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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, 2002
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 organization) (I.R.S. Employer 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 12, 2002, 89,282,362 shares of the Registrant's Common Stock
were outstanding. In addition, as of November 12, 2002, the Registrant had
agreed to deliver 4,556,160 shares of its Common Stock on certain future dates
for no additional consideration.
US Oncology, Inc.
FORM 10-Q
September 30, 2002
TABLE OF CONTENTS
-----------------
Page No.
--------
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.......................... 17
Item 3. Quantitative and Qualitative Disclosures about Market Risks..... 34
Item 4. Controls and Procedures......................................... 34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................... 35
Item 6. Exhibits and Reports on Form 8-K................................ 36
SIGNATURES........................................................................ 37
CERTIFICATIONS.................................................................... 38
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands, except par value)
September 30, December 31,
------------- ------------
ASSETS 2002 2001
---- ----
(unaudited)
Current assets:
Cash and equivalents ................................................. $ 117,427 $ 20,017
Accounts receivable .................................................. 269,936 275,884
Prepaid expenses and other current assets ............................ 63,902 35,334
Due from affiliates .................................................. 43,219 50,652
----------- -----------
Total current assets ............................... 494,484 381,887
Property and equipment, net ............................................. 281,790 286,218
Management service agreements, net ...................................... 261,241 379,249
Deferred income taxes ................................................... 47,952 18,085
Other assets ............................................................ 33,935 29,228
----------- -----------
$ 1,119,402 $ 1,094,667
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term indebtedness ......................... $ 19,313 $ 44,040
Accounts payable ..................................................... 150,244 135,570
Due to affiliates .................................................... 42,644 15,242
Accrued compensation cost ............................................ 17,373 15,455
Income taxes payable ................................................. 31,380 22,498
Other accrued liabilities ............................................ 44,487 47,201
----------- -----------
Total current liabilities ............................. 305,441 280,006
Long-term indebtedness .................................................. 204,223 128,826
----------- -----------
Total liabilities ..................................... 509,664 408,832
Minority interests ...................................................... 10,579 9,067
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, 95,318 and
94,819 issued, 90,515 and 92,510 outstanding ......................... 953 948
Additional paid in capital .............................................. 476,424 469,999
Common Stock to be issued, approximately 5,385 and 7,295 shares ......... 40,275 56,955
Treasury Stock, 4,803 and 2,309 shares .................................. (38,096) (11,235)
Retained earnings ....................................................... 119,603 160,101
----------- -----------
Total stockholders' equity ............................ 599,159 676,768
----------- -----------
$ 1,119,402 $ 1,094,667
=========== ===========
The accompanying notes are an integral part of this statement.
-3-
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND
COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenue .................................................. $ 420,177 $ 375,499 $ 1,222,501 $ 1,127,002
Operating expenses:
Pharmaceuticals and supplies ......................... 223,149 192,515 634,964 577,147
Field compensation and benefits ...................... 84,108 81,005 256,401 239,983
Other field costs .................................... 49,027 43,915 143,288 135,991
General and administrative ........................... 16,623 14,662 45,893 43,450
Depreciation and amortization ........................ 17,112 17,373 53,330 51,926
Impairment, restructuring and other charges .......... 76,831 - 116,804 5,868
----------- ----------- ----------- -----------
466,850 349,470 1,250,680 1,054,365
----------- ----------- ----------- -----------
Income (loss) from operations ............................ (46,673) 26,029 (28,179) 72,637
Interest expense, net .................................... (6,073) (5,216) (17,856) (18,596)
----------- ----------- ----------- -----------
Income (loss) before income taxes and extraordinary loss . (52,746) 20,813 (46,035) 54,041
Income tax benefit (provision) ........................... 16,539 (7,909) 13,989 (20,536)
----------- ----------- ----------- -----------
Net income (loss) before extraordinary loss .............. (36,207) 12,904 (32,046) 33,505
Extraordinary loss on early extinguishment of debt,
net of income taxes of $5,181 ......................... - - (8,452) -
----------- ----------- ----------- -----------
Net income (loss) and comprehensive income (loss) ........ $ (36,207) $ 12,904 $ (40,498) $ 33,505
=========== =========== =========== ===========
Earnings per share - basic:
Net income (loss) before extraordinary loss per share .... $ (0.37) $ 0.13 $ (0.32) $ 0.34
Extraordinary loss, net of income taxes, per share ....... - - (0.09) -
----------- ----------- ----------- -----------
Net income (loss) per share .............................. $ (0.37) $ 0.13 $ (0.41) $ 0.34
=========== =========== =========== ===========
Shares used in per share calculations - basic ............ 97,148 100,229 98,845 99,946
=========== =========== =========== ===========
Earnings per share - diluted:
Net income (loss) before extraordinary loss per share .... $ (0.37) $ 0.13 $ (0.32) $ 0.33
Extraordinary loss, net of income taxes, per share ....... - - (0.09) -
----------- ----------- ----------- -----------
Net income (loss) per share .............................. $ (0.37) $ 0.13 $ (0.41) $ 0.33
=========== =========== =========== ===========
Shares used in per share calculations - diluted .......... 97,148 100,351 98,845 100,235
=========== =========== =========== ===========
The accompanying notes are an integral part of this statement
-4-
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
September 30,
2002 2001
--------- ---------
Cash flows from operating activities:
Net income (loss) ......................................................... $ (40,498) $ 33,505
Non cash adjustments:
Depreciation and amortization ......................................... 53,330 51,925
Impairment, restructuring and other charges ........................... 115,026 331
Extraordinary loss on early extinguishment of debt,
net of income taxes .................................................. 8,452 -
Gain on sale of assets ................................................ (3,354) -
Deferred income taxes ................................................. (29,867) 14,340
Undistributed earnings in joint ventures .............................. 1,424 12
Changes in operating assets and liabilities: .......................... 29,349 60,994
--------- ---------
Net cash provided by operating activities ......................... 133,862 161,107
--------- ---------
Cash flows from investing activities:
Acquisition of property and equipment ................................. (45,114) (48,155)
Net payments in affiliation transactions .............................. - (1,005)
Net proceeds in separation transactions ............................... 3,150 -
--------- ---------
Net cash used by investing activities ............................. (41,964) (49,160)
--------- ---------
Cash flows from financing activities:
Proceeds from Credit Facility ......................................... 24,500 25,000
Repayment of Credit Facility .......................................... (24,500) (122,500)
Proceeds from Senior Subordinated Notes ............................... 175,000 -
Repayment of Senior Secured Notes ..................................... (100,000) -
Repayment of other indebtedness ....................................... (24,602) (12,518)
Payments in lieu of stock issuance .................................... (3,481) -
Deferred financing costs .............................................. (7,449) -
Proceeds from exercise of options ..................................... 2,309 3,438
Purchase of Treasury Stock ............................................ (24,534) -
Payment of premium upon early extinguishment of debt .................. (11,731) -
--------- ---------
Net cash provided (used) by financing activities .................. 5,512 (106,580)
--------- ---------
Increase in cash and equivalents .......................................... 97,410 5,367
Cash and equivalents:
Beginning of period ................................................... 20,017 3,389
--------- ---------
End of period ......................................................... $ 117,427 $ 8,756
========= =========
Interest paid ............................................................. $ 16,566 $ 17,849
Taxes paid ................................................................ $ 1,815 $ 9,100
Non cash transactions:
Value of Common Stock to be issued in affiliation transactions ........ $ - $ 606
Delivery of Common Stock in affiliation transactions .................. 10,678 6,872
Debt issued in affiliation transactions ............................... - 1,787
Value of Common Stock, received in exchange for assets ................ 9,735 -
Value of forfeited Common Stock to be issued from contract separations. 105 -
Debt forfeited from contract separations .............................. 867 -
The accompanying notes are an integral part of this statement
-5-
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 29, 2002.
Certain reclassifications have been made to the prior year amounts in order to
conform to the current year presentation. Such reclassifications had no effect
on the Company's consolidated earnings or cash flows.
NOTE 2 - REVENUE
The Company provides the following services to physician practices: oncology
pharmaceutical management, outpatient cancer center operations, cancer research
and development, and other practice management services. The Company currently
earns revenue from physician practices under two models, the physician practice
management (PPM) model and the service line model. Under the PPM model, the
Company enters into long term agreements with affiliated practices to provide
comprehensive services, including all those described above, and the practices
pay the Company a service fee and reimburse all expenses. Under the service line
model, the first three services described above are offered by the Company under
separate agreements for each service line.
Net operating revenue includes two components - net patient revenue and the
Company's other revenue.
o Net patient revenue. The Company reports net patient revenue for those
business lines under which the Company's revenue is derived from
payments for medical services to patients and the Company is
responsible for billing those patients. Currently, net patient revenue
consists of patient revenue of affiliated practices under the PPM
model. Net patient revenue also will include revenues of practices
that enter into agreements under the outpatient cancer center
operations service line.
o Other revenue. Other revenue is revenue derived from sources other
than services provided to patients by affiliated practices. Other
revenue includes revenue from pharmaceutical research, informational
services and activities as a group purchasing organization. Other
revenue also includes revenues from pharmaceutical services rendered
by the Company under its oncology pharmaceutical management service
line agreements.
Net patient revenue is recorded when services are rendered to patients 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.
Under the Company's PPM service agreements, amounts retained by the affiliated
physician groups for physician compensation are primarily derived under two
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 earnings model), amounts
retained by practices are based upon a percentage (typically 65% - 75%) of the
difference between net patient revenues less direct expenses, excluding interest
expense and taxes.
-6-
US Oncology, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
The Company's revenue is equal to net operating revenue minus amounts retained
by the practices under the Company's PPM service agreements.
The following presents the amounts included in the determination of the
Company's revenue (in thousands):
Three Months Nine Months
Ended September 30, Ended September 30,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net operating revenue ............ $ 541,649 $ 478,673 $ 1,574,393 $ 1,444,408
Amounts retained by practices .... (121,472) (103,174) (351,892) (317,406)
----------- ----------- ----------- -----------
Revenue .......................... $ 420,177 $ 375,499 $ 1,222,501 $ 1,127,002
=========== =========== =========== ===========
The Company's most significant service agreement, which is the only service
agreement that represents more than 10% of revenues to the Company, is with
Texas Oncology, P.A. (TOPA), which is managed under the earnings model. TOPA
accounted for approximately 24% and 22%, respectively, of the Company's total
revenue for the third quarter of 2002 and 2001, and for 23% and 22%, of the
Company's total revenue for the nine month periods ended September 30, 2002 and
2001, respectively.
NOTE 3 - IMPAIRMENT, RESTRUCTURING AND OTHER CHARGES
In the fourth quarter of 2000, the Company comprehensively analyzed its
operations and cost structure, focusing on non-core assets and activities of the
Company to determine whether they were still consistent with the Company's
strategic direction. As a result, the Company recorded pre-tax restructuring
charges in the fourth quarter of 2000 of $16.1 million, consisting of (i) $6.6
million relating to the abandonment of information systems, (ii) $6.5 million
impairment of a home health business, (iii) $2.6 million for remaining lease
obligations and related improvements at sites the Company determined to close,
and (iv) $0.4 million related to severance payments from the termination of an
executive position. Details of restructuring charge activity relating to these
charges for the nine months ended September 30, 2002 are as follows (in
thousands):
Accrual at Accrual at
December 31, 2001 Payments September 30, 2002
----------------- -------- ------------------
Severance of employment agreement ....... $ 215 $ (18) $ 197
Site closures ........................... 1,081 (241) 840
------- ------- -------
Total ................................... $ 1,296 $ (259) $ 1,037
======= ======= =======
The Company has recognized a deferred income tax benefit for substantially all
of these charges as many of these items will be deductible for income tax
purposes in subsequent periods.
In the first quarter of 2001, the Company announced plans to further reduce
overhead costs and recognized additional pre-tax restructuring charges of $5.9
million, consisting of (i) a $3.1 million charge relating to the elimination of
approximately 50 personnel positions, (ii) a $2.5 million charge for remaining
lease obligations and related improvements at sites the Company determined to
close, and (iii) a $0.3 million charge relating to abandoning certain software
applications. All of the charges were recorded in the first quarter of 2001. The
Company has recognized and accounted for these costs in accordance with the
provisions of Emerging Issues Task Force Consensus No. 94-3 "Accounting for
Restructuring Costs". Details of restructuring charge activity, related to these
charges for the nine months ended September 30, 2002 are as follows (in
thousands):
Accrual at Accrual at
December 31, 2001 Payments September 30, 2002
----------------- -------- ------------------
Costs related to personnel reductions ... $ 213 $ (213) $ -
Closure of facilities.................... 1,132 (177) 955
------- ------- -------
Total................................. $ 1,345 $ (390) $ 955
======= ======= =======
-7-
US Oncology, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
During the three months and nine months ended September 30, 2002, the Company
recognized the following impairment, restructuring and other charges (in
thousands):
Three Months Ended Nine Months Ended
September 30, 2002 September 30, 2002
------------------ ------------------
Write-off of service agreements .................... $ 68,314 $ 107,999
Gain on sale of practice assets .................... (3,415) (5,433)
Personnel reduction costs .......................... 882 1,791
Allowance on an affiliate receivable ............... 11,050 11,050
Consulting costs for implementing service line ..... - 1,397
--------- ---------
$ 76,831 $ 116,804
========= =========
The following is a detailed summary of the third quarter charges (in thousands):
Impairment of
Net Revenue Affiliate
Conversion to Practice Model Service Processing Receivable
Service Line Disaffiliations Agreements Centralization Allowance Total
------------- --------------- ------------- -------------- ---------- -----
Write-off of service agreements .... $ 13,054 $ 4,253 $ 51,007 $ - $ - $ 68,314
Gain on sale of practice assets .... (1,063) (2,352) - - - (3,415)
Personnel reduction costs .......... - - - 882 - 882
Allowance on an affiliate receivable - - - - 11,050 11,050
-------- -------- -------- -------- -------- --------
$ 11,991 $ 1,901 $ 51,007 $ 882 $ 11,050 $ 76,831
======== ======== ======== ======== ======== ========
During the first nine months of 2002, the Company transitioned three of its PPM
practices with an aggregate of 23 physicians to the service line model,
including one such transition in the third quarter. In each transaction, the
existing PPM service agreement was terminated, the practice repurchased its
assets, and future consideration owed to physicians for their initial
affiliation with the Company was either accelerated or forfeited.
The Company also disaffiliated with physicians in four net revenue markets
during the third quarter and terminated a service agreement in one market with
respect to certain radiology sites during the second quarter. In these
transactions, future consideration due to the physicians (if any) from the
Company with respect to their original PPM affiliation transaction was
accelerated.
The impairment of service agreement during the third quarter was a non-cash,
pretax charge of $68.3 million comprising (i) a $13.0 million charge related to
a PPM service agreement that was terminated in connection with conversion to the
service line model, (ii) a $51.0 million charge related to three net revenue
model service agreements that became impaired during the third quarter based
upon management's analysis of projected cash flows under those agreements,
taking into account developments in those markets during the third quarter and
(iii) a $4.3 million charge related to a group of physicians under a net revenue
model service agreement with which the Company disaffiliated during the third
quarter. The remainder of the charge relating to impairment of service
agreements for the first nine months of 2002 was a non-cash, pretax charge of
$33.8 million related to a net revenue model service agreement that became
impaired during the second quarter based upon management's analysis of projected
cash flows under that agreement, taking into account developments in that market
during the second quarter and a non-cash, pre-tax charge of $6.0 million related
to two PPM service agreements that terminated in connection with conversions to
the service line model in the second quarter.
The $3.4 million net gain on sale of practice assets during the third quarter
comprised (a) net proceeds of $4.3 million paid by converting and disaffiliating
physicians and (b) a $0.2 million net recovery of working capital assets,
partially offset by a $1.1 million net charge arising from the Company
accelerating consideration that would have been due to physicians in the future
in connection with those transactions.
-8-
US Oncology, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
During the second quarter the Company recognized a $2.0 million net gain on sale
of practice assets. During that quarter, the Company terminated a service
agreement as it related to certain radiology sites and sold the related assets,
including the right to future revenues attributable to radiology technical fee
revenue at those sites, in exchange for delivery of 1.1 million shares of the
Company's Common Stock. In connection with that sale, the Company also
recognized a write-off of a receivable of $0.5 million due from the physicians
and agreed to make a cash payment to the buyer of $0.6 million to reflect
purchase price adjustments during the third quarter. The transaction resulted in
a $3.9 million gain based on the market price of the Company's Common Stock as
of the date of the termination. This gain was partially offset by a $1.9 million
net impairment of working capital assets relating to service line conversions,
disaffiliations and potential disaffiliations.
During the third quarter, in connection with the Company's transition,
management commenced an initiative to further centralize certain accounting and
financial reporting functions at its headquarters in Houston, resulting in a
$0.9 million charge for personnel reduction costs. Management believes that such
centralization will enhance efficiency and improve internal operating controls
of those functions. During the first and second quarters of 2002, the Company
recognized $0.6 million and $0.3 million, respectively, for personnel reduction
costs.
During the third quarter, the Company recognized an $11.1 million allowance
related to an $11.1 million receivable due from one of its affiliated practices.
In the course of its PPM activities, the Company advances amounts to physician
groups and retains fees based upon its estimates of practice performance.
Subsequent events and related adjustments may result in the creation of a
receivable with respect to certain amounts advanced. During the third quarter,
the Company made the determination that a portion of such amounts owed by
physician practices may have become uncollectible due to, among other things the
age of the receivable and circumstances relating to practice operations.
During the second quarter the Company recognized $1.0 million professional fees
for consulting on the implementation of the service line. During the first
quarter of 2002, the Company also recognized charges of $0.4 million in
consulting fees related to its introduction of the service line model.
As discussed above, during the first nine months of 2002, the Company recorded
charges related to the impairment of certain net revenue model service
agreements. From time to time, management evaluates its long-lived assets for
impairment, by comparing the aggregate expected future cash flows under the
agreement to its carrying value on its balance sheet. In estimating future cash
flows, management considers past performance as well as known trends that are
likely to affect future performance. In some cases management also takes into
account current activities with respect to that agreement that may be aimed at
altering performance or reversing trends. All of these factors used in
management's estimates are subject to error and uncertainty.
NOTE 4 - EXTRAORDINARY LOSS
During the first quarter of 2002, the Company recorded an extraordinary loss of
$13.6 million, before income taxes of $5.2 million, in connection with the early
extinguishment of the $100 million Senior Secured Notes due 2006 and the
previously existing credit facility. The loss consists of a prepayment penalty
of $11.7 million on the Senior Secured Notes and a write-off of unamortized
deferred financing costs of $1.9 million related to the terminated debt
agreements.
NOTE 5 - CAPITALIZATION
During 2000, the Company acquired 5,057,786 shares of Common Stock at an average
price of $4.72 per share, pursuant to a share repurchase authorized by the Board
of Directors in March 2000.
In March 2002, the Board of Directors of the Company authorized the repurchase
of up to $35 million in shares of its Common Stock in public or private
transactions and authorized the Company to accept up to $15 million in shares of
its Common Stock in connection with terminating service agreements with
physician groups. As of September 30, 2002, the Company had repurchased
2,898,250 shares of its Common Stock for $24.5 million, at an average price of
$8.47 per share under this authorization. Subsequently, through October 17,
2002, the Company purchased an additional 1,219,000 shares of its Common Stock
for $10.5 million, at an average price of $8.58 per share, thus purchasing the
full amount of stock authorized by the Board of Directors in March 2002.
-9-
US Oncology, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
In November 2002, the Board of Directors of the Company authorized the
repurchase of up to an additional $50 million in shares of Common Stock in
public or private transactions.
The table below sets forth the Company's Treasury Stock activity for the nine
months ended September 30, 2002 (shares in thousands):
Shares
------
Treasury Stock shares as of December 31, 2001 ................................... 2,309
Treasury Stock purchases ........................................................ 2,898
Treasury Stock received in connection with the sale of certain assets ........... 1,100
Treasury Stock issued in connection with affiliation transactions
and exercise of employee stock options ....................................... (1,504)
------
Treasury Stock shares as of September 30, 2002 .................................. 4,803
======
NOTE 6 - INDEBTEDNESS
As of September 30, 2002 and December 31, 2001, respectively, the Company's
long-term indebtedness consisted of the following (in thousands):
September 30, December 31,
2002 2001
--------- ---------
8.42% Senior Secured Notes due 2006 ...... $ - $ 100,000
9.625% Senior Subordinated Notes due 2012. 175,000 -
Notes Payable ............................ 1,610 2,733
Subordinated Notes ....................... 44,869 67,438
Capital lease obligations and other ...... 2,057 2,695
--------- ---------
223,536 172,866
Less: current maturities ................. (19,313) (44,040)
--------- ---------
$ 204,223 $ 128,826
========= =========
Credit Facility
In June 1999, the Company amended and restated its existing loan agreement and
revolving credit/term facility. Under the terms of the amended and restated
agreement, the amounts available for borrowing were $275 million, including a
$100 million facility that expired in June 2000, leaving availability of $175
million expiring in June 2004.
On February 1, 2002, the Company terminated its $175 million revolving facility
and entered into a new $100 million five-year revolving credit facility (New
Credit Facility), which expires in February 2007. Proceeds from loans under the
New Credit Facility may be used to finance development of cancer centers and new
positron emission tomography (PET) facilities, to provide working capital or for
other general business uses. Costs incurred in connection with the
extinguishment of the Company's previous credit facility were expensed during
the first quarter of 2002 and recorded as an extraordinary loss in the Company's
condensed consolidated statement of operations and comprehensive income. Costs
incurred in connection with establishing the New Credit Facility are being
capitalized and amortized over the term of the New Credit Facility.
Borrowings under the New Credit Facility are secured by substantially all of the
Company's assets. 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
National Bank (First Union) and is defined as its prime rate or Federal Funds
Rate plus 1/2%. No amounts were borrowed or outstanding under the New Credit
Facility during the first nine months of 2002.
-10-
US Oncology, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
Senior Secured Notes
In November 1999, the Company issued $100 million in senior secured notes
(Senior Secured Notes) to a group of institutional investors. The notes bore
interest at 8.42%, matured in equal annual installments of $20 million from 2002
through 2006 and ranked equally in right of payment with all current and future
senior indebtedness of the Company. The Senior Secured Notes contained
restrictive financial and operational covenants and were secured by the same
collateral as the Company's previous Credit Facility.
The Senior Secured Notes were repaid in full on February 1, 2002 with the
proceeds of the Company's Senior Subordinated Notes.
Senior Subordinated Notes
On February 1, 2002, the Company issued $175 million in 9.625% senior
subordinated notes (Senior Subordinated Notes) to various institutional
investors in a private offering pursuant to Rule 144A. The notes were
subsequently exchanged for substantially identical notes in an offering
registered under the Securities Act of 1933. The notes are unsecured, bear
interest at 9.625% annually and mature in February 2012. Payments under the
Senior Subordinated Notes are subordinated, in substantially all respects, to
the Company's New Credit Facility and other "Senior Indebtedness," as defined in
the indenture governing the Senior Subordinated Notes.
Proceeds from the Senior Subordinated Notes were used to pay off the $100
million in borrowings under the existing Senior Secured Notes, an $11.7 million
prepayment penalty on the early termination of the Senior Secured Notes and
facility fees and related expenses associated with establishing the Senior
Subordinated Notes and New Credit Facility of $4.8 million and $2.7 million,
respectively. Costs incurred in connection with extinguishment of the Company's
previous Senior Secured Notes, including the prepayment penalty were expensed in
the first quarter of 2002 and reflected as an extraordinary loss in the
Company's condensed consolidated statement of operations and comprehensive
income. Costs incurred in connection with establishing the Senior Subordinated
Notes, including facility fees, were capitalized and are being amortized over
the term of those notes.
Notes Payable
The notes payable bear interest, which is payable annually, at rates ranging
from 5.3% to 10% and mature between 2002 to 2005. The notes are payable to
physicians with whom the Company entered into long-term service agreements and
were delivered in connection with physician affiliation transactions. The notes
payable are unsecured.
Subordinated Notes
The subordinated notes are issued in substantially the same form in different
series and are payable to the physicians with whom the Company entered into
service agreements. Substantially all of the subordinated notes outstanding at
September 30, 2002 bear interest at 7%, are due in installments through 2007 and
are subordinated to senior bank and certain other debt (including the Senior
Subordinated Notes). If the Company fails to make payments under any of the
subordinated notes, the respective practice can terminate the related service
agreement.
Capital Lease Obligations and Other Indebtedness
Leases for medical and office equipment are capitalized using effective interest
rates between 6.5% and 11.5% with original lease terms between two and seven
years. Other indebtedness consists principally of installment notes and bank
debt, with varying interest rates, assumed in affiliation transactions.
Synthetic Lease Facility
The Company has entered into an operating lease arrangement, known as a
"synthetic lease", under which a special purpose entity has acquired title to
properties, paid for the construction costs and leased to the Company the real
estate and equipment at some of the Company's cancer centers. The synthetic
lease facility was funded by a syndicate of financial institutions.
-11-
US Oncology, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
The synthetic lease was entered into in December 1997 and matures in June 2004.
As of September 30, 2002, the Company had $72.0 million outstanding under the
synthetic lease facility, and no further amounts are available under that
facility. The annual lease cost of the synthetic lease is approximately $3.6
million, based on interest rates in effect as of September 30, 2002. At
September 30, 2002, the lessor under the synthetic lease held real estate assets
(based on original acquisition and construction costs) of approximately $59.2
million and equipment of approximately $12.8 million (based on original
acquisition cost) at nineteen locations. On February 1, 2002, the Company
amended and restated the synthetic lease agreement primarily to replace certain
lenders.
The lease is renewable in one-year increments, but only with consent of the
financial institutions that are parties thereto. In the event the lease is not
renewed at maturity, or is otherwise terminated, the Company must either
purchase the properties under the lease for the total amount outstanding or
market the properties to third parties. Defaults under the lease, which include
cross-defaults to other material debt, could result in such a termination and
require the Company to purchase or remarket the properties. If the Company sells
the properties to third parties, it has guaranteed a residual value of at least
to 85% of the total amount outstanding for the properties. The guarantee
obligations are secured by substantially all of the Company's assets. The
primary lease obligations are secured by the lease properties.
The synthetic lease includes customary covenants, representations, and events of
default, including cross-defaults to material indebtedness, including the New
Credit Facility and Senior Subordinated Notes. If the properties were sold to a
third party at a price such that the Company would be required to make a
residual value guarantee payment, such amount would be recognized as an expense
in the Company's statement of operations.
The synthetic lease is an operating lease under generally accepted accounting
principles (GAAP) and therefore the obligations are not recorded as debt and the
underlying properties and equipment are not recorded as assets on the Company's
balance sheet. The Company's rental payments (which approximate interest amounts
under the synthetic lease financing) are treated as operating rent commitments,
and are excluded from the Company's aggregate debt maturities.
The Financial Accounting Standards Board (FASB) determined that synthetic lease
properties meeting certain criteria would be required to be recognized as assets
with a corresponding liability effective April 1, 2003. The Company's synthetic
lease meets these criteria. The determination is not final and is subject to
additional rule-making procedures, but assuming the determination becomes a
formal accounting pronouncement and assuming the Company does not alter the
arrangement to maintain off-balance sheet treatment under the new rules, the
Company would expect to reflect additional property and equipment with a
corresponding liability on its balance sheet as of April 1, 2003.
During October 2002, the Company entered into an amendment to the synthetic
lease that would allow it greater operational flexibility with respect to the
properties covered by the synthetic lease. In order to make the amendment
effective, the Company will be required to fully guarantee 100% of the residual
value of the synthetic lease properties, which would require the Company to
reflect on its balance sheet amounts outstanding under the lease and the
underlying properties under the lease. This amendment will give the Company more
latitude to implement key operational initiatives during this transitional
period in its business, by, for example, allowing the Company to close
underperforming facilities or move equipment within its network. The Company is
in the process of evaluating the cancer center assets leased under the synthetic
lease to determine the appropriate asset values at which those assets would be
brought onto its balance sheet. To the extent such asset values are less than
the total amount outstanding under the lease, the Company would recognize a
charge to reflect the difference between such asset values and the amount
outstanding under the synthetic lease at such time as the Company brings the
properties onto its balance sheet. The Company expects that the timing of such
activity would be in the fourth quarter of 2002.
-12-
US Oncology, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
NOTE 7 - EARNINGS PER SHARE
The Company computes earnings per share and discloses 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 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 potentially dilutive
potential Common Stock calculated under the treasury stock method.
The table below summarizes the determination of shares used in per share
calculations (in thousands):
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
2002 2001 2002 2001
-------- -------- -------- --------
Outstanding at end of period:
Common Stock ........................................... 90,515 91,734 90,515 91,734
Common Stock to be issued .............................. 5,385 9,114 5,385 9,114
-------- -------- -------- --------
95,900 100,848 95,900 100,848
Effect of weighting and Treasury Stock ................. 1,248 (619) 2,945 (902)
-------- -------- -------- --------
Shares used in per share calculations-basic ............... 97,148 100,229 98,845 99,946
Effect of weighting and assumed share equivalents for
outstanding stock options at less than the weighted
average stock price ....................................... - 122 - 289
-------- -------- -------- --------
Shares used in per share calculations-diluted ............. 97,148 100,351 98,845 100,235
======== ======== ======== ========
Anti-dilutive stock options not included above ............ 16,233 5,916 16,233 5,044
======== ======== ======== ========
NOTE 8 - SEGMENT FINANCIAL INFORMATION
The Company has adopted the provisions of FASB Statement of Financial Accounting
Standards No. 131 (FAS 131), "Disclosure About Segments of an Enterprise and
Related Information". FAS 131 requires the utilization of a "management
approach" to define and report the financial results of operating segments. The
management approach defines operating segments along the lines used by
management to assess performance and make operating and resource allocation
decisions.
Beginning in the first quarter of 2002, the Company has determined that its
reportable segments are those that are based on the Company's method of internal
reporting, which disaggregates its business by service line, and that sufficient
information is now available to permit such reporting. The Company's reportable
segments are oncology
-13-
US Oncology, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
pharmaceutical management, other practice management services, outpatient cancer
center operations, and cancer research and development. The oncology
pharmaceutical management segment purchases and manages specialty oncology
pharmaceuticals for the Company's affiliated practices. Management of the
administrative aspects of affiliated medical oncology practices is included in
the other practice management services segment. The outpatient cancer center
operations segment develops and manages comprehensive, community-based cancer
centers, which integrate all aspects of outpatient cancer care, from laboratory
and radiology diagnostic capabilities to chemotherapy and radiation therapy. The
cancer research and development services segment contracts with pharmaceutical
and biotechnology firms to provide a comprehensive range of services relating to
clinical trials. The operating results of this segment are reflected in the
"other" category. The Company's business is conducted entirely in the United
States.
The financial results of the Company's segments are presented on the accrual
basis. For the first nine months of 2002, 97.8% of the Company's oncology
pharmaceutical management revenue and outpatient cancer center revenue was
derived from the PPM model with the remainder derived under service line model
agreements providing oncology pharmaceutical management services. To determine
results of the oncology pharmaceutical management segment with respect to
practices managed under the Company's PPM model, management has assumed that the
pharmaceuticals purchased and pharmacy management services under this segment
are provided at rates consistent with the rates at which the Company is
currently offering those services outside of the PPM model. Therefore, the
financial results of that segment include inter-segment revenues while other
practice management services reflects PPM results after the effect of removing
the oncology pharmaceutical management results and outpatient cancer center
operations results (which are actual results of that service line within the PPM
model) disclosed below. As such, the combined operating results of the oncology
pharmaceutical management segment and other practice management segments for the
nine months ended September 30, 2002 represent the operating results under the
Company's PPM activities relative to the management of the non-medical aspects
of affiliated medical oncology practices plus the results under oncology
pharmaceutical management services for practices under service line model
agreements.
The Company evaluates the performance of its segments based on, among other
things, earnings before interest, taxes, depreciation, amortization, impairment,
restructuring and other charges and extraordinary loss (EBITDA).
The Company has not disclosed prior year's segment data on a comparative basis
because management could not obtain comparative data for prior years due to
financial systems limitations. Asset information by reportable segment is not
reported since the Company does not produce such information internally.
The table below presents information about reported segments for the three and
nine months ended September 30, 2002 (in thousands):
Three Months Ended Nine Months Ended
September 30, 2002 September 30, 2002
------------------ ------------------
Net operating revenue:
Oncology pharmaceutical management .......... $ 234,635 $ 665,219
Other practice management services .......... 215,505 630,141
----------- -----------
Medical oncology ............................ 450,140 1,295,360
Outpatient cancer center operations ......... 73,948 230,192
Other ....................................... 17,561 48,841
----------- -----------
$ 541,649 $ 1,574,393
=========== ===========
Revenue:
Oncology pharmaceutical management .......... $ 232,846 $ 664,538
Other practice management services .......... 120,520 355,271
----------- -----------
Medical oncology ............................ 353,366 1,019,809
Outpatient cancer center operations ......... 49,952 157,086
Other ....................................... 16,859 45,606
----------- -----------
-14-
US Oncology, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
$ 420,177 $ 1,222,501
=========== ===========
EBITDA:
Oncology pharmaceutical management .......... $ 23,114 $ 62,149
Other practice management services .......... 22,429 69,529
----------- -----------
Medical oncology ............................ 45,543 131,678
Outpatient cancer center operations ......... 15,155 49,076
Other ....................................... 3,195 7,094
----------- -----------
63,893 187,848
General and administrative expenses ......... (16,623) (45,893)
----------- -----------
$ 47,270 $ 141,955
=========== ===========
The following is a reconciliation of net operating revenue to consolidated
revenue (in thousands):
Three Months Ended Nine Months Ended
September 30, 2002 September 30, 2002
------------------ ------------------
Net operating revenue........................ $ 541,649 $ 1,574,393
Less: amounts retained by the practices ..... (121,472) (351,892)
----------- -----------
Revenue...................................... $ 420,177 $ 1,222,501
=========== ===========
The following is a reconciliation of EBITDA to consolidated income (loss) from
operations (in thousands):
Three Months Ended Nine Months Ended
September 30, 2002 September 30, 2002
------------------ ------------------
EBITDA $ 47,270 $ 141,955
Depreciation and amortization................ (17,112) (53,330)
Impairment, restructuring and other charges.. (76,831) (116,804)
----------- -----------
Income (loss) from operations................ $ (46,673) $ (28,179)
=========== ===========
NOTE 9 - COMMITMENTS AND CONTINGENCIES
As disclosed in Part II, Item 1, under the heading "Legal Proceedings," the
Company is aware that it and certain of its subsidiaries and affiliated
practices are the subject of allegations that their billing practices may
violate the Federal False Claims Act. These allegations are contained in qui tam
lawsuits filed under seal. The Department of Justice has informed the Company
that it does not intend to pursue these lawsuits, but individual plaintiffs may
still do so. 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.
NOTE 10 - RECENT PRONOUNCEMENTS
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
143, "Accounting for Asset Retirement Obligations" (FAS 143), which addresses
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. FAS 143 is
effective for fiscal years beginning after June 15, 2002. The Company is
currently assessing the impact of this new standard.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Impairment or Disposal of Long-Lived Assets" (FAS 144), which is effective
for fiscal years beginning after December 15, 2001. The provisions of FAS 144
provide a single accounting model for impairment of long-lived assets. The
Company's adoption of FAS 144 has not had a material effect on the Company's
financial position or operating results.
-15-
US Oncology, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
In May 2002, the FASB issued Statement of Financial Accounting Standards No.
145, "Rescission of FAS Nos. 4, 44 and 64, Amendment of FAS 13, and Technical
Corrections as of April 2002" (FAS 145), under which gains and losses from
extinguishment of debt should be classified as extraordinary items only if they
meet the criteria in APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." Under FAS 145 the
Company will be required to reclassify any gain or loss on extinguishment of
debt that was classified as an extraordinary item to normal operations for all
fiscal years beginning after May 15, 2002, including all prior period
presentations. The Company expects to implement FAS 145 by no later than the
first quarter of 2003, at which time the comparatives will be restated to
classify the extraordinary loss on early extinguishment of debt to be included
within income (loss) from continuing operations.
-16-
US Oncology, Inc.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
The following discussion should be read in conjunction with the financial
statements, related notes, and other financial information appearing elsewhere
in this report. In addition, see "Forward-Looking Statements and Risk Factors"
included in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission (SEC).
General
We provide comprehensive services to our network of affiliated practices, made
up of more than 850 affiliated physicians in over 440 sites, with the mission of
expanding access to and improving the quality of cancer care in local
communities and advancing the delivery of care. The services we offer include:
o Oncology Pharmaceutical Management. We purchase and manage specialty
oncology pharmaceuticals for our affiliated practices. Annually, we are
responsible for purchasing, delivering and managing more than $800 million
of pharmaceuticals through a network of more than 400 admixture sites, 31
licensed pharmacies, 51 pharmacists and 180 pharmacy technicians.
o Outpatient Cancer Center Operations. We develop and manage comprehensive,
community-based cancer centers which integrate all aspects of outpatient
cancer care, from laboratory and radiology diagnostic capabilities to
chemotherapy and radiation therapy. We have developed and operate 77
integrated community-based cancer centers and manage over one million
square feet of medical office space. We have installed and manage 14
Positron Emission Tomography (PET) units, as well as 59 Computerized Axial
Tomography (CT) units.
o Cancer Research and Development Services. We facilitate a broad range of
cancer research and development activities through our network. We contract
with pharmaceutical and biotechnology firms to provide a comprehensive
range of services relating to clinical trials. We currently manage 90
clinical trials, supported by our network of over 650 participating
physicians in more than 180 research locations. During the first nine
months of 2002, we enrolled over 2,400 new patients in research studies.
o Other Practice Management Services. Under our physician practice management
arrangements, we act as the exclusive manager and administrator of all
day-to-day non-medical business functions connected with our affiliated
practices. As such, we are responsible for billing and collecting for
medical oncology services, physician recruiting, data management,
accounting, systems, and capital allocation to facilitate growth in
practice operations.
We offer these services through two business models, the Physician Practice
Management ("PPM") model, under which we provide all of the above services under
a single contract with a single fee based on overall practice performance, and
the service line model, under which practices contract with us to purchase only
certain of the above services, each under a separate contract, with a separate
fee methodology for each service.
Under the PPM model, we are reimbursed for all expenses and receive a fee based
on one of two models. Under some agreements, the fees are based on practice
earnings before taxes - known as the "earnings model". In others, the fee
consists of a fixed fee, a percentage of the practice's revenues (in most
states) and, if certain performance criteria are met, a performance fee - known
as the "net revenue model". Under the net revenue model, the practice is
entitled to retain a fixed portion of its net revenue before any service fee is
paid, provided that all operating expenses have been reimbursed.
We believe that the earnings model properly aligns practice priorities with
respect to appropriate business operations and cost control, with us and the
practice sharing proportionately in practice profitability, while the net
revenue model results in us disproportionately bearing the impact of increases
or declines in operating margins. For this reason, we have, since 2001, been
negotiating with practices under the net revenue model to convert to the
earnings
-17-
US Oncology, Inc.
model. Since the beginning of 2001 and through September 30, 2002, seventeen
practices accounting for 28.6% of our net operating revenue in the first nine
months of 2002 have converted to the earnings model. 68.2% of net operating
revenue in the third quarter of 2002 is attributable to practices on the
earnings model as of September 30, 2002. Currently, 71.9% of the net operating
revenue is attributable to practices that are either on the earnings model or
the service line model.
In certain net revenue model markets where we have not been successful in
transitioning the practice away from a net revenue model agreement, we have
recognized charges for impairments of the service agreement as a result of our
projection of future results under those agreements, given declining performance
trends. We may in the future be required to recognize additional such
impairments in such underperforming markets.
In October 2001, we commenced a strategy to focus our operations on three core
service lines: oncology pharmaceutical management, outpatient cancer center
operations, and cancer research and development services and began marketing
these core services through a non-PPM model. Under the new model, which we refer
to as the "service line model", each of those core service lines is offered to
physician groups under a separate contract, and we do not necessarily provide
the other practice management services described above.
To implement this service line strategy, we have organized the company in three
divisions, and manage and operate our business under distinct service lines.
This report includes segment financial information (See Note 8 to Condensed
Consolidated Financial Statements), which reflects a division of our existing
PPM operations into the various service line offerings in the PPM relationship.
As we enter into new service line model agreements, we will report revenue from
those agreements in the appropriate segment.
Under the service line model, we are offering physician groups three service
lines, each with a separate agreement. Those agreements are structured as
follows:
o Oncology Pharmaceutical Management. We are responsible for providing
comprehensive pharmaceutical management and will be paid on a per-dose
basis for the pharmaceutical agent and on a per-dose basis for admixture
services. Affiliated practices are required to purchase substantially all
of their drugs through us. We also act as a group purchasing organization
and will receive a fee from pharmaceutical manufacturers for this service,
as well as for providing data and informational services to pharmaceutical
companies.
o Outpatient Cancer Center Operations. We agree to develop outpatient cancer
centers under development agreements and leases with physician practices.
Under the leases, we expect to receive our economic costs of the property
plus an amount sufficient to give us a predetermined rate of return on
invested capital. In addition, we provide management services and expect to
receive an additional fee of 30% of net earnings from radiation and
diagnostic operations, subject to adjustments.
o Cancer Research and Development. We contract with pharmaceutical companies
and others needing research services on a per trial basis. Our contracts
with physician groups outline the terms of access to clinical trials and
provide for research related services. We will pay physicians for each
trial based on economic considerations relating to that trial.
We are continuing to operate under the PPM model, but are affording our PPM
practices the opportunity to terminate their existing service agreements,
repurchase certain of their operating assets, and enter into new service line
model agreements. We currently expect that a large percentage of existing
affiliated practices will remain on the PPM model for the foreseeable future.
During the first nine months of 2002, three of our PPM practices, comprising 34
physicians, terminated their PPM agreements and entered into service line model
agreements. As practices transition to this service line model or otherwise
terminate PPM agreements, we would expect the financial impact to be receipt of
cash payments, recognition of restructuring and reorganization costs (which are
mainly non-cash charges), and a reduction in our revenues and earnings related
to those practices. We cannot predict the magnitude or timing of this financial
impact until practices agree to change structures, but do not expect that all
practices will transition away from the PPM model.
-18-
US Oncology, Inc.
For those practices that remain on the PPM model, we will continue to negotiate
with "net revenue model" practices to move to the "earnings model," and
otherwise to manage those practices pursuant to existing agreements. In addition
to converting three PPM practices to the service line model, we had entered into
service line model agreements with two practices, comprising eleven physicians,
in new markets through September 30, 2002. Effective October 1, 2002, we have
entered into a service line model agreement with one additional practice
comprising of five physicians in a new market.
We terminated service agreements with four oncology practices during both the
first nine months ended September 30, 2002 and 2001. For purposes of the
following discussion and analysis, same practice revenues exclude the results of
these disaffiliated practices, as well as the results of the service line model
agreements entered into in 2002.
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 contained
in "Management's Discussion and Analysis of Financial Condition and Results of
Operations," (ii) any statements contained herein regarding the prospects for
any of our business or services and our development activities relating to the
service line model, cancer centers and PET installations; (iii) any statements
preceded by, followed by or that include the words "believes", "expects",
"anticipates", "intends", "estimates", "plans" or similar expressions; and (iv)
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 investors 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, the degree to which
practices managed by us convert to the earnings model or service line model, our
ability to attract and retain additional physicians and practices under the
service line model, expansion into new markets, our ability to develop and
complete cancer centers and PET installations, our ability to maintain good
relationships with our affiliated practices, government regulation and
enforcement, proposed changes in accounting rules relating to our leasing
facility, reimbursement for healthcare services, particularly including
reimbursement for pharmaceuticals, changes in cancer therapy or the manner in
which cancer care is delivered, drug utilization, our ability to create and
maintain favorable relationships with pharmaceutical companies and other
suppliers, 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, 2001, 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 the date
thereof or to reflect the occurrence of unanticipated events.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires management to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, we evaluate these estimates, including
those related to service agreements, accounts and affiliate receivables,
intangible assets, income taxes, and contingencies and litigation. We base our
estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances. The introduction of a new
business model, the service line structure, and the coincident stress it is
placing on our network, represent changes in our business and may make our
historical experiences less informative in making future estimates. These
estimates form the basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions.
Our consolidated financial statements include the results of US Oncology, Inc.
and its wholly-owned subsidiaries. We do not include the results of our
affiliated practices (and the amounts they retain for physician compensation),
-19-
US Oncology, Inc.
because we have determined that our relationships with the practices under our
service agreements do not warrant consolidation under the applicable accounting
rules.
Management believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
condensed financial statements. These critical accounting policies include our
policy of non-consolidation, revenue recognition (including calculation of
physician compensation), general estimates of accruals, intangible asset
amortization and impairment, and the treatment of synthetic leases. Please refer
to the notes to our condensed consolidated financial statements, particularly
Note 1, and the "Critical Accounting Policies" section of our Annual Report on
Form 10-K for the year ended December 31, 2001 for a more detailed discussion of
such policies.
Currently, there is a tentative conclusion regarding accounting treatment of
off-balance sheet financing vehicles. A change in accounting rules relating to
off-balance sheet financing might require us to change our accounting treatment
of our synthetic lease financing. On February 27, 2002, the Financial Standards
Accounting Board (FASB) determined that synthetic lease properties meeting
certain criteria would be required to be recognized as assets with a
corresponding liability effective April 1, 2003. Our synthetic lease meets these
criteria. The determination is not final and is subject to additional
rule-making procedures, but assuming the determination becomes a formal
accounting pronouncement and we do not alter the arrangement to maintain
off-balance sheet treatment under the new rules, we would expect to recognize
additional property and equipment with a corresponding liability on our balance
sheet. The possible impact of such a change is discussed below in "Liquidity and
Capital Resources."
During October 2002, we entered into an amendment to the synthetic lease that
would allow us greater operational flexibility with respect to the properties
covered by the synthetic lease. In order to make the amendment effective, we
will be required to fully guarantee 100% of the residual value of the synthetic
lease properties, which would require us to reflect on our balance sheet amounts
outstanding under the lease and the underlying properties under the lease. This
amendment will give us more latitude to implement key operational initiatives
during this transitional period in our business, by, for example, allowing us to
close underperforming facilities or move equipment within our network. We are
currently in the process of evaluating the cancer center assets leased under the
synthetic lease to determine the appropriate asset values at which those assets
would be brought onto our balance sheet. To the extent such asset values are
less than the total amount outstanding under the lease, we would recognize a
charge to reflect the difference between such asset values and the amount
outstanding under the synthetic lease at such time as we bring the properties
onto our balance sheet.
Results of Operations
The Company was affiliated with the following number of physicians by specialty
as of September 30, 2002 and 2001:
September 30,
-------------
2002 2001
---- ----
Medical oncologists ............................ 670 677
Radiation oncologists .......................... 123 127
Diagnostic radiologists / other oncologists .... 77 69
---- ----
870 873
==== ====
-20-
US Oncology, Inc.
The following table sets forth the number of physicians affiliated with us:
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Affiliated physicians, beginning of period .... 871 844 868 869
Physician practice affiliations ............... - 1 11 7
Recruited physicians .......................... 32 40 51 62
Physician practice separations ................ (23) (3) (23) (22)
Retiring/Other ................................ (10) (9) (37) (43)
---- ---- ---- ----
Affiliated physicians, end of period .......... 870 873 870 873
==== ==== ==== ====
The following table sets forth the number of cancer centers and PET units
managed by us as of September 30, 2002 and 2001:
September 30,
-------------
2002 2001
---- ----
Cancer centers ................... 77 76
PET units ........................ 14 9
The following table sets forth the key operating statistics as a measure of the
volume of services provided by the practices:
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
--------- --------- --------- ---------
Medical oncology visits ................... 595,484 589,527 1,830,332 1,806,974
Radiation treatments ...................... 160,645 157,437 485,915 480,575
PET scans ................................. 3,084 1,747 9,096 4,003
New patients enrolled in research studies 821 967 2,435 2,916
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 following information should be read in conjunction with our
unaudited condensed consolidated financial statements and notes thereto included
elsewhere herein.
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
------ ------ ------ ------
Revenue ...................................................... 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Pharmaceuticals and supplies .............................. 53.1 51.3 51.9 51.2
Field compensation and benefits ........................... 20.0 21.6 21.0 21.3
Other field costs ......................................... 11.7 11.7 11.7 12.1
General and administrative ................................ 3.9 3.9 3.8 3.8
Impairment, restructuring and other charges ............... 18.3 - 9.5 0.5
Depreciation and amortization ............................. 4.1 4.6 4.4 4.6
----- ----- ----- -----
Income (loss) from operations ................................ (11.1) 6.9 (2.3) 6.5
-21-
US Oncology, Inc.
Interest expense, net ........................................ (1.4) (1.4) (1.5) (1.7)
----- ----- ----- -----
Income (loss) before income taxes, and extraordinary loss .... (12.5) 5.5 (3.8) 4.8
Income tax benefit (provision) ............................... 3.9 (2.1) 1.2 (1.8)
----- ----- ----- -----
Net income (loss) before extraordinary loss .................. (8.6) 3.4 (2.6) 3.0
Extraordinary loss, net of income taxes ...................... - - (0.7) -
----- ----- ----- -----
Net income (loss) ............................................ (8.6)% 3.4% (3.3)% 3.0%
===== ===== ===== =====
Net Operating Revenue.
Net operating revenue includes two components - net patient revenue and our
other revenue:
o Net patient revenue. We report net patient revenue for those business lines
under which our revenue is derived from payments for medical services to
patients and we are responsible for billing those patients. Currently, net
patient revenue consists of patient revenue of affiliated practices under
the PPM model. Net patient revenue also will include revenues of practices
that enter into agreements under the Outpatient Cancer Center Operations
service line.
o Other revenue. Other revenue is revenue derived from sources other than
services to patients by affiliated practices. Other revenue includes
revenue from pharmaceutical research, informational services and activities
as a group purchasing organization. Other revenue also includes revenues
from pharmaceutical services rendered by us under our Oncology
Pharmaceutical Management service line agreements.
The following table shows the components of our net operating revenue for the
three and nine months ended September 30, 2002 and 2001 (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net patient revenue ..... $ 514,742 $ 463,013 $1,513,309 $1,402,241
Other revenue ........... 26,907 15,660 61,084 42,167
---------- ---------- ---------- ----------
Net operating revenue ... $ 541,649 $ 478,673 $1,574,393 $1,444,408
========== ========== ========== ==========
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US Oncology, Inc.
Net patient revenue 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. Net operating revenue is reduced by amounts retained by the
practices under our services agreement to arrive at the amount we report as
revenue in our financial statements.
Net operating revenue increased from $1,444.4 million in the first nine months
of 2001 to $1,574.4 million in the first nine months of 2002, an increase of
$130.0 million, or 9.0%. Same practice net operating revenue (which excludes the
results of practices with which we disaffiliated since January 30, 2001 and
service line practices) increased from $1,372.9 million for the first nine
months of 2001 to $1,540.0 million for the first nine months of 2002, an
increase of $167.0 million, or 12.2%. Net operating revenue increased from
$478.7 million for the third quarter of 2001 to $541.7 million for the third
quarter of 2002, an increase of $63.0 million, or 13.2%. Same practice net
operating revenue increased from $464.7 million for the third quarter of 2001 to
$535.2 million for the third quarter of 2002, an increase of $70.5 million, or
15.2%. Revenue growth was caused by increases in revenues attributable to
pharmaceuticals. However, this growth is primarily attributable to increased
utilization of more expensive chemotherapy agents and additional supportive care
drugs, rather than increased patient volume. During the third quarter of 2002,
medical oncology visits increased 1.0% over the same period during the prior
year and declined by 3.6% from the second quarter of 2002. In the outpatient
cancer center product line, revenues declined, primarily as a result of our
disaffiliation with a radiation oncology facility during the third quarter and
our sale of technical assets with respect to certain technical radiology
revenues during the second quarter, with only revenues related to PET services
increasing.
PET scans increased from 4,003 in the first nine months of 2001 to 9,096 in the
first nine months of 2002, an increase of 5,093 or 127.2%. PET scans increased
from 1,747 in the third quarter of 2001 to 3,084 for the third quarter of 2002,
an increase of 1,337 or 76.5%. The increase in the number of PET scans is
attributable to our opening five PET units since September 30, 2001, as well as
growth of 68.0% in the number of treatments on the nine PET units that were
operational during the first nine months of 2001. We currently have nine cancer
centers and seven PET installations in various stages of development. We expect
to open two cancer centers and two PET installations during the remainder of
2002.
The following table shows our net operating revenue by segment for the three
months ended September 30, 2002 and June 30, 2002, and the nine months ended
September 30, 2002 (in thousands). Since this is the first year in which we have
reportable segments, and for which sufficient information is now available to
permit such reporting, no prior year comparable information is available (see
Note 8 to Condensed Consolidated Financial Statements):
Three Months Ended Three Months Ended Nine Months Ended
September 30, 2002 June 30, 2002 September 30, 2002
------------------ ------------- ------------------
Oncology pharmaceutical management ...... $ 234,635 $ 224,952 $ 665,219
Other practice management services ...... 215,505 213,335 630,141
---------- ---------- ----------
Medical oncology ..................... 450,140 438,287 1,295,360
Outpatient cancer center operations ..... 73,948 78,509 230,192
Other ................................... 17,561 14,999 48,841
---------- ---------- ----------
$ 541,649 $ 531,795 $1,574,393
========== ========== ==========
Medical oncology net operating revenue increased from $438.3 million in the
second quarter of 2002 to $450.1 million for the third quarter of 2002, an
increase of $11.9 million or 2.7%. This increase was due to the increased
utilization of certain drugs, partially offset by a decline in medical oncology
visits.
Outpatient cancer center operations net operating revenue decreased from $78.5
million in the second quarter of 2002 to $73.9 million for the third quarter of
2002, a decrease of $4.6 million, or 5.8%. This decrease is attributable to our
disaffiliation with a radiation oncology facility during the third quarter and
our sale of technical assets with respect to certain technical radiology
revenues during the second quarter.
-23-
US Oncology, Inc.
Currently 96.3% of our net operating revenue is derived under the PPM model. The
following table shows the amount of operating revenue we derived under each type
of service agreement for the three and nine months ended September 30, 2002 and
2001 (in thousands):
Three Months Ended September 30, Nine Months Ended September 30,
2002 2001 2002 2001
---- ---- ---- ----
Revenue % Revenue % Revenue % Revenue %
------- - ------- - ------- - ------- -
Earnings model ....... $ 368,153 68.0% $ 280,387 58.6% $1,070,213 68.0% $ 826,367 57.2%
Net revenue model .... 156,978 29.0% 189,957 39.7% 469,481 29.8% 594,529 41.2%
Service line model ... 6,020 1.1% - 0.0% 7,576 0.5% - 0.0%
Other ................ 10,498 1.9% 8,329 1.7% 27,123 1.7% 23,512 1.6%
---------- ----- ---------- ----- ---------- ----- ---------- -----
$ 541,649 100.0% $ 478,673 100.0% $1,574,393 100.0% $1,444,408 100.0%
========== ===== ========== ===== ========== ===== ========== =====
During the first nine months of 2002, five net revenue model practices
accounting for 7.2% of our net operating revenue for the first nine months of
2002 converted to the earnings model. Since the beginning of 2001 and through
September 30, 2002, seventeen practices accounting for 28.6% of net operating
revenue in the first nine months of 2002 have converted from the net revenue
model to the earnings model. As of September 30, 2002, twenty-five service
agreements were on the earnings model and twelve service agreements were on the
net revenue model. In addition during the first nine months of 2002, we
transitioned three PPM practices from the earnings model to the service line
model and commenced operations at two new practices, under the service line
model. Also, during the first nine months of 2002, we disaffiliated with
practices consisting of a total of twenty-three physicians, which had been
operating under the net revenue model. These practices represented 3.6% of our
net operating revenue for the first nine months of 2002.
Revenue. Our revenue is net operating revenue, less the amount of net operating
revenue retained by our affiliated physician practices under PPM service
agreements. The following presents the amounts included in determination of our
revenue (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net operating revenue ............... $ 541,649 $ 478,673 $ 1,574,393 $ 1,444,408
Amounts retained by the practices ... (121,472) (103,174) (351,892) (317,406)
----------- ----------- ----------- -----------
Revenue .......................... $ 420,177 $ 375,499 $ 1,222,501 $ 1,127,002
=========== =========== =========== ===========
Amounts retained by practices increased from $317.4 million for the first nine
months of 2001 to $351.9 million for the first nine months of 2002, an increase
of $34.5 million, or 10.9%. Amounts retained by practices increased from $103.2
million in the third quarter of 2001 to $121.5 million in the third quarter of
2002, an increase of $18.3 million, or 17.7%. Such increase in amounts retained
by practices is directly attributable to the growth in net patient revenue
combined with the increase in profitability of affiliated practices. Amounts
retained by practices as a percentage of net operating revenue increased from
22.0% to 22.4% for the nine months ended September 30, 2001 and 2002,
respectively, and from 21.6% to 22.4% for the third quarters of 2001 and 2002,
respectively, as a result of increased profitability and improved operating
margins prior to physician compensation and general and administrative expenses.
Revenue increased from $411.0 million for the second quarter of 2002 to $420.2
million for the third quarter of 2002, an increase of $9.2 million, or 2.2%.
Revenue growth was caused by increases in revenues attributable to
pharmaceuticals.
-24-
US Oncology, Inc.
The following table shows our revenue by segment for the three months ended
September 30, 2002 and June 30, 2002 and the nine months ended September 30,
2002 (in thousands):
Three Months Three Months Nine Months
Ended Ended Ended
September 30, 2002 June 30, 2002 September 30, 2002
------------------ ------------- ------------------
Oncology pharmaceutical management .... $ 232,846 $ 225,439 $ 664,538
Other practice management services .... 120,520 117,753 355,271
---------- ---------- ----------
Medical oncology ................... 353,366 343,192 1,019,809
Outpatient cancer center operations ... 49,952 54,076 157,086
Other ................................. 16,859 13,704 45,606
---------- ---------- ----------
$ 420,177 $ 410,972 $1,222,501
========== ========== ==========
Medicare and Medicaid are the practices' largest payors. During the first nine
months of 2002, approximately 43% of the practices' net patient revenue was
derived from Medicare and Medicaid payments and 39% was so derived in the
comparable period last year. During the third quarter of 2002, approximately 43%
of the practices' net patient revenue was derived from Medicare and Medicaid
payments and 41% was so derived in the comparable period last year. This
percentage varies among practices. No other single payor accounted for more than
10% of our revenues in the first nine months of 2002 and 2001.
Pharmaceuticals and Supplies. Pharmaceuticals and supplies expense, which
includes drugs, medications and other supplies used by the practices, increased
from $577.1 million in the first nine months of 2001 to $635.0 million in the
same period of 2002, an increase of $57.8 million, or 10.0%. Pharmaceuticals and
supplies expense increased from $192.5 million in the third quarter of 2001 to
$223.1 million in the third quarter of 2002, an increase of $30.6 million, or
15.9%. As a percentage of revenue, pharmaceuticals and supplies increased from
51.2% in the first nine months of 2001 to 51.9% in the same period in 2002 and
increased from 51.3% in the third quarter of 2001 to 53.1% in the third quarter
of 2002. The increase was attributable to an increase in the percentage of our
revenue attributable to pharmaceuticals as a result of higher levels of drug
utilization and more expensive drugs and to a lesser extent the conversion of
three affiliated practices to, and the addition of two practices in new markets
under, the service line model. Such increases were partially offset by more
favorable drug pricing with respect to some drugs.
We expect that third-party payors, particularly government payors, will continue
to negotiate or mandate the reimbursement rates for pharmaceuticals and
supplies, with the goal of lowering reimbursement rates, and that such lower
reimbursement rates together with shifts in revenue mix may continue to
adversely impact our margins with respect to such items. Current governmental
focus on average wholesale price (AWP) as a basis for reimbursement could also
lead to a wide-ranging reduction in the reimbursement for pharmaceuticals by
payors. Payors also continue to try to implement both voluntary and mandatory
programs in which the practice must obtain drugs they administer to patients
from a third party and that third party, rather than the practice, receives
payment for the drugs directly from the payor. We continue to believe that
single-source drugs, possibly including oral drugs, will continue to be
introduced at a rapid pace, thus further negatively impacting margins. In
response to this decline in margin relating to certain pharmaceutical agents, we
have adopted several strategies. The successful conversion of net revenue model
practices to the earnings model will help reduce the impact of the increasing
cost of pharmaceuticals and supplies and the effect of reduced levels of
reimbursement. Likewise, the implementation of the service line model should
have a similar effect, since our revenues and earnings are not directly
dependent on pharmaceutical margins under that model. In addition, we have
numerous efforts underway to reduce the cost of pharmaceuticals by negotiating
discounts for volume purchases and by streamlining processes for efficient
ordering and inventory control and are assessing other strategies to address
this trend. We also continue to seek to expand into areas that are less affected
by lower pharmaceutical margins, such as radiation oncology and diagnostic
radiology. However, as long as pharmaceuticals continue to become a larger part
of our revenue mix as a result of changing usage patterns (rather than growth),
we believe that our overall margins will continue to be adversely impacted.
Field Compensation and Benefits. Field compensation and benefits, which includes
salaries and wages of our field-level employees and the practices' employees
(other than physicians), increased from $240.0 million in the first nine months
of 2001 to $256.4 million in the comparable 2002 period, an increase of $16.4
million or 6.8%. Field compensation and benefits increased from $81.0 million in
the third quarter of 2001 to $84.1 million in the third
-25-
US Oncology, Inc.
quarter of 2002, an increase of $3.1 million, or 3.8%. As a percentage of
revenue, field compensation and benefits decreased from 21.3% in the first nine
months of 2001 to 21.0% in the first nine months of 2002 and decreased from
21.6% in the third quarter of 2001 to 20.0% in the third quarter of 2002. The
increase in costs is attributed to increases in employee compensation rates to
address shortages of certain key personnel such as oncology nurses and radiation
technicians. We continue to experience a severe shortage of qualified radiation
personnel, with a vacancy rate up to 20%. This scarcity of full-time employees
requires us to hire more expensive temporary employees, and to incur significant
costs in recruitment efforts. The decrease as a percentage of revenue is
attributable to pharmaceutical revenues increasing at a more rapid rate than
compensation and benefits.
Other Field Costs. Other field costs, which consist of rent, utilities, repairs
and maintenance, insurance and other direct field costs, increased from $136.0
million in the first nine months of 2001 to $143.3 million in the first nine
months of 2002, an increase of $7.3 million or 5.4%. Other field costs increased
from $43.9 million in the third quarter of 2001 to $49.0 million in the third
quarter of 2002, an increase of $5.1 million, or 11.6%. As a percentage of
revenue, other field costs decreased from 12.1% in the first nine months of 2001
to 11.7% in the first nine months of 2002 and remained at 11.7% for the third
quarters of 2001 and 2002. The decrease for the first nine months is
attributable to economies of scale realized by increased pharmaceuticals
revenues.
General and Administrative. General and administrative expenses increased from
$43.5 million for the first nine months of 2001 to $45.9 million for the first
nine months of 2002, an increase of $2.4 million, or 5.6%. General and
administrative expenses increased from $14.7 million in the third quarter of
2001 to $16.6 million in the third quarter of 2002, an increase of $2.0 million,
or 13.4%. In 2002, several new personnel positions have been created to help
manage and support our introduction of the service line model combined with the
implementation of our program to provide industry advisory services to
pharmaceutical companies and other vendors. We anticipate incurring additional
general and administrative costs during the remainder of 2002 and early 2003, as
we add additional resources in our sales and marketing areas in connection with
the foregoing business lines. As a percentage of revenue, general and
administrative costs remained steady at 3.8% in the first nine months of 2001
and 2002 and 3.9% in the third quarters of 2001 and 2002.
Overall, we experienced steady operating margins from the first nine months of
2001 to the first nine months of 2002, with earnings before taxes, interest,
depreciation and amortization, impairment, restructuring and other charges and
extraordinary loss (EBITDA), as a percentage of revenue, remaining at 11.6%.
The following is the EBITDA of our operations by operating segment for the three
months ended September 30, 2002 and June 30, 2002 and the nine months ended
September 30, 2002 (in thousands). Since this is the first year in which we have
reportable segments, and for which sufficient information is now available to
permit such reporting, no prior year comparable information is available (See
Note 8 to Condensed Consolidated Financial Statements):
Three Months Ended Three Months Ended Nine Months Ended
September 30, 2002 June 30, 2002 September 30, 2002
------------------ ------------------ ------------------
Oncology pharmaceutical management .... $ 23,114 $ 20,761 $ 62,149
Other practice management services .... 22,429 23,613 69,529
--------- --------- ---------
Medical oncology ................... 45,543 44,374 131,678
Outpatient cancer center operations ... 15,155 17,938 49,076
Other ................................. 3,195 1,846 7,094
--------- --------- ---------
63,893 64,158 187,848
General and administrative expenses ... (16,623) (15,708) (45,893)
--------- --------- ---------
$ 47,270 $ 48,450 $ 141,955
========= ========= =========
The decrease in EBITDA for the outpatient cancer center operations is
attributable to our disaffiliation with radiation oncologists during the third
quarter and our sale of technical assets with respect to certain technical
radiology revenues during the second quarter.
Impairment, restructuring and other charges. In the fourth quarter of 2000, we
comprehensively analyzed our operations and cost structure, focusing on our
non-core assets and activities to determine whether they were still
-26-
US Oncology, Inc.
consistent with our strategic direction. As a result, we recorded a
restructuring charge during the fourth quarter of 2000. Details of the
restructuring charge activity relating to that charge for the first nine months
of 2002 are as follows (in thousands):
Accrual at Accrual at
December 31, 2001 Payments September 30, 2002
----------------- -------- ------------------
Severance of employment agreement ........ $ 215 $ (18) $ 197
Site closures ............................ 1,081 (241) 840
------ ------ ------
Total .................................... $1,296 $ (259) $1,037
====== ====== ======
During the first quarter of 2001, we announced plans to further reduce overhead
costs and recognized additional pre-tax restructuring charges of $5.9 million,
consisting of (i) a $3.1 million charge relating to the elimination of
approximately 50 personnel positions, (ii) a $2.5 million charge for remaining
lease obligations and related improvements at sites we decided to close and
(iii) a $0.3 million charge relating to software applications we decided to
abandon. Details of the restructuring charge activity relating to that charge
for the first nine months of 2002 are as follows (in thousands):
Accrual at Accrual at
December 31, 2001 Payments September 30, 2002
----------------- -------- ------------------
Costs related to personnel reductions .... $ 213 $ (213) $ -
Closure of facilities .................... 1,132 (177) 955
------ ------ ------
Total ................................. $1,345 $ (390) $ 955
====== ====== ======
During the first nine months of 2002, we have incurred impairment and
restructuring costs related to transitional activity, including the following:
o Termination of service agreements related to the conversion of PPM
practices to the service line model and in connection with practice
disaffiliations.
o Gains and losses related to sales of assets back to practices converting to
the service line model or in connection with practice disaffiliations.
o Impairment of intangible assets related to net revenue model service
agreements.
o Centralization of accounting and financial processes.
o Allowance on an affiliate receivable.
In that context, we recognized the following impairment, restructuring and other
charges during the three months and nine months ending September 30, 2002 (in
thousands):
Three Months Ended Nine Months Ended
September 30, 2002 September 30, 2002
------------------ ------------------
Write-off of service agreements .................. $ 68,314 $ 107,999
Gain on sale of practice assets .................. (3,415) (5,433)
Personnel reduction costs ........................ 882 1,791
Allowance on an affiliate receivable ............. 11,050 11,050
Consulting costs for implementing service line ... 0 1,397
--------- ---------
$ 76,831 $ 116,804
========= =========
-27-
US Oncology, Inc.
The following is a detailed summary of the third quarter charges (in thousands):
Impairment of
Net Revenue
Conversion to Practice Model Service Processing Affiliate
Service Line Disaffiliations Agreements Centralization Allowance Total
------------ --------------- ---------- -------------- --------- -----
Write-off of service agreements ........ $ 13,054 $ 4,253 $ 51,007 $ - $ - $ 68,314
Gain on sale of practice assets......... (1,063) (2,352) - - - (3,415)
Personnel reduction costs .............. - - - 882 - 882
Allowance on an affiliate receivable ... - - - - 11,050 11,050
-------- -------- -------- -------- -------- --------
$ 11,991 $ 1,901 $ 51,007 $ 882 $ 11,050 $ 76,831
======== ======== ======== ======== ======== ========
During the first nine months of 2002, we transitioned three of our PPM practices
with an aggregate of 23 physicians to the service line model, including one such
transition in the third quarter. In each transaction, the existing PPM service
agreement was terminated, the practice repurchased its assets, and future
consideration owing to physicians for their initial affiliation with the Company
was either accelerated or forfeited.
We also disaffiliated with physicians in four net revenue markets during the
third quarter and terminated a service agreement in one market with respect to
certain radiology sites during the second quarter. In these terminations,
practice assets were repurchased and fees were paid in connection with the
termination. Remaining consideration owed to the physicians (if any) by us with
respect to their original PPM affiliation transaction was accelerated.
The impairment of service agreement during the third quarter was a non-cash,
pretax charge of $68.3 million comprising (i) a $13.0 million charge related to
a PPM service agreement that was terminated in connection with conversion to the
service line model, (ii) a $51.0 million charge related to three net revenue
model service agreements that became impaired during the third quarter based
upon our analysis of projected cash flows under those agreements, taking into
account developments in those markets during the third quarter and (iii) a $4.3
million charge related to a group of physicians under a net revenue model
service agreement with which we disaffiliated during the third quarter. The
remainder of the charge relating to impairment of service agreements for the
first nine months of 2002 was a non-cash, pretax charge of $33.8 million related
to a net revenue model service agreement that became impaired during the second
quarter based upon our analysis of projected cash flows under that agreement,
taking into account developments in that market during the second quarter.
The $3.4 million net gain on sale of practice assets during the third quarter
comprised (a) net proceeds of $4.3 million paid by converting and disaffiliating
physicians and (b) a $0.2 million net recovery of working capital assets,
partially offset by a $1.1 million net charge arising from our accelerating
consideration that would have been due to physicians in the future in connection
with those transactions.
During the second quarter we recognized a $2.0 million net gain on sale of
practice assets. During that quarter, we terminated a service agreement as it
related to certain radiology sites and sold the related assets, including the
right to future revenues attributable to radiology technical fee revenue at
those sites, in exchange for delivery to us of 1.1 million shares of our common
stock. In connection with that sale, we also recognized a write-off of a
receivable of $0.5 million due from the physicians and agreed to make a cash
payment to the buyer of $0.6 million to reflect purchase price adjustments
during the third quarter. The transaction resulted in a $3.9 million gain based
on the market price of our Common Stock as of the date of the termination. This
gain was partially offset by a $1.9 million net impairment of working capital
assets relating to service line conversions, disaffiliations and potential
disaffiliations.
During the third quarter, in connection with our transition, we commenced an
initiative to further centralize certain of our accounting and financial
reporting functions at our headquarters in Houston, resulting in a $0.9 million
charge for personnel reduction costs. Management believes that such
centralization will enhance efficiency and improve internal operating controls
of those functions. During the first and second quarters of 2002, we recognized
$0.3 million and $0.6 million, respectively, for personnel reduction costs.
During the third quarter, we recognized an $11.1 million allowance related to an
$11.1 million receivable due to us from one of our affiliated practices. In the
course of our PPM activities, we advance amounts to physician groups
-28-
US Oncology, Inc.
and retain fees based upon our estimates of practice performance. Subsequent
events and related adjustments may result in the creation of a receivable with
respect to certain amounts advanced. During the third quarter, we made the
determination that a portion of such amounts owed by physician practices to us
may have become uncollectible due to, among other things the age of the
receivable and circumstances relating to practice operations.
During the second quarter we recognized $1.0 million professional fees for
consultants advising us on the implementation of the service line. During the
first quarter of 2002, we also recognized charges of $0.4 million in consulting
fees related to our introduction of the service line model.
As discussed above, during the first nine months of 2002, we have recorded
charges related to the impairment of certain net revenue model service
agreements. From time to time, we evaluate our intangible assets for impairment,
which involves an analysis comparing the aggregate expected future cash flows
under the agreement to its carrying value as an intangible asset on our balance
sheet. In estimating future cash flows, we consider past performance as well as
known trends that are likely to affect future performance. In some cases we also
take into account our current activities with respect to that agreement that may
be aimed at altering performance or reversing trends. All of these factors used
in our estimates are subject to error and uncertainty.
Interest. Net interest expense decreased from $18.6 million in the first nine
months of 2001 to $17.9 million for the first nine months of 2002, a decrease of
$0.7 million or 4.0%. Net interest expense increased from $5.2 million in the
third quarter of 2001 to $6.1 million in the third quarter of 2002, an increase
of $0.9 million, or 16.4%. As a percentage of revenue, net interest expense
decreased from 1.7% for the first nine months of 2001 to 1.5% for the first nine
months of 2002 and remained at 1.4% for the third quarters of 2001 and 2002.
Such decreases are due to lower borrowing levels during the first nine months of
2002. On February 1, 2002, we refinanced our indebtedness by issuing $175
million in 9.625% Senior Subordinated Notes due 2012 and repaying in full our
existing senior secured notes and terminating our existing credit facility. Our
previously existing $100 million senior secured notes bore interest at a fixed
rate of 8.42% and would have matured as to $20 million in each of 2002-2006.
Lower levels of debt during the first nine months of 2002, as compared to the
same period in 2001, partially offset by the increased rate of interest
contributed to the decrease of interest expense.
Income Taxes. For the first nine months of 2002, we recognized a tax benefit of
19.2 million, after extraordinary loss, resulting in an effective tax rate of
32.1%, compared to 38.0% for the same prior year period. For the third quarter
of 2002, we recognized an income tax benefit of $16.5 million as a result of the
impairment and restructuring charges discussed above. The effective tax rate in
the three and nine month periods ended September 30, 2002 reflects management's
estimate of the limited extent to which the Company will be able to deduct the
impairment, restructuring and other charges at the state level.
Extraordinary Loss. During the first quarter of 2002, we recorded an
extraordinary loss of $13.6 million, before income taxes of $5.2 million, in
connection with the early extinguishment of our $100 million Senior Secured
Notes due 2006 and our existing credit facility. The loss consisted of payment
of a prepayment penalty of $11.7 million on the Senior Secured Notes and a
write-off of unamortized deferred financing costs of $1.9 million related to the
terminated debt agreements.
In September 2001, we announced in a press release that our introduction of the
service line structure and transition away from the net revenue model, and the
related realignment of our business would cause us to record unusual charges for
write-offs of service agreements and other assets and other charges. These
charges include the impairment, restructuring and other charges and
extraordinary loss we have recorded during 2002. Through September 30, we had
recorded $10.6 million in unusual cash charges and $119.8 million in unusual
non-cash charges in connection with our transition process.
In that September 2001 press release, we disclosed that if all of our PPM model
practices converted to the service line we would anticipate incurring
approximately $480 million in such charges. Although that analysis would still
hold true if all practices converted, we do not believe full conversion is
likely and do not believe that we are likely to recognize the full $480 million
amount in connection with our transition.
Net Income. Net income decreased from $33.5 million, or $0.33 per diluted share,
in the first nine months of 2001 to a net loss of $(40.5) million, or $(0.41)
per share, in the first nine months of 2002, a decrease of $74.0 million or
220.9%. Net income as a percentage of revenue changed from 3.0% for the first
nine months of 2001 to (3.3)% for
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US Oncology, Inc.
the first nine months of 2002 and from 3.4% in the third quarter of 2001 to
(8.6)% in the third quarter of 2002. Included in net income for the first nine
months of 2002 are impairment, restructuring and other charges of $116,804
million and an extraordinary loss on early extinguishment of debt of $8.5
million, net of income taxes. Excluding the extraordinary loss and impairment,
restructuring and other charges, net income for the nine months ended September
30, 2002 would have been $43.9 million, which represents earnings per share of
$0.44. Included in net income for the nine months ended September 30, 2001 were
pre-tax restructuring charges of $5.9 million. Excluding the restructuring
charges, net income for the first nine months of 2001 would have been $37.1
million, which represents earnings per share of $0.37.
Liquidity and Capital Resources
As of September 30, 2002, we had net working capital of $189.0 million,
including cash and cash equivalents of $117.4 million. We had current
liabilities of $305.4 million, including $19.3 million in current maturities of
long-term debt, and $204.2 million of long-term indebtedness. During the first
nine months of 2002, we provided $133.9 million in net operating cash flow,
invested $42.0 million, and provided cash from financing activities in the
amount of $5.5 million. As of October 24, 2002, we had cash and cash equivalents
of $115.6 million.
Cash Flows From Operating Activities
During the first nine months of 2002, we generated $133.9 million in cash flows
from operating activities as compared to $161.1 million in the comparable prior
year period. The decrease in cash flow is attributable to (i) advance purchases
of certain pharmaceutical products during the first nine months of 2002 in order
to obtain favorable pricing and qualify for certain rebates, (ii) reduction in
number of accounts receivable days outstanding, and (iii) timing of certain
working capital payments. Our accounts receivable days outstanding as of
September 30, 2002, decreased to 47 days from 50 days as of December 31, 2001,
as compared to a decrease to 56 days as of September 30, 2001, from 67 days as
of December 31, 2000.
Cash Flows from Investing Activities
During the first nine months of 2002 and 2001, we expended $45.1 million and
$48.2 million in capital expenditures and financed an additional $8.6 million
and $16.8 million through various leasing facilities, respectively. During the
first nine months of 2002 and 2001, we expended $23.9 million and $21.8 million
on the development and construction of cancer centers, respectively. In
addition, we expended $8.8 million and $6.8 million on installation of PET
centers, respectively, during the nine months ended September 30, 2002 and 2001,
of which $8.0 million and $5.6 million, respectively, was financed through
various equipment operating leases. Maintenance capital expenditures were $20.5
million and $25.2 million in the first nine months of 2002 and 2001,
respectively. For all of 2002, we anticipate expending a total of approximately
$30-$35 million on maintenance capital expenditures and approximately $40-$45
million on development of new cancer centers and PET installations. Expected
capital expenditures on cancer center and PET development are below forecasted
amounts due to the Company's focus on transitional activity.
Cash Flows from Financing Activities
During the first nine months of 2002, we provided cash from financing activities
of $5.5 million as compared to cash used of $106.6 million in the first nine
months of 2001. Such increase in cash flow is primarily attributed to the
proceeds from the issuance of our Senior Subordinated Notes due 2012, net of the
cash payments for the retirement of our previously existing indebtedness,
including a prepayment premium paid as a result of early extinguishment of our
Senior Secured Notes due 2006. In addition, we expended $24.5 million to
repurchase 2.9 million shares of our Common Stock during the second and third
quarters of 2002. Additionally, we received 1.1 million shares of our Common
Stock in exchange for certain technical assets in the second quarter of 2002.
Subsequent to September 30, 2002, we repurchased 1.2 million shares of our
Common Stock, bringing the total number of shares acquired through repurchase
and exchange for assets to 5.2 million through October 17, 2002.
Historically, we satisfied our development and transaction needs through various
debt and equity financings and through borrowings under a $175 million
syndicated revolving credit facility with First Union National Bank (First
Union), as a lender and as an agent for various other lenders. We also used a
$75 million synthetic leasing facility in connection with developing integrated
cancer centers. Availability of new advances under the leasing facility
terminated in June 2001. We discuss this in more detail below.
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US Oncology, Inc.
On February 1, 2002, we entered into a five-year $100 million syndicated
revolving credit facility and terminated our existing syndicated revolving
credit facility. Proceeds under that credit facility may be used to finance the
development of cancer centers and new PET facilities, to provide working capital
or for other general business purposes. No amounts have been borrowed under that
facility. Our credit facility bears interest at a variable rate that floats with
a referenced interest rate. Therefore, to the extent we have amounts outstanding
under the credit facility in the future, we would be exposed to interest rate
risk under our credit facility.
On February 1, 2002, we issued $175 million in 9.625% Senior Subordinated Notes
due 2012 to various institutional investors in a private offering under Rule
144A under the Securities Act of 1933. The notes were subsequently exchanged for
substantially identical notes in an offering registered under the Securities Act
of 1933. The notes are unsecured, bear interest at 9.625% annually and mature in
February 2012. Payments under those notes are subordinated in substantially all
respects to payments under our new credit facility and certain other debt.
We used the proceeds from the Senior Subordinated Notes to repay in full our
existing $100 million in Senior Secured Notes due 2006, including a prepayment
penalty of $11.7 million due as a result of our repayment of the notes before
their scheduled maturity. We also used proceeds from the Senior Subordinated
Notes to pay fees and related expenses of $4.8 million associated with issuing
those notes and to pay fees and related expenses of $2.7 million in connection
with the new credit facility. During the first quarter of 2002, we recognized
the prepayment penalty of $11.7 million and a write-off of unamortized deferred
financing costs related to the terminated debt agreements of $1.9 million, which
were recorded as an extraordinary item during the first quarter of 2002.
Our introduction of the service line structure and transition away from the net
revenue model and the related realignment of our business required an amendment
or refinancing of our existing facilities. The new credit facility and Senior
Subordinated Notes give us flexibility in this regard. In addition, we believe
that the longer maturity of the Senior Subordinated Notes adds stability to our
capital structure.
We have entered into an operating lease arrangement known as a "synthetic
lease," under which a special purpose entity has acquired title to properties,
paid construction costs and leased to us the real estate and equipment at some
of our cancer centers. The synthetic lease facility was funded by a syndicate of
financial institutions. A synthetic lease is preferable to a conventional real
estate lease since the lessee benefits from attractive interest rates, the
ability to claim depreciation under tax laws and the ability to participate in
the development process.
We entered into the synthetic lease in December 1997. It matures in June 2004.
As of September 30, 2001, we had $72.0 million outstanding under the synthetic
lease facility and no further amounts are available under that facility. The
annual lease cost of the synthetic lease is approximately $3.6 million, based on
interest rates in effect as of September 30, 2002. The lessor under the
synthetic lease holds real estate assets (based on original acquisition and
construction costs) of approximately $59.2 million and equipment of
approximately $12.8 million (based on original acquisition cost) at nineteen
locations.
The lease is renewable in one-year increments, but only with consent of the
financial institutions that are parties thereto. If the lease is not renewed at
maturity or otherwise terminates, we must either purchase the properties under
the lease for the total amount outstanding or market the properties to third
parties. Defaults under the lease, which includes cross-defaults to other
material debt, could result in such a termination, and require us to purchase or
remarket the properties. If we sell the properties to third parties, we have
guaranteed a residual value of at least 85% of the total amount outstanding for
the properties. The guarantees are secured by substantially all of our assets.
If the properties were sold to a third party at a price such that we were
required to make a residual value guarantee payment, such amount would be
recognized as an expense in our statement of operations.
A synthetic lease is an operating lease according to accounting principles
generally accepted in the United States (GAAP). Thus, our obligations under the
synthetic lease are not recorded as debt and the underlying properties and
equipment are not recorded as assets on our balance sheet. Our rental payments
(which approximate interest amounts under the synthetic lease financing) are
treated as operating rent commitments, and are excluded from our aggregate debt
maturities.
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US Oncology, Inc.
On February 27, 2002, the FASB determined that synthetic lease properties
meeting certain criteria would be required to be recognized as assets with a
corresponding liability effective April 1, 2003. Our synthetic lease meets these
criteria. The determination is not final and is subject to additional
rule-making procedures, but assuming the determination becomes a formal
accounting pronouncement and assuming that we do not alter the arrangement to
maintain off-balance sheet treatment under the new rules, we would expect to
recognize additional property and equipment with a corresponding liability on
our balance sheet as of April 1, 2003.
If we were to purchase all of the properties currently covered by the synthetic
lease or if changes in accounting rules or treatment of the lease were to
require us to reflect the properties on our balance sheet, the impact to the
consolidated financial statements would be as follows:
o Property and equipment would increase by the fair market value of the
assets, and to the extent such asset values are less than the total amount
outstanding under the lease, we would recognize a charge to reflect the
difference between such asset values and the amount outstanding under the
synthetic lease at such time as we bring the properties onto our balance
sheet;
o Assuming the purchase of the properties were financed through borrowing, or
in the event the existing arrangement were required to be characterized as
debt, indebtedness would increase by $72.0 million; and
o Depreciation would increase as a result of our owning the assets.
Acquiring the properties may require us to borrow additional funds. We may not
be able to do so, particularly if we are required to purchase the properties as
the result of an event of default. Any borrowing would also likely reduce the
amount we could borrow for other purposes. In addition, changes in future
operating decisions or changes in the fair market values of underlying leased
properties or the associated rentals could result in significant charges or
acceleration of charges in our statement of operations for leasehold
abandonments or residual value guarantees. Because the synthetic lease payment
floats with a referenced interest rate, we are also exposed to interest rate
risk under the synthetic lease. A 1% increase in the referenced rate would
result in an increase in lease payments of $0.7 million annually.
During October 2002, we entered into an amendment to the synthetic lease that,
once effective, would allow greater operational flexibility with respect to the
properties covered by the synthetic lease. The amendment will only become
effective at our election and, in order to make the amendment effective, we will
be required to fully guarantee 100% of the residual value of the synthetic lease
properties, which would require us to reflect on our balance sheet amounts
outstanding under the lease and the underlying properties under the lease. This
amendment will give us more latitude to implement key operational initiatives
during this transitional period in our business, by, for example, allowing us to
close under-performing facilities or move equipment within our network. We are
currently in the process of evaluating the cancer center assets leased under the
synthetic lease to determine the appropriate asset values at which those assets
would be brought onto our balance sheet. To the extent such asset values are
less than the total amount outstanding under the lease, we would recognize a
charge to reflect the difference between such asset values and the amount
outstanding under the synthetic lease at such time as we bring the properties
onto our balance sheet. We expect that the timing of such activity would be in
the fourth quarter of 2002.
Borrowings under the revolving credit facility and advances under the synthetic
leasing 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, synthetic leasing facility and Senior Subordinated 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. Events of default under our credit facility, synthetic leasing
facility and Senior Subordinated Notes include cross-defaults to all material
indebtedness, including each of those financings. Substantially all of our
assets, including certain real property, are pledged as security under the
credit facility and the guarantee obligations of our synthetic leasing facility.
We are currently in compliance with covenants under our synthetic leasing
facility, revolving credit facility and Senior Subordinated Notes, with no
borrowings currently outstanding under the revolving credit facility. We have
relied primarily on cash flows from our operations to fund working capital.
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US Oncology, Inc.
We currently expect that our principal use of funds in the near future will be
in connection with 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, as well as implementation of the
service line structure, with less emphasis than in past years on transactions
with medical oncology practices. It is likely that our capital needs in the next
several years will exceed the cash generated from operations. Thus, we may incur
additional debt or issue additional debt or equity securities from time to time.
Capital available for health care companies, whether raised through the issuance
of debt or equity securities, is quite limited. As a result, we may be unable to
obtain sufficient financing on terms satisfactory to management or at all.
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US Oncology, Inc.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
In the normal course of business, our financial position is routinely subjected
to a variety of risks. Among these risks is the market risk associated with
interest rate movements on outstanding debt. We regularly assess these risks and
have established policies and business practices to protect against the adverse
effects of these and other potential exposures.
Our borrowings under our synthetic leasing facility and revolving credit
facility contain an element of market risk from changes in interest rates. We
have, in the past managed this risk, in part, through the use of interest rate
swaps; however, no such agreements have been entered into in the first nine
months of 2002, and we were not obligated under any interest rate swap
agreements during the nine-month period ended September 30, 2002. We do not
enter into interest rate swaps or hold other derivative financial instruments
for speculative purposes. No amounts are currently outstanding under the
revolving credit facility, nor were any amounts outstanding under the revolving
credit facility during the first nine months of 2002. $72.0 million is
outstanding under the synthetic leasing facility at September 30, 2002. Our
Senior Subordinated Notes due 2012 bear interest at a fixed rate of 9.625%.
For purposes of specific risk analysis, we use sensitivity analysis to determine
the impact that market risk exposures may have on us. The financial instruments
included in the sensitivity analysis consist of all of our cash and equivalents,
long-term and short-term debt and all derivative financial instruments.
To perform sensitivity analysis, we assess 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, 2002. The market values that result from these
computations are compared with the market values of these financial instruments
at September 30, 2002. 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 our results of
operations or financial position or the fair value of its financial instruments.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in our periodic SEC filings.
The CEO and CFO note that, since the date of the evaluation to the date of this
report, there have been no significant changes in internal controls or in other
factors that could significantly affect internal controls, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
While the disclosure controls and procedures have been effective in providing
material information, we continue to seek to strengthen such disclosure controls
and procedures. We are currently engaged in a reconfiguration of our financial
reporting controls and procedures to centralize those functions at our corporate
offices in Houston. This process change will result in the elimination of
certain functions that were previously performed on a regional and local basis.
We believe that this change will result in enhanced reliability and timeliness
of disclosure and believe that centralization will eliminate certain of the
risks with respect to financial reporting that are inherent in a broad,
decentralized system.
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US Oncology, Inc.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The provision of medical services by our affiliated practices entails an
inherent risk of professional liability claims. We do not control the practice
of medicine by the clinical staff or their compliance with regulatory and other
requirements directly applicable to practices. In addition, because the
practices purchase and resell pharmaceutical products, they face the risk of
product liability claims. Although we maintain insurance coverage, successful
malpractice, regulatory or product liability claims asserted against us or one
of the practices could have a material adverse effect on us.
We have become aware and previously disclosed that we and certain of our
subsidiaries and affiliated practices are the subject of qui tam lawsuits
commonly referred to as "whistle-blower" lawsuits that remain under seal,
meaning that they were filed on a confidential basis with a U.S. federal court
and are not publicly available or disclosable. The U.S. Department of Justice
has determined that it will not intervene in any of those qui tam suits of which
we are aware. In these suits, the individual who filed the complaint may choose
to continue to pursue litigation in the absence of government intervention, but
has not yet indicated an intent to do so. Because qui tam actions are filed
under seal, there is a possibility that we could be the subject of other qui tam
actions of which we are unaware. We intend to continue to investigate and
vigorously defend ourselves against any and all such claims, and we continue to
believe that we conduct our operations in compliance with law.
Qui tam suits are brought by private individuals, and there is no minimum
evidentiary or legal threshold for bringing such a suit. However, the Department
of Justice is legally required to investigate the allegations in these suits.
The subject matter of many such claims may relate both to our alleged actions
and alleged actions of an affiliated practice. Because the affiliated practices
are separate legal entities not controlled by us, such claims necessarily
involve a more complicated, higher cost defense, and may adversely impact the
relationship between us and the practices. If the individuals who file
complaints and/or the United States were to prevail in these claims against us,
and the magnitude of the alleged wrongdoing were determined to be significant,
the resulting judgment could have a material adverse financial and operational
effect on us including potential limitations in future participation in
governmental reimbursement programs. In addition, addressing complaints and
government investigations requires us to devote significant financial and other
resources to the process, regardless of the ultimate outcome of the claims.
We and our network physicians are defendants in a number of lawsuits involving
employment and other disputes and breach of contract claims. In addition, we are
involved from time to time in disputes with, and claims by, our affiliated
practices against us. Although we believe the allegations are customary for the
size and scope of our operations, adverse judgments, individually or in the
aggregate, could have a material adverse effect on us.
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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, with Amendment effective March
22, 2001 (filed as Exhibit 3.2 to the Company's Form 10-K
filed March 28, 2001 and incorporated herein by reference)
4.1 Rights Agreement between the Company and American Stock
Transfer & Trust Company (incorporated by reference from the
Company's Form 8-A filed June 2, 1997).
4.2 Indenture dated February 1, 2002 among US Oncology, Inc., the
Guarantors named therein, and JP Morgan Chase Bank as Trustee
(filed as Exhibit 3 to, and incorporated by reference from,
the Company's Form 8-K filed February 5, 2002).
4.3 Registration Rights Agreement dated as of February 1, 2002 by
and among US Oncology, Inc., the Guarantors named therein and
UBS Warburg LLC, Deutsche Banc Alex. Brown Inc. and First
Union Securities, Inc. as Initial Purchasers (filed as Exhibit
4 to, and incorporated by reference from, the Form 8-K filed
February 5, 2002).
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
(b) Reports on Form 8-K
On August 13, 2002, the Registrant filed a Form 8-K disclosing that its Chief
Executive Officer and Chief Financial Officer had each filed with the Securities
and Exchange Commission a sworn statement regarding facts and circumstances
relating to the Securities Exchange Act filings for the Registrant as required
by the SEC's Order Requiring the Filing of Sworn Statements pursuant to Section
21(a)(1) of the Securities Exchange Act of 1934 (File no. 4-460, June 27, 2002).
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US Oncology, Inc.
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
US ONCOLOGY, INC.
Date: November 13, 2002: By: /s/ R. Dale Ross
-------------------------------------------
R. Dale Ross, Chief Executive Officer
(duly authorized signatory)
Date: November 13, 2002: By: /s/ Bruce D. Broussard
-------------------------------------------
Bruce D. Broussard, Chief Financial Officer
(principal financial and accounting officer)
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US Oncology, Inc.
CERTIFICATIONS
I, R. Dale Ross, Chief Executive Officer of US Oncology, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of US Oncology,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ R. Dale Ross
--------------------------------------------
R. Dale Ross
Chief Executive Officer of US Oncology, Inc.
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US Oncology, Inc.
I, Bruce D. Broussard, Chief Financial Officer of US Oncology, Inc., certify
that:
1. I have reviewed this quarterly report on Form 10-Q of US Oncology,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ Bruce D. Broussard
--------------------------------------------
Bruce D. Broussard
Chief Financial Officer of US Oncology, Inc.
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