in an
increase in the amortization expense reported by those companies. The Company
has entered into discussions with the SEC regarding the amortization periods of
its intangible assets. A significant change in the estimated useful lives of
certain intangible assets of the Company could have an adverse impact on its
future net income and reported earnings per share. Such an accounting change, if
made, would have no impact on the Company's cash flow or operations nor would it
reflect a change in management's estimate of the value and expected duration of
such intangible assets.
RESULTS OF OPERATIONS
The following table shows certain statement of operations data expressed as
percentage of net revenue:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ----------------------
1998 1997 1998 1997
---------- ---------- --------- --------
(in thousands)
Revenue:
<S> <C> <C> <C> <C>
Patient services revenue.......................... 97.0% 96.8% 97.0% 96.7%
Management fees................................... 3.0 3.2 3.0 3.3
---------- ---------- --------- --------
Total net revenue.................................... 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Direct facility expenses.......................... 68.5 70.5 67.9 70.2
Provision for bad debts........................... 5.0 3.9 4.9 3.9
Salaries and benefits............................. 6.7 7.3 6.8 7.7
General and administrative........................ 3.5 5.0 3.7 5.1
Amortization...................................... 3.3 2.0 3.0 1.9
Depreciation...................................... 0.7 0.6 0.7 0.6
--------- --------- --------- --------
Total operating expenses..................... 87.7 89.3 87.0 89.4
--------- --------- --------- --------
Operating income..................................... 12.3% 10.7% 13.0% 10.6%
========= ========= ========= ========
</TABLE>
17
<PAGE>
Three Months Ended September 30, 1998 Compared to Three Months Ended
September 30, 1997
Patient service revenue was $27.6 million in 1998 compared to $24.2 million in
1997, an increase of $3.4 million or 14.0%. Of this increase, $1.4 million was
due to the acquisition of a hospital-based physician practice during the first
quarter of 1998, $1.3 million was due to the acquisition of several office-based
practices during the past year, and $600,000 was due to the acquisition of a
hospital-based practice in June 1998. An increase in management fees generated
from management agreements with two hospital-based practices entered into in
December 1997 and February 1998 offset a decrease in management fees earned from
two primary care practices whose agreements were terminated in December 1997 and
April 1998.
Direct facility expenses increased $1.9 million, or 10.5%, from $17.6 million in
1997 to $19.5 million in 1998. Direct facility expenses include all operating
expenses that are incurred at the location of the physician practice, including
salaries, employee benefits, referral claims (in the case of shared-risk
capitation business), office expenses, medical supplies, insurance and other
expenses. The increase in direct facility expenses corresponds to the increase
in net revenue as noted above. Direct facility expenses as a percentage of net
revenue decreased from 70.5% in 1997 to 68.5% in 1998. The decrease in the
direct facility expense percentage is attributable to the Company's divestiture
of its remaining shared risk capitation business which historically incurred a
higher percentage of direct facility expenses compared to the Company's
fee-for-service practices.
The provision for bad debts increased $442,000, or 45.3%, from $975,000 in 1997
to $1,417,000 in 1998. This increase was due to a 14.0% increase in net revenue,
as discussed above, and an increase in the Company's overall bad debt percentage
which increased from 3.9% in 1997 to 5.0% in 1998. The increase in the Company's
bad debt percentage is due to an increase in the Company's net revenue derived
from office-based practices with a concentration of fee-for-service revenue
rather than capitation revenue, which was substantially eliminated with the
divestiture of two primary care locations in April 1998. Capitated practices
incur minimal bad debt expense.
Salaries and benefits increased $92,000, or 5.1%. Salaries and benefits includes
salaries, payroll taxes and employee benefits related to employees located at
the Company's central office, including employees related to hospital-based
operations, office-based operations and general corporate functions. The
increase in salaries and benefits was due to an increase in administrative
personnel at the corporate office to support the Company's growth. As a
percentage of net revenue, salaries and benefits decreased from 7.3% in 1997 to
6.7% in 1998.
General and administrative expense decreased $250,000, or 20.0%, from $1.2
million in 1997 to $1.0 million in 1998. General and administrative expense
includes expenses incurred at the Company's central office, including office
expenses, accounting and legal fees, insurance, travel and other similar
expenses. The decrease in general and administrative expense was due to a
decrease in legal fees incurred in connection with malpractice cases which are
now reflected as a direct facility expense, a decrease in rent expense at the
corporate office and a decrease in advertising expense. As a percentage of net
revenue, general and administrative expense decreased from 5.0% in 1997 to 3.5%
in 1998.
Amortization expense increased $449,000, or 90.9%, from $494,000 in 1997 to
$943,000 in 1998. This increase was related to several acquisitions of physician
practices and management agreements with physician practices, completed from
March 1997 to September 1998, which are included in the transactions discussed
in Note 6 to the accompanying consolidated financial statements.
Operating income increased approximately $800,000, or 29.8%, from $2.7 million
in 1997 to $3.5 million in 1998. This increase was due to growth from
acquisitions and new contracts. As a percentage of net revenue, operating income
increased from 10.7% in 1997 to 12.3% in 1998. This increase was primarily due
to the fact that net revenue increased at a greater rate than salaries and
benefits or general and administrative expense and the reduction in the direct
facility expense percentage from 70.5% in 1997 to 68.5% in 1998 as noted above.
Other income recognized was $549,000 for the third quarter of 1998. Other income
primarily represents an amount recognized by the Company pursuant to a favorable
judgement received by the Company in connection with certain litigation.
18
<PAGE>
Nine Months Ended September 30, 1998 Compared to Nine Months Ended
September 30, 1997
Patient service revenue was $81.4 million in 1998 compared to $69.9 million in
1997, an increase of $11.5 million or 16.5%. Of this increase, $4.8 million was
due to the acquisition of a hospital-based physician practices during the first
quarter and second quarter of 1998, $4.9 million was due to the acquisition of
several office-based practices during the past year, $150,000 was due to the
addition of new contracts for hospital-based services during the past year and
$1.6 million was due to growth in revenue from the Company's same-store
hospital-based contracts. Management fees increased from $2.4 million in 1997 to
$2.5 million in 1998, or 8.1%. This increase was attributable to the execution
of long-term management agreements with two hospital-based practices in December
1997 and February 1998, respectively, offset by the termination of management
services agreements with two primary care practices in December 1997 and April
1998.
Direct facility expenses increased $6.3 million, or 12.4%, from $50.7 million in
1997 to $57.0 million in 1998. Direct facility expenses include all operating
expenses that are incurred at the location of the physician practice, including
salaries, employee benefits, referral claims (in the case of shared-risk
capitation business), office expenses, medical supplies, insurance and other
expenses. The increase in direct facility expenses corresponds to the increase
in net revenue as noted above. Direct facility expenses as a percentage of net
revenue decreased from 70.2% in 1997 to 67.9% in 1998. The decrease in the
direct facility expense percentage is attributable to the Company's divestiture
of its remaining shared risk capitation business which historically incurred a
higher percentage of direct facility expenses compared to the Company's
fee-for-service practices.
The provision for bad debts increased $1.3 million, or 44.8%, from $2.9 million
in 1997 to $4.1 million in 1998. This increase was due to a 16.5% increase in
net revenue, as discussed above, and an increase in the Company's overall bad
debt percentage which increased from 3.9% in 1997 to 4.9% in 1998. The increase
in the Company's bad debt percentage is due to an increase in the Company's net
revenue derived from office-based practices with a concentration of
fee-for-service revenue rather than capitation revenue. Capitated practices
incur minimal bad debt expense.
Salaries and benefits increased $129,000, or 2.3%, in 1998. Salaries and
benefits include salaries, payroll taxes and employee benefits related to
employees located at the Company's central office, including employees related
to hospital-based operations, office-based operations and general corporate
functions. The increase in salaries and benefits was due to an increase in
personnel used to support the growth in the Company's hospital-based contracts.
As a percentage of net revenue, salaries and benefits decreased from 7.7% in
1997 to 6.8% in 1998.
General and administrative expense decreased $581,000, or 15.9%, from $3.7
million in 1997 to $3.1 million in 1998. General and administrative expense
includes expenses incurred at the Company's central office, including office
expenses, accounting and legal fees, insurance, travel and other similar
expenses. The decrease in general and administrative expense was due to a
decrease in legal fees incurred in connection with malpractice cases which are
now reflected as a direct facility expense a decrease in rent expense at the
Company's corporate office and a decrease in advertising expense. As a
percentage of net revenue, general and administrative expense decreased from
5.1% in 1997 to 3.7% in 1998.
Amortization expense increased $1.2 million, or 81.6%, from $1.4 million in 1997
to $2.6 million in 1998. This increase was related to several acquisitions of
physician practices and management agreements with physician practices,
completed from March 1997 to September 1998, which are included in the
transactions discussed in Note 6 to the accompanying consolidated financial
statements.
Operating income increased $3.3 million, or 43.0%, from $7.6 million in 1997 to
$10.9 million in 1998. This increase was due to growth from acquisitions and new
contracts. As a percentage of net revenue, operating income increased from 10.6%
in 1997 to 13.0% in 1998. This increase was primarily due to the fact net
revenue increased at a greater rate than salaries and benefits or general and
administrative expense and the reduction in the direct facility expense
percentage from 70.2% in 1997 to 67.9% in 1998.
19
<PAGE>
Other income recognized was $549,000 for the nine months ended September 30,
1998. Other income primarily represents an amount recognized by the Company
pursuant to a favorable judgement received by the Company in connection with
certain litigation.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal uses of cash during the nine months ended September 30,
1998 were to finance acquisitions of physician practices and the cost of
investments in management agreements with practices ($26.2 million) and to
finance increases in accounts receivable ($4.7 million). The Company met its
cash needs during this period primarily from its net income plus non-cash
expenses (amortization, depreciation and deferred income taxes) ($10.3 million),
and net borrowings on long-term debt ($23.5 million).
On March 12, 1997, the Company established a $35 million revolving credit
facility with NationsBank, National Association ("NationsBank"), which was used
to repay the outstanding balance under the previous facility, which was $25.2
million. On December 17, 1997, the Company amended its existing revolving credit
facility with NationsBank, which increased the total revolving credit commitment
from $35 million to $50 million which was further amended on April 30, 1998 to
increase the total revolving credit commitment from $50 million to $75 million.
This amendment included the syndication of the revolving credit facility with a
group of seven banks led by NationsBank. The credit facility bears interest at
the London interbank offered rate plus an applicable margin which is subject to
quarterly adjustment based on a leverage ratio defined in the credit agreement.
As of November 1, 1998, the applicable margin was 1.88%. The Company is also
required to pay a commitment fee on a quarterly basis based on the unused
portion of the total commitment. The fee ranges from 0.25% to 0.50% and is
subject to quarterly adjustments based on a leverage ratio defined in the credit
agreement. There are no principal payments due under the amended credit facility
until the maturity date of April 30, 2001.
The outstanding balance under the credit facility increased from $29.0 million
at December 31, 1997 to $52.5 million at September 30, 1998 primarily due to
acquisitions of, and investments in management agreements with, physician
practices in 1998, as discussed above. The amount that can be borrowed under the
new credit facility is potentially restricted by a leverage ratio defined in the
credit agreement. Based on the value of this leverage ratio at September 30,
1998, the Company had the ability to borrow the entire unused portion of the
credit facility, which was $22.5 million at September 30, 1998. Certain
conditions must be met, including the maintenance of certain financial ratios,
and in certain circumstances, the approval of the Company's lenders must be
obtained, in order to use the credit facility to finance acquisitions of
physician practices or investments in management agreements. There can be no
assurance that the Company will be able to satisfy such conditions in order to
use its credit facility to finance any future acquisitions or investments in
management agreements.
In November 1997, the Company issued approximately 14,000 shares of its common
stock as partial consideration for an acquisition of an office-based general
surgical practice completed in November 1997. During the period from January
1998 to September 1998 the Company completed nine transactions with physician
practices for consideration of approximately $25.3 million in cash and the
issuance of approximately 1,428,000 shares of the Company's common stock. During
the quarter ended September 30, 1998 the Company repurchased approximately
188,000 share of its common stock for approximately $1.9 million.
In order to provide funds necessary for the Company's future expansion
strategies, it will be necessary for the Company to incur, from time to time,
additional long-term bank indebtedness and/or issue equity or debt securities,
depending on market and other conditions.
The Company, as directed by its Board of Directors, has engaged investment
advisors to assist the Company in evaluating its strategic alternatives
including the procurement of additional capital. The additional capital, in
excess of amounts available under its existing credit facility, will be
necessary to fund the Company's long-term future growth and expansion. Possible
strategic alternatives include an expansion of the Company's existing credit
facility, merger, sale or an equity investment by a private capital firm or
other similar party. The Company can give no assurances that any of the
alternatives presented will occur.
20
<PAGE>
Nine Months Ended September 30, 1998 Compared to Nine Months Ended
September 30, 1997
Net cash provided by operating activities increased by $5.4 million from 1997 to
1998. This increase was due to several factors, the largest of which was an
increase of net income plus non-cash expenses (amortization, depreciation and
deferred income taxes) which increased from $5.0 million in 1997 to $10.3
million in 1998.
Net cash used by investing activities increased from $6.3 million in 1997 to
$27.0 million in 1998. This increase was primarily due to an increase in cash
used for physician practice acquisitions and investments in management
agreements from $9.0 million in 1997 to $26.2 million in 1998.
Net cash provided by financing activities increased from $6.5 million in 1997 to
$21.3 million in 1998. This increase was primarily due to an increase in net
borrowings under the Company's revolving credit facility from $7.6 million in
1997 to $23.5 million in 1998, which is related to the increase in cash used for
physician practice acquisitions and investments in management agreements and
cash used for the repurchase of the Company's common stock.
YEAR 2000 ISSUES
The Company has conducted a review of its computer systems to identify those
systems that may be affected by the Year 2000 issue and has developed a plan to
address the issue. The Year 2000 issue is the result of computer programs being
written using two digits rather than four to define the applicable year.
Computer programs that have time sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices or
engage in similar business activities.
The Company's information systems have been internally developed and maintained
for its hospital-based operations and developed and maintained by third-party
vendors for its office-based operations and administrative support departments.
Beginning in 1997 the Company's personnel began reprogramming the Company's
internal systems for Year 2000 compliance. These modifications are expected to
be complete by December 31, 1998. The Company has begun the process of
standardizing the information systems used by its office-based practices. A
single third-party product that is Year 2000 compliant has been selected for
implementation in the Company's office-based practices throughout 1998 and 1999.
Information systems used by the Company's administrative support departments are
being upgraded during 1998 and 1999 to be Year 2000 compliant. The Company does
not presently have a contingency plan to respond to the year 2000 issue if
future events prevent it from completing its Year 2000 project on a timely
basis.
The Company has employed additional personnel to support the Year 2000 project
and incurred additional expense for software and hardware. The Company estimates
that it will incur approximately $100,000 to $150,000 per year for the next two
years in operating expenses and total capital expenditures of between $500,000
and $700,000 for the Year 2000 project. These expenditures will be funded
through the Company's operating cash flow and its credit facility and are not
expected to have a material adverse effect on the Company's results of
operations or cash flow. The Company estimates that to date it has incurred
approximately $100,000 in operating expenses and $200,000 in capital
expenditures for the project.
The costs of this effort and the date on which the Company believes it will
complete its Year 2000 project are based on management's best estimate, which
was derived utilizing numerous assumptions of future events, including the
continued availability of certain resources, third party modification plans and
other factors. There can be no assurance that those estimates will be achieved
and actual results could differ materially from those anticipated. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained and resources utilized in
this area, the ability to locate and correct all relevant computer codes,
reliance on third party payors to modify their systems to be Year 2000
compliant, and similar uncertainties. The Company's inability to complete its
Year 2000 project on a timely basis or the lack of compliance of third party
payor systems could have an adverse impact on the Company's operating cash flow,
the impact of which cannot be estimated.
21
<PAGE>
PART II. OTHER INFORMATION
Item 1: Legal Proceedings
From time to time, the Company is party to various claims,
suits, and complaints. Currently, there are no such claims,
suits or complaints which, in the opinion of management, would
have a material adverse effect on the Company's financial
position, liquidity or results of operations.
Item 6: Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this report:
Exhibit
Number Description
27 Financial Data Schedule (for SEC use only).
(b) No reports on Form 8-K have been filed during the quarter for
which this report is filed.
22
<PAGE>
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.
SHERIDAN HEALTHCARE, INC.
(Registrant)
Date: November 12, 1998 By: /s/ Michael F. Schundler
--------------------- -----------------------------
Michael F. Schundler
Chief Financial Officer
(principal financial officer)
23
<PAGE>
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