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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
AMERIPATH, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 65-0642485
(State or Other Jurisdiction (I.R.S. Employer
Incorporation or Organization) Identification No.)
7289 Garden Road, Suite 200, Riviera Beach, Florida 33404
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (561) 845-1850
Securities Registered Pursuant to Section 12(B) of the Act:
Securities Registered Pursuant to Section 12(G) of the Act:
Common Stock (Par Value $.01 Per Share)
(Title of Class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant as of March 15, 2002 was approximately $858.7 million based on the
$28.20 closing sale price for the Common Stock on the NASDAQ National Market
System on such date. For purposes of this computation, all executive officers
and directors of the Registrant have been deemed to be affiliates. Such
determination should not be deemed to be an admission that such directors and
officers are, in fact, affiliates of the Registrant.
The number of shares of Common Stock of the Registrant outstanding as of
March 15, 2002 was 30,449,989.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement relating to the
Registrant's 2002 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission no later than 120 days after the end of the
year covered by this Report are incorporated by reference into Part III of
this Report.
INDEX TO ITEMS
Page
----
PART I.
Item 1. General Business 1
Item 2. Properties 19
Item 3. Legal Proceedings 19
Submission of Matters to a Vote of
Item 4. Security Holders 19
PART II.
Item 5. Market for the Registrant's Common Stock
and Related
Stockholder Matters 20
Item 6. Selected Financial Data 20
Item 7. Management's Discussion and Analysis of
Financial
Condition and Results of Operations 22
Quantitative and Qualitative Disclosures
Item 7A. about Market Risk 51
Item 8. Financial Statements and Supplementary
Data; Index to
Consolidated Financial Statements 52
Item 9. Changes in and Disagreements with
Accountants on
Accounting and Financial Disclosure 52
PART III.
Directors and Executive Officers of the
Item 10. Registrant 53
Item 11. Executive Compensation 53
Security Ownership of Certain Beneficial
Item 12. Owners and Management 53
Certain Relationships and Related
Item 13. Transactions 53
PART IV.
Exhibits, Financial Statement Schedules
Item 14. and Reports on Form 8-K 54
Signatures 56
Financial Statements F-1
PART I
ITEM 1. GENERAL BUSINESS
AmeriPath is one of the nation's leading providers of anatomic pathology
services. The Company has over 400 anatomic pathologists as of December 31,
2001 who work either in one of more than 200 hospitals to which AmeriPath
provides professional pathology and medical director services or in one of
AmeriPath's more than 40 outpatient laboratories. AmeriPath typically serves
as the exclusive provider of professional pathology services for the hospitals
in which its pathologists work. Under these arrangements, AmeriPath typically
bills third-party payors for the professional component of the inpatient
testing and may earn small medical director fees from the hospitals.
AmeriPath's hospital arrangements provide a relatively steady stream of
revenue and, while not long-term commitments, tend to continue uninterrupted.
In the hospital setting, key revenue sources include the study of tissues, or
surgical pathology, and the study of cells, or cytopathology. The Company also
has roughly 20 large outpatient laboratories and numerous satellite labs where
AmeriPath performs outpatient pathology services. These outpatient pathology
services are provided to primary care physicians and other specialty
physicians including dermatologists, gastroenterologists, urologists,
oncologists and gynecologists. Key referral sources for the outpatient
business include dermatopathology and urologic pathology, which consist
principally of the study of biopsies for skin and prostate cancer,
respectively.
AmeriPath generally manages and controls all of the non-medical functions of
the operations, including:
. recruiting, training, employing and managing the technical and support
staff;
. developing, equipping and staffing laboratory facilities;
. establishing and maintaining courier services to transport specimens;
. negotiating and maintaining contracts with hospitals, national clinical
laboratories and managed care organizations and other payors;
. providing financial reporting and administration, clerical, purchasing,
payroll, billing and collection, information systems, sales and
marketing, risk management, employee benefits, legal, tax and accounting
services;
. maintaining compliance with applicable laws, rules and regulations; and
. with respect to our ownership and operation of anatomic pathology
laboratories, providing slide preparation and other technical services.
Since the first quarter of 1996, the Company has completed the acquisition
of 50 physician practices located in 21 states. This includes the acquisition
of Inform DX in the fourth quarter of 2000. As a result of the Inform DX
acquisition, the Company now manages several pathology operations from which
it derives management fees. Although the managed operations are not owned or
controlled by the Company, the statistical data appearing throughout,
including items such as the number of pathologists, hospitals, employees and
outpatient laboratories, incorporates the statistical data from the managed
operations as if they were owned by the Company. In addition, because the
Inform DX transaction was accounted for as a pooling-of-interests, the
information presented includes Inform DX for all periods, unless otherwise
indicated. Further discussion of matters pertaining to this Item 1 is
addressed in the Consolidated Financial Statements attached hereto.
Industry Overview
Pathologists are medical doctors who specialize in the study of disease.
Pathologists do not treat patients, but rather assist other physicians in
determining the correct diagnosis of their patient's ailments. A pathologist's
diagnosis represents a critical factor in determining a patient's future care.
Pathologists perform their duties in hospital laboratories, in independent
freestanding local, regional and national laboratories, in ambulatory surgery
centers and in a variety of other settings.
Anatomic pathology involves evaluating tissues and cells that have been
processed and mounted on slides for examination under a microscope. In
surgical pathology, tissues removed from a patient during inpatient or
outpatient procedures are examined to determine whether disease is present.
Examples of surgical pathology include breast, prostate, skin and bone marrow
biopsies. Cytopathology involves the examination of cells obtained from body
fluids, from solid tissues aspirated through needles and from scrapings of
body tissues. An example of cytopathology is the "Pap" smear, a test for
determining cervical cancer.
According to the College of American Pathologists, there are more than
12,000 pathologists in the United States. The Company believes that many of
these pathologists work in small, independent practices. However, the Company
believes there has been a recent trend among pathologists to form larger
practices in order to offer a broader range of outpatient and inpatient
services and enhance the utilization of the practices' pathologists. The
Company believes this trend can be attributed to several factors, including
cost containment pressures by government and other third-party payors,
increased competition and the increased costs and complexities associated with
operating a medical practice. Because tissue and fluid samples are easily
transportable, pathologists working in one setting may receive samples from
many sources, thereby enhancing productivity and permitting a large pathology
practice to service a wider geographic area. The Company believes scale leads
to competitive advantages in anatomic pathology because of resulting
improvements in sales, operations and contracting efficiency.
The Company believes the market for anatomic pathology, esoteric testing and
related services is approximately $6.0 billion and will continue to grow for
the following reasons:
Aging Population. According to the American Geriatrics Society, the number
of people aged 65 and older in the United States will increase approximately
60% by the year 2020. Older populations consume a greater amount of health
care services than do younger populations. The Company believes these factors
will combine to drive the demand for anatomic pathology services to diagnose
and treat disease.
Increasing Incidence of Cancer. The National Cancer Institute estimates that
approximately 8.9 million Americans with a history of cancer were alive in
1997. The most common type of cancer is skin cancer. The American Cancer
Society estimates that over 1.3 million cases of basal cell and squamous cell
skin cancer are expected to be diagnosed this year. From 1981 to 1997, the
incidence rate of melanoma increased about 3% per year on average, to a rate
of 14.3 per 100,000 in 1997. Dermatopathology, or the study of diseases of the
skin, is a growing anatomic pathology specialty because of the increasing
incidence of skin cancer and the biopsies that must be performed to diagnose
it.
Esoteric Testing. Esoteric tests are highly complex tests, typically ordered
when a physician requires additional information to establish a diagnosis or
to choose a therapeutic regimen. Esoteric tests require sophisticated
instrumentation and highly skilled personnel to perform and analyze results,
and consequently carry higher prices than routine tests. Commonly ordered
esoteric tests include flow cytometry (leukemia/ lymphoma testing), DNA
analysis, molecular genetics and cytogenetics. According to the Lab Industry
Strategic Outlook 2000, published by Washington G-2 Reports, the esoteric
clinical laboratory testing market accounts for approximately $2.0 billion in
annual revenue and is poised for approximately 10%-15% annual growth. We
believe that the future growth in the esoteric testing market will be fueled
by scientific advances facilitating the development of more sophisticated and
specialized esoteric tests, increased focus on cost-effective disease
prevention, detection and management and increased life expectancy.
The Genomic Revolution. Genetic and biotech companies are developing
therapeutics, which allow physicians to target treatments for individuals
based on their particular genetic make-up. Anatomic pathology laboratories
have access to large volumes of tissue samples that contain important genetic
data that is valuable to drug discovery companies in the development of new
drugs. We believe a significant opportunity exists to build tissue banks with
samples from normal, diseased and cancerous tissues and, subject to patient
confidentiality and informed consent procedures, make such tissues available
to drug testing and drug discovery companies.
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Business Strategy
The Company's objective is to be the premier provider of diagnostic health
care information by continuing to enhance its position as a leading provider
of anatomic pathology services. Historically, the Company's growth strategy
was focused primarily on acquiring leading pathology practices in order to
enter new markets and expand its national presence. While acquisitions remain
an important element of the Company's strategy, AmeriPath is increasingly
focused on maximizing its internal, or same store, growth. The Company is
pursuing the following strategies to achieve its objective:
. Enhance its regional business model with its recently augmented sales
and marketing organization. The Company is utilizing its regional
business model to deploy new sales people focused on general anatomic
pathology markets such as urology, gastroenterology and obstetrics and
gynecology (OB/GYN). Through regionally focused direct sales and
marketing efforts, AmeriPath is seeking to penetrate more deeply the
base of referring physicians in its markets and expand its contracts
with managed care payors, hospitals and national clinical laboratories.
In addition, the Company has recently established a separate sales and
marketing division called Dermpath Diagnostics to market exclusively the
Company's substantial dermatopathology resources, which include over 60
board certified dermatopathologists.
. Expand its exclusive relationships with hospitals and multi-hospital
systems. The Company continues to seek additional exclusive hospital
relationships through the acquisition of anatomic pathology practices
and the expansion of existing relationships with multi-hospital systems.
AmeriPath's hospital relationships provide a relatively stable and
recurring source of revenue. Moreover, the Company believes that
providing inpatient laboratory services to multiple hospitals within a
geographic area enhances its ability to contract with managed care
companies, facilitates the development and effectiveness of successful
outpatient services networks and increases opportunities to perform
esoteric and other specialty testing services. As of December 31, 2001,
AmeriPath's pathologists were providing services in over 200 hospitals
in the U.S., typically on an exclusive basis.
. Broaden its range of testing services and penetrate further the high
growth esoteric testing markets. The Company has undertaken a number of
initiatives to broaden its range of testing services into the high
growth market segment of esoteric testing. Because many requests for
these specialty tests originate in the hospital, the Company believes
its large network of hospital-based pathologists and its relationships
with multi-hospital systems provide it with significant competitive
advantages in pursuing this business. As part of this strategy, the
Company opened the Center for Advanced Diagnostics, or CAD, in 1999 in
an effort to capture specialty testing services that historically had to
be performed by third parties. The success of this strategy to date is
evidenced by the strong revenue growth CAD has experienced.
. Acquire leading anatomic pathology practices to further expand its
national presence and support its regional growth model. The Company has
successfully completed 50 acquisitions since 1996. The Company expects
to increase its presence in existing markets and enter into new markets
through additional acquisitions of leading pathology practices.
Acquisitions are intended to enhance the Company's profitability,
augment its range of subspecialties and testing services and strengthen
its reputation by adding locally or nationally prominent pathologists.
. The Company intends to build upon its leadership position in anatomic
pathology to participate in the rapidly growing genomics and genomics
testing market. The Company is aggressively exploring ways to build upon
its national scale, leading market position and access to tissue
samples. The Company's objective is to create new revenue streams
distinct from its anatomic, esoteric and genomic testing revenues. In
the third quarter of 2000, the Company formed an alliance with Genomics
Collaborative, Inc. ("GCI") to provide fresh frozen samples from normal,
diseased, and cancerous tissue to GCI for subsequent sale to researchers
in industry and academic laboratories who are working to discover genes
associated with certain common disease categories. Under this alliance,
the Company will be paid a fee for each sample it supplies to
researchers and will be compensated for developing new laboratory tests
for use in research or clinical settings. In addition to providing the
Company with
3
expected new revenue streams, this alliance should give it a "first
look" at genetic markers and tests resulting from the research and
should provide a corresponding competitive advantage with respect to the
commercialization of such markers and tests.
Sales and Marketing
Outpatient Market
The Company's marketing efforts are focused on physicians, hospital and
ambulatory surgery center administrators, national clinical laboratories and
managed care organizations. With the exception of Inform DX, the pre-
acquisition marketing efforts of operations acquired by the Company were
primarily based on the professional reputations and the individual efforts of
pathologists. The Company believes that there is an opportunity to capitalize
on these professional reputations by hiring experienced personnel and
utilizing professional sales and marketing techniques. Historically, some of
the outpatient operations marketed outpatient services primarily to
dermatologists, over a broad geographic area including neighboring states. The
Company continues to expand its sales and marketing team with additional sales
personnel and management staff to accommodate new acquisitions, develop and
introduce new products, as well as increase same store growth. These field
representatives are supervised by regional sales managers who coordinate the
implementation of regional contracting efforts, leverage operational
capabilities, support national sales strategies and provide ongoing training
and field sales support. The regional sales managers report to the Vice
President of Sales and Marketing to ensure the implementation of consistent
and effective sales activities nationwide. In addition, the Company's Vice
President of Managed Care directs regional managers of managed care in
negotiating additional contracts. In 2001, the Company added 21 people to the
sales and marketing organization, including managed care. This brings the
total sales and marketing organization to 84 people as of December 31, 2001,
compared to 63 at the end of the prior year.
After examining its current business model and conducting market research,
including customer focus groups and an analysis of the demographic
distribution of patients and referring physicians, AmeriPath created two
distinct field sales divisions to provide dedicated service and support to
referring physicians along specialty lines. Dermpath Diagnostics will focus on
servicing and growing the national skin pathology market comprised of
dermatologists, plastic surgeons, family practitioners, otolaryngologists and
podiatrists. This division, which promotes AmeriPath's dermatopathologists,
will expand its sales and marketing initiative throughout the U.S. market. The
other field sales division, General Anatomic, has the responsibility for
servicing and growing the outpatient anatomic pathology market with
urologists, gastroenterologists, gynecologists, surgery centers, oncologists
and any specialist requiring esoteric laboratory testing, which is provided
through CAD. AmeriPath's managed care and national clinical laboratory
contracting organization will support both organizations in an effort to
expand such contracts.
National Clinical Laboratory Marketing
The national clinical laboratories contract with managed care organizations
to provide clinical laboratory services, as well as anatomic pathology and
cytology services. The clinical laboratory market is primarily dominated by
two laboratories, Quest and LabCorp. Their contracts with managed care
organizations are typically capitated, meaning they generally get paid a fixed
fee per covered member per month to provide all necessary testing services for
such members regardless of the number of tests actually performed. Ten of
AmeriPath's operations have subcontracts with national clinical laboratories
to provide anatomic pathology and cytology services. Under these contracts,
which typically run from one to three years with automatic renewals unless
terminated earlier, the operations bill the national clinical laboratories on
a discounted fee-for-service basis. The reduced fee is partially offset by the
national clinical laboratories provision of courier services, supplies, and
reduced billing costs and lower bad debts, since the national clinical
laboratories bear the capitation risk. Net revenues from these contracts
constituted 9.0% and 7.0% of the Company's net revenues in 2000 and 2001,
respectively. The Company is directing its marketing efforts to national
clinical laboratories to expand these contracts on a regional basis to
additional operations as well as to enter into new contracts. At the same
time, the Company is seeking to secure new contracts and expand existing
provider contracts with managed care
4
organizations for the provision of anatomic pathology services directly to
their members and is prepared to negotiate flexible arrangements with managed
care organizations, including discounted fee- for-service or capitated
contracts. There can be no assurance that the Company's effort to contract
directly with managed care organizations will not adversely affect the
Company's relationship with the national clinical laboratories.
AmeriPath Corporate Structure
AmeriPath's revenues are derived primarily from two segments: owned
operations and managed operations. In the owned operations, AmeriPath either
directly employs physicians or, in states with laws that restrict the direct
employment of physicians by for-profit corporations, contracts with an
affiliated operation which, in turn, employs physicians. As a result of the
corporate practice of medicine restrictions, the affiliated physicians in
these states retain ownership of a separate affiliated operation through which
they practice medicine, but the Company enters into contractual arrangements
that generally (1) prohibit the affiliated physicians from transferring their
ownership interests in the affiliated operation, except in very limited
circumstances, and (2) require the affiliated physicians to transfer their
ownership interests in the affiliated operation to designees of AmeriPath upon
the occurrence of specified events. Through these contractual arrangements,
AmeriPath, either directly or through its designees, has a controlling voting
or financial interest in the separate affiliated operations and, therefore,
refers to them as owned operations. Managed operations are operations that are
not owned by AmeriPath and that are not subject to contractual arrangements
that give AmeriPath a controlling interest in the practice. Rather, the
managed operations are controlled by the physicians who own them, and the
Company provides management services to them under long-term management
services agreements.
The manner in which AmeriPath operates a particular operation is determined
primarily by whether it is an owned or managed operation and the corporate
practice of medicine restrictions of the respective state and other applicable
regulations. The Company exercises care in structuring its operations and
arrangements with hospitals, physicians and other providers in an effort to
comply with applicable federal and state laws and regulations, and the Company
believes that its current structure and arrangements do comply in all material
respects with applicable laws and regulations. However, due to uncertainties
in the law there can be no assurance that the Company's legal structure and
arrangements would be deemed to be in compliance with applicable laws and
regulations, and any noncompliance could result in a material adverse effect
on the Company.
Owned operations are owned and operated by AmeriPath through one or more
subsidiaries or physician-owned operations controlled by AmeriPath through
contractual arrangements. The financial statements of the owned operations are
included in the consolidated financial statements of AmeriPath.
Managed operations refers to AmeriPath's management of pathology practices
under long-term management services agreements with physician groups.
Generally, the Company acquires the operation's assets, and the physician
groups maintain their separate corporate or partnership entities that enter
into employment agreements with the practicing physicians. The management
service agreements give AmeriPath the exclusive right to manage the operations
during the term of the agreements. Pursuant to the management services
agreements, the Company provides the managed operations with equipment,
supplies, support personnel, and management and financial advisory services.
The managed operations are responsible for the recruitment and hiring of
physicians and all other personnel who provide pathology services, and for all
issues related to the professional, clinical and ethical aspects of the
business. As part of the management services agreements, managed operations
are required to maintain medical malpractice insurance that names the Company
as an additional insured. The Company is required to maintain general
liability insurance and name the physician groups as additional insureds. Upon
termination of the management services agreements, the respective physician
groups are required to obtain continuing liability insurance coverage under
either a "tail policy" or a "prior acts policy."
The management services fees charged under the management services
agreements are based on a predetermined percentage of net operating income of
the managed operations. The Company also participates to varying degrees in
non-physician revenues generated from ancillary services offered through the
managed operations' laboratories. The Company charges a capital fee for the
use of depreciable assets owned by the
5
Company and recognizes revenue for all operation expenses that are paid on
behalf of the operations and reimbursed to the Company pursuant to the
management service agreements. Such operation expenses exclude the salaries
and benefits of the physicians.
AmeriPath manages and controls all of the non-medical functions of the owned
and managed operations. AmeriPath is not licensed to practice medicine. The
practice of medicine is conducted solely by the physicians in the owned and
managed operations.
In operating the owned operations, the Board of Directors and management of
AmeriPath formulate strategies and policies that are implemented locally on a
day-to-day basis by each owned operation. Each owned operation has a
pathologist managing director who is responsible for overseeing the day-to-day
management, who reports to one of six regional managing directors, two of whom
are pathologists, who in turn report to executive officers of the Company.
AmeriPath's Medical Director develops and reviews standards for the practicing
physicians and reviews quality and peer review matters with each owned
operation's medical director (or a medical review committee).
Pursuant to its management services agreements with managed operations,
AmeriPath manages all aspects of the managed operations other than the
provision of medical services, which is controlled solely by the physicians.
The managed operations have joint policy boards, equally represented by the
managed operation's physicians and employees of AmeriPath, that focus on
strategic and operational planning, marketing, managed care arrangements and
other major issues facing the managed operation.
AmeriPath's owned and managed operations typically serve as the exclusive
provider of professional pathology services for the hospitals in which
AmeriPath's pathologists work. The operations staff each hospital with
appropriate pathologist staffing, and our pathologist will generally serve as
the medical director of the hospital laboratory and facilitate the hospital's
compliance with licensing requirements. The operations are generally
responsible for recruiting, staffing and scheduling the operation's affiliated
physicians in the hospital's inpatient laboratories. The medical director of
the laboratory is generally responsible for: (1) the overall management of the
laboratory, including quality of care, professional discipline and utilization
review; (2) serving as a liaison to the hospital administrators and medical
staff; and (3) maintaining professional and public relations in the hospital
and the community. Several operations have both outpatient laboratories and
hospital contracts or relationships, which allow outpatient specimens to be
examined by the hospital pathologists, enhancing the utilization of
pathologists in inpatient facilities. In the hospitals, technical personnel
are typically employed by the hospital, rather than by the operations.
As of December 31, 2001, the owned and managed operations had contracts or
relationships with over 200 hospitals. Substantially all of the operations'
hospital contracts are short-term in nature and allow for termination by
either party with relatively short notice. In many cases, the operations'
relationships with hospitals are not subject to written contracts.
Accordingly, AmeriPath's hospital contracts and relationships can easily be
terminated. AmeriPath believes, however, that the long-standing associations
that many of its pathologists have with hospitals generally tend to cause
AmeriPath's contracts and relationships with hospitals to continue
uninterrupted. Loss of any particular hospital contract or relationship would
not only result in a loss of net revenue to the Company, but also a loss of
outpatient net revenue that may be derived from the relationship with a
hospital and its medical staff. Continuing consolidation in the hospital
industry may result in fewer hospitals or fewer laboratories as hospitals move
to combine their operations.
In the past, the Company provided services at four hospitals and an
ambulatory care facility owned by Primary Health Systems ("PHS"), a regional
hospital network in Cleveland, Ohio. During the first quarter of 2000, PHS
began implementing a plan of reorganization, filed under Chapter 11 with the
U.S. Bankruptcy Court for the District of Delaware, and closed one hospital.
During the second quarter, the bankruptcy court approved the sale of two
hospitals and the ambulatory care facility to local purchasers in the
Cleveland area. The purchasers, who elected to employ their own pathologists,
did not accept the Company's contracts with these two hospitals and the
ambulatory care facility. One hospital has not been sold and continues to do
business with
6
the Company. This resulted in asset impairment and related charges of $5.2
million in 2000. In addition, during the fourth quarter of 2000, a hospital in
South Florida where AmeriPath had the pathology contract, requested proposals
for its pathology services, and AmeriPath was unsuccessful in retaining this
contract. Based upon the remaining projected cash flow from this hospital
network, the Company determined that the intangible assets were impaired and
recorded a pre-tax non-cash charge of approximately $1.0 million.
As of December 31, 2001, the Company had contracts or relationships with 31
hospitals that are owned by HCA. Net revenues generated from contracts with
HCA hospitals were $39.4 million in 1999, $43.5 million in 2000 and $50.5
million in 2001. HCA has been under government investigation for some time and
we believe that it is evaluating its operating strategies, including the
possible sale, spin-off or closure of certain hospitals. Closures and/or sales
of HCA hospitals and/or terminations or non-renewals of one or more of our
contracts or relationships with HCA hospitals could have a material adverse
effect on our financial position and results of operations.
All of AmeriPath's outpatient laboratories are licensed and certified under
the guidelines established by the Clinical Laboratory Improvement Amendments,
or CLIA, and applicable state statutes and are managed by a medical director
of the laboratory. AmeriPath's corporate compliance, quality assurance and
quality improvement programs are designed to assure that all laboratories and
other operations are in compliance in all material respects with applicable
laws, rules and regulations.
Regional Business Model
The Company believes that its strategy of developing integrated networks of
anatomic pathology operations on a regional basis benefits the Company, its
pathologists, referring physicians, third-party payors and patients. These
networks, which generally will be modeled on the Company's existing Florida
network, will consist of a number of operations that together: (i) have a
substantial regional market presence; (ii) offer a broad range of services;
(iii) have extensive physician contacts; and (iv) possess complementary
strengths and opportunities for operational and production efficiencies. The
Company continues to integrate the operations' administrative and technical
support functions, including accounting, payroll, purchasing, risk management,
billing and collections, and expects such integration to result in enhanced
operational efficiencies. The Company's courier system for transporting
specimens enables the operations to penetrate areas outside their current
markets and enhance the utilization of their laboratory facilities. The
Company also integrates and coordinates the sales and marketing effort
targeting physicians, hospitals, surgery centers, managed care organizations
and national clinical laboratories, on a local and regional basis. This
marketing effort is based upon promoting the broad geographic coverage,
professional pathologist expertise and the extensive professional services
offered by the Company. The Company's strategy is to leverage its size to
expand its contracts with national clinical laboratories to all of the areas
covered by its operations. The Company markets its services under the name
"AmeriPath" and "Dermpath Diagnostics" in order to develop brand
identification of products and services to payors and other clients. The
Company plans to integrate the operations' management information systems into
a single system (or at a minimum consolidate the information resident on the
various lab information systems) that will expand the financial and diagnostic
reporting capabilities of each of the operations and the Company. Based on the
foregoing, the Company believes that implementation of this regional model
increases the revenues and profitability of the operations in the region, and
the Company is applying this regional business model, in whole or in part, to
other states in which it operates.
The Company has developed its regional business model in Florida and is
replicating its model in Texas and the Midwest. The Florida regional model has
been an effective tool in building the Company's business. Net revenues for
the Florida region have increased from $93 million to $118 million over the
past three years while adding three pathologists to the region. Operating
margins as a percent of net revenue for the region have declined, primarily
due to an increase in laboratory staffing costs, including physicians, and a
higher percentage of revenue from national clinical laboratory contracts which
have lower revenue per unit. However, this lower net revenue per unit from
national lab contracts has been offset in part by increased efficiencies
attributable to the Florida regional business model. The Florida region's
operating margin was 28.0% for the year ended
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December 31, 2001 compared to the Company's overall operating margin,
excluding corporate expenses, of 27.6% for the same period.
The Company believes that its improving performance in Florida, as reflected
in the following table, is due in part to the favorable results of its
regional model in Florida:
As of December 31,
---------------------
1999 2000 2001
----- ------ ------
(dollars in
millions)
Florida Statistics:
Pathologists.......................................... 80 83 83
Hospital relationships................................ 31 32 31
Net revenues.......................................... $92.5 $104.0 $118.4
Operating profit before amortization.................. $27.7 $ 30.4 $ 33.1
Operating margin as a percent of net revenues......... 30.0% 29.2% 28.0%
The Company has a higher concentration of operations, laboratories and
administrative offices in Florida than in any other region. In addition,
Florida is an attractive market due to its population and demographics,
including the growth of the general population and the large elderly
population, and the Company's familiarity and understanding of the anatomic
pathology market in Florida. Accordingly, there can be no assurance that the
Company's regional business model will be as effective outside of Florida as
it has been in Florida, or that it will be effective at all outside of
Florida.
Information Technology
The Company's Information Technology ("IT") Group was reorganized in 2000 to
better serve the Company's information needs. During 2000, IT staffing was
increased, including the hiring of a Chief Information Officer, Director of IT
Operations, Director of Software Development, and the establishment of a
Project Management Office. The new team established a "Best Practice" approach
to managing services to the Company's laboratories. The Company believes these
services have resulted in better performing information systems, increased
focus on centralization of information and a greater level of standardization
across the Company's businesses. IT has several major development efforts
underway. These efforts include building enhanced reporting capabilities,
creating a data mart, developing a customer information system and converting
to a new billing system.
The Company recognized the opportunity in the market for enhanced reporting
to customers and has launched a technology initiative to produce reports that
include organ maps, photomicrographs and patient education. Enhanced reports
in gastroenterology, obstetrics and gynecology and urology are available in
most of the Company's markets and this technology initiative has been
implemented at four regional sites. The Company believes its software programs
for acquiring the images and producing the reports are efficient and the
Company intends to implement additional software programs as customer sales
increase.
Because information management systems for our operations are not
integrated, it is difficult to access consolidated operating data for the
Company. The creation of a data mart involves the consolidation, from numerous
information systems, of select utilization data for services provided by all
specialties and includes inpatient and outpatient information. Approximately
90% of the Company's pre-Inform DX merger data for 2000 and 2001 has been
loaded into a single database. The Company intends to use this database to
help develop new products and services for its customers. Also, this system
provides a better opportunity to benchmark the Company's laboratories and
monitor the use of CAD, the Company's esoteric testing facility in Orlando.
There have been several reports developed using the data mart including
Commissions, Revenue by Customer, Revenue Variance, Revenue by Payor, and Lab
Utilization. The Company is currently reconciling and validating its data,
8
organizing the effort to consolidate the remaining locations and establishing
the procedures and processes to make the data mart operational. The Company
intends to make all reports web enabled.
The AmeriPath Customer Information System is in the early stages of planning
and currently the Company has outlined a set of goals and objectives that were
defined by personnel in the Company's sales and marketing and operations
departments as well as certain of the Company's pathologists. The plans for
this system are under development, and process with the Company's customers is
being established. Generally, the Company initially will build on-line
reporting and then use the data mart and program interfaces in an effort to
meet demand by customers for improved interoperability and information.
Billing for the Company's operations is currently performed by several
different internal billing systems and outsourcing billing arrangements.
Approximately 70% of the Company's billed revenue in 2001 was done through
four of these billing systems. Conversion from current billing systems to one
of these four billing systems is anticipated to be completed by the second
quarter of 2003. Once converted to four billing platforms, the Company will
evaluate the feasibility and necessity of converting to one system. The
Company has installed a complete general ledger and financial reporting system
to handle accounting for the operations and to consolidate all accounting and
financial information. As of March 2002, all of the operations have been
integrated onto one common accounting system.
The Company believes that its increasing integration and consolidation of
its laboratory information, billing and collections and financial reporting
systems enable it to monitor the operations, enhance utilization of the
pathologists, develop practice protocols and archives and provides the Company
with a competitive advantage in negotiating national clinical laboratory and
managed care contracts. Each of the Company's laboratories has a laboratory
information system that enables laboratory personnel to track, process, report
and archive patient diagnostic information.
The Company is also focused on being compliant with new regulations under
the Health Insurance Portability and Accountability Act of 1996 ("HIPAA")
regarding privacy, security and transmission of health information. The
Company's sensitivity to these new regulations will increase as the Company
moves its information systems on-line. The Company is currently in the
planning stages of a compliance assessment and has engaged an outside
consulting firm to assist in the assessment and measurement of its existing
standards and policies, and in determining which requirements remain to be
implemented. At this time, the Company is not able to determine the full
consequences of the HIPAA regulations to the Company's business or the total
cost of complying with these regulations. However, the HIPAA regulations are
expected to significantly impact the Company operationally and financially.
Client and Payor Relationships
The operations also provide services to a wide variety of other health care
providers and payors including physicians, government programs, indemnity
insurance companies, managed care organizations and national clinical
laboratories. Fees for anatomic pathology services rendered to physicians are
billed either to the physicians, the patient's third party payor, or the
patient. The following table provides the percentages of cash collections from
the identified sources:
Years Ended December 31,
------------------------------
1999 2000 2001
-------- -------- --------
Source of cash collec-
tions:
Government payors....... 18% 18% 21%
National clinical labo-
ratories............... 9% 10% 8%
Management services..... 11% 8% 9%
Other................... 62% 64% 62%
9
Other sources of cash collections consists primarily of third-party payors,
such as preferred provider organizations (PPOs), health maintenance
organizations (HMOs) and indemnity insurance companies.
Contracts and Relationships with Physicians of Owned Operations
For the owned operations, the Company employs pathologists, or controls the
operation that employs pathologists, who provide medical services in hospitals
or in other inpatient and outpatient laboratories. While the Company or its
designee exercises legal control over the owned operations, the Company does
not exercise control over, or otherwise influence, the medical judgment or
professional decisions of any pathologist associated with the owned
operations. Although pathologist employment agreements typically have terms of
three to five years, they generally can be terminated at any time, without
cause, upon 60 to 180 days' notice. The pathologists generally receive a base
salary, fringe benefits and may be eligible for an incentive performance
bonus. In addition to compensation, the Company provides its pathologists with
uniform benefit plans, such as disability, supplemental retirement, life and
group health insurance and medical malpractice insurance. The pathologists are
required to hold a valid license to practice medicine in the jurisdiction in
which they practice and, with respect to inpatient or hospital services, to
become a member of the medical staff at the contracting hospital with
privileges in pathology. The Company is responsible for billing patients,
physicians and third party payors for services rendered by the pathologists.
Most of the employment agreements prohibit the physician from competing with
the Company within a defined geographic area and prohibit solicitation of
pathologists, other employees or clients of the Company for a period of one to
two years after termination of employment.
The Company's business is dependent upon the recruitment and retention of
pathologists, particularly those with subspecialties, such as
dermatopathology. While the Company has been able to recruit (principally
through practice acquisitions) and retain pathologists, no assurance can be
given that the Company will be able to continue to do so successfully or on
terms similar to its current arrangements. The relationship between the
Company's pathologists and their respective local medical communities is
important to the operation and continued profitability of the Company. In the
event that a significant number of pathologists terminate their relationships
with the Company or become unable or unwilling to continue their employment,
the Company's business could be materially harmed.
Government Regulations
The Company's business is subject to the governmental and regulatory
requirements relating to health care matters as well as laws and regulations
that relate to business corporations. The Company believes that it exercises
care to structure its operations and arrangements with hospitals and
physicians to comply with relevant federal and state law. It also believes
such current arrangements and practices are in material compliance with
applicable statutes and regulations. However, the Company has not received or
applied for legal opinions from counsel or from any federal or state
regulation authority to this effect, and many aspects of the Company's
business operations have not been the subject of federal or state regulatory
interpretation. As a result, there can be no assurance that the Company's
current or prior practices or arrangements will not be found to be in
noncompliance with applicable laws and regulations, or that any such
occurrence will not result in a material adverse effect to the Company.
The Company derived approximately 18%, 18% and 21% of its collections for
the years ended December 31, 1999, 2000, and 2001, respectively, from payments
made by government sponsored health care programs (principally Medicare and
Medicaid). These programs are subject to substantial regulation by the federal
and state governments. Any change in payment regulations, policies, practices,
interpretations or statutes that places limitations on reimbursement amounts,
or changes in reimbursement coding or practices could materially and adversely
affect the Company's financial condition and results of operations. Increasing
budgetary pressures at both the federal and state level and concerns over the
continued increase of the costs of health care have led, and may continue to
lead, to significant reductions in health care payments. State concerns over
the growth in Medicaid also could result in payment reductions. Although
governmental payment reductions have not materially affected the Company in
the past, it is possible that such changes in the future could have a
10
material adverse effect on the Company's financial condition and results of
operations. In addition, Medicare, Medicaid and other government sponsored
health care programs are increasingly shifting to some form of managed care.
Some states have recently enacted legislation to require that all Medicaid
patients be converted to managed care organizations, and similar legislation
may be enacted in other states, which could result in reduced payments to the
Company for such patients. In addition, a state-legislated shift in a Medicaid
plan to managed care could cause the loss of some, or all, Medicaid business
for the Company in that state if the Company were not selected as a
participating provider. Additionally, funds received under all health care
reimbursement programs are subject to audit with respect to the proper billing
for physician services. Retroactive adjustments of revenue from these programs
could occur. The Company expects that there will continue to be proposals to
reduce or limit Medicare and Medicaid payment for services.
In connection with acquisitions, the Company performs certain due diligence
investigations with respect to the potential liabilities of acquired
operations and obtains indemnification with respect to certain liabilities
from the sellers of such operations. Nevertheless, there can be undiscovered
claims that subsequently arise. There can be no assurance that any liabilities
for which the Company becomes responsible (despite such indemnification) will
not be material or will not exceed either the limitations of any applicable
indemnification provisions or the financial resources of the indemnifying
parties. Furthermore, the Company, through its Corporate Compliance Program,
regularly reviews the acquired operations' compliance with federal and state
health care laws and regulations and revises, as appropriate, the operations"
policies and procedures to conform to the Company's policies and procedures
and applicable law. While the Company believes that the operations prior to
their acquisition were generally in compliance with such laws and regulations,
there can be no assurance that the prior operations were in full compliance
with such laws, as such laws may ultimately be interpreted. Moreover, although
the Company maintains an active compliance program, it is possible that the
government might challenge some of the current practices of the Company as not
being in full compliance with such laws and regulations. A violation of such
laws by the Company could result in civil and criminal penalties, exclusion of
the physician, the operation or the Company from participation in Medicare and
Medicaid programs and/or loss of a physician's license to practice medicine.
Fraud and Abuse. Federal anti-kickback law and regulations prohibit any
knowing and willful offer, payment, solicitation or receipt of any form of
remuneration, either directly or indirectly, in return for, or to induce: (i)
the referral of an individual for a service for which payment may be made by
Medicare and Medicaid or certain other federal health care programs; or (ii)
the purchasing, leasing, ordering or arranging for, or recommending the
purchase, lease or order of, any service or item for which payment may be made
by Medicare, Medicaid or certain other federal health care programs.
Violations of federal anti-kickback rules are punishable by monetary fines,
civil and criminal penalties and exclusion from participation in Medicare,
Medicaid and other federal health care programs. Several states have laws that
are similar.
The federal government has published regulations that provide "safe-harbors"
that protect from prosecution under federal anti-kickback laws business
transactions that meet certain requirements. Failure to meet the requirements
of a safe harbor, however, does not necessarily mean a transaction violates
the anti-kickback law. The Company believes its operations are in material
compliance with applicable Medicare and fraud and abuse laws and seeks to
structure arrangements to comply with applicable safe harbors where reasonably
possible. There is a risk that the federal government might investigate such
arrangements and conclude they do not satisfy safe harbor requirements or
violate the anti-kickback statute. If any of the Company's arrangements were
found to be illegal, the Company and/or the individual physicians could be
subject to civil and criminal penalties, including exclusion from the
participation in government reimbursement programs, which could materially
adversely affect the Company.
The Department of Health and Human Services Office of Inspector General
("OIG") issues advisory opinions that provide advice on whether proposed
business arrangements violate the anti-kickback law. In Advisory Opinion 99-
13, the OIG opined that when prices for laboratory services for non-
governmental patients are discounted below Medicare reimbursable rates, the
anti-kickback law may be implicated. The OIG found prices discounted below the
laboratory supplier's costs to be particularly problematic. In the same
opinion, OIG
11
suggested that a laboratory may be excluded from federal health care programs
if it charges the Medicare or Medicaid programs amounts substantially in
excess of discounted charges to other customers. In the OIG's opinion, charges
are likely excessive if the profit margin for Medicare business exceeds the
profit margin for non-federally reimbursed business.
The OIG also has addressed physician practice management arrangements in an
advisory opinion. In Advisory Opinion 98-4, the OIG found that management fees
based on a percentage of practice revenues may violate the anti-kickback
statute. These Advisory Opinions suggest that OIG might challenge certain
prices below Medicare reimbursement rates or arrangements based on a
percentage of revenues. While the Company believes its arrangements are in
material compliance with applicable law and regulations, OIG's advisory
opinions suggest there is a risk of an adverse OIG finding relating to
practices reviewed in the advisory opinions. Any such finding could have a
material adverse impact on the Company.
Self-Referral and Financial Inducement Laws. The Company is also subject to
federal and state statutes and regulations banning payments for referral of
patients and referrals by physicians to health care providers with whom the
physicians have a financial relationship. The federal Stark Physician Anti-
Self-Referral Law applies to Medicare and Medicaid and prohibits a physician
from referring patients for certain designated health services, including
laboratory services, to an entity with which the physician has a financial
relationship. Financial relationships include both investment interests in an
entity and compensation arrangements with an entity. If an arrangement or
relationship is covered by the Stark Law, all of the requirements of a Stark
Law exception must be satisfied. The state laws and regulations vary
significantly from state to state, are often vague and, in many cases, have
not been interpreted by courts or regulatory agencies. The state statutes and
regulations generally apply to services reimbursed by both governmental and
private payors. Violations of these laws may result in prohibition of payment
for services rendered, loss of licenses as well as fines and criminal
penalties. In addition, violation of the Stark Law may result in exclusion
from Medicare and Medicaid. State statutes and regulations affecting the
referral of patients to health care providers range from statutes and
regulations that are substantially the same as the federal laws and safe
harbor regulations to a simple requirement that physicians or other health
care professionals disclose to patients any financial relationship the
physicians or health care professionals have with a health care provider that
is being recommended to the patients. These laws and regulations vary
significantly from state to state, are often vague and, in many cases, have
not been interpreted by courts or regulatory agencies. Adverse judicial or
administrative interpretations of any of these laws could have a material
adverse effect on the operating results and financial condition of the
Company. In addition, expansion of the Company's operations to new
jurisdictions, or new interpretations of laws in existing jurisdictions, could
require structural and organizational modifications of the Company's
relationships with physicians to comply with that jurisdiction's laws. Such
structural and organizational modifications could have a material adverse
effect on the operating results and financial condition of the Company.
Some pathologists affiliated with the Company may make referrals for
services that are covered by the Stark Law. Many of these physicians have
financial relationships with the Company in the form of compensation
arrangements, ownership of Company stock or ownership of contingent promissory
notes issued by the Company. The Company believes, however, that its current
operations comply in all material respects with the Stark Law due to, among
other things, various exceptions stated in the Stark Law and regulations that
except either the referral or the financial relationship involved. For
example, many referrals fall within exceptions applicable to pathologists or
to ancillary services performed by members of a common group practice. The
Company believes that its existing compensation arrangements with its
pathologists are structured to comply with an applicable Stark Law exception.
With respect to the ownership of stock, the Company believes that the
ownership of Company stock by physicians should fall within the publicly
traded stock exception to the Stark Law's definition of financial
relationship. However, certain physician-owned shares were acquired prior to
the Company's initial public offering and, as a result, the government could
take the position that all of the requirements for this exception are not met.
With respect to contingent notes, the Company believes that an exception to
the Stark Law's definition of financial relationship is available. The
contingent notes do contain provisions that permit the Company to modify or
replace them if necessary to comply with law. Nevertheless, to the extent
pathologists
12
affiliated with the Company make referrals to the Company and a financial
relationship exists between the Company and the referring physicians, the
government might take the position that the arrangement does not comply with
the Stark Law. Any such finding could have a material adverse impact on the
Company.
False Claims Laws. Under the federal False Claims Act, the government may
fine any person who knowingly submits, or participates in submitting, claims
for payment to the federal government that are false or fraudulent, or that
contain false or misleading information. In addition, knowingly making or
using a false record or statement to avoid paying the federal government is
also a violation. Entities found to have violated the False Claims Act may be
required to make significant payments to the government (including damages and
penalties in addition to the reimbursements previously collected) and may be
excluded from participating in Medicare, Medicaid and other federal health
care programs. Many states have similar false claims statutes.
Health care fraud is a priority of the United States Department of Justice
and the FBI. They have devoted a significant amount of resources to
investigating health care fraud. Medicare carriers and state Medicaid agencies
also have certain fraud and abuse authority. In addition, private insurers may
bring actions under false claim laws. In certain circumstances, federal and
some state laws authorize private whistleblowers to bring false claim suits on
behalf of the government against providers and reward the whistleblower with a
portion of any final recovery. In addition, the federal government has engaged
a number of nongovernmental-audit organizations to assist it in tracking and
recovering false claims for health care services. The practices targeted
include: billing for tests not performed; billing for tests not medically
necessary or not ordered by the physician; "upcoding" tests to realize higher
reimbursement than what is owed; offering inducements to physicians to induce
them to refer testing; and duplicate billing. These practices have led to
governmental investigations and whistleblower suits that have resulted in
financially significant payments made by a number of health care providers in
the past decade.
Since investigations relating to false claims have increased in recent
years, it is more likely companies conducting business in the health care
industry could become the subject of a federal or state civil or criminal
investigation or action, could be required to defend the results of such
investigation, be subjected to possible civil and criminal fines, be sued by
private payors and be excluded from Medicare, Medicaid or other federally
funded health care programs. Although the Company monitors its billing
practices for compliance with prevailing industry practice under applicable
laws, such laws are complex and constantly evolving and there can be no
assurance that governmental investors, private insurers or private
whistleblowers will not challenge the Company's or industry practice. For
example, the announcement of a governmental investigation into the billing
practices of one of the Company's practices in the fourth quarter of 1998
resulted in a significant decrease in the market price of the Company's common
stock, even though the issue was eventually resolved to the Company's
satisfaction and resulted only in the repayment of a small overpayment.
In August 2001, we received two letters from the United States Attorney for
the Southern District of Ohio (the "U.S. Attorney") requesting information
regarding billing practices and documentation of gross descriptions on skin
biopsy reports. We provided documentation to the U.S. Attorney regarding the
tests that were the subject of its requests for information. Requests for
information such as these are often the result of a qui tam, or whistleblower,
action filed by a private party relator. In February 2002, we received
notification that the U.S. Attorney would not pursue this matter any further.
In addition, we were notified that there were then no presently pending
lawsuits in the Southern District of Ohio against the Company relating to the
request by any private party relator bringing a qui tam action.
Government Investigations of Hospitals and Hospital
Laboratories. Significant media and public attention has been focused on the
health care industry due to ongoing federal and state investigations
reportedly related to certain referral and billing practices, laboratory and
home health care services and physician ownership and joint ventures involving
hospitals. Most notably, HCA is under investigation with respect to such
practices. The Company provides medical director services for numerous
hospital laboratories, including 31 HCA hospital laboratories as of December
31, 2001. The government's ongoing investigation of HCA could result in a
governmental investigation of one or more of the Company's operations that
have arrangements with HCA. In
13
addition, the OIG and the Department of Justice have initiated hospital
laboratory billing review projects in certain states and are expected to
extend such projects to additional states, including states in which the
Company operates hospital laboratories. These projects increase the likelihood
of governmental investigations of laboratories owned and operated by the
Company. Although the Company monitors its billing practices and hospital
arrangements for compliance with prevailing industry practices under
applicable laws, such laws are complex and constantly evolving and there can
be no assurance that the governmental investigators will not challenge the
Company's or industry practices. The government's investigations of entities
with which the Company contracts may have other effects which could materially
and adversely affect the Company, including termination or amendment of one or
more of the Company's contracts or the sale of hospitals potentially
disrupting the performance of services under such contracts.
Corporate Practice of Medicine. The Company is not licensed to practice
medicine. The practice of medicine is conducted solely by its licensed
pathologists. The manner in which licensed physicians can be organized to
perform and bill for medical services is governed by the laws of the state in
which medical services are provided and by the medical boards or other
entities authorized by such states to oversee the practice of medicine.
Business corporations are generally not permitted under certain state laws to
exercise control over the medical judgments or decisions of physicians, or
engage in certain practices such as fee-splitting with physicians. In states
where the Company is not permitted to directly own a medical practice, the
Company performs only non-medical and administrative and support services,
does not represent to the public or its clients that it offers medical
services and does not exercise influence or control over the practice of
medicine. See discussion "AmeriPath Corporate Structure", above.
The Company believes that it currently is in material compliance with the
corporate practice laws in the states in which it operates. Nevertheless,
there can be no assurance that regulatory authorities or other parties will
not assert that the Company is engaged in the corporate practice of medicine.
If such a claim were successfully asserted in any jurisdiction, the Company,
and its pathologists could be subject to civil and criminal penalties under
such jurisdiction's laws and could be required to restructure their
contractual and other arrangements. Alternatively, some of the Company's
existing contracts could be found to be illegal and unenforceable. In
addition, expansion of the operations of the Company to other states may
require structural and organizational modification of the Company's form of
relationship with physicians, practices or hospitals. Such results or the
inability to successfully restructure contractual arrangements could have a
material adverse effect on the Company's financial condition and results of
operations.
Fee-Splitting. Many states prohibit the splitting or sharing of fees between
physicians and non-physicians. These laws vary from state to state and are
enforced by courts and regulatory agencies, each with broad discretion. Most
of the states with fee-splitting laws only prohibit a physician from sharing
fees with a referral source. However, some states have interpreted management
agreements between entities and physicians as unlawful fee-splitting.
The Company believes its arrangements with pathologists comply in all
material respects with the fee-splitting laws of the states in which it
operates. Nevertheless, it is possible regulatory authorities or other parties
could claim the Company is engaged in fee-splitting. If such a claim were
successfully asserted in any jurisdiction, the Company and its pathologists
could be subject to civil and criminal penalties and the Company could be
required to restructure its contractual and other arrangements. Any
restructuring of the Company's contractual and other arrangements could result
in lower revenues, increased expenses and reduced influence over the business
decisions of its operations. Alternatively, some of the Company's existing
contracts could be found to be illegal and unenforceable, which could result
in the termination of those contracts and an associated loss of revenue. In
addition, expansion of the Company's operations to other states with fee-
splitting prohibitions may require structural and organizational modification
to the form of relationships that the Company currently has with pathologists,
affiliated operations and hospitals. Any modifications could result in less
profitable relationships with pathologists, affiliated operations and
hospitals, less influence over the business decisions of pathologists and
affiliated operations and failure to achieve the Company's growth objectives.
14
Medicare Fee Schedule Payment for Clinical Diagnostic Laboratory
Testing. Medicare reimburses hospitals based on locality-specific fee
schedules on the basis of a reimbursement methodology with Consumer Price
Index ("CPI") related adjustments. Medicare includes payment for services
performed for clinical diagnostic laboratory inpatients within the
prospectively determined Diagnosis Related Group rate paid to the hospital.
Additionally, state Medicaid programs may pay no more than the Medicare fee
schedule amount. Congress also has implemented a national cap on Medicare
clinical diagnostic laboratory fee schedules. This national cap has been
lowered several times and is now at approximately 74% of the national median.
In addition, Congress frequently has either limited or eliminated the annual
CPI adjustments of the Medicare clinical diagnostic laboratory fee schedules.
The Omnibus Budget Reconciliation Act of 1993 eliminated the adjustment for
the years 1994 and 1995. In 1996 and 1997, however, the fee schedule
adjustments were 3.2% and 2.7%, respectively. Even these modest increases were
reduced in some areas due to a recalculation of national medians and by
conversion in some carrier areas to a single statewide fee schedule. In the
Balanced Budget Act of 1997 ("BBA"), Congress again eliminated the annual
adjustments, this time for the years 1998 through 2002. The adjustment
limitations and changes in the national cap made to date have not had, and are
not expected by the Company to have, a material adverse effect on the
Company's results of operations. Any further significant decrease in such fee
schedules could have a material adverse effect on the Company.
Due to uncertainty regarding the implementation of the above-described
Medicare developments, the Company currently is unable to predict their
ultimate impact on the laboratory industry generally or on the Company in
particular. Reforms may also occur at the state level (and other reforms may
occur at the federal level) and, as a result of market pressures, changes are
occurring in the marketplace as the number of patients covered by some form of
managed care continues to increase. In the past, the Company has offset a
substantial portion of the impact of price decreases and coverage changes
through the achievement of economies of scale, more favorable purchase
contracts and greater operational efficiencies. However, if further
substantial price decreases or coverage changes were to occur, or if the
government were to seek any substantial repayments or penalties from the
Company, such developments would likely have an adverse impact on gross
profits from the Company's testing services unless management had an
opportunity to mitigate such impact.
Reevaluations and Examination of Billing. Payors periodically reevaluate the
services they cover. In some cases, government payors such as Medicare also
may seek to recoup payments previously made for services determined not to be
covered. Any such action by payors would have an adverse affect on the
Company's revenues and earnings.
Moreover, in recent months the federal government has become more aggressive
in examining laboratory billing and seeking repayments and penalties as the
result of improper billing for services (e.g., using an improper billing code
for a test to realize higher reimbursement), regardless of whether carriers
had furnished clear guidance on this subject. The primary focus of this
initiative has been on hospital laboratories and on routine clinical chemistry
tests which comprise only a small part of the Company's revenues. Although the
scope of this initiative could expand, it is not possible to predict whether
or in what direction the expansion might occur. The Company believes its
practices are proper and do not include any allegedly improper practices now
being examined. However, no assurance can be given that the government will
not broaden its initiative to focus on the type of services furnished by the
Company or, if this were to happen, on how much money, if any, the Company
might be required to repay.
Furthermore, the Health Insurance Portability and Accountability Act
("HIPAA") and the joint federal and state anti-fraud initiative commenced in
1995 called Operation Restore Trust have strengthened the powers of the OIG
and increased the funding for Medicare and Medicaid audits and investigations.
As a result, the OIG has expanded and continues to expand the scope of its
health care audits and investigations. State enforcement actions are similarly
expanding. Federal and state audits and inspections, whether on a scheduled or
unannounced basis, are conducted from time to time at the Company's
facilities.
Due to the uncertain nature of coding for pathology services, the Company
cannot assure that issues such as those addressed in the government
investigation it announced in the fourth quarter of 1998, which was related to
15
the Operation Restore Trust initiative, will not arise again. If a negative
finding is made as a result of such an investigation, the Company could be
required to change coding practices or repay amounts paid for incorrect
practices either of which could have a materially adverse effect on the
operating results and financial condition of the Company.
Laboratory Compliance Plan. In February 1997, the OIG released a model
compliance plan for laboratories that is based largely on the corporate
integrity agreements negotiated with the laboratories which settled a number
of government enforcement actions against laboratories under Operation Restore
Trust. The Company adopted and maintains a compliance plan, which includes
components of the OIG's model compliance plan, as the Company deemed
appropriate to the conduct of its business. The Company's Senior Vice
President of Operations serves as the Company's Chief Compliance Officer and
reports directly to the Audit Committee of the Board of Directors.
Anti-trust Laws. In connection with state corporate practice of medicine
laws discussed above, the operations with which the Company is affiliated in
some states are organized as separate legal entities. As such, the physician
practice entities may be deemed to be persons separate both from the Company
and from each other under the anti-trust laws and, accordingly, subject to a
wide range of federal and state laws that prohibit anti-competitive conduct
among separate legal entities. In addition, the Company also is seeking to
acquire or affiliate with established and reputable operations in its target
geographic markets and any market concentration could lead to anti-trust
claims. The Company believes it is in compliance with federal and state anti-
trust laws and intends to comply with any state and federal laws that may
affect its development of integrated health care delivery networks. There can
be no assurance, however, that a review of the Company's business by courts or
regulatory authorities would not adversely affect the operations of the
Company and its affiliated operations.
HIPAA Criminal Penalties. HIPAA created criminal provisions, which impose
criminal penalties for fraud against any health care benefit program for theft
or embezzlement involving health care and for false statements in connection
with the payment of any health benefits. HIPAA also provided broad
prosecutorial subpoena authority and authorized property forfeiture upon
conviction of a federal health care offense. Significantly, the HIPAA
provisions apply not only to federal programs, but also to private health
benefit programs as well. HIPAA also broadened the authority of the OIG to
exclude participants from federal health care programs. Because of the
uncertainties as to how the HIPAA provisions will be enforced, the Company
currently is unable to predict their ultimate impact on the Company. If the
government were to seek any substantial penalties against the Company, this
could have a material adverse effect on the Company.
Licensing. CLIA extends federal oversight to virtually all clinical
laboratories by requiring that laboratories be certified by the government.
Many laboratories must also meet governmental quality and personnel standards,
undergo proficiency testing and be subject to biennial inspection. Rather than
focusing on location, size or type of laboratory, this extended oversight is
based on the complexity of the test performed by the laboratory. The CLIA
quality standards regulations divide all tests into three categories (waived,
moderate complexity and high complexity) and establish varying requirements
depending upon the complexity of the test performed. The Company's outpatient
laboratories are licensed by Health and Human Services ("HHS") under CLIA to
perform high complexity testing. Generally, the HHS regulations require
laboratories that perform high complexity or moderate complexity tests to
implement systems that ensure the accurate performance and reporting of test
results, establish quality control systems, have proficiency testing conducted
by approved agencies and have biennial inspections. The Company is also
subject to state regulation. CLIA provides that a state may adopt more
stringent regulations than federal law. For example, some states in which the
Company operates require that laboratory personnel meet certain
qualifications, specify certain quality controls, maintain certain records and
undergo proficiency testing.
Persons engaged in the practice of medicine must be licensed by each state
in which they practice. The professional practice of physicians is regulated
in each state by the state board of medicine. Each board of medicine has rules
enumerating the activities that constitute unprofessional conduct. A board may
sanction
16
unprofessional conduct by suspending, restricting or revoking a professional's
license. Other possible sanctions include restraining orders, injunctions,
imprisonment and fines.
HIPAA Regulations Relating to the Privacy, Security, and Transmission of
Health Information. Congress passed HIPAA in 1996. Among other things, HIPAA
established several requirements regarding the privacy, security and
transmission of health information. The Department of Health and Human
Services, or HHS, has issued several sets of regulations in accordance with
its authority under HIPAA. In general, these regulations apply to health care
providers, health plans, and health care clearinghouses. Some operations of
the Company will be subject to the HIPAA regulations.
Pursuant to HIPAA, HHS issued final privacy regulations establishing
comprehensive federal standards relating to the use and disclosure of
protected health information. These regulations, among other things, establish
limits on the use and release of protected health information, provide for
patients' rights to access, amend, and receive an accounting of the uses and
disclosures of protected health information, and require certain safeguards to
protect identifiable health information. The federal privacy regulations do
not supersede state laws that are more stringent. Thus, the Company must
reconcile both the federal privacy regulations and other state privacy laws
that are more stringent than the federal laws. Those operations of the Company
that are regulated by HIPAA must be in compliance with the federal privacy
regulations by April 2003. Prior to the compliance date, it is expected that
HHS will release several guidance documents addressing questions or concerns
raised by the privacy regulations. On July 6, 2001, HHS issued its first
guidance document relating to these regulations.
Like the privacy regulations, the electronic transaction standards are also
final. These regulations establish uniform standards relating to data
reporting, formatting, and coding that covered entities must use in conducting
certain transactions. The electronic transaction standards presently apply to
eight different transactions, including transactions relating to health care
claims and health care payment and remittance advice. Upon the compliance
date, health care providers must use these standards when electronically
conducting a covered transaction with health plans or other health care
providers. The compliance date for these regulations is October 2002, unless
an entity files for a one-year extension with HHS.
The security regulations promulgated pursuant to HIPAA have not been
finalized. The purpose of the proposed security regulations is to establish a
minimum standard for the protection of individual health information that is
stored or transmitted electronically. The regulations provide administrative
procedures, physical safeguards, and technical mechanisms that may be
implemented to satisfy the regulations.
The HIPAA regulations could result in significant financial obligations for
the Company and will pose increased regulatory risk. The privacy regulations
could limit the Company's use and disclosure of patient health information.
For example, HHS has indicated that cells and tissues are not protected health
information, but that analyses of them are protected. HHS has stated that if a
person provides cells to a researcher and tells the researcher that the cells
are an identified individual's cancer cells, that accompanying statement is
protected health information about that individual. At this time, the Company
is not able to determine the full consequences of the HIPAA regulations to the
Company's business or the total cost of complying with these regulations.
However, the HIPAA regulations are expected to significantly impact the
Company operationally and financially.
Violations of the privacy regulations are punishable by civil and criminal
penalties. State privacy laws may impose similar sanctions on the Company.
Violations of the standards for electronic transaction are punishable by civil
penalties.
Other Regulations. In addition, the Company is subject to licensing and
regulation under federal, state and local laws relating to the collecting,
storing, handling and disposal of medical specimens, infectious and hazardous
waste and radioactive materials as well as the safety and health of laboratory
employees. The Company believes its laboratory operations are in material
compliance with applicable federal and state laws and regulations relating to
the generation, storage, treatment and disposal of all laboratory specimens
and other biohazardous waste. Nevertheless, there can be no assurance that the
Company's current or past laboratory
17
operations would be deemed to be in compliance with applicable laws and
regulations, and any noncompliance could result in a material adverse effect
on the Company. The Company utilizes licensed vendors for the disposal of such
specimen and waste.
In addition to its comprehensive regulation of safety in the workplace, the
federal Occupational Safety and Health Administration ("OSHA") has established
extensive requirements relating to workplace safety for health care employees,
including clinical laboratories, whose workers may be exposed to blood-borne
pathogens, such as HIV and the hepatitis B virus. These regulations require
work practice controls, protective clothing and equipment, training, medical
follow-up, vaccinations and other measures designed to minimize exposure to,
and transmission of, blood-borne pathogens. Regulations of the Department of
Transportation, the Public Health Services and the U.S. Postal Service also
apply to the transportation of laboratory specimens.
Competition
The Company's operations and pathologists provide pathology and cytology
diagnostic services and pathology practice management services. Competition
may result from other anatomic pathology practices, companies in other health
care industry segments, such as other hospital-based specialties, national
clinical laboratories, large physician group practices or pathology physician
practice management companies that may enter the Company's markets, some of
which may have greater financial and other resources than the Company.
The Company competes primarily on the basis of service capability and
convenience of facilities, scope of testing services performed, accuracy,
timeliness and consistency in reporting test results, reputation in the
medical community, and pricing of testing services. The Company believes that
its principal competitive advantages are its pathologist leadership,
subspecialty focus, sales and marketing expertise and administrative support
capabilities (e.g., billing, collections, accounting and financial reporting,
information systems, and human resources). The Company competes with several
other companies, and such competition can reasonably be expected to increase.
In addition, companies in other health care segments, such as hospitals,
national clinical laboratories, third party payors, and HMOs, many of which
have greater financial resources than the Company, may become competitive with
the Company in the employment of pathologists and management of pathology
practices. The Company competes for acquisitions and affiliations on the basis
of its reputation, management experience, status and resources as a public
company and its single focus on anatomic pathology. There can be no assurance
that the Company will be able to compete effectively or that additional
competitors will not enter the Company's markets or make it more difficult for
the Company to acquire or affiliate with practices on favorable terms.
Intellectual Property
The Company has registered the service marks "AmeriPath", "CAD-The Center
for Advanced Diagnostics" and the AmeriPath logo with the United States Patent
and Trademark Office.
To date, the Company has not relied heavily on patents or other intellectual
property in operating its business. Nevertheless, some of the tests or related
diagnostic products or the information technology purchased or used by the
Company may be patented or subject to other intellectual property rights. As a
result, the Company may be found to be, or actions may be brought against it
alleging that it is, infringing on the patent or other intellectual property
rights of others, which could give rise to substantial claims against the
Company. In addition, the Company's expansion into the genomics testing market
may result in its obtaining or developing patent or other intellectual
property. However, other practice and public entities, including universities,
may have filed applications for (or have been issued) patents that may be the
same as or similar to those developed or otherwise obtained by the Company or
that it may need in the development of its own products. The scope and
validity of such patent and other intellectual property rights, the extent to
which the Company may wish or need to acquire such rights, and the cost or
availability of such rights are presently unknown. In addition, the Company
cannot provide assurance that others will not obtain access to its
intellectual property or independently develop the same or similar products,
tests or other intellectual property to that developed or otherwise obtained
by the
18
Company. This may impede the Company's ability to achieve its overall growth
strategy, including its ability to broaden the range of testing services it
offers and to penetrate the genomic and genomic testing markets.
Employees
At December 31, 2001, the Company's owned and managed operations employ
2,515 people, including
423 physicians. In addition to physicians, the employees of the Company and
the managed practices include
732 laboratory technicians, 169 couriers and 1,191 billing, marketing,
transcription and administrative staff, of which 124 personnel are located at
the Company's executive offices. None of the Company's employees or
prospective employees is subject to collective bargaining agreements.
ITEM 2. PROPERTIES
The Company leases its executive offices located in Riviera Beach, Florida
(approximately 24,000 square feet) and its centralized billing office in Fort
Lauderdale, Florida (approximately 18,000 square feet) and the Company and its
managed operations lease 65 other facilities: 25 in Florida, eight in Texas,
five in Pennsylvania, four in Ohio, three in Kentucky, two in Mississippi, New
York, Oklahoma, Alabama, Tennessee and North Carolina, and one in Indiana,
Massachusetts, Colorado, Wisconsin, West Virginia, Georgia, California and
Missouri. These facilities are used for laboratory operations, administrative
and billing and collections operations and storage space. The 67 facilities
encompass an aggregate of approximately 335,000 square feet, have an aggregate
annual rent of approximately $5.2 million and have lease terms expiring from
2002 to 2006. As laboratory leases are scheduled to expire, the Company will
consider whether to extend or renegotiate the existing lease or move the
facility to another location within the defined geographic area of the
operation.
ITEM 3. LEGAL PROCEEDINGS
During the ordinary course of business, the Company has become and may in
the future become subject to pending and threatened legal actions and
proceedings. The Company may have liability with respect to its employees and
its pathologists as well as with respect to hospital employees who are under
the supervision of the hospital based pathologists. The majority of the
pending legal proceedings involve claims of medical malpractice. These claims
are generally covered by insurance. Based upon investigations conducted to
date, the Company believes the outcome of such pending legal actions and
proceedings, individually or in the aggregate, will not have a material
adverse effect on the Company's financial condition, results of operations or
liquidity. If the Company is ultimately found liable under these medical
malpractice claims, there can be no assurance that the Company's medical
malpractice insurance coverage will be adequate to cover any such liability.
The Company may also, from time to time, be involved with legal actions
related to the acquisition of and affiliation with physician practices, the
prior conduct of such practices, or the employment (and restriction on
competition of) physicians. There can be no assurance any costs or liabilities
for which the Company becomes responsible in connection with such claims or
actions will not be material or will not exceed the limitations of any
applicable indemnification provisions or the financial resources of the
indemnifying parties.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fiscal
quarter ended December 31, 2001.
19
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
AmeriPath's Common Stock, is listed for quotation on the NASDAQ National
Market System under the symbol "PATH". The following table sets forth, the
high and low sales prices for the Common Stock, as reported on the NASDAQ
National Market System during the Company's fiscal quarters indicated below.
The Common Stock first began trading on October 21, 1997. As of March 15,
2002, there were approximately 300 shareholders of record and over 7,000
beneficial owners based upon broker searches conducted for solicitation
purposes.
High Low
------ ------
First Quarter 2000................................................ $10.00 $ 7.50
Second Quarter 2000............................................... $ 9.50 $ 7.00
Third Quarter 2000................................................ $14.88 $ 8.00
Fourth Quarter 2000............................................... $27.13 $13.25
First Quarter 2001................................................ $27.75 $16.00
Second Quarter 2001............................................... $32.00 $20.06
Third Quarter 2001................................................ $37.16 $24.26
Fourth Quarter 2001............................................... $32.86 $23.64
The Company has not during the past two fiscal years and presently has no
plans to pay any dividends on its Common Stock. All earnings will be retained
for the foreseeable future to support operations and to finance the growth and
development of the Company's business. The payment of future cash dividends,
if any, will be at the discretion of the Board of Directors of the Company and
will depend upon, among other things, future earnings, capital requirements,
the Company's financial condition, any applicable restrictions under credit
agreements existing from time to time and on such other factors as the Board
of Directors may consider relevant. The terms of the Company's existing credit
facility prohibit the payment of dividends without the lenders' consent.
Recent Sales of Unregistered Securities
Recent Sales of Unregistered Securities--In connection with the one
acquisition completed during the fourth quarter of 2001, the Company issued
the following shares of Common Stock pursuant to Regulation D promulgated
under the Securities Act of 1933, as amended:
Effective Shares
Location Date Issued
-------------- ---------------- -------
Dermatopathology Services, PC and
Histology Services, Inc.......... Birmingham, AL November 1, 2001 113,899
ITEM 6. SELECTED FINANCIAL DATA
The selected Consolidated Financial Data set forth below have been derived
from the Company's consolidated financial statements and should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," the Consolidated Financial Statements and the
related Notes thereto and the other financial information included elsewhere
in this Annual Report on Form 10-K. All information for the prior years has
been restated to reflect the acquisition of Inform DX, which has been
accounted for as a pooling of interests.
20
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
YEAR ENDED DECEMBER 31,
(in thousands, except per share data)
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
Net revenue................. $108,406 $193,316 $257,432 $330,094 $418,732
-------- -------- -------- -------- --------
Operating costs:
Cost of services.......... 48,833 87,700 122,685 163,390 200,102
Selling, general and ad-
ministrative expense..... 21,386 36,709 47,159 58,411 71,856
Provision for doubtful ac-
counts................... 10,892 18,698 25,289 34,040 48,287
Amortization expense...... 5,763 9,615 12,827 16,172 18,659
Merger-related costs (1).. -- -- -- 6,209 7,103
Asset impairment and re-
lated charges (2)........ -- -- -- 9,562 3,809
-------- -------- -------- -------- --------
Total................... 86,874 152,722 207,960 287,784 349,816
-------- -------- -------- -------- --------
Income from operations...... 21,532 40,594 49,472 42,310 68,916
Interest expense............ (8,772) (8,560) (9,573) (15,376) (16,350)
Termination of interest rate
swap agreement (3)......... -- -- -- -- (10,386)
Nonrecurring charge (4)..... (1,289) -- -- -- --
Other (expense) income,
net........................ (96) 150 286 226 145
-------- -------- -------- -------- --------
Income before income taxes
and extraordinary loss..... 11,375 32,184 40,185 27,160 42,325
Provision for income taxes.. 5,522 13,941 17,474 14,068 18,008
-------- -------- -------- -------- --------
Income before extraordinary
loss....................... 5,853 18,243 22,711 13,092 24,317
Extraordinary loss, net of
tax (5).................... -- -- -- -- (965)
-------- -------- -------- -------- --------
Net income.................. 5,853 18,243 22,711 13,092 23,352
Induced conversion and ac-
cretion of redeemable
preferred stock (6)........ -- (75) (131) (1,604) --
-------- -------- -------- -------- --------
Net income available to com-
mon shareholders........... $ 5,853 $ 18,168 $ 22,580 $ 11,488 $ 23,352
======== ======== ======== ======== ========
Basic earnings per common
share.................... $ 0.66 $ 0.87 $ 1.03 $ 0.49 $ 0.90
======== ======== ======== ======== ========
Diluted earnings per com-
mon share................ $ 0.42 $ 0.84 $ 1.00 $ 0.47 $ 0.86
======== ======== ======== ======== ========
Basic weighted average
shares outstanding....... 8,880 20,911 21,984 23,473 25,974
======== ======== ======== ======== ========
Diluted weighted average
shares outstanding....... 13,986 21,610 22,516 24,237 27,049
======== ======== ======== ======== ========
Earnings per share data (7)
CONSOLIDATED BALANCE SHEET DATA:
DECEMBER 31,
(in thousands)
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
Cash and cash equivalents... $ 2,030 $ 6,383 $ 1,713 $ 2,418 $ 4,808
Total assets................ 272,532 390,413 478,896 562,166 604,462
Long-term debt, including
current portion............ 77,630 123,917 168,614 201,747 93,322
Redeemable equity securities
(8)........................ -- 15,373 15,504 -- --
Stockholders' equity........ 145,603 180,378 206,214 249,665 399,190
- --------
(1) In connection with the Inform DX merger, the Company recorded $6.2 million
and $7.1 million for 2000 and 2001, respectively, of costs related to
transaction fees, change in control payments and various exit costs
associated with the consolidation of certain operations.
21
(2) During 2000, the Company recorded asset impairment and related charges
totaling $9.6 million in connection with Quest Diagnostics' termination of
its contract in South Florida, the loss of a contract with a hospital in
South Florida and the loss of three hospital contracts and an ambulatory
care facility contract in Cleveland, Ohio. The charges were based on the
remaining projected cash flows from these contracts in which the Company
determined that the intangible assets that were recorded from acquisitions
in these areas had been impaired. During the fourth quarter of 2001, the
Company recorded an asset impairment charge of $3.8 million related to the
closure of an Alabama laboratory acquired in 1996.
(3) In connection with the extinguishment of the Company's former credit
facility during the fourth quarter of 2001, the Company made a one-time
pre-tax payment of $10.4 million to terminate the Company's interest rate
swap agreements.
(4) In the year ended December 31, 1997, the Company recorded a nonrecurring
charge of $1.3 million, primarily attributable to professional fees and
printing costs, as a result of the postponement of the Company's planned
initial public offering of Common Stock.
(5) During the fourth quarter of 2001, the Company terminated its former
credit facility and recorded an extraordinary loss, net of tax of $965,000
in connection with the write-off of previously deferred financing costs.
(6) In connection with an acquisition by Inform DX completed on June 30, 2000,
Inform DX provided for an induced conversion of preferred stock. The
induced conversion resulted in the issuance of 642,640 shares of common
stock. Inform DX estimated, based on a third party valuation, the fair
market value of its common stock at June 30, 2000 to be $6.22 per share.
Based on this valuation, in the second quarter of 2000 Inform DX recorded
a charge for the induced conversion of approximately $1.5 million, or
$5.22 per share times the additional common shares issued of 247,169.
(7) Earnings per share for all periods are computed and presented in
accordance with Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings Per Share". Basic earnings per share excludes dilution and
is computed by dividing income attributable to common stockholders by the
weighted-average number of common shares outstanding for the period.
Diluted earnings per share reflects the potential dilution that could
occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. Prior
reported earnings per share data have been restated in accordance with
SFAS No. 128.
(8) For December 31, 1998 and 1999 amounts included Convertible Preferred
Stock of $15.4 million and
$15.5 million, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the Company's results of operations and
financial condition should be read together with the consolidated financial
statements and other financial information included elsewhere in this Report.
General
We are one of the leading national providers of anatomic pathology services.
The more than 400 pathologists in our owned and managed operations as of
December 31, 2001 provide medical diagnostic services in outpatient
laboratories owned, operated and managed by us, in hospitals, and in
ambulatory surgery centers. Under our ownership or employment model, we
acquire a controlling equity (i.e., voting) interest or have a controlling
financial interest in pathology operations. We refer to these operations as
our owned operations. Under our management or equity model, we acquire certain
assets of, and operate pathology laboratories under long-term management
services agreements. We refer to these as our managed operations. Under the
management services agreements, we provide facilities and equipment as well as
administrative and technical
22
support for the managed operations. As of December 31, 2001, we had seven
managed operations. When we refer to "companies" generally, we mean our owned
and managed operations as a group.
As of December 31, 2001, our companies had contracts or business
relationships with more than 200 hospitals pursuant to which we manage their
clinical pathology and other laboratories and provide professional pathology
services. The majority of these hospital contracts and relationships are
exclusive provider relationships. We also have more than 40 licensed
outpatient laboratories.
Generally, we manage and control all of the non-medical functions of the
companies, including:
. recruiting, training, employing and managing the technical and support
staff;
. developing, equipping and staffing laboratory facilities;
. establishing and maintaining courier services to transport specimens;
. negotiating and maintaining contracts with hospitals, national clinical
laboratories and managed care organizations and other payors;
. providing financial reporting and administration, clerical, purchasing,
payroll, billing and collection, information systems, sales and
marketing, risk management, employee benefits, legal, tax and accounting
services;
. maintaining compliance with applicable laws, rules and regulations; and
. with respect to our ownership and operation of outpatient anatomic
pathology laboratories, providing slide preparation and other technical
services.
Acquisitions
Since the first quarter of 1996, we have completed the acquisition of 50
pathology organizations located in 21 states. These acquisitions included the
acquisition of Inform DX, during the fourth quarter of 2000. We accounted for
the Inform DX transaction as a pooling of interests and, therefore, we have
restated all historical information to reflect the acquisition of Inform DX.
As a result of the Inform DX acquisition, we now have managed operations from
which we derive management fees. Prior to the Inform DX transaction, we only
had owned operations.
During 2001, we acquired one small anatomic pathology operation located in
Alabama. The total consideration paid by us in connection with this
acquisition included cash, 113,899 shares of common stock, and consideration
in the form of contingent notes. During 2000, we acquired nine anatomic
pathology organizations, including two acquired by the former Inform DX. The
total consideration paid by us in connection with these acquisitions included
cash of $32.5 million, 1.5 million shares of common stock (with an aggregate
value of $12.2 million based upon amounts recorded on our consolidated
financial statements) and subordinated debt of $2.8 million. In addition, we
issued additional purchase price consideration in the form of contingent
notes.
During the year ended December 31, 2001, we made contingent note payments of
$36.1 million and other purchase price adjustments of approximately $565,000
in connection with certain post-closing adjustments and acquisition costs.
During the year ended December 31, 2000, we made contingent note payments of
$26.6 million and other purchase price adjustments of approximately $2.9
million in connection with certain post-closing adjustments and acquisition
costs.
While we regularly explore additional acquisition opportunities and are in
various stages of discussions with a number of acquisition candidates, we
currently have no material agreements or commitments with any third party
regarding any potential acquisition.
Business Collaborations
We have commenced our transition to becoming a fully integrated health care
diagnostic information provider. As part of this transition, we have entered
into business collaborations intended to generate additional
23
revenues through leveraging our personnel, technology and resources. Three
examples of such endeavors, including one with Genomics Collaborative, Inc.
("GCI"), one with Molecular Diagnostics, Inc. ("Molecular Diagnostics" (f/k/a
Ampersand Medical of Chicago)), and one with TriPath Oncology, Inc. ("TriPath
Oncology"), are described below. Although we believe such new endeavors are
promising, we cannot assure you that they will be profitable.
During the third quarter of 2000, we formed an alliance with GCI to provide
fresh frozen samples from normal, diseased, and cancerous tissue to GCI for
subsequent sale to researchers in industry and academic laboratories who are
working to discover genes associated with more common disease categories, such
as heart disease, hypertension, diabetes, osteoporosis, depression, dementia,
asthma and cancer, with a special focus on breast, colon and prostate tumors.
This alliance utilizes our national network of hospitals, physicians and
pathologists and GCI's capabilities in large-scale DNA tissue analysis and
handling, tied together by proprietary information systems and bioinformatics.
In connection with our alliance, we made a $1.0 million investment in GCI in
exchange for 333,333 shares of Series D Preferred Stock, par value $0.01. The
net revenue resulting from our alliance with GCI was not material to our
operations during 2000 or 2001. Working with GCI, we have developed procedures
to comply with informed consent requirements and other regulations regarding
the taking and processing of specimens from donors and related records.
Failure to comply with such regulations could result in adverse consequences
including potential liability to us.
On March 27, 2001, we announced an agreement with Molecular Diagnostics
which illustrates another example of leveraging our existing resources. In
this alliance, we will be performing clinical trial work for Molecular
Diagnostics' cytology platform that utilizes proteomic biomarkers to help
pathologists and cytologists identify abnormal and cancerous cells in pap
smears and other body fluids, such as sputum and urine. We will be paid on a
fee-for-service basis for each clinical trial we conduct. The agreement also
calls for us to assist Molecular Diagnostics with the development of
associated products and tests. We would receive equity in Molecular
Diagnostics for the developmental work and would be entitled to royalty
payments based on future sales of these products and tests. One of the
Molecular Diagnostics products we are currently evaluating is a new test for
human papilloma virus or HPV, which causes over 99% of all cervical dysplasia
and cancer. This new test involves the application of genomic and proteomic
markers directed against the specific oncogenes and oncoproteins of HPV that
are directly responsible for the virus's ability to cause cancer. Preliminary
studies indicate superior performance of these markers compared to currently
available tests. However, there can be no assurance that such tests or such
markers will be successful or become commercially viable.
On February 5, 2002, AmeriPath signed a letter of intent with TriPath
Oncology to validate and offer exclusively a novel gene expression assay for
Melastatin, a prognostic marker for melanoma. Melanoma represents the
deadliest skin cancer whose incidence is rapidly increasing. Given our
outstanding team of dermatopathologists and our market leadership in this
field, we believe that this agreement may provide revenue to the Company as
well as lead to additional opportunities.
Sources of Net Revenue
We derive our net revenue primarily from our owned and managed operations.
Net revenue was comprised of net patient service revenue from our owned
operations and net management service revenue from our managed operations.
The percent of our net revenue from outpatient and inpatient pathology and
management services is presented below. The type and mix of business among
these three categories, which can change from period to period as a result of
new acquisitions and other factors, may change our ratio of operating costs to
net revenue, particularly the provision for doubtful accounts as discussed
below in our results of operations.
Years Ended December 31,
------------------------
1999 2000 2001
-------- -------- --------
Revenue Type
Outpatient.............. 39% 42% 46%
Inpatient............... 51% 51% 47%
Management service reve-
nues................... 10% 7% 7%
24
Net patient revenues
The majority of services furnished by our pathologists are anatomic
pathology diagnostic services. We typically bill government programs,
principally Medicare and Medicaid, indemnity insurance companies, managed care
organizations, national clinical laboratories, physicians and patients. Net
patient revenue differs from amounts billed for services due to:
. Medicare and Medicaid reimbursements at annually established rates;
. payments from managed care organizations at discounted fee-for-service
rates;
. negotiated reimbursement rates with national clinical laboratories and
other third-party payors; and
. other discounts and allowances.
In many instances, the national clinical laboratories contract directly
under capitated agreements with managed care organizations to provide clinical
as well as anatomic pathology services. We, in turn, subcontract with national
clinical laboratories to provide anatomic pathology services at a discounted
fee-for-service rate and are, in most cases, attempting to increase the number
of such subcontracts to increase test volume. Since the majority of our
operating costs--principally the compensation of physicians and non-physician
technical personnel--are relatively fixed, increases in test volume generally
enhance our profitability. Historically, net patient service revenue from
capitated contracts has represented an insignificant amount of total net
patient service revenue. However, we may be required to enter into more
capitated arrangements in order to compete effectively for managed care
contracts in the future.
Virtually all of our net patient service revenue is derived from charging
for services on a fee-for-service basis. Accordingly, we assume the financial
risk related to collection, including potential uncollectability of accounts,
long collection cycles for accounts receivable and delays in reimbursement by
third-party payors, such as governmental programs, private insurance plans and
managed care organizations. Increases in write-offs of doubtful accounts,
delays in receiving payments or potential retroactive adjustments and
penalties resulting from audits by payors may require us to borrow funds to
meet current obligations or may otherwise have a material adverse effect on
our financial condition and results of operations.
In addition to services billed on a fee-for-service basis, the hospital-
based pathologists have supervision and oversight responsibility for their
roles as Medical Directors of the hospitals' clinical, microbiology and blood
banking operations. For this role, we bill non-Medicare patients according to
a fee schedule for what is referred to as clinical professional component
charges. For Medicare patients, the pathologist is typically paid a director's
fee or a "Part A" fee by the hospital. Hospitals and third-party payors are
continuing to increase pressure to reduce the payment of these clinical
professional component charges and "Part A" fees, and in the future we may
sustain substantial decreases in these payments.
Approximately 21% of our collections in 2001 was from government-sponsored
health care programs, principally Medicare and Medicaid, and is subject to
audit and adjustments by applicable regulatory agencies. Failure to comply
with any of these laws or regulations, the results of increased regulatory
audits and adjustments, or changes in the interpretation of the coding of
services or the amounts payable for services under these programs could have a
material adverse effect on our financial position and results of operations.
The impact of legislative changes on our results of operations will depend
upon several factors, including the mix of inpatient and outpatient pathology
services, the amount of Medicare business, and changes in reimbursement levels
which are published in November of each year. Management continuously monitors
changes in legislation impacting reimbursement.
In prior years, we have been able to mitigate the impact of reductions in
Medicare reimbursement rates for anatomic pathology services through the
achievement of economies of scale and production efficiencies. Despite any
offsets, the recent substantial modifications to the physician fee schedule,
along with additional adjustments by Medicare, could have a material adverse
effect on average unit reimbursement in the future. In addition, other
25
third-party payors could adjust their reimbursement based on changes to the
Medicare fee schedule. Any reductions made by other payors could also have a
material negative impact on average unit reimbursement.
Net management service revenue
Net management service revenue is based on a predetermined percentage of
operating income of the managed operations, before physician group retainage,
plus reimbursement of certain practice expenses as defined in each management
service agreement. Management fees are recognized at the time the net
physician group revenue is recorded by the physician group.
Generally, net management service revenue equates to net physician group
revenue less amounts retained by the physician groups, which we refer to as
physician group retainage. Net physician group revenue is equal to billed
charges reduced by provisions for bad debt and contractual adjustments.
Contractual adjustments represent the difference between amounts billed and
amounts reimbursable by commercial insurers and other third-party payors
pursuant to their respective contracts with the physician group. The provision
for bad debts represents an estimate of potential credit issues associated
with amounts due from patients, commercial insurers, and other third-party
payors. Net physician group revenue, which underlies our management service
revenue, is subject to the same legislative and regulatory factors discussed
above with respect to net patient revenue.
Medicare Reimbursement
Since 1992 the Centers for Medicare and Medicaid Services ("CMS") (formerly
known as the Health Care Financing Administration, or "HCFA") had paid for
physician's services under section 1848 of the Social Security Act. CMS
calculates and reimburses fees for all physician services ("Part B" fees),
including anatomic pathology services, based on a fee schedule methodology
known as the resource-based relative value system ("RBRVS"). The RBRVS
initially was phased in over a four-year period. Subsequently, CMS proposed
changes in the computation of the malpractice portion and practice expense
portion of the relative value units ("RVUs"). Although these changes have
changed reimbursement to some extent, they are not expected to have a material
impact on the Company's revenues. Overall, anatomic pathology reimbursement
rates declined during the fee schedule phase-in period, despite an increase in
payment rates for certain pathology services performed by us.
The Medicare Part B fee schedule payment for each service is determined by
multiplying the total RVUs established for the service by a Geographic
Practice Cost Index ("GPCI"). The sum of this value is multiplied by a
statutory conversion factor. The number of RVUs assigned to each service is in
turn calculated by adding three separate components: work RVU (intensity of
work), practice exposure RVU (expense related to performing the service) and
malpractice RVU (malpractice costs associated with the service).
CMS reviews annually the RBRVS payment schedule in conjunction with its
budgeting process. The resulting payment schedule is published each year in
the Federal Register in November. The blended payment rates for services
provided by AmeriPath to Medicare patients, based on our values and locations
of services, increased by 11.3% from 1999 to 2000, and by 6.8% from 2000 to
2001. However, there can be no assurance that we will receive similar
increases in the future, and it is possible that our blended rates may
decrease at some point in the future.
A final rule published in the Federal Register on November 1, 2001 indicates
that the conversion factor used in the Medicare Physician Fee Schedule will be
reduced by 5.4%. The RVUs will also be changing in 2002, with certain services
getting an increase in RVUs, while others are decreased. We estimate the
overall impact to be neutral for 2002.
In 1999, CMS announced that it would cease the direct payment by Medicare
for the technical component of inpatient physician pathology services to an
outside independent laboratory because they concluded payment for the
technical component is included already in the payment to hospitals under the
hospital inpatient prospective payment system. Implementation of this change
commenced January 1, 2001. Under these rules,
26
independent pathology laboratories would be required to bill the hospital
directly for technical services on hospital Medicare inpatients. Congress,
however, "grandfathered," for a period of two years, certain existing
hospital-lab arrangements in effect before July 22, 1999. Effective January
2001, hospital arrangements that were not grandfathered are not reimbursed by
Medicare for the technical component. The majority of our hospital
arrangements were grandfathered under the proposed rules. Upon expiration of
the two years, the grandfather provision is scheduled to expire.
Additionally, with the implementation of the hospital outpatient prospective
payment system ("PPS") during 2000, independent pathology laboratories
providing technical services to Medicare hospital outpatients generally are no
longer able to bill Medicare for the technical component ("TC") of those
services. Rather, they need to bill the hospital for the TC. The hospital is
reimbursed as part of the new Ambulatory Payment Classification ("APC")
payment system. Laboratories providing these services now need to contract
directly with hospitals for reimbursement. As the amount paid to hospitals for
the most common pathology services is less than the technical component under
the RBRVS, it is likely that those laboratories will incur substantial
reductions in reimbursement under PPS. However, services provided by us which
are subject to PPS are not material to our total net revenue.
Recent Developments
During the fourth quarter of 2001, we completed a secondary offering of 4.7
million shares of common stock. The net proceeds from the offering of $115.8
million were used to repay a portion of the outstanding indebtedness under our
prior credit facility. In addition, we put in place a new $200.0 million
credit facility, with commitments of $175.0 million, which was used to repay
the remaining balance of our former credit facility. In connection with the
termination of the former credit facility, we terminated our three interest
rate swaps with a combined notional amount of $105 million and wrote-off the
associated unamortized debt costs of approximately $1.6 million ($965,000, net
of tax). The termination of these interest rate swaps resulted in a charge of
approximately $10.4 million, ($6.0 million, net of tax). By breaking these
interest rate swaps, we have been able to lower our effective interest rate as
well as obtain greater flexibility to pursue our strategic objectives,
including further acquisitions.
During the third quarter of 2001, two pathologists in our Birmingham,
Alabama practice terminated their employment with us and opened their own
pathology laboratory. During the fourth quarter, we were unable to retain most
of these customers. Consequently, we recorded a non-cash asset impairment
charge of $3.8 million. We have implemented a strategy to retain our Alabama
customers and service them through other AmeriPath facilities and in November
2001 purchased a lab in Birmingham, Alabama to help regain and service these
customers.
The Company was recently notified by its medical malpractice carrier that
they will no longer be underwriting medical malpractice insurance and has
placed the Company on non-renewal status effective July 1, 2002. The Company
is currently evaluating other potential carriers for medical malpractice
coverage and conducting a feasibility study of a captive insurance company.
There can be no assurance the Company will be able to obtain medical
malpractice insurance on terms consistent with our current coverage, which may
increase our cost.
Critical Accounting Policies and Methods
Intangible Assets
As of December 31, 2001 we had net identifiable intangible assets and
goodwill of $253.6 million and $216.2 million, respectively. Management
assesses on an ongoing basis if there has been an impairment in the carrying
value of its intangible assets. If the undiscounted future cash flows over the
remaining amortization period of the respective intangible asset indicates
that the value assigned to the intangible asset may not be recoverable, the
carrying value of the respective intangible asset will be reduced. The amount
of any such
27
impairment would be determined by comparing anticipated discounted future cash
flows from acquired businesses with the carrying value of the related assets.
In performing this analysis, management considers such factors as current
results, trends and future prospects, in addition to other relevant factors.
As the result of this analysis, we recorded asset impairment charges of $9.6
million and $3.8 million for the years ended 2000 and 2001, respectively.
Significant changes in our future cash flow resulting from events such as loss
of hospital or national lab contracts, physician referrals, or management
service agreements could result in further charge offs of intangible assets.
Identifiable intangible assets include hospital contracts, physician
referral lists, laboratory contracts, and management service contracts
acquired in connection with acquisitions. Such assets are recorded at fair
value the date of acquisition as determined by management and are being
amortized over the estimated periods to be benefited, ranging from 10 to 40
years. In determining these lives, the Company considered each practice's
operating history, contract renewals, stability of physician referral lists
and industry statistics. If circumstances change, indicating a shorter
estimated period of benefit, future amortization expense could increase.
Revenue Recognition
The Company recognizes net patient service revenue at the time services are
performed. Unbilled receivables are recorded for services rendered during, but
billed subsequent to, the reporting period. Net patient service revenue is
reported at the estimated realizable amounts from patients, third-party payors
and others for services rendered. Revenue under certain third-party payor
agreements is subject to audit and retroactive adjustments. Provision for
estimated third-party payor settlements and adjustments are estimated in the
period the related services are rendered and adjusted in future periods as
final settlements are determined. The provision and the related allowance are
adjusted periodically, based upon an evaluation of historical collection
experience with specific payors for particular services, anticipated
collection levels with specific payors for new services, industry
reimbursement trends, and other relevant factors. Changes in these factors in
future periods could result in increases or decreases in the provision , our
results of operations and financial position.
Contingent Purchase Price
Our acquisitions, except for the pooling with Inform DX, have been accounted
for using the purchase method of accounting. The aggregate consideration paid,
and to be paid, is based on a number of factors, including the acquired
operation's demographics, size, local prominence, position in the marketplace
and historical cash flows from operations. Assessment of these and other
factors, including uncertainties regarding the health care environment,
resulted in the sellers and the Company being unable to reach agreement on the
final purchase price. We agreed to pay a minimum purchase price and to pay
additional purchase price considerations to the sellers in proportion to their
respective ownership interest. The additional payments are contingent upon the
achievement of stipulated levels of operating earnings (as defined) by each of
the operations over periods of three to five years from the date of the
acquisition as set forth in the respective agreements, and are not contingent
on the continued employment of the sellers. In certain cases, the payments are
contingent upon other factors such as the retention of certain hospital
contracts for periods ranging from three to five years. The amount of the
payments cannot be determined until the achievement of the operating earnings
levels or other factors during the terms of the respective agreements.
Additional payments made in connection with the contingent notes are accounted
for as additional purchase price, which increases the recorded goodwill and,
in accordance with accounting principles, generally accepted in the United
States of America, are not reflected in our results of operations.
Provision for Doubtful Accounts and Related Allowance
The provision for doubtful accounts is estimated in the period the related
services are rendered and adjusted in future accounting periods as necessary.
The estimates for the provision and the related allowance are based on an
evaluation of historical collection experience, the aging profile of the
accounts receivable, the historical doubtful account write-off percentages,
revenue channel (i.e., inpatient vs. outpatient) and other relevant factors.
Changes in these factors in future periods could result in increases or
decreases in the provision , our results of operations and financial position.
28
Principles of Consolidation
Our consolidated financial statements include the accounts of AmeriPath,
Inc., its wholly-owned subsidiaries, and companies in which the Company has
the controlling financial interest by means other than the direct record
ownership of voting stock. Intercompany accounts and transactions have been
eliminated. If it was determined that we do not have a controlling financial
interest for any or all companies where we do not have a direct ownership of
voting stock, the results of operations could be materially affected. We do
not consolidate the affiliated physician groups we manage as we do not have
controlling financial interest as described in
EITF 97-2.
Results of Operations
The following table outlines, for the periods indicated, selected operating
data as a percentage of net operating revenues.
Years Ended
December 31,
-------------------
1999 2000 2001
----- ----- -----
Net revenues.......................................... 100.0% 100.0% 100.0%
----- ----- -----
Operating costs and expenses:
Cost of services..................................... 47.7 49.5 47.8
Selling, general and administrative expenses......... 18.3 17.7 17.2
Provision for doubtful accounts...................... 9.8 10.3 11.5
Amortization expense................................. 5.0 4.9 4.4
Merger-related charges............................... -- 1.9 1.7
Asset impairment and related charges................. -- 2.9 0.9
----- ----- -----
Total operating costs and expenses.................. 80.8 87.2 83.5
----- ----- -----
Income from operations................................ 19.2 12.8 16.5
Termination of interest rate swap agreement........... -- -- (2.5)
Interest (expense) and other income, net.............. (3.6) (4.6) (3.9)
----- ----- -----
Income before income taxes and extraordinary loss..... 15.6 8.2 10.1
Provision for income taxes............................ 6.8 4.2 4.3
----- ----- -----
Income before extraordinary loss...................... 8.8 4.0 5.8
Extraordinary loss, net of tax........................ -- -- 0.2
----- ----- -----
Net income............................................ 8.8 4.0 5.6
Induced conversion and accretion of redeemable pre-
ferred stock......................................... -- (0.5) --
----- ----- -----
Net income available to common stockholders........... 8.8% 3.5% 5.6%
===== ===== =====
Years ended December 31, 2001 and 2000
Net Revenues
Net revenues for the year 2001 increased by $88.6 million, or 27%, from
$330.1 million for 2000 to
$418.7 million for 2001. Same store net revenue increased $45.7 million, or
14%, from $318.9 million for 2000 to $364.6 million for 2001. We estimate that
2% to 3% of the same store net revenue increase was attributable to price,
including approximately $5.1 million related to the increase in Medicare
reimbursement, while the remaining 11% to 12% of the same store net revenue
increase was attributable to volume and mix. Same store outpatient revenue
increased $26.4 million, or 20%, same store hospital revenue increased $14.5
million, or 9%, and same store management service revenue increased $4.8
million, or 18%, compared to the same period of the prior year. Reference to
same store means practices at which we provided services for the entire period
for which the amount is calculated and the entire prior comparable period,
including acquired hospital contracts and relationships, the New York
laboratory operations and expanded ancillary testing services added to
existing
29
practices. The remaining increase in revenue of $42.9 million resulted from
the operations acquired during the year 2000 and 2001. Our objective is to
achieve annual same store net revenue growth in excess of 10%; however, there
can be no assurance that we will achieve this objective.
During the year ended December 31, 2001, approximately $30.3 million, or 7%,
of our net revenue was attributable to contracts with national laboratories
including Quest Diagnostics ("Quest") and Laboratory Corporation of America
Holdings ("LabCorp"). Effective December 31, 2000, Quest terminated our
pathology contract in South Florida. In 2000, this contract accounted for
approximately $1.5 million of net patient service revenue. This contract
termination resulted in a $3.3 million asset impairment charge in the fourth
quarter of 2000. In addition, during 2000, we discontinued our Quest work in
San Antonio. We are currently experiencing substantial declines in volume from
Quest work in our Philadelphia laboratory. As a result, we are attempting to
broaden our customer base in this market to lessen any potential impact. There
can be no assurances that we will be able to recover lost volume. Decisions by
Quest or LabCorp to discontinue or redirect pathology services, or our
decision to discontinue processing work from the national laboratories, could
materially harm our financial position and results of operations, including
the potential impairment of intangible assets. As of December 31, 2001, we had
net identifiable intangible assets related to lab contracts of $2.9 million.
During the year ended December 31, 2001, approximately $50.5 million, or
12%, of our net revenue was derived from 31 hospitals operated by HCA--The
Healthcare Company ("HCA"), formerly known as Columbia/HCA Healthcare
Corporation. Generally, any contracts or relationships we may have with these
and other hospitals are short-term and allow for termination by either party
with relatively short notice. HCA has been under government investigation for
some time, and we believe that HCA is evaluating its operating strategies,
including the possible sale, spin-off or closure of certain hospitals.
Closures or sales of HCA hospitals or terminations or non-renewals of one or
more of our contracts or relationships with HCA hospitals could have a
material adverse effect on our financial position and results of operations.
Cost of Services
Cost of services consists principally of the compensation and fringe
benefits of pathologists, licensed technicians and support personnel,
laboratory supplies, shipping and distribution costs and facility costs.
Cost of services for 2001 increased by $36.7 million, or 23%, from $163.4
million for 2000 to
$200.1 million for 2001. The increase in cost of services can be attributed
primarily to the 27% increase in net revenues. Histology costs increased $9.0
million or 26%, physician costs increased $17.0 million or 20%, with the
remaining increases occurring in the areas of transcription, courier,
distribution, and cytology. Cost of services as a percentage of net revenues
decreased from 49.5% for 2000 to 47.8% for 2001. Gross margin increased from
50.5% for 2000 to 52.2% for 2001 in part due to the price increases and also
as the result of synergies attained in connection with the Inform DX
transaction. Because a substantial portion of our net revenues come from
third-party payors and managed care, whose reimbursement is often fixed by
contract, it is often difficult to compensate for cost increases through price
increases.
Selling, General and Administrative Expenses
The cost of corporate support, sales and marketing, and billing and
collections comprise the majority of what is classified as selling, general
and administrative expenses ("SG&A").
As a percentage of consolidated net revenues, SG&A decreased from 17.7% for
2000 to 17.2% for 2001. SG&A increased by $13.4 million, or 23.0%, from $58.5
million for 2000 to $71.9 million for 2001. Of this increase, approximately
$4.2 million is attributable to the increase in billing and collection costs
which typically increases as revenue and cash collections increase. In
addition, in connection with our focus on increasing our sales and marketing
and information technology efforts, these costs increased $5.6 million and
$1.4 million,
30
respectively. The increase in marketing costs includes the cost of additional
marketing personnel to cover new markets for dermatopathology, marketing
literature, and products to expand our penetration in the urology,
gastroenterology and oncology markets. The remaining increase was due
primarily to increased staffing levels in human resources and accounting,
salary increases effected during the fourth quarter of 2000 and 2001, and
costs incurred to expand our administrative support infrastructure and to
enhance our services.
One of our objectives is to decrease these costs as a percentage of net
revenues; however, these costs, as a percentage of net revenue, may increase
as we continue to invest in marketing, information systems and billing
operations. During 2001, we made significant investments in sales and
marketing focused on achieving our goal for same store revenue growth.
Therefore we do not expect any significant reduction in the ratio of SG&A to
net revenue in 2002.
Provision for Doubtful Accounts
Our provision for doubtful accounts can be affected by our mix of revenue
from outpatient, inpatient, and management services. The provision for
doubtful accounts for outpatient revenue, including revenue from national labs
for 2001, is approximately 3% and for inpatient revenue is approximately 19%.
Management service revenue generally does not have a provision for doubtful
accounts. The provision for doubtful accounts as a percentage of net revenue
is higher for inpatient services than for outpatient services due primarily to
a larger concentration of indigent and private pay patients, more difficulties
gathering complete and accurate billing information, and longer billing and
collection cycles for inpatient services. If our revenue from hospital-based
services increases as a percentage of our total net revenues, our provision
for doubtful accounts as a percentage of total net revenues may increase.
Our provision for doubtful accounts increased by $14.3 million, or 41.9%,
from $34.0 million for 2000 to $48.3 million for 2001. The provision for
doubtful accounts as a percentage of net revenues was 10.3% and 11.5% for 2000
and 2001, respectively. This increase was driven principally by two factors:
extended account aging in some practices where billing systems have been
standardized, and increased hospital clinical professional component billing,
which generally has a higher bad debt ratio.
Amortization Expense
Our acquisitions completed since 1996 resulted in significant increases in
net identifiable intangible assets and goodwill. Net identifiable intangible
assets are recorded at fair value on the date of acquisition and are amortized
over periods ranging from 10 to 40 years. We amortize goodwill on a straight-
line basis over periods ranging from 10 to 35 years. We cannot assure you that
we will ever realize the value of intangible assets.
Amortization expense increased by $2.5 million, or 15.4%, from $16.2 million
for 2000 to $18.7 million for 2001. The increase is attributable to the
amortization of goodwill and other identifiable intangible assets recorded in
connection with anatomic pathology operations acquired in 2000 and 2001,
payments made on contingent notes, and a reduction in the weighted average
amortization periods from 30 to 28 years. Approximately $7.4 million of the
2001 amortization is associated with goodwill. Under the new accounting
standard (see Recent Accounting Pronouncements), this goodwill amortization
will no longer be recorded. For 2002 and beyond, amortization expense will
relate only to our identifiable intangibles.
We continually evaluate whether events or circumstances have occurred that
may warrant revisions to the carrying values of our goodwill and other
identifiable intangible assets, or to the estimated useful lives assigned to
such assets. Any significant impairment recorded on the carrying values of our
goodwill or other identifiable intangible assets could materially harm results
of operations. Such impairment would be recorded as a charge to operating
profit and reduction in intangible assets.
31
Merger-related Charges, Asset Impairment and Related Charges, Termination of
Interest Rate Swap Agreements and Extraordinary Loss (Special Charges)
During 2001, we recorded special charges totaling $10.9 million for merger-
related charges and certain asset impairments. The merger-related charges of
$7.1 million for 2001 relate to our acquisition of Inform DX and include
transaction costs and costs related to the closing of the Inform DX corporate
office in Nashville and the integration or closing of the overlapping
operations of Inform DX in New York and Pennsylvania. We effectively closed
the Nashville office on March 31, 2001 and we completed the integration of the
New York and Pennsylvania operations in the latter half of 2001. The
restructuring of the combined operations of AmeriPath and Inform DX has
resulted in annual operating synergies of approximately $5.0 million. Since
the majority of the positive effect of such savings on operations did not
begin to be realized until the second half of 2001, the acquisition of Inform
DX has been only slightly accretive for the year 2001.
During the third quarter of 2001, two pathologists in our Birmingham,
Alabama practice terminated their employment with us and opened their own
pathology laboratory. During the fourth quarter, we determined that we had
been unable to retain most of these customers. Therefore, we recorded a non-
cash asset impairment charge of $3.8 million. We have implemented a strategy
to retain our Alabama customers and service them through other AmeriPath
facilities and in November 2001 purchased a lab in Birmingham, Alabama to help
regain these customers and service them.
In addition, in connection with the early termination of our former credit
facility in November 2001, we terminated three interest rate swaps with a
combined notional amount of $105 million. The termination of these interest
rate swaps resulted in a special charge of approximately $10.4 million, ($6.0
million, net of tax). In addition, we wrote-off the associated unamortized
debt costs of the facility of approximately $1.6 million ($965,000, net of
tax), which is shown as an extraordinary loss, net of tax, in the consolidated
financial statements.
Of the total $22.9 million in special charges in 2001, approximately $5.4
million are non-cash charges, and the remaining $17.5 million are cash
charges.
During 2000, we recorded special charges totaling $21.0 million for merger-
related charges, an allowance against uncollectible accounts receivable
related to our acquisition of Inform DX and certain asset impairment charges.
The merger-related charges of $6.2 million in 2000 relate to our acquisition
of Inform DX and include transaction costs, change in control payments and
costs related to the closing of the Inform DX corporate office in Nashville.
Of the $6.2 million, approximately $4.3 million related to transaction costs
and $1.9 million related to employee-related costs of closing the Nashville
facility. During the second quarter of 2000, we recorded a pre-tax non-cash
charge of approximately $4.7 million and related cash charges of approximately
$545,000 in connection with the impairment of intangible assets at an acquired
practice in Cleveland, Ohio. During the fourth quarter of 2000, we recorded a
pre-tax non-cash charge of approximately $4.3 million related to the
impairment of certain intangible assets. $3.3 million of the fourth quarter
charge relates to Quest Diagnostics' termination of our contract with them in
South Florida, effective December 31, 2000. The net patient service revenue in
2000 related to this contract was approximately $1.5 million. Although we have
aggressively marketed and retained a portion of this operating income,
accounting rules required a charge to be taken, as there was no longer a
contract. In addition, during the fourth quarter of 2000, a hospital in South
Florida with which we had a pathology contract requested proposals for its
pathology services and we were unsuccessful in retaining this contract. Based
upon the remaining projected cash flow from this hospital network, we
determined that the intangible assets were impaired and recorded a pre-tax
non-cash charge of approximately $1.0 million. For 2000, this contract
accounted for approximately $800,000 of net revenue.
Of the total $21.0 million in special charges in 2000, approximately $14.7
million are non-cash charges, and the remaining $6.3 million are cash charges.
32
The following summarizes the pretax effect of these special charges by
category for 2000 and 2001 (in millions).
2000 2001
----- -----
Merger-related charges......................................... $ 6.2 $ 7.1
Allowance against accounts receivable.......................... 5.2 --
Asset impairment and related charges........................... 9.6 3.8
----- -----
Total special charges in income from operations.............. 21.0 10.9
Termination of interest rate swap agreement.................... -- 10.4
----- -----
Total special charges in net income before extraordinary
loss........................................................ 21.0 21.3
Write-off of unamortized debt costs............................ -- 1.6
----- -----
Total special charges in net income.......................... $21.0 $22.9
===== =====
Income from Operations
Income from operations, including special charges, increased $26.5 million,
or 63%, from $42.3 million for 2000 to $68.9 million for 2001. Excluding the
special charges described above, income from operations increased by $16.5
million, or 26%, from $63.3 million for 2000 to $79.8 million for 2001.
Interest Expense
Interest expense increased by $1.0 million, or 6%, from $15.4 million for
2000 to $16.4 million for 2001. This increase was attributable to the higher
average amount of debt outstanding during 2001 and a slightly higher effective
interest rate. For the year ended December 31, 2001, average indebtedness
outstanding was
$179.3 million compared to average indebtedness of $178.1 million outstanding
in the same period of 2000. Our effective interest rate was 9.1% and 8.6% for
the years ended 2001 and 2000, respectively. Although there have been some
declines in interest rates during 2001, $105 million of the credit facility
was hedged with an interest rate swap at a fixed rate of roughly 10%, while
the remaining balance of the credit facility floated with LIBOR. During the
fourth quarter of 2001, the Company completed a secondary offering and used
the proceeds of
$115.8 million to repay debt. In addition, during the fourth quarter, the
Company entered into a new credit facility agreement and terminated these
interest rate swaps. The new credit facility has a borrowing rate based on the
Company's leverage ratio. As of December 31, 2001, the borrowing rate was
LIBOR plus 150 basis points.
Provision for Income Taxes
The effective income tax rate was approximately 51.8% and 42.5% for 2000 and
2001, respectively. Generally, the effective tax rate is higher than our
statutory rates primarily due to the non-deductibility of the goodwill
amortization related to our acquisitions. In addition to non-deductible
goodwill amortization, we had non-deductible asset impairment charges and
merger-related charges for 2000, which further increased the effective tax
rate. The effective tax rate for 2000 and 2001 excluding these items would
have been approximately 41.8% and 41.5%, respectively.
Income before Extraordinary Loss
Income before extraordinary loss, including special charges, for 2001 was
$24.3 million, an increase of $11.2 million, or 86%, over 2000. Excluding
special charges, income before extraordinary loss increased by
$9.2 million, or 33%, from $28.0 million for 2000 to $37.2 million for 2001.
Net Income Available to Common Stockholders
Income available to common stockholders, including special charges, for 2001
was $23.4 million, an increase of $11.9 million, or 103%, over 2000. Excluding
the special charges described above and a $1.6 million charge for the induced
conversion of redeemable preferred stock in 2000, net income increased by $9.2
million,
33
or 33%, from $28.0 million in 2000 to $37.2 million in 2001. Diluted earnings
per share for 2001 increased to $0.86 from $0.47 for 2000, based on 27.0
million and 24.2 million weighted average shares outstanding, respectively.
Diluted earnings per share was $1.38 and $1.16 for 2001 and 2000,
respectively, without giving effect to any special charges.
Years Ended December 31, 2000 and 1999
Net Revenues
Net revenue for the year 2000 increased by $72.7 million, or 28%, from
$257.4 million for 1999 to
$330.1 million for 2000. During the fourth quarter of 2000, we reviewed the
collectability of Inform DX's accounts receivable in light of historical
collections, aging of accounts receivable, our reserve methods and policies,
and billing and collection performance. In addition, two of Inform DX's
laboratories converted billing systems in the fourth quarter of 1999. As a
result of these conversions, the billings and collections for 2000 were
negatively impacted. Based on this review and evaluation, during the fourth
quarter we recorded an additional estimated allowance against accounts
receivable of $5.2 million. Since the majority of this allowance relates to
the accounts receivable of our managed practices, as discussed above, the
additional allowance was recorded as a reduction of net management service
revenue, resulting in a decline in net management services revenue from 1999
to 2000.
Without the $5.2 million adjustment to net revenue, 2000 net revenue would
have increased $77.9 million, or 30%, over the year ended 1999. Of this $77.9
million increase, $44.3 million resulted from the operations of practices
acquired during 1999 and 2000. Same store net revenue for 2000 increased by
$33.6 million, or 14%, over the prior year. Of the same store increase we
estimate that approximately $6.8 million resulted from the increase in
Medicare reimbursement in 2000. The remaining $26.8 million resulted from a
combination of volume increases and price impacts of other payors. Same store
outpatient net revenue increased $23.8 million, or 24%, same store hospital
net revenue increased $6.5 million, or 5%, and management service revenue
increased $3.3 million, or 15%, compared to the same period of the prior year.
An expansion of our New York operation contributed approximately $4.2 million
to the same store outpatient growth for the year 2000.
During 2000, approximately $29.4 million, or 9%, of our revenue was from
contracts with national laboratories including Quest and LabCorp. This
represents a 35% increase over the prior year revenue from national laboratory
contracts of approximately $21.7 million. Effective December 31, 2000, Quest
terminated our pathology contract in South Florida. In 2000, this contract
accounted for approximately $1.5 million of net patient service revenue. This
contract termination resulted in a $3.3 million asset impairment charge in the
fourth quarter of 2000. In addition, during the fourth quarter we discontinued
our Quest work in San Antonio.
Approximately 13% and 15% of our 2000 and 1999 net revenue, respectively,
came from pathology contracts with 27 HCA hospitals. During 1999, HCA closed
one hospital and sold another hospital where we provided pathology services.
The estimated net revenue from these hospitals was less than 1% of our 1999
consolidated net patient revenue.
Cost of Services
Cost of services for 2000 increased by $40.7 million, or 33.2%, from $122.7
million for 1999 to
$163.4 million for 2000. Cost of services, as a percentage of net revenues,
increased from 47.7% in 1999 to 49.5% in 2000. Gross margin decreased from
approximately 52.3% in 1999 to 50.5% in 2000. Excluding the impact of the
increased reimbursement from Medicare, the gross margin in 2000 would have
decreased to approximately 49.5%. The increase in cost of services, and
corresponding reduction in gross margin, resulted primarily from higher
pathologist and medical technicians salaries and medical malpractice and
health
benefit costs.
Selling, General and Administrative Expense
SG&A expense, as a percentage of net revenues decreased from 18.3% in 1999
to 17.7% in 2000, as we imposed measures to control the growth in these costs
and continued to spread these costs over a larger revenue base. Our objective
is to decrease these costs as a percentage of net revenues; however, these
costs, as a
34
percentage of net revenue, may increase as we continue to invest in marketing,
information systems and billing operations.
Provision for Doubtful Accounts
The provision for doubtful accounts, which relates to our owned practices,
increased by $8.8 million, or 34.6%, from $25.3 million for 1999 to $34.0
million for 2000. The dollar increase is primarily due to the increase in net
revenues and accounts receivable from the acquisitions completed during 1998
and 1999. The provision for doubtful accounts as a percentage of net revenues
was 9.8% and 10.3% for 1999 and 2000, respectively. The increase as a
percentage of net revenue was primarily attributable to a shift in revenue mix
from management service to outpatient.
Amortization Expense
Amortization expense increased by $3.4 million, or 26.1%, from $12.8 million
for 1999 to $16.2 million for 2000. This increase is attributable to the
amortization of goodwill and net identifiable intangible assets from the
acquisitions we completed during 2000 and a full year of amortization from the
acquisitions we completed during 1999. In addition, during 2000, we made
contingent note payments totaling $26.6 million. These contingent note
payments are recorded as goodwill and, therefore, create additional
amortization expense. Amortization expense, as a percentage of net revenues,
was 5.0% and 4.9% in 1999 and 2000, respectively.
Income from Operations
Income from operations decreased $7.2 million, or 14.5%, from $49.5 million
in 1999 to $42.3 million in 2000. Without giving effect to asset impairment
charges of $6.2 million and merger-related charges of
$9.6 million in 2000, income from operations increased by $8.6 million, or
17.4%, from $49.5 million in 1999 to $58.1 million in 2000.
Interest Expense
Interest expense increased by $5.8 million, or 60.6%, from $9.6 million for
1999 to $15.4 million for 2000. The increase was due in part to an increase in
the average outstanding balance under the credit facility. In 2000, the
average indebtedness under the credit facility was $175.5 million compared to
$140.0 million outstanding in 1999. In addition, the effective interest rate
on the credit facility increased from 6.8% to 8.7% primarily due to the
periodic increases in interest rates during the year by the Federal Reserve
Board and the expiration of our interest rate swap in October 2000. The
interest rate swap was renewed in October 2000 at approximately 7.65% plus the
credit spread (2.0% as of December 31, 2000) compared to 5% plus credit spread
for the expired swap, therefore increasing interest expense.
Provision for Income Taxes
The effective income tax rate was approximately 43.5% and 51.8% for 1999 and
2000, respectively. Generally, the effective tax rate is higher than our
statutory rates primarily due to the non-deductibility of the goodwill
amortization related to our acquisitions. In addition, for 2000 we had non-
deductible asset impairment charges and merger-related charges that further
increased the effective tax rate. The effective tax rate for 2000, excluding
these items would have been approximately 41.8%.
Net Income Available to Common Stockholders
Net income attributable to common stockholders for 2000 was $11.5 million, a
decrease of $11.1 million, or 49.1%, from 1999. Without giving effect to asset
impairment charges of $9.6 million, the merger-related charges of $6.2 million
and a $1.6 million charge for the induced conversion of redeemable preferred
stock in 2000, net income attributable to common stockholders increased by
$5.4 million, or 24.1%, from $22.6 million in 1999 to $28.0 million in 2000.
Diluted earnings per share for 2000 decreased to $0.47 from $1.00 for 1999,
35
based on 24.2 million and 22.5 million weighted average shares outstanding,
respectively. Diluted earnings per share were $1.16 and $1.00 for 2000 and
1999, respectively, without giving effect to any special charges.
Liquidity and Capital Resources
At December 31, 2001, we had working capital of approximately $56.8 million,
an increase of $16.0 million from the working capital of $40.8 million at
December 31, 2000. The increase in working capital was due primarily to
increases in net accounts receivable of $10.7 million and other current
assets, primarily deferred taxes, of $5.3 million.
For the years ended December 31, 1999, 2000 and 2001, cash flows from
operations were $32.7 million, or 12.7% of net revenue, $31.9 million, or 9.7%
of net revenue, and $48.0 million, or 11.5% of net revenue, respectively.
Excluding pooling merger-related charges paid for Inform DX of $3.8 million
and $6.1 million in 2000 and 2001, respectively, cash flow from operations for
2000 and 2001 would have been $35.7 million, or 10.8% of net revenue and $54.2
million, or 12.9% of net revenue. For the year ended December 31, 2001, cash
flow from operations and borrowings under our credit facility were used
primarily: (1) for capital expenditures aggregating $7.8 million; (2) to fund
the $5.0 million cash portion of our acquisitions; (3) for payments on our
contingent notes of $36.1 million; (4) to pay $600,000 of other merger-related
charges, mainly for Inform DX; and (5) to make $1.1million in principal
payments on long-term debt.
On June 11, 2001 we increased committed funding from $230.0 million to
$282.5 million under our former credit facility. Citicorp, USA, Inc. committed
$37.5 million and agreed to serve as documentation agent for the credit
facility. Credit Suisse First Boston committed $15.0 million. During the
fourth quarter, the Company completed a secondary offering of 4.7 million
shares of common stock (including exercise of the underwriters over allotment
option), resulting in net proceeds of $115.8 million. These proceeds were used
to repay a portion of the amount outstanding under our former credit facility.
In addition, we secured a new $200.0 million credit facility with commitments
totaling $175.0 million. The new credit facility was used to extinguish the
remaining balance outstanding under the former credit facility. The new credit
facility has a five-year term with a final maturity date of November 30, 2006.
Interest is payable monthly at variable rates which are based, at the
Company's option, on the agent's base rate (4.75% at December 31, 2001) or the
LIBOR rate plus a premium that is based on the Company's ratio of total funded
debt to pro forma consolidated earnings before interest, taxes, depreciation
and amortization. As of December 31, 2001, the LIBOR premium was 1.5%. The new
facility also requires a commitment fee to be paid quarterly equal to 0.375%
of the unused portion of the total commitment. The new credit facility has
three basic financial covenants regarding leverage, fixed charge coverage and
interest coverage. In addition, the agreement has a number of nonfinancial
covenants. At
December 31, 2001, we believe we are in compliance with the covenants of the
credit facility. The unused commitments under the credit facility will be used
for general working capital needs and our acquisition program.
In May 2000, we entered into three interest rate swaps transactions with an
effective date of October 5, 2000, variable maturity dates, and a combined
notional amount of $105.0 million. These interest rate swap transactions
involved the exchange of floating for fixed rate interest payments over the
life of the agreements without the exchange of the underlying principal
amounts. The differential to be paid or received was accrued and recognized as
an adjustment to interest expense. These agreements were indexed to 30 day
LIBOR. We used these derivative financial instruments to reduce interest rate
volatility and associated risks arising from the floating rate structure of
our former credit facility and such derivative financial instruments were not
held or issued for trading purposes. We were required by the terms of our
former credit facility to keep some form of interest rate protection in place.
In connection with the early termination of the former credit facility, we
made a cash payment of $10.6 million to terminate these interest rate swaps.
During 2000, we acquired nine anatomic pathology practices, including the
two practices acquired by Inform DX. The total consideration paid by us in
connection with these acquisitions included cash of
$32.5 million and approximately 1,532,000 shares of common stock (aggregate
value of $12.2 million based upon amounts recorded on our consolidated
financial statements). In addition, we issued approximately 2,600,000
36
shares of common stock (1,219,000 shares of which are included above) in
exchange for all the outstanding common stock of Inform DX. In addition, we
assumed certain obligations to issue shares of common stock pursuant to
outstanding Inform DX stock options and warrants. During 2001, we made one
small acquisition in Alabama.
In connection with our acquisitions, we generally agree to pay a base
purchase price plus additional contingent purchase price consideration to the
sellers of the practices. The additional payments are generally contingent
upon the achievement of stipulated levels of operating earnings by the
acquired practices over periods of three to seven years (generally five years)
from the date of the acquisition, and are not contingent on the continued
employment of the sellers of the practices. In certain cases, the payments are
contingent upon other factors such as the retention of certain hospital
contracts or relationships for periods ranging from three to five years. The
amount of the payments cannot be determined until the achievement of the
operating earnings levels or other factors during the terms of the respective
agreements. If the maximum specified levels of operating earnings for each
acquired practice are achieved, we would make aggregate maximum payments,
including principal and interest, of approximately $150.0 million over the
next three to five years. At the mid-point level, the aggregate principal and
interest would be approximately $77.0 million over the next three to five
years. A lesser amount or no payments at all would be made if the stipulated
levels of operating earnings specified in each agreement were not met. In
2001, we made contingent note payments aggregating $36.1 million. These
contingent note payments are currently estimated to be $35 to $36 million and
$34 to $35 million for 2002 and 2003, respectively. After 2003 these payments
are projected to decline.
Historically, our capital expenditures have been primarily for laboratory
equipment, information technology equipment and leasehold improvements. Total
capital expenditures were $8.7 million, $9.2 million and
$7.8 million in 1999, 2000, and 2001, respectively. During 2001, capital
expenditures included approximately $4.4 million related to information
technology, $2.0 million for laboratory equipment and $1.3 million for various
other capital assets. During 2000, capital expenditures included approximately
$2.9 million related to information technology, $2.4 million for laboratory
equipment, $2.6 million for leasehold improvements and $1.3 million for office
equipment and furniture and fixtures. During 1999, capital expenditures
included approximately
$1.6 million related to information systems, $2.0 million for laboratory
equipment, $1.7 million for leasehold improvements, $1.5 million for the
construction of the New York lab and $1.2 million for the new billing system
at the consolidated billing office in Fort Lauderdale.
Planned capital expenditures for 2002 are estimated to be $9.0 million to
$11.0 million, with priority being given to new billing systems and
enhancements in financial and lab information systems. Historically, we have
funded our capital expenditures with cash flows from operations. For the years
ended December 31, 1999, 2000, and 2001, capital expenditures were
approximately 3.4%, 2.8% and 1.8% of net revenue, respectively. We are
consolidating and integrating our financial information, billing and
collection systems, which may result in an increase in capital expenditures as
a percentage of net revenue. We believe, however, that such information
systems enhancements may result in cost savings that will enable us to
continue to fund capital expenditures with cash flows from operations.
We expect to continue to use our credit facility to fund acquisitions and
for working capital. We anticipate that funds generated by operations and
funds available under our credit facility will be sufficient to meet working
capital requirements and anticipated contingent note obligations, and to
finance capital expenditures over the next 12 months. Further, in the event
additional payments under the contingent notes issued in connection with
acquisitions become due, we believe that the incremental cash generated from
operations would exceed the cash required to satisfy our payment, if any, of
the contingent obligations in any one-year period. Such payments, if any, will
result in a corresponding increase in goodwill. Funds generated from
operations and funds available under the credit facility may not be sufficient
to implement our longer-term growth strategy. We may be required to seek
additional financing through additional increases in the credit facility, to
negotiate credit facilities with other banks or institutions or to seek
additional capital through private placements or public offerings of equity or
debt securities. No assurances can be given that we will be able to extend or
increase the existing credit
37
facility, secure additional bank borrowings or complete additional debt or
equity financings on terms favorable to us or at all.
Interest Rate Risk
We are subject to market risk associated principally with changes in
interest rates. Interest rate exposure is principally limited to the amount
outstanding under the credit facility of $90.0 million at December 31, 2001.
Currently the balances outstanding under the credit facility are at floating
rates. Based on the outstanding balance of $90.0 million, each quarter point
increase or decrease in the floating rate changes interest expense by $225,000
per year. In the future, the Company may evaluate entering into interest rate
swaps, involving the exchange of floating for fixed rate interest payments, to
reduce interest rate volatility.
Inflation
Inflation was not a material factor in either revenue or operating expenses
during the periods presented.
Recent Accounting Pronouncements
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements, which provided the staff's views in applying generally accepted
accounting principles to selected revenue recognition issues. In June 2000,
SAB 101 was amended by SAB 101B, which delayed the implementation of SAB 101
until no later than the fourth fiscal quarter of fiscal years beginning after
December 15, 1999. We adopted SAB 101 in the fourth quarter of 2000. The
adoption of the provisions of SAB 101 did not have a material impact on our
financial position or results of operations.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
("SFAS 133") and in June 1999, the FASB issued Statement of Financial
Accounting Standards No. 137 "Accounting for Derivative Instruments and
Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133,"
which delayed the effective date we are required to adopt SFAS 133 until its
fiscal year 2001. In June 2000, the FASB issued Statement of Financial
Accounting Standards No. 138, "Accounting for Certain Derivative Instruments
and Certain Hedging Activities--an Amendment to FASB Statement No. 133." This
statement amended certain provisions of SFAS 133. SFAS 133 requires us to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the
fair value of derivatives will either be offset against the change in fair
value of the hedged assets, liabilities, or firm commitments through earnings
or recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change in
fair value will be immediately recognized in earnings. We do not enter into
derivative financial instruments for trading purposes. Since the adoption of
SFAS 133 in the first fiscal quarter of 2001, these activities have been
recognized on our Consolidated Balance Sheet. Our adoption of FAS 133 has not
had a material effect on our earnings. The adoption of SFAS 133 resulted in a
negative transition adjustment of $3.0 million (net of tax of $2.0 million)
recorded on January 1, 2001. As of December 31, 2001, we have no derivative
instruments.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 141, "Business Combinations" ("SFAS 141"). SFAS 141 requires the purchase
method of accounting for business combinations initiated after June 30, 2001
and eliminates the pooling-of-interests method. We do not believe that the
adoption of SFAS 141 will have a significant impact on our financial
statements.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which is
effective January 1, 2002. SFAS 142 requires, among other things, the
discontinuance of goodwill amortization. In addition, the standard includes
provisions for the reclassification of certain existing recognized intangibles
as goodwill, reassessment of the useful lives of existing recognized
38
intangibles, reclassification of certain intangibles out of previously
reported goodwill and the identification of reporting units for purposes of
assessing potential future impairments of goodwill. SFAS 142 also requires us
to complete a transitional goodwill impairment test six months from the date
of adoption. We are currently assessing, but have not yet determined, the
impact of SFAS 142 on our financial position and results of operations. For
the year ending December 31, 2001, goodwill amortization was approximately
$7.4 million. Based on our preliminary assessment of SFAS 142, we expect this
amortization to no longer be recorded in future periods. In addition, due to
the fact that a portion of this goodwill was not tax deductible, our effective
tax rate was greater than the statutory rate. The elimination of the goodwill
amortization, including nondeductible goodwill amortization, from future
periods should result in a 1% to 2% reduction in our effective tax rate.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143
addresses financial accounting and reporting for obligations associated with
the retirement of tangible long-lived assets and the associated asset
retirement costs. It applies to legal obligations associated with the
retirement of long-lived assets that result from the acquisition,
construction, development, and (or) the normal operation of a long-lived
asset, except for certain obligations of lessees. The provisions of SFAS 143
will be effective for fiscal years beginning after June 15, 2002; however
early application is permitted. We are currently evaluating the implications
of adoption of SFAS 143 on its financial statements.
In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
("SFAS 144"). SFAS 144 provides accounting guidance for financial accounting
and reporting for impairment or disposal of long-lived assets. SFAS 144
supersedes SFAS 121. SFAS 144 is effective for the Company in fiscal 2002.
Management does not currently believe that the implementation of SFAS 144 will
have a material impact on the Company's financial condition or results of
operations.
Qualification of Forward-looking Statements
This Annual Report on Form 10-K contains forward-looking statements made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Statements contained anywhere in this Annual Report on
Form 10-K that are not limited to historical information are considered
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including,
without limitation, statements regarding the Company's expectations, beliefs,
intentions, plans or strategies regarding the future. These forward-looking
statements are based largely on the Company's expectations which are subject
to a number of known and unknown risks, uncertainties and other factors
discussed in this report and in other documents filed by the Company with the
Securities and Exchange Commission, which may cause actual results to be
materially different from those anticipated, expressed or implied by the
forward-looking statements. All forward-looking statements included in this
document are based on information available to the Company on the date hereof,
and the Company assumes no obligation to update any such forward-looking
statements to reflect future events or circumstances. Forward-looking
statements are sometimes indicated by words such as "may," "should,"
"believe," "expect," "anticipate" and similar expressions.
In addition to the risks and uncertainties identified elsewhere herein and
in other documents filed by the Company with the Securities and Exchange
Commission, the following factors should be carefully considered when
evaluating the Company's business and future prospects: general economic
conditions; competition and changes in competitive factors; the extent of
success of the Company's operating initiatives and growth strategies
(including without limitation, the Company's continuing efforts to (i) achieve
continuing improvements in performance of its current operations, by reason of
various synergies, marketing efforts, revenue growth, cost savings or
otherwise, (ii) transition into becoming a fully integrated healthcare
diagnostic information provider, including the Company's efforts to develop,
and the Company's investment in, new products, services, technologies and
related alliances, such as the alliance with Genomics Collaborative, Inc.,
(iii) acquire or develop additional pathology practices (as further described
below), and (iv) develop and expand its managed care and national clinical lab
contracts); federal and state healthcare regulation (and compliance);
reimbursement rates under government-sponsored and third party healthcare
programs and the payments received under such
39
programs; changes in coding; changes in technology; dependence upon
pathologists and contracts; the ability to attract, motivate, and retain
pathologists; labor and technology costs; marketing and promotional efforts;
the availability of pathology practices in appropriate locations that the
Company is able to acquire on suitable terms or develop; the successful
completion and integration of acquisitions (and achievement of planned or
expected synergies); access to sufficient amounts of capital on satisfactory
terms; and tax laws. In addition, the Company's strategy to penetrate and
develop new markets involves a number of risks and challenges and there can be
no assurance that the healthcare regulations of the new states in which the
Company enters and other factors will not have a material adverse effect on
the Company. The factors which may influence the Company's success in each
targeted market in connection with this strategy include: the selection of
appropriate qualified practices; negotiation, execution and consummation of
definitive acquisition, affiliation, management and/or employment agreements;
the economic stability of each targeted market; compliance with state, local
and federal healthcare and/or other laws and regulations in each targeted
market (including health, safety, waste disposal and zoning laws); compliance
with applicable licensing approval procedures; restrictions under labor and
employment laws, especially non-competition covenants. Past performance is not
necessarily indicative of future results. Certain of the risks, uncertainties
and other factors discussed or noted above are more fully described elsewhere
in this Report, including under the caption--"Risk Factors" below.
Risk Factors
You should carefully consider each of the following risks and all of the
other information set forth in this report on Form 10-K. The risks and
uncertainties described below are not the only ones we face. Additional risks
and uncertainties not presently known to us or that we currently believe to be
immaterial may also adversely affect our business.
If any of the following risks actually occur, our business prospects,
financial condition and results of operations could be materially adversely
affected and the trading price of our common stock could decline. In any such
case, you could lose all or part of your investment in our company.
Our business could be materially harmed by future interpretation or
implementation of state laws regarding prohibitions on the corporate practice
of medicine.
We acquire or affiliate with pathology operations located in many states
across the country. However, the laws of many states prohibit business
corporations, including AmeriPath and its subsidiaries, from owning
corporations that employ physicians, or from exercising control over the
medical judgments or decisions of physicians. These laws and their
interpretations vary from state to state and are enforced by both the courts
and regulatory authorities, each with broad discretion. The manner in which we
operate each organization is determined primarily by the corporate practice of
medicine restrictions of the state in which the organization is located and
other applicable regulations.
We believe that we are currently in material compliance with the corporate
practice of medicine laws in each of the states in which we operate.
Nevertheless, it is possible that regulatory authorities or other parties may
assert that we are engaged in the unauthorized corporate practice of medicine.
If such a claim were successfully asserted in any jurisdiction, we could be
subject to civil and criminal penalties, which could exclude us from
participating in Medicare, Medicaid and other governmental health care
programs, or we could be required to restructure our contractual and other
arrangements. Any restructuring of our contractual and other arrangements with
our operations could result in lower revenues, increased expenses and reduced
influence over the business decisions of those operations. Alternatively, some
of our existing contracts could be found to be illegal and unenforceable,
which could result in the termination of those contracts and an associated
loss of revenue. In addition, expansion of our operations to other corporate
practice states may require structural and organizational modification to the
form of relationships that we currently have with our operations and
hospitals. Such modifications could result in less profitable operations, less
influence over the business decisions and failure to achieve our growth
objectives.
40
We could be hurt by future interpretation or implementation of federal and
state anti-kickback laws.
Federal anti-kickback laws and regulations prohibit the offer, payment,
solicitation and receipt of any form of remuneration in exchange for referrals
of products or services for which payment may be made by Medicare, Medicaid or
other federal health care programs. Violations of federal anti-kickback laws
are punishable by monetary fines, civil and criminal penalties and exclusion
from participation in Medicare, Medicaid and other governmental health care
programs. Several states have similar laws. While we believe our operations
are in material compliance with applicable Medicare and fraud and abuse laws,
including the anti-kickback law, there is a risk that government authorities
might take a contrary position or might investigate our arrangements with
physicians and third parties, particularly those arrangements that do not
satisfy the compliance safe harbors provided under the relevant regulations or
that are similar to arrangements found to be problematic in advisory opinions
of the Department of Health and Human Services Office of Inspector General
(OIG). For example, the OIG has addressed physician practice management
arrangements in an advisory opinion and found that management fees based on a
percentage of practice revenues may violate the federal anti-kickback statute.
While we believe our fee arrangements can be distinguished from those
addressed in the opinion, government authorities may disagree. Such
occurrences, regardless of their outcome, could damage our reputation and
adversely affect important business relationships that we have with third
parties, including physicians, hospitals and private payors. If our
arrangements with physicians and third parties were found to be illegal, we
could be subject to civil and criminal penalties, including fines and possible
exclusion from participation in government payor programs. Significant fines
could cause liquidity problems and adversely affect our results of operations.
Exclusion from participation in government payor programs, which represented
21% of our collections from owned operations in 2001, would eliminate an
important source of revenue and could materially adversely affect our
business. In addition, some of our existing contracts could be found to be
illegal and unenforceable, which could result in the termination of those
contracts and an associated loss of revenue.
Our business could be harmed by future interpretation or implementation of the
federal Stark Law and other state and federal anti-referral laws.
We are also subject to federal and state statutes and regulations banning
payments for referrals of patients and referrals by physicians to health care
providers with whom the physicians have a financial relationship. The federal
Stark Law applies to Medicare and Medicaid and prohibits a physician from
referring patients for certain services, including laboratory services, to an
entity with which the physician has a financial relationship. Financial
relationship includes both investment interests in an entity and compensation
arrangements with an entity. The state laws and regulations vary significantly
from state to state, are often vague and, in many cases, have not been
interpreted by courts or regulatory agencies. These state laws and regulations
generally apply to services reimbursed by both governmental and private
payors. Violations of these federal and state laws and regulations may result
in prohibition of payment for services rendered, loss of licenses, fines,
criminal penalties and exclusion from governmental and private payor programs.
We have financial relationships with our pathologists, as defined by the
federal Stark Law, in the form of compensation arrangements, ownership of our
common stock and contingent promissory notes issued by us in connection with
acquisitions. While we believe that our financial relationships with
pathologists and referral practices are in material compliance with applicable
laws and regulations, government authorities might take a contrary position or
prohibited referrals may occur. We cannot be certain that pathologists who own
our capital stock or hold contingent promissory notes will not violate these
laws or that we will have knowledge of the identity of all beneficial owners
of our capital stock. If our financial relationships with pathologists were
found to be illegal, or if prohibited referrals were found to have been made,
we could be subject to civil and criminal penalties, including fines,
exclusion from participation in government and private payor programs and
requirements to refund amounts previously received from government and private
payors. In addition, expansion of our operations to new jurisdictions, or new
interpretations of laws in our existing jurisdictions, could require
structural and organizational modifications of our relationships with
physicians to comply with that jurisdiction's laws. Such structural and
organizational modifications could result in lower profitability and failure
to achieve our growth objectives.
41
Our business could be materially harmed by future interpretation or
implementation of state laws regarding prohibitions on fee-splitting.
Many states prohibit the splitting or sharing of fees between physicians and
non-physicians. These laws vary from state to state and are enforced by courts
and regulatory agencies, each with broad discretion. Some states have
interpreted management agreements between entities and physicians as unlawful
fee-splitting. We believe our arrangements with physicians comply in all
material respects with the fee-splitting laws of the states in which we
operate. Nevertheless, it is possible regulatory authorities or other parties
could claim we are engaged in fee-splitting. If such a claim were successfully
asserted in any jurisdiction, our pathologists could be subject to civil and
criminal penalties and we could be required to restructure our contractual and
other arrangements. Any restructuring of our contractual and other
arrangements with our operations could result in lower revenues, increased
expenses in the operations and reduced influence over the business decisions.
Alternatively, some of our existing contracts could be found to be illegal and
unenforceable, which could result in the termination of those contracts and an
associated loss of revenue. In addition, expansion of our operations to other
states with fee-splitting prohibitions may require structural and
organizational modification to the form of our current relationships. Any
modifications could result in less profitable relationships, less influence
over the business decisions and failure to achieve our growth objectives.
We could be hurt by future interpretation or implementation of state and
federal anti-trust laws.
In connection with the corporate practice of medicine laws, the operations
with which we are affiliated in some states are organized as separate legal
entities. As such, the separate legal entities may be deemed to be persons
separate both from us and from each other under the antitrust laws and,
accordingly, subject to a wide range of laws that prohibit anti-competitive
conduct among separate legal entities. In addition, we are seeking to acquire
or affiliate with established and reputable pathology organizations in new
geographic markets. While we believe that we are in material compliance with
these laws and intend to comply with any laws that may apply to our
development of integrated health care delivery networks, courts or regulatory
authorities could nevertheless take a contrary position or investigate our
business practices. If our business practices were found to violate these
laws, we could be required to pay substantial fines, penalties and damage
awards, or we could be required to restructure our business in a manner that
would materially reduce our profitability or impede our growth.
Our business could be harmed by future interpretation or implementation of the
Health Care Insurance Portability and Accountability Act.
The Health Care Insurance Portability and Accountability Act, or HIPAA,
created provisions that impose criminal penalties for fraud against any health
care benefit program, for theft or embezzlement involving health care and for
false statements in connection with the payment of any health benefits. The
HIPAA provisions apply not only to federal programs, but also to private
health benefit programs. HIPAA also broadened the authority of the OIG to
exclude participants from federal health care programs. Because of the
uncertainties as to how the HIPAA provisions will be enforced, we are
currently unable to predict their ultimate impact on us. Compliance with HIPAA
could cause us to modify our business operations in a manner that would
increase our operating costs or impede our growth. In addition, although we
are unaware of any current violations of HIPAA, if we were found to be in
violation of HIPAA, the government could seek penalties against us or seek to
exclude us from participation in government payor programs. Significant fines
could cause liquidity problems and adversely affect our results of operations.
Exclusion from participation in government payor programs, which represented
21% of collections for 2001, would eliminate an important source of revenue
and could materially adversely affect our business.
Federal and state regulation of the privacy, security and transmission of
health information could restrict our operations, impede the implementation of
our business strategies or cause us to incur significant costs.
The privacy, security and transmission of health information is subject to
federal and state laws and regulations, including HIPAA. Some of our
operations will be subject to HIPAA and its regulations. Because
42
HIPAA's privacy regulations do not supercede state laws that are more
stringent, we will have to comply both with the federal privacy regulations
under HIPAA and with any state privacy laws that are more stringent than
HIPAA. Our operations that are subject to HIPAA must be in compliance with
HIPAA's regulations by April 2003. Another set of regulations issued under
HIPAA establishes uniform standards relating to data reporting, formatting,
and coding that covered entities must use when conducting certain transactions
involving health information. The compliance date for these regulations is
October 2002. A third set of regulations, which have not yet been finalized,
will establish minimum security requirements to protect health information.
The HIPAA regulations could result in significant financial obligations for us
and will pose increased regulatory risk. The privacy regulations could limit
our use and disclosure of patient health information and could impede the
implementation of some of our business strategies, such as our genomics
initiatives. For example, the Department of Health and Human Services, or HHS,
has indicated that cells and tissues are not protected health information, but
that analyses of them are protected. HHS has stated that if a person provides
cells to a researcher and tells the researcher that the cells are an
identified individual's cancer cells, that accompanying statement is protected
health information. At this time, we are unable to determine the full impact
of the HIPAA regulations on our business and our business strategies or the
total cost of complying with the regulations, but the impact and the cost
could be significant. Many states have enacted, or indicated an intention to
enact, privacy laws similar to HIPAA. These state laws could also restrict our
operations, impede the implementation of our business strategies or cause us
to incur significant compliance costs. In addition, failure to comply with
federal or state privacy laws and regulations could subject us to civil or
criminal penalties.
We charge our clients on a fee-for-service basis, so we incur financial risk
related to collections as well as potentially long collection cycles when
seeking reimbursement from third-party payors.
Substantially all of our net revenues are derived from our operations'
charging for services on a fee-for-service basis. Accordingly, we assume the
financial risk related to collection, including the potential uncollectability
of accounts, long collection cycles for accounts receivable and delays
attendant to reimbursement by third-party payors, such as governmental
programs, private insurance plans and managed care organizations. Our
provision for doubtful accounts for the year ended December 31, 2001 was 11.5%
of net revenues, with net revenues from inpatient services having a provision
for doubtful accounts of approximately 19.0%. If our revenue from hospital-
based services increases as a percentage of our total net revenues, our
provision for doubtful accounts as a percentage of total net revenues may
increase. Increases in write-offs of doubtful accounts, delays in receiving
payments or potential retroactive adjustments and penalties resulting from
audits by payors may adversely affect our operating cash flow and liquidity,
require us to borrow funds to meet our current obligations, reduce our
profitability, impede our growth or otherwise materially adversely affect our
business.
We rely upon reimbursement from government programs for a significant portion
of our collections, and therefore our business would be harmed if
reimbursement rates from government programs decline.
We derived 21% of our collections in 2001 from payments made by government
sponsored health care programs, principally Medicare and Medicaid. These
programs are subject to substantial regulation by federal and state
governments. Any changes in reimbursement regulations, policies, practices,
interpretations or statutes that place limitations on reimbursement amounts or
change reimbursement coding practices could materially harm our business by
reducing revenues and lowering profitability. Increasing budgetary pressures
at both the federal and state levels and concerns over escalating costs of
health care have led, and may continue to lead, to significant reductions in
health care reimbursements. State concerns over the growth in Medicaid
expenditures also could result in significant payment reductions. Since these
programs generally reimburse on a fee schedule basis, rather than a charge-
related basis, we generally cannot increase net revenue by increasing the
amount charged for services provided. As a result, cost increases may not be
able to be recovered from government payors. In addition, Medicare, Medicaid
and other government health care programs are increasingly shifting to forms
of managed care, which generally offer lower reimbursement rates. Some states
have enacted legislation to require that all Medicaid patients be transitioned
to managed care organizations, which could result in reduced payments to us
for such patients. Similar legislation may be enacted in other states. In
addition, a state-legislated shift of Medicaid patients to a managed care
organization could cause us to lose some or all Medicaid business
43
in that state if we were not selected by the managed care organization as a
participating provider. Additionally, funds received under all health care
reimbursement programs are subject to audit with respect to the proper billing
for physician services and, accordingly, repayments and retroactive
adjustments of revenue from these programs could occur. We expect that there
will continue to be proposals to reduce or limit Medicare and Medicaid
reimbursements.
The continued growth of managed care may have a material adverse effect on our
business.
The number of individuals covered under managed care contracts or other
similar arrangements has grown over the past several years and may continue to
grow in the future and a substantial portion of our net revenue is from
reimbursement from managed care organizations. Entities providing managed care
coverage have been successful in reducing payments for medical services in
numerous ways, including entering into arrangements under which payments to a
service provider are capitated, limiting testing to specified procedures,
denying payment for services performed without prior authorization and
refusing to increase fees for specified services. These trends reduce
revenues, increase the cost of doing business and limit the ability to pass
cost increases on to customers. The continued growth of the managed care
industry and increased efforts to reduce payments to medical care providers
could materially harm our business.
There have been an increasing number of state and federal investigations of
hospitals and hospital laboratories, which may increase the likelihood of
investigations of our business practices.
Significant media and public attention has been focused on the health care
industry due to ongoing federal and state investigations reportedly related to
referral and billing practices, laboratory and home health care services and
physician ownership and joint ventures involving hospitals. Most notably,
HCA--The Healthcare Company, or HCA, is reportedly under investigation with
respect to such practices. We provide medical director services for numerous
hospital laboratories, including 31 HCA hospital laboratories as of December
31, 2001. Therefore, the government's ongoing investigation of HCA or other
hospital operators could result in governmental investigations of one or more
of our operations. In addition, the OIG and the Department of Justice have
initiated hospital laboratory billing review projects in certain states,
including some in which we operate, and are expected to extend such projects
to additional states, including states in which we operate. These projects
further increase the likelihood of governmental investigations of laboratories
that we own or operate. Although we monitor our billing practices and hospital
arrangements for compliance with prevailing industry practices under
applicable laws, such laws are complex and constantly evolving, and it is
possible that governmental investigators may take positions that are
inconsistent with our practices or industry practices. The government's
investigations of entities with which we contract may materially harm our
business, including termination or amendment of one or more of our contracts
or the sale of hospitals, potentially disrupting the performance of services
under our contracts. In addition, some indemnity insurers and other non-
governmental payors have sought repayment from providers, including
laboratories, for alleged overpayments.
The heightened scrutiny of Medicare and Medicaid billing practices in recent
years may increase the possibility that we will become subject to costly and
time-consuming lawsuits and investigations.
Payors periodically reevaluate the services for which they provide
reimbursement. In some cases, government payors such as Medicare also may seek
to recoup payments previously made for services determined not to be
reimbursable. Any such action by payors would adversely affect our revenues
and earnings. In addition, under the federal False Claims Act, any person
convicted of submitting false or fraudulent claims to the government may be
required to make significant payments, including damages and penalties in
addition to repayments of amounts not properly billed, and may be excluded
from participating in Medicare, Medicaid and other government health care
programs. Many states have similar false claims laws. The federal government
has become more aggressive in examining laboratory billing practices and
seeking repayments and penalties allegedly resulting from improper billing for
services, such as using an improper billing code for a test to realize higher
reimbursement. While the primary focus of this initiative has been on hospital
laboratories and on routine clinical chemistry tests, which comprise only a
portion of our revenues, the scope of this initiative could expand
44
and it is not possible to predict whether or in what direction the expansion
might occur. In addition, recent government enforcement efforts have asserted
poor quality of care as the basis for a false claims action. Private insurers
may also bring actions under false claims laws and, in some circumstances,
private whistleblowers may bring false claim suits on behalf of the
government. While we believe that our practices are proper and do not include
any allegedly improper practices now being examined, the government could take
a contrary position or could investigate our practices. Furthermore, HIPAA and
the joint federal and state anti-fraud initiative commenced in 1995 called
Operation Restore Trust have strengthened the powers of the OIG and increased
funding for Medicare and Medicaid audits and investigations. As a result, the
OIG is expanding the scope of its health care audits and investigations.
Federal and state audits and inspections, whether on a scheduled or
unannounced basis, are conducted from time to time at our facilities. If a
negative finding is made as a result of any such investigation, we could be
required to change coding practices, repay amounts paid for incorrect
practices, pay substantial penalties or cease participating in Medicare,
Medicaid and other government health care programs.
In August 2001, we received two letters from the United States Attorney for
the Southern District of Ohio (the "U.S. Attorney") requesting information
regarding billing practices and documentation of gross descriptions on skin
biopsy reports. We provided documentation to the U.S. Attorney regarding the
tests that were the subject of its requests for information. Requests for
information such as these are often the result of a qui tam, or whistleblower,
action filed by a private party relator. In February 2002, we received
notification that the U.S. Attorney would not pursue this matter any further.
In addition, we were notified that there were then no presently pending
lawsuits in the Southern District of Ohio against the Company relating to the
request by any private party relator bringing a qui tam action.
We derive a significant portion of our revenues from short-term hospital
contracts and hospital
relationships that can easily be terminated.
Many of our hospital contracts provide that the hospital or we may terminate
the agreement prior to the expiration of the initial or any renewal term with
relatively short notice and without cause. We also have business relationships
with hospitals that are not subject to written contracts and that may be
terminated by the hospitals at any time. Loss of any particular hospital
contract or relationship would not only result in a loss of net revenue to us
under that contract or relationship, but may also result in a loss of
outpatient net revenue that may be derived from our association with the
hospital and its medical staff. Any such loss could also result in an
impairment of the value of the assets we have acquired or may acquire,
requiring substantial charges to earnings. For example, during the fourth
quarter of 2000, we were unsuccessful in retaining a contract to perform
pathology services for a hospital in South Florida. Based upon the remaining
projected cash flow from this hospital network, we determined that the
intangible assets were impaired and recorded a pre-tax non-cash charge of
approximately $1.0 million. This hospital contract accounted for approximately
$800,000 of net revenue during 2000. Continuing consolidation in the hospital
industry may result in fewer hospitals or fewer laboratories as hospitals move
to combine their operations. Our contracts and relationships with hospitals
may be terminated or, in the case of contracts, may not be renewed as their
current terms expire.
Our business strategy emphasizes growth, which places significant demands on
our financial, operational and management resources and creates the risk of
failing to meet the growth expectations of investors.
Our growth strategy includes efforts to acquire and develop new practices,
develop and expand managed care and national clinical laboratory contracts and
develop new products, services, technologies and related alliances with third
parties. The pursuit of this growth strategy consumes capital resources,
thereby creating the financial risk that we will not realize an adequate
return on this investment. In addition, our growth may involve the acquisition
of companies, the development of products or services or the creation of
strategic alliances in areas in which we do not currently operate. This would
require our management to develop expertise in new areas, manage new business
relationships and attract new types of customers. The success of our growth
strategy
45
also depends on our ability to expand our physician and employee base and to
train, motivate and manage employees. The success or failure of our growth
strategy is difficult to predict. The failure to achieve our stated growth
objectives or the growth expectations of investors could disappoint investors
and harm our stock price. We may not be able to implement our growth strategy
successfully or to manage our expanded operations effectively and profitably.
We are pursuing business opportunities in new markets, such as genomics, which
adds uncertainty to our future results of operations and could divert
financial and management resources away from our core business.
As we pursue business opportunities in new markets, such as genomics, we
anticipate that significant investments and costs will be related to, and
future revenue may be derived from, products, services and alliances that do
not exist today or have not been marketed in sufficient quantities to measure
accurately market acceptance. Similarly, operating costs associated with new
business endeavors are difficult to predict with accuracy, thereby adding
further uncertainty to our future results of operations. We may experience
difficulties that could delay or prevent the successful development and
introduction of new products and services and such products and services may
not achieve market acceptance. Any failure by us to pursue new business
opportunities successfully could result in financial losses and could inhibit
our anticipated growth. In addition, the pursuit of new business endeavors
could divert financial and management resources away from our core business.
Ethical, social and legal issues concerning genomic research and testing may
result in regulations restricting the use of genomic testing or reduce the
demand for genomic testing products, which could impede our ability to achieve
our growth objectives.
Ethical, social and legal concerns about genomic testing and genomic
research could result in regulations restricting our or our customers'
activities or in only limited demand for those products. For example, the
potential availability of testing for some genomic predispositions to illness
has raised issues regarding the use and confidentiality of information
obtained from this testing. Some states in the United States have enacted
legislation restricting the use of information from some genomic testing, and
the United States Congress and some foreign governments are considering
similar legislation. The United States Food and Drug Administration, or FDA,
has subjected the commercialization of certain elements of genomic testing to
limited regulation. The federal Centers for Disease Control and Prevention has
published notice of its intent to revise the regulations under the Clinical
Laboratory Improvements Amendments, or CLIA, to specifically recognize and
regulate a genomic testing specialty. The Department of Health and Human
Services' Secretary's Advisory Committee on Genetic Testing advises the
Department of Health and Human Services as to various issues raised by the
development and use of genomic testing and has published preliminary
recommendations for increased participation on the part of the FDA and
increased regulation of genomic testing under CLIA. As a result of these
activities, it is likely that genomic testing will be subject to heightened
regulatory standards. Restrictions on our or our customers' use of genomic
information or testing products could impede our ability to broaden the range
of testing services we offer and to penetrate the genomic and genomic testing
markets.
If we are unable to make acquisitions in the future, our rate of growth could
slow.
Much of our historical growth has come from acquisitions, and we continue to
pursue growth through the acquisition and development of laboratories and
pathology operations. However, we may be unable to continue to identify and
complete suitable acquisitions at prices we are willing to pay or to obtain
the necessary financing on acceptable terms. In addition, as we become a
bigger company, the amount that acquired businesses contribute to our revenue
and profits will likely be smaller on a percentage basis. We compete with
other companies to identify and complete suitable acquisitions. We expect this
competition to intensify, making it more difficult to acquire suitable
companies on favorable terms. For example, we may be unable to accurately and
consistently identify operations whose pathologists have strong professional
reputations in their local medical communities. Further, we may acquire
operations whose pathologists' individual marketing and other sales efforts do
not produce a profitable customer base. As a result, the businesses we acquire
may not perform well enough to justify our investment.
46
We may raise additional capital, which could be difficult to obtain at
attractive prices and which could cause us to engage in financing transactions
that adversely affect our stock price.
We need capital for both internal growth and the acquisition and integration
of new practices, products and services. Therefore, we may raise additional
capital through public or private offerings of equity securities or debt
financings. Our issuance of additional equity securities could cause dilution
to holders of our common stock and may adversely affect the market price of
our common stock. The incurrence of additional debt could increase our
interest expense and other debt service obligations and could result in the
imposition of covenants that restrict our operational and financial
flexibility. Additional capital may not be available to us on commercially
reasonable terms or at all. The failure to raise additional needed capital
could impede the implementation of our operating and growth strategies.
The success of our growth strategy depends on our ability to adapt to new
markets and effectively integrate newly acquired operations.
Our expansion into new markets will require us to maintain and establish
payor and customer relationships and to convert the patient tracking and
financial reporting systems of new operations to our systems. Significant
delays or expenses with regard to this process could materially harm the
integration of additional operations and our profitability. The integration of
acquisitions also requires the implementation and centralization of
purchasing, accounting, sales and marketing, payroll, human resources,
management information systems, cash management, risk management and other
systems, which may be difficult, costly and time-consuming. Accordingly, our
operating results, particularly in fiscal quarters immediately following an
acquisition, may be adversely affected while we attempt to complete the
integration process. We may encounter significant unanticipated costs or other
problems associated with the future integration into our combined network. Our
expansion into new markets may require us to comply with present or future
laws and regulations that may differ from those to which we are currently
subject. Failure to meet these requirements could materially impede our growth
objectives or materially harm our business.
We may inherit significant liabilities from operations that we have acquired
or acquire in the future.
We perform due diligence investigations with respect to potential
liabilities of acquisitions and typically obtain indemnification with respect
to liabilities from the sellers. Nevertheless, undiscovered claims may arise
and liabilities for which we become responsible may be material and may exceed
either the limitations of any applicable indemnification provisions or the
financial resources of the indemnifying parties. Claims or liabilities of
acquired and affiliated operations may include matters involving compliance
with laws, including health care laws. While we believe, based on our due
diligence investigations, that the operations of our operations prior to their
acquisition were generally in compliance with applicable health care laws, it
is nevertheless possible that such operations were not in full compliance with
such laws and that we will become accountable for their non-compliance. We
have, from time to time, identified certain past practices of acquired
operations that do not conform to our standards. A violation of applicable
health care laws, whether or not the violation occurred prior to our
acquisition, could result in civil and criminal penalties, exclusion of the
physician, the operation or us from participation in Medicare and Medicaid
programs and loss of a physician's license to practice medicine. Significant
fines and other penalties could cause liquidity problems and adversely affect
our results of operations. Exclusion from participation in government payor
programs, which represented 21% of our collections in 2001, would eliminate an
important source of revenue and could materially harm our business.
We have significant contingent liabilities payable to many of the sellers of
practices that we have acquired.
In connection with our practice acquisitions, we typically agree to pay the
sellers additional consideration in the form of contingent debt obligations,
payment of which depends upon the practice achieving specified profitability
criteria over periods ranging from three to five years after the acquisition.
The amount of these contingent payments cannot be determined until the
contingency periods terminate and achievement of the profitability criteria is
determined. As of December 31, 2001, if the maximum criteria for the
contingency
47
payments with respect to all prior acquisitions were achieved, we would be
obligated to make payments, including principal and interest, of approximately
$150.0 million over the next three to five years. This amount could increase
significantly as we continue selectively to acquire new practices. Lesser
amounts would be paid if the maximum criteria were not met. Although we
believe we will be able to make such payments from internally generated funds
or proceeds of future borrowings, it is possible that such payments could
cause significant liquidity problems for us. We continue to use contingent
notes as partial consideration for acquisitions and affiliations.
We have recorded a significant amount of intangible assets, which may never be
realized.
Our acquisitions have resulted in significant increases in net identifiable
intangible assets and goodwill. Net identifiable intangible assets, which
include hospital contracts, physician client lists, management service
agreements and laboratory contracts acquired in acquisitions were
approximately $253.6 million at
December 31, 2001, representing approximately 42% of our total assets. Net
identifiable intangible assets are recorded at fair value on the date of
acquisition and are being amortized over periods ranging from 10 to 40 years.
Goodwill, which relates to the excess of cost over the fair value of net
assets of businesses acquired, was approximately $216.2 million at December
31, 2001, representing approximately 36% of our total assets. On an ongoing
basis, we make an evaluation to determine whether events and circumstances
indicate that all or a portion of the carrying value of intangible assets may
no longer be recoverable, in which case an additional charge to earnings may
be necessary. For example, during the years ended December 31, 2000 and 2001,
we recorded asset impairment charges to intangible assets in the amount of
$9.6 million and $3.8 million, respectively. We may not ever realize the full
value of our intangible assets. Any future determination requiring the write-
off of a significant portion of intangible assets could materially harm our
results of operations for the period in which the write-off occurs, which
could adversely affect our stock price.
Our business is highly dependent on the recruitment and retention of qualified
pathologists.
Our business is dependent upon recruiting and retaining pathologists,
particularly those with subspecialties, such as dermatopathology,
hematopathology, immunopathology and cytopathology. While we have been able to
recruit, principally through acquisitions, and retain pathologists, we may be
unable to continue to do so in the future as competition for the services of
pathologists increases. In addition, we may have to modify the economic terms
of our relationships with pathologists in order to enhance our recruitment and
retention efforts. Because it may not be possible to recover increased costs
through price increases, this could materially harm our profitability. The
relationship between the pathologists and their respective local medical
communities is important to the operation and continued profitability of each
practice. Loss of one of our pathologists for any reason could lead to the
loss of hospital contracts or other sources of revenue that depend on our
continuing relationship with that pathologist. Our revenues and earnings could
be adversely affected if a significant number of pathologists terminate their
relationships with our practices or become unable or unwilling to continue
their employment, or if a number of our non-competition agreements with
physicians are terminated or determined to be invalid or unenforceable. For
example, the two pathologists in our Birmingham, Alabama practice recently
terminated their employment with us and opened their own pathology lab. As a
result, we closed an operating lab in Alabama. We have implemented a strategy
to retain those customers and service them through other AmeriPath facilities,
including another lab recently acquired in Alabama. As of December 31, 2001,
we had been unable to retain these customers, and therefore recorded a non-
cash asset impairment charge of $3.8 million. We continue to aggressively
market in Alabama and expect to be successful in gaining some of these
customers back during 2002.
Enactment of proposals to reform the health care industry may restrict our
existing operations, impose additional requirements on us, limit our expansion
or increase our costs of regulatory compliance.
Federal and state governments periodically focus significant attention on
health care reform. It is not possible to predict which, if any, proposal will
be adopted. It is possible that the health care regulatory environment will
change so as to restrict our existing operations, impose additional
requirements on us or limit
48
our expansion. Costs of compliance with changes in government regulations may
not be subject to recovery through price increases.
Competition from other providers of pathology services may materially harm our
business.
Health care companies such as hospitals, national clinical laboratories,
third-party payors and health maintenance organizations may compete with us in
the employment of pathologists and the management of pathology practices. We
also expect to experience increasing competition in the provision of pathology
and cytology diagnostic services from other anatomic pathology practices,
companies in other health care industry segments, such as other hospital-based
specialties, national clinical laboratories, large physician group practices
or other pathology physician practice management companies. Some of our
competitors may have greater financial and other resources than we, which
could further intensify competition. Increasing competition may erode our
customer base, reduce our sources of revenue, cause us to reduce prices or
enter into a greater number of capitated contracts in which we take on greater
pricing risks or increase our marketing and other costs of doing business.
Increasing competition may also impede our growth objectives by making it more
difficult or more expensive for us to acquire or affiliate with additional
pathology practices.
We are subject to significant professional or other liability claims, and we
cannot assure you that insurance coverage will be available or sufficient to
cover such claims.
Our business entails an inherent risk of claims of physician professional
liability or other liability for acts or omissions of our physicians and
laboratory personnel or of hospital employees who are under the supervision of
our hospital-based pathologists. We and our physicians periodically become
involved as defendants in medical malpractice and other lawsuits, some of
which are currently ongoing, and are subject to the attendant risk of
substantial damage awards. While we believe that we have a prudent risk
management program, including professional liability and general liability
insurance coverage as well as agreements from third parties, such as hospitals
and national clinical laboratories, to indemnify or insure us, it is possible
that pending or future claims will not be covered by or will exceed the limits
of our risk management program, including the limits of our insurance coverage
or applicable indemnification provisions, or that third parties will fail or
otherwise be unable to comply with their obligations to us. While we believe
this practice is routine, in a number of pending claims our insurers have
reserved their rights to deny coverage. In addition, we are currently in a
dispute with our former medical malpractice carrier on an issue related to the
applicability of excess insurance coverage. If we do not prevail, a gap of
several months in our excess insurance coverage may exist for a period in
which significant claims have been made. It is also possible that the costs of
our insurance coverage will rise causing us either to incur additional costs
or to further limit the amount of coverage we have. In addition, our insurance
does not cover all potential liabilities arising from governmental fines and
penalties, indemnification agreements and certain other uninsurable losses.
For example, from time to time we agree to indemnify third parties, such as
hospitals and national clinical laboratories, for various claims that may not
be covered by insurance. As a result, we may become responsible for
substantial damage awards that are uninsured. We are currently subject to
indemnity claims which, if determined adversely to us, could result in
substantial uninsured losses.
The Company was recently notified by its medical malpractice carrier that
they will no longer be underwriting medical malpractice insurance and has
placed the Company on non-renewal status effective July 1, 2002. The Company
is currently evaluating other potential carriers for medical malpractice
coverage and conducting a feasibility study of a captive insurance company.
There can be no assurance the Company will be able to obtain medical
malpractice insurance on terms consistent with our current coverage, which may
increase our cost.
We depend on certain key executives, the loss of whom could disrupt our
operations, cause us to incur additional expenses and impede our ability to
expand our operations.
Our success is dependent upon the efforts and abilities of our key
management personnel, particularly James C. New, our Chairman and Chief
Executive Officer, Brian C. Carr, our President, Gregory A. Marsh, our Vice
President and Chief Financial Officer, and Dennis M. Smith, Jr., M.D., our
Executive Vice President of Genomic Strategies and Medical Director. It would
be costly, time-consuming and difficult to find suitable replacements
49
for these individuals. The need to find replacements combined with the
temporary loss of these key services could also materially disrupt our
operations and impede our growth by diverting management attention away from
our core business and growth strategies.
We depend on numerous complex information systems and any failure to
successfully maintain those systems or implement new systems could materially
harm our operations.
We depend upon numerous information systems to provide operational and
financial information on our operations, provide test reporting to physicians
and handle our complex billing operations. We currently have several major
information technology initiatives underway, including the integration of
information from our operations. No assurance can be given that we will be
able to enhance existing and/or implement new information systems that can
integrate successfully the disparate operational and financial information
systems of our operations. In addition to their integral role in helping our
operations realize operating efficiencies, such new systems are critical to
developing and implementing a comprehensive enterprise-wide management
information database. To develop such an integrated network, we must continue
to invest in and administer sophisticated management information systems. We
may experience unanticipated delays, complications and expenses in
implementing, integrating and operating such systems. Furthermore, our
information systems may require modifications, improvements or replacements as
we expand and as new technologies become available. Such modifications,
improvements or replacements may require substantial expenditures and may
require interruptions in operations during periods of implementation.
Moreover, implementation of such systems is subject to the availability of
information technology and skilled personnel to assist us in creating and
implementing the systems. The failure to successfully implement and maintain
operation, financial, test reports, billing and physician practice information
systems could substantially impede the implementation of our operating and
growth strategies and the realization of expected operating efficiencies.
Failure to timely or accurately bill for our services may have a substantial
negative impact on our
revenues, cash flow and bad debt expense.
Billing for laboratory testing services is complicated. The industry
practice of performing tests in advance of payment and without certainty as to
the outcome of the billing process may have a substantial negative impact on
our revenues, cash flow and bad debt expense. We bill various payors, such as
patients, insurance companies, Medicare, Medicaid, and national clinical
laboratories, all of which have different billing requirements. In addition,
the billing information requirements of the various payors have become
increasingly stringent, typically conditioning reimbursement to us on the
provision of proper medical necessity and diagnosis codes by the
requisitioning client. This complexity may increase our bad debt expense, due
primarily to several non-credit related issues such as missing or incorrect
billing information on test requisitions.
Among many other factors complicating our billing are:
. disputes between payors as to which party is responsible for payment;
. disparity in coverage among various payors; and
. the difficulty of adherence to specific compliance requirements, diagnosis
coding and procedures mandated by various payors.
The complexity of laboratory billing also tends to cause delays in our cash
collections. Confirming incorrect or missing billing information generally
slows down the billing process and increases the aging of accounts receivable.
We assume the financial risk related to collection, including the potential
uncollectability of accounts and delays due to incorrect and missing
information and the other complex factors identified above.
Disruption in New York City and in U.S. commercial activities generally
following the September 2001 terrorist attacks on the U.S. adversely impacted
and may continue to adversely impact our results of operations and could
adversely impact our ability to raise capital or our future growth.
50
The operations of our laboratories were and may continue to be harmed by
terrorist attacks on the U.S., like the one in New York City. For example,
transportation systems and couriers that we rely on to receive and process
specimens have been and may continue to be disrupted, thereby causing a
decrease in testing volumes and revenues. In addition, we may experience a
rise in operating costs, such as costs for transportation, courier services,
insurance and security. We also may experience delays in receiving payments
from payors that have been affected by attacks, which, in turn, would harm our
cash flow. The U.S. economy in general may be adversely affected by the
terrorist attacks or by any related outbreak of hostilities. Any such economic
downturn could adversely impact our results of operations, impair our ability
to raise capital or impede our ability to continue growing our business.
Our stock price is volatile and the value of your investment may decrease for
various reasons, including reasons that are unrelated to the performance of
our business.
There has been significant volatility in the market price of securities of
health care companies that often has been unrelated to the operating
performance of such companies. In fact, since January 1, 2000, our common
stock, which trades on the NASDAQ National Market, has traded from a low of
$7.00 per share to a high of $37.16 per share. We believe that various
factors, such as legislative and regulatory developments, investigations by
regulatory bodies or third-party payors, quarterly variations in our actual or
anticipated results of operations, lower revenues or earnings than those
anticipated by securities analysts, the overall economy and the financial
markets could cause the price of our common stock to fluctuate substantially.
For example, in the fourth quarter of 1998, our stock price declined
significantly as a result of an announcement by the government of its intent
to seek recovery of amounts allegedly improperly reimbursed to us under
Medicare. Although the claim was resolved to our satisfaction and resulted
only in a small fine, similar investigations may be announced having the same
effect on the market price of our stock. In addition, securities class action
claims have been brought against companies whose stock prices have been
volatile. Several such suits were brought against us, and subsequently
dismissed, as a result of the decline in our stock price described above. This
kind of litigation could be very costly and could divert our management's
attention and resources. Any adverse determination in this type of litigation
could also subject us to significant liabilities, any or all of which could
materially harm our liquidity and capital resources.
Certain provisions of our charter, by-laws and Delaware law may delay or
prevent a change of control of our company.
Our corporate documents and Delaware law contain provisions that may enable
our board of directors or management to resist a change of control of our
company. These provisions include a staggered board of directors, limitations
on persons authorized to call a special meeting of stockholders and advance
notice procedures required for stockholders to make nominations of candidates
for election as directors or to bring matters before an annual meeting of
stockholders. We also have a rights plan designed to make it more costly and
more difficult to gain control of our company. These anti-takeover defenses
could discourage, delay or prevent a change of control. These provisions could
also discourage proxy contests and make it more difficult for you and other
stockholders to elect directors and cause us to take other corporate actions.
In addition, the existence of these provisions, together with Delaware law,
might hinder or delay an attempted takeover other than through negotiations
with our board of directors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to market risk associated principally with changes in
interest rates. Interest rate exposure is principally limited to the amount
outstanding under the credit facility of $90.0 million at December 31, 2001.
Currently the balances outstanding under the credit facility are at floating
rates. Based on the outstanding balance of $90.0 million, each quarter point
increase or decrease in the floating rate changes interest expense by $225,000
per year. In the future, the Company may evaluate entering into interest rate
swaps, involving the exchange of floating for fixed rate interest payments, to
reduce interest rate volatility.
51
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA; INDEX TO CONSOLIDATED
FINANCIAL STATEMENTS
The Company's consolidated financial statements and financial statement
schedule and independent auditors' report thereon appear beginning on page F-
2. See index to such consolidated financial statements and schedules and
reports on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
52
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information required by this Item 10 will be contained in the section
entitled "Management" of the Company's definitive proxy materials to be filed
with the Securities and Exchange Commission and is incorporated in this Annual
Report on Form 10-K by this reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 will be contained in the section
entitled "Executive Compensation" of the Company's definitive proxy materials
to be filed with the Securities and Exchange Commission and is incorporated in
this Annual Report on Form 10-K by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 will be contained in the section
entitled "Beneficial Security Ownership" of the Company's definitive proxy
materials to be filed with the Securities and Exchange Commission and is
incorporated in this Annual Report on Form 10-K by this reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 will be contained in the section
entitled "Certain Transactions" of the Company's definitive proxy materials to
be filed with the Securities and Exchange Commission and is incorporated in
this Annual Report on Form 10-K by this reference.
53
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)1. Financial Statements:
Reference is made to the index set forth on page F-1 of this Annual Report
on Form 10-K.
2. Financial Statement Schedules:
Reference is made to the index set forth on page F-1 of this Annual Report
on Form 10-K.
3. Exhibits:
Exhibit
No. Description
------- -----------
2.1 Agreement and Plan of Merger by and among Ameripath, Inc. AMP Merger
Corp., and Pathology Consultants of America, Inc. (D/B/A Inform DX),
dated as of November 7, 2000 (1)
3.1 AmeriPath's Amended and Restated Bylaws (2)
3.2 AmeriPath's Certificate of Amendment to the Amended and Restated
Certificate of Incorporation (2)
4.1 Rights Agreement, dated as of April 8, 1999, between the Registrant
and American Stock Transfer & Trust Company, as Rights Agent including
the form of Certificate of Designations of Series A Junior
Participating Preferred Stock, the form of Rights Certificate, and the
form of Summary of Rights (3)
10.1 Amended and Restated 1996 Stock Option Plan (4)
10.2 2001 Stock Option Plan (5)
10.3 1996 Director Stock Option Plan (2)
10.4 Agreement for Professional Pathology Services between SmithKline
Beecham Clinical Laboratories, Inc. and Derrick and Associates
Pathology, P.A., dated April 1, 1992 (2)
10.5 Agreement for Medical Directorship between SmithKline Beecham Clinical
Laboratories, Inc. and Derrick and Associates Pathology, P.A., dated
April 1, 1992 (2)
10.6 Agreement for Professional Pathology Services between SmithKline
Beecham Clinical Laboratories, Inc. and AmeriPath Florida, Inc., dated
November 1, 1996 (2)
10.7 Form of Nonqualified Stock Option Agreement (2)
10.8 Amendment to Alan Levin, M.D. Employment Agreement, dated June 1, 2001
(6)
10.9 Amendment to Dennis M. Smith, Jr., M.D. Employment Agreement, dated
June 11, 2001 (6)
10.10 Employment Agreement, dated April 9, 2001, between AmeriPath and
Gregory A. Marsh (6)
10.11 Employment Agreement, dated April 9, 2001, between AmeriPath and
Stephen V. Fuller (6)
10.12 Employment Agreement, dated April 9, 2001, between AmeriPath and James
C. New (6)
10.13 Employment Agreement, dated April 9, 2001, between AmeriPath and James
Billington (6)
10.14 Employment Agreement, dated April 9, 2001, between AmeriPath and Brian
C. Carr (6)
10.15 Amendment to James Billington Employment Agreement, dated April 1,
2001 (6)
10.16 Amendment to Brian C. Carr Employment Agreement, dated April 1, 2001
(6)
10.17 Registration Rights Agreement, dated November 30, 2000, among the
Company and PCA's Shareholders and Warrant Holders (1)
10.18 Credit Agreement dated November 30, 2001 among AmeriPath, Inc.,
certain subsidiaries and affiliates of AmeriPath, Inc., and Bank of
America, N.A., First Union National Bank and certain other lenders (7)
21.1 Subsidiaries of AmeriPath (7)
23.1 Independent Auditors' Consent of Deloitte & Touche LLP (7)
23.2 Independent Auditors' Consent of Ernst & Young LLP (7)
54
- --------
(1) Incorporated by reference to the exhibit referenced and filed with
AmeriPath Annual Report on Form 10-K for the year ended December 31, 2000,
dated April 2, 2001.
(2) Incorporated by reference to the exhibit referenced and filed with the
AmeriPath Form S-1 (File No. 333-34265), effective October 21, 1997, and
the AmeriPath Form 8-A (File No. 000-22313), filed September 8, 1997.
(3) Incorporated by reference to the exhibit referenced and filed with
AmeriPath Form 8-K, dated April 8, 1999.
(4) Incorporated by reference to the Company's Proxy Statement for its 1999
Annual Meeting of Shareholders.
(5) Incorporated by reference to the Company's Proxy Statement for its 2001
Annual Meeting of Shareholders
(6) Incorporated by reference to the exhibit referenced and filed with
AmeriPath Form 10-Q for the quarter ended June 30, 2001 dated August 14,
2001.
(7) Filed herewith.
(b)Reports on Form 8-K
The Company did not file any reports on Form 8K during the last quarter of
2001.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in Riviera Beach,
Florida, on April 2, 2001.
AMERIPATH, INC.
/s/ James C. New
By___________________________________
James C. New,Chairman and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant in
the capacities and on the date indicated.
Signatures Title Date
/s/ James C. New Chairman and Chief April 2, 2002
- ------------------------------------- Executive Officer
James C. New and Director
/s/ Gregory A. Marsh Vice President, April 2, 2002
- ------------------------------------- Chief Financial
Gregory A. Marsh Officer and
Secretary
/s/ Brian C. Carr President and April 2, 2002
- ------------------------------------- Director
Brian C. Carr
/s/ E. Martin Gibson Director April 2, 2002
- -------------------------------------
E. Martin Gibson
/s/ C. Arnold Renschler, M.D. Director April 2, 2002
- -------------------------------------
C. Arnold Renschler, M.D.
/s/ Dennis M. Smith, Jr., M.D. Executive Vice April 2, 2002
- ------------------------------------- President of
Dennis M. Smith, Jr., M.D. Genomic Strategies
and Chief Medical
Officer and
Director
/s/ James T. Kelly Director April 2, 2002
- -------------------------------------
James T. Kelly
/s/ Haywood D. Cochrane, Director April 2, 2002
- -------------------------------------
Haywood D. Cochrane, Jr.
56
AMERIPATH, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Page
-----------
Independent Auditors' Reports..................................... F-2 to F-3
Consolidated Balance Sheets as of December 31, 2000 and 2001...... F-4
Consolidated Statements of Operations for the years ended December
31, 1999, 2000, and 2001......................................... F-5
Consolidated Statements of Redeemable Preferred Stock and Common
Stockholders' Equity for the years ended December 31, 1999, 2000,
and 2001......................................................... F-6
Consolidated Statements of Cash Flows for the years ended December
31, 1999, 2000, and 2001......................................... F-7
Notes to Consolidated Financial Statements........................ F-8 to F-34
All schedules called for by Regulation S-X have been omitted because they are
not applicable or because the required information is included in the financial
statements or the notes thereto.
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of AmeriPath, Inc.:
We have audited the consolidated balance sheets of AmeriPath, Inc. and
subsidiaries (the "Company") as of December 31, 2001 and 2000, and the related
consolidated statements of operations, of redeemable preferred stock and
common stockholders' equity, and of cash flows for each of the three years in
the period ended December 31, 2001. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on the financial statements based on our audits. The consolidated
financial statements give retroactive effect to the merger of AmeriPath, Inc.
and subsidiaries and Pathology Consultants of America, Inc. (d/b/a "Inform
DX"), which has been accounted for as a pooling of interests as described in
Note 3 to the consolidated financial statements. We did not audit the related
statements of operations, stockholders' equity, and cash flows of Inform DX
for the year ended December 31, 1999, which statements reflect total revenues
of $24,652,000 for the year ended December 31, 1999. Those statements were
audited by other auditors whose report has been furnished to us, and our
opinion, insofar as it relates to the amounts included for Inform DX for 1999,
is based solely on the report of such other auditors.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits and the report of the other auditors provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of the Company as of
December 31, 2001 and 2000, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States
of America.
As discussed in Note 2 to the consolidated financial statements, in 2001 the
Company changed its method of accounting for derivative instruments to conform
to Statement of Financial Accounting Standard No. 133.
/s/ DELOITTE & TOUCHE LLP
Certified Public Accountants
Miami, Florida
February 22, 2002
F-2
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Pathology Consultants of America, Inc. and Subsidiaries
We have audited the consolidated balance sheet of Pathology Consultants of
America, Inc. and subsidiaries as of December 31, 1999, and the related
consolidated statement of operations, stockholders' equity, and cash flow for
the year then ended (not presented separately herein). These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Pathology Consultants of America, Inc. and subsidiaries at
December 31, 1999, and the consolidated results of their operations and their
cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States.
/s/ Ernst & Young LLP
Certified Public Accountants
Nashville, Tennessee
March 24, 2000
F-3
AMERIPATH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
December 31,
-----------------
2000 2001
-------- --------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,418 $ 4,808
Accounts receivable, net 70,939 81,595
Inventories 1,406 1,892
Other current assets 11,446 15,780
-------- --------
Total current assets 86,209 104,075
-------- --------
PROPERTY AND EQUIPMENT, NET 23,580 24,118
-------- --------
OTHER ASSETS:
Goodwill, net 177,263 216,222
Identifiable intangibles, net 268,627 253,562
Other 6,487 6,485
-------- --------
Total other assets 452,377 476,269
-------- --------
TOTAL ASSETS $562,166 $604,462
======== ========
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 35,712 $ 42,876
Current portion of long-term debt 1,055 469
Other current liabilities 8,627 3,910
-------- --------
Total current liabilities 45,394 47,255
-------- --------
LONG-TERM LIABILITIES:
Revolving loan 197,216 90,000
Long-term debt, less current portion 3,476 2,853
Other liabilities 2,369 2,690
Deferred tax liability 64,046 62,474
-------- --------
Total long-term liabilities 267,107 158,017
-------- --------
COMMITMENTS AND CONTINGENCIES (Notes 3, 14 and 19)
COMMON STOCKHOLDERS' EQUITY
Common stock, $.01 par value, 60,000 shares authorized,
24,734 and 30,194 shares issued and outstanding
at December 31, 2000 and 2001, respectively 247 302
Additional paid-in capital 188,050 314,168
Retained earnings 61,368 84,720
-------- --------
Total common stockholders' equity 249,665 399,190
-------- --------
TOTAL LIABILITIES AND COMMON STOCKHOLDERS' EQUITY $562,166 $604,462
======== ========
See accompanying notes to consolidated financial statements.
F-4
AMERIPATH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Years Ended December 31,
----------------------------
1999 2000 2001
-------- -------- --------
NET REVENUE:
Net patient service revenue $233,269 $308,365 $387,384
Net management service revenue 24,163 21,729 31,348
-------- -------- --------
Total net revenues 257,432 330,094 418,732
-------- -------- --------
OPERATING COSTS AND EXPENSES:
COST OF SERVICES:
Net patient service revenue 108,408 146,426 178,760
Net management service revenue 14,277 16,964 21,342
-------- -------- --------
Total cost of services 122,685 163,390 200,102
Selling, general and administrative expenses 47,159 58,411 71,856
Provision for doubtful accounts 25,289 34,040 48,287
Amortization expense 12,827 16,172 18,659
Merger-related charges -- 6,209 7,103
Asset impairment and related charges -- 9,562 3,809
-------- -------- --------
Total operating costs and expenses 207,960 287,784 349,816
-------- -------- --------
INCOME FROM OPERATIONS 49,472 42,310 68,916
-------- -------- --------
OTHER INCOME (EXPENSE):
Interest expense (9,573) (15,376) (16,350)
Termination of interest rate swap agreement -- -- (10,386)
Other, net 286 226 145
-------- -------- --------
Total other expense (9,287) (15,150) (26,591)
-------- -------- --------
Income before income taxes and extraordinary
loss 40,185 27,160 42,325
Provision for income taxes 17,474 14,068 18,008
-------- -------- --------
INCOME BEFORE EXTRAORDINARY LOSS 22,711 13,092 24,317
Extraordinary loss, net of tax benefit -- -- (965)
-------- -------- --------
NET INCOME 22,711 13,092 23,352
Induced conversion and accretion of preferred
stock (131) (1,604) --
-------- -------- --------
NET INCOME AVAILABLE TO COMOMON STOCKHOLDERS $ 22,580 $ 11,488 $ 23,352
======== ======== ========
Basic Earnings Per Common Share:
Basic earnings per common share $ 1.03 $ 0.49 $ 0.90
======== ======== ========
Basic weighted average shares outstanding 21,984 23,473 25,974
======== ======== ========
Diluted Earnings Per Common Share:
Diluted earnings per common share $ 1.00 $ 0.47 $ 0.86
======== ======== ========
Diluted weighted average shares outstanding 22,516 24,237 27,049
======== ======== ========
See accompanying notes to consolidated financial statements.
F-5
AMERIPATH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED
STOCK AND COMMON STOCKHOLDERS' EQUITY
(IN THOUSANDS)
Redeemable
Preferred
Stock Common Stockholder's Equity
-------------- -----------------------------------------------
Common Stock Additional Other
------------- Paid-in Retained Comprehensive
Shares Amount Shares Amount Capital Earnings (Loss) Income
------ ------- ------ ------ ---------- -------- -------------
BALANCE, DECEMBER 31,
1998 395 $15,373 21,748 $217 $152,861 $27,300 $ --
Stock issued in
connection with
acquisitions -- -- 511 5 3,144 -- --
Exercise of options and
warrants -- -- 12 1 15 -- --
Tax benefit from stock
options -- -- -- -- 91 -- --
Accretion of redeemable
preferred stock -- 131 -- -- -- -- --
Net income -- -- -- -- -- 22,580 --
---- ------- ------ ---- -------- ------- ------
BALANCE, DECEMBER 31,
1999 395 15,504 22,271 223 156,111 49,880 --
Stock issued in
connection with
acquisitions -- -- 1,532 15 12,165 -- --
Exercise of options and
warrants -- -- 288 3 1,584 -- --
Tax benefit from stock
options -- -- -- -- 858 -- --
Accretion of redeemable
preferred stock -- 65 -- -- -- -- --
Redemption of preferred
stock (395) (15,569) 643 6 17,102 -- --
Lapse of warrant put
option -- -- -- -- 230 -- --
Net income -- -- -- -- -- 11,488 --
---- ------- ------ ---- -------- ------- ------
BALANCE, DECEMBER 31,
2000 -- -- 24,734 247 188,050 61,368 --
Stock issued in
connection with
acquisitions -- -- 114 1 2,152 -- --
Exercise of options and
warrants -- -- 582 6 3,421 -- --
Tax benefit from stock
options -- -- -- -- 3,971 -- --
Secondary offering 4,744 48 115,752 -- --
Contingent shares
issued 20 -- 822 -- --
Net income -- -- -- -- -- 23,352 --
Transition adjustment,
net of tax -- -- -- -- -- -- (3,000)
Change in fair value of
derivative financial
instruments, net of
tax -- -- -- -- -- -- (2,946)
Termination of swap
agreement, net of tax -- -- -- -- -- -- 5,946
---- ------- ------ ---- -------- ------- ------
BALANCE, DECEMBER 31,
2001 -- $ -- 30,194 $302 $314,168 $84,720 $ --
==== ======= ====== ==== ======== ======= ======
See accompanying notes to consolidated financial statements.
F-6
AMERIPATH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Years Ended December 31,
--------------------------
1999 2000 2001
------- ------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $22,711 $13,092 $ 23,352
Extraordinary item, net of tax -- -- 965
Adjustments to reconcile net income to net cash
flows provided by operating activities:
Depreciation and amortization 16,807 21,291 25,675
Loss on disposal of assets -- 22 110
Deferred income tax benefits (2,006) (9,117) (5,999)
Provision for doubtful accounts 25,289 34,040 48,287
Asset impairment and related charges -- 9,562 3,809
Accretion of put warrants 92 -- --
Merger-related charges -- 6,209 7,103
Termination of interest swap agreement -- -- 10,386
Changes in assets and liabilities (net of
effects of acquisitions):
Increase in accounts receivable (31,756) (40,008) (59,174)
Increase in inventories (39) (411) (486)
Decrease (increase) in other current assets 2,382 (265) 58
Increase in other assets (731) (1,638) (801)
Increase (decrease) in accounts payable and
accrued expenses (56) 2,958 881
Pooling merger-related charges paid -- (3,782) (6,139)
------- ------- --------
Net cash flows provided by operating
activities 32,693 31,953 48,027
------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (8,716) (9,235) (7,773)
Cash paid for acquisitions and acquisition
costs, net of cash acquired (51,643) (24,929) (5,045)
Merger-related charges paid (1,741) (2,414) (625)
Investment in Genomics Collaborative, Inc. -- (1,000) --
Decrease in restricted cash 229 -- --
Payments of contingent notes (17,440) (26,645) (36,101)
------- ------- --------
Net cash flows used in investing activities (79,311) (64,223) (49,544)
------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) under former credit
facility 44,713 31,416 (197,216)
Net borrowings under new credit facility -- -- 90,000
Principal payments on long-term debt and capital
leases (1,701) (818) (1,129)
Debt issuance costs (1,171) (82) (560)
Termination of interest swap agreement -- -- (10,386)
Tax benefit from stock options 91 858 3,971
Proceeds from secondary offering -- -- 115,800
Proceeds from exercise of stock option and
warrants 16 1,587 3,427
Other -- 14 --
------- ------- --------
Net cash flows provided by financing
activities 41,948 32,975 3,907
------- ------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (4,670) 705 2,390
------- ------- --------
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 6,383 1,713 2,418
------- ------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,713 $ 2,418 $ 4,808
======= ======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Contingent stock issued $ -- $ -- $ 822
Cash paid during the period for:
Interest $ 8,924 $14,645 $ 17,295
Income taxes $15,890 $23,798 $ 21,001
See accompanying notes to consolidated statements.
F-7
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. Business and Organization
AmeriPath, Inc. and its subsidiaries ("AmeriPath" or the "Company") was
incorporated in February 1996 to be the largest integrated physician group
practice focused on anatomic pathology diagnostic services, based on an
analysis of geographic breadth, number of physicians, number of hospital
contracts, number of practices and net revenues. On November 30, 2000, the
Company acquired Pathology Consultants of America, Inc., d/b/a Inform DX
("Inform DX"). In connection with the acquisition, the Company issued
approximately 2.6 million shares of common stock in exchange for all the
outstanding common stock of Inform DX. In addition, the Company assumed
certain obligations to issue shares of common stock pursuant to outstanding
Inform DX stock option plans. This transaction was accounted for as a pooling
of interests. All prior years information has been restated to reflect the
acquisition of Inform DX.
Anatomic and clinical pathology diagnostic services are provided under
contractual arrangements with hospitals and in free-standing, independent
laboratory settings. The contractual arrangements with hospitals vary, but
essentially provide that, in exchange for physician representatives of the
Company serving as the medical director of a hospital's anatomic and clinical
laboratory operations, the Company is able to bill and collect the
professional component of the charges for medical services rendered by the
Company's pathologists. In some cases, the Company is also paid an annual fee
for providing the medical director for the hospital's clinical laboratory. The
Company also owns and operates outpatient pathology laboratories, for which it
bills patients and third party payors, principally on a fee-for-service basis,
covering both the professional and technical components of such services. In
addition, the Company contracts directly with national clinical laboratories,
principally on a fee-for-service basis.
The Company operates using either an ownership or employment model or a
management or equity model. Under management or equity model, the Company
acquires certain assets of and operates pathology practices under long-term
service agreements with affiliated physician groups (the "Managed
Operations"). The Company provides facilities and equipment as well as
administrative and technical support for the affiliated physician groups under
service agreements. Through its ownership or employment model, the Company
acquires a controlling equity interest in the pathology practice (the "Owned
Operations").
Corporate practice of medicine restrictions generally prohibit corporate
entities from employing or otherwise exercising control over physicians. In
states that do not prohibit a for-profit corporation from employing physicians
such as Florida, Alabama, Mississippi and Kentucky, AmeriPath operates its
Owned Practices through Practice Subsidiaries, which are subsidiary
corporations of AmeriPath that directly employ the physicians. In states that
prohibit a for-profit corporation from employing physicians, such as Texas,
Indiana, Ohio, North Carolina, Michigan, Wisconsin, New York and Pennsylvania,
AmeriPath operates each Owned Practice through a Manager Subsidiary, which is
a subsidiary of AmeriPath that has a long-term management agreement with the
applicable PA Contractor, which in turn employs the physicians. In many cases,
several Practices are included within or organized under a single Practice
Subsidiary or PA Contractor, as the case may be.
Owned Operations. Owned operations are operated through Manager and
Practice Subsidiaries. The Manager and Practice Subsidiaries are wholly-owned
subsidiaries of AmeriPath and the officers and directors of such companies are
generally members of AmeriPath's executive management team. The financial
statements of the Manager and Practice Subsidiaries are included in the
consolidated financial statements of AmeriPath.
Ownership and Management of the PA Contractors. The PA Contractors are
entities which have contractual relationships with the Company but are not
owned directly by AmeriPath. These entities can be a professional corporation
or professional association, as permitted and defined in various state
statutes. The PA
F-8
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
Contractors operating in North Carolina, Wisconsin, New York, Michigan and
Pennsylvania are owned by physicians affiliated with AmeriPath. To the extent
permitted by law, the officers and directors of the PA Contractors are members
of AmeriPath's executive management team. However, in states where law
prohibits such non-licensed physician personnel from serving as an officer or
director of a PA Contractor, eligible affiliated physicians serve in such
positions. The affiliated physicians who own PA Contractors have entered into
agreements with AmeriPath that generally (i) prohibit such affiliated
physicians from transferring their ownership interests in the PA Contractor,
except in very limited circumstances and (ii) require such affiliated
physicians to transfer their ownership in the PA Contractor to designees of
AmeriPath upon the occurrence of specified events.
The PA Contractors in Ohio and Indiana are owned by trusts. The beneficiary
of such trusts is AmeriPath and the Trustees of such trusts are affiliated
physicians. The PA Contractors operating in Texas are organized as not-for-
profit 5.01(a) corporations. The sole member of the not-for-profit PA
Contractors in Texas is AmeriPath.
Each PA Contractor is party to a long-term management agreement with one of
the Company's Manager Subsidiaries. Under the terms of these management
agreements, AmeriPath generally provides all non-medical and administrative
support services to the practices including accounting and financial
reporting, human resources, payroll, billing, and employee benefits
administration. In addition, the management agreements give the Manager
Subsidiaries certain rights with respect to the management of the non-medical
operations of the PA Contractors. The management agreements require the PA
Contractors to pay a management fee to the applicable Manager Subsidiaries.
The fee structure is different for each Practice based upon various factors,
including applicable law, and includes fees based on a percentage of earnings,
performance-based fees, and flat fees that are adjusted from time to time.
In accordance with Emerging Issues Task Force 97-2:"Application of FASB
Statement No. 94 and APB Opinion No. 16 to Physician Practice Management
Entities and Certain Other Entities with Contractual Management Agreements"
("EITF 97-2"), the financial statements of the PA Contractors are included in
the consolidated financial statements of AmeriPath since AmeriPath has a
controlling interest in the PA Contractor.
Managed Operations. The term Managed Operations refers to AmeriPath's
operation and management of pathology practices under long-term service
agreements with affiliated physician groups. Generally, the Company acquires
the practice's assets, and the physician groups maintain their separate
corporate or partnership entities and enter into employment and noncompete
agreements with the practicing physicians. Costs of obtaining service
agreements are amortized using the straight-line method over 25 years.
Service agreements represent the exclusive right to operate the Company's
practices in affiliation with the related physician groups during the term of
the agreements. Pursuant to the service agreements, the Company provides the
physician groups with equipment, supplies, support personnel, and management
and financial advisory services. Physician groups are responsible for the
recruitment and hiring of physicians and all other personnel who provide
pathological services, and for all issues related to the professional,
clinical and ethical aspects of the practice. As part of the service
agreements, physician groups are required to maintain medical malpractice
insurance which names the Company as an additional insured. The Company is
also required to maintain general liability insurance and name the physician
groups as additional insureds. Upon termination of the service agreements, the
respective physician groups are required to obtain continuing liability
insurance coverage under either a "tail policy" or a "prior acts policy."
The management services fees charged under the service agreements are based
on a predetermined percentage of net operating income of the Managed
Practices. Management service revenue is recognized by the Company at the time
physician service revenue is recorded by the physician group. The Company also
F-9
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
participates to varying degrees in non-physician revenues generated from
ancillary services offered through the laboratories. The Company charges a
capital fee for the use of depreciable assets owned by the Company and
recognizes revenue for all practice expenses that are paid on behalf of the
practices. Practice expenses exclude the salaries and benefits of the
physicians.
2. Summary of Significant Accounting Policies
A summary of significant accounting policies followed by the Company is as
follows:
Principles of Consolidation
The consolidated financial statements of the Company include the accounts of
AmeriPath, Inc., its wholly-owned subsidiaries, and companies in which the
Company has the controlling financial interest by means other than the direct
record ownership of voting stock, as discussed in Note 1. Intercompany
accounts and transactions have been eliminated. The Company does not
consolidate the affiliated physician groups it manages as it does not have
controlling financial interest as described in EITF 97-2.
Accounting Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States ("generally
accepted accounting principles") requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue
and expenses. Because of the inherent uncertainties in this process, actual
results could differ from those estimates. Such estimates include the
recoverability of intangible assets and the collectibility of receivables.
Fair Value of Financial Instruments
The Company's financial instruments consist mainly of cash and cash
equivalents, accounts receivable, accounts payable and the credit facility.
The carrying amounts of the Company's cash and cash equivalents, accounts
receivable and accounts payable approximate fair value due to the short-term
nature of these instruments.
At December 31, 2000, approximately $197.2 million of the credit facility
bears interest at a variable market rate, and thus, has a carrying amount that
approximates fair value. Of the credit facility, $105.0 million was subject to
interest rate swaps as described in Note 13. The estimated fair value of the
interest rate swaps, which is the amount necessary to unwind the swaps, was
approximately ($5.0 million) as of December 31, 2000. The interest rate swaps
were terminated in November 2001 in connection with the termination of the
former credit facility (see Note 12).
At December 31, 2001, the entire $90.0 million outstanding under the new
credit facility bears interest at a variable market rate, and thus has a
carrying amount that approximates fair value.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid instruments with maturities at the
time of purchase of three months or less. Included in cash and cash
equivalents at December 31, 2001 was $1.6 million of restricted cash used as
collateral under certain letters of credit.
Inventories
Inventories, consisting primarily of laboratory supplies, are stated at the
lower of cost, determined on a first-in-first-out basis, or market.
F-10
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
Property and Equipment
Property and equipment are stated at cost. Routine maintenance and repairs
are charged to expense as incurred, while cost of betterments and renewals are
capitalized.
Depreciation and amortization are calculated on a straight-line basis and
accelerated methods, over the estimated useful lives of the respective assets
which lives range from 3 to 7 years. Leasehold improvements are amortized over
the shorter of the term of the related lease, including renewal options, or
the useful life of the asset.
Intangible Assets
The allocation of the purchase price of the 2001 acquisition is preliminary,
while the Company continues to obtain the information necessary to determine
the fair value of the assets acquired and liabilities assumed. When the
Company obtains final information, management believes that adjustments, if
any, will not be material in relation to the consolidated financial
statements.
Identifiable intangible assets include hospital contracts, physician
referral lists and laboratory contracts acquired in connection with
acquisitions. Such assets are recorded at fair value on the date of
acquisition as determined by management and are being amortized over the
estimated periods to be benefited, ranging from 10 to 40 years. In determining
these lives the Company considered each practice's operating history, contract
renewals, stability of physician referral lists and industry statistics.
Goodwill relates to the excess of cost over the fair value of net assets of
the businesses acquired. The amortization periods for goodwill were determined
by the Company with consideration given to the lives assigned to the
identifiable intangibles, the reputation of the practice, the length of the
practice's operating history, and the potential of the market in which the
acquired practice is located. Amortization is calculated on a straight line
basis over periods ranging from 10 to 35 years.
The Company has entered into a management service agreement with each of the
physician groups of the Managed Practices for a period up to 40 years. Upon
the Company's acquisition of the practice's assets, the physician groups
maintain their separate corporate or partnership entities and enter into
employment and noncompete agreements with the practicing physicians. Costs of
obtaining these management service agreements are amortized using the
straight-line method over 25 years.
Management assesses on an ongoing basis if there has been an impairment in
the carrying value of its intangible assets. If the undiscounted future cash
flows over the remaining amortization period of the respective intangible
asset indicates that the value assigned to the intangible asset may not be
recoverable, the carrying value of the respective intangible asset will be
reduced. The amount of any such impairment would be determined by comparing
anticipated discounted future cash flows from acquired businesses with the
carrying value of the related assets. In performing this analysis, management
considers such factors as current results, trends and future prospects, in
addition to other relevant factors.
Deferred Debt Issuance Costs
The Company incurred costs in connection with bank financing. These costs
have been capitalized and are being amortized on a straight-line basis, which
approximates the interest method, over the five-year term. Such amounts are
included in other assets in the consolidated balance sheets.
Revenue Recognition
The Company recognizes net patient service revenue at the time services are
performed. Unbilled receivables are recorded for services rendered during, but
billed subsequent to, the reporting period. Net patient
F-11
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
service revenue is reported at the estimated realizable amounts from patients,
third-party payors and others for services rendered. Revenue under certain
third-party payor agreements is subject to audit and retroactive adjustments.
Provision for estimated third-party payor settlements and adjustments are
estimated in the period the related services are rendered and adjusted in
future periods as final settlements are determined. The provision and the
related allowance are adjusted periodically, based upon an evaluation of
historical collection experience with specific payors for particular services,
anticipated collection levels with specific payors for new services, industry
reimbursement trends, and other relevant factors. Changes in these factors in
future periods could result in increases or decreases in the provision for
doubtful accounts and the results of operations and financial position.
Unbilled receivables for the Owned Practices, net of allowances, as of
December 31, 2000 and 2001 amounted to approximately $8.6 million and $8.3
million, respectively.
Net management service revenue reported by the Company represents net
physician group revenue less amounts retained by physician groups. The amounts
retained by physician groups represent amounts paid to the physicians pursuant
to the management service agreements between the Company and the physician
groups. Net physician group revenue is equal to billed charges reduced by
provisions for bad debt and contractual adjustments. Contractual adjustments
represent the difference between amounts billed and amounts reimbursable by
commercial insurers and other third-party payors pursuant to their respective
contracts with the physician groups. The provision for bad debts represents
management's estimate of potential credit issues associated with amounts due
from patients, commercial insurers, and other third-party payors.
Stock Options
In October 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123 "Accounting for
Stock-Based Compensation" ("SFAS 123"), which requires companies to either
recognize expense for stock-based awards based on their fair value on the date
of grant or provide footnote disclosures regarding the impact of such changes.
The Company adopted the disclosure provisions of SFAS 123, but has continued
to account for options issued to employees or directors under the Company's
stock option plans in accordance with Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25").
Income Taxes
The Company's provision for income taxes includes federal and state income
taxes currently payable and changes in deferred tax assets and liabilities,
excluding the establishment of deferred tax assets and liabilities related to
acquisitions. Deferred income taxes are accounted for in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for
Income Taxes ("SFAS 109") and represent the estimated future tax effects
resulting from temporary differences between financial statement carrying
values and tax reporting bases of assets and liabilities. In addition, future
tax benefits, such as net operating loss ("NOL") carryforwards, are required
to be recognized to the extent that realization of such benefits is more
likely than not. A valuation allowance is established for those benefits that
do not meet the more likely than not criteria. A valuation allowance has been
established for $5.5 million of the net deferred tax assets at December 31,
2001 due to the uncertainty regarding the Company's ability to utilize the
acquired net operating loss carryforwards of Inform DX due to Internal Revenue
Code limitations.
Segment Reporting
The Company has two reportable segments, Owned Practices and Managed
Practices, based upon management reporting and the consolidated reporting
structure.
F-12
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
Comprehensive Income
The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" ("SFAS 130"), which requires the Company to
report and display certain information related to comprehensive income. As of
December 31, 1999, 2000 and 2001 net income equaled comprehensive income.
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
("SFAS 133") and in June 1999, the FASB issued Statement of Financial
Accounting Standards No. 137 "Accounting for Derivative Instruments and
Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133,"
("SFAS 137") which delayed the effective date the Company is required to adopt
SFAS 133 until its fiscal year 2001. In June 2000, the FASB issued Statement
of Financial Accounting Standards No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities--an Amendment to FASB Statement No.
133" ("SFAS 138") This statement amended certain provisions of SFAS 133. The
Company adopted SFAS 133 effective January 1, 2001. SFAS 133 requires the
Company to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of derivatives will either be offset against the change in fair
value of the hedged assets, liabilities, or firm commitments through earnings
or recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change in
fair value will be immediately recognized in earnings. The Company does not
enter into derivative financial instruments for trading purposes.
In September 2000, the FASB issued Statement of Financial Accounting
Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities" ("SFAS 140"). SFAS 140 is a replacement of
Statement of Financial Accounting Standards No. 125. SFAS 140 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishment of liabilities occurring after March 31, 2001. The
Company has evaluated this standard and has concluded that the provisions of
SFAS 140 will not have a significant effect on the financial condition or
results of operations of the Company.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 141, "Business Combinations" ("SFAS 141"). SFAS 141 requires the purchase
method of accounting for business combinations initiated after June 30, 2001
and eliminates the pooling-of-interests method. The Company does not believe
that the adoption of SFAS 141 will have a significant impact on its financial
statements.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which became
effective January 1, 2002. SFAS 142 requires, among other things, the
discontinuance of goodwill amortization. In addition, the standard includes
provisions for the reclassification of certain existing recognized intangibles
as goodwill, reassessment of the useful lives of existing recognized
intangibles, reclassification of certain intangibles out of previously
reported goodwill and the identification of reporting units for purposes of
assessing potential future impairments of goodwill. SFAS 142 also requires the
Company to complete a transitional goodwill impairment test six months from
the date of adoption. The Company is currently assessing but has not yet
determined the impact of SFAS 142 on its financial position and results of
operations. For the year ending December 31, 2001, goodwill amortization was
approximately $7.4 million. Based on the Company's preliminary assessment of
SFAS 142, the Company expects this amortization to no longer be recorded in
future periods. In addition, due to the fact that a portion of this goodwill
was not tax deductible, the effective tax rate was greater than the statutory
rate. The elimination of the goodwill amortization, including nondeductible
goodwill amortization, from future periods should result in a 1% to 2%
reduction in the effective tax rate.
F-13
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143
addresses financial accounting and reporting for obligations associated with
the retirement of tangible long-lived assets and the associated asset
retirement costs. It applies to legal obligations associated with the
retirement of long-lived assets that result from the acquisition,
construction, development, and (or) the normal operation of a long-lived
asset, except for certain obligations of lessees. The provisions of SFAS 143
will be effective for fiscal years beginning after June 15, 2002; however
early application is permitted. The Company is currently evaluating the
implications of adoption of SFAS 143 on its financial statements.
In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
("SFAS 144"). SFAS 144 provides accounting guidance for financial accounting
and reporting for impairment or disposal of long-lived assets. SFAS 144
supersedes SFAS 121. SFAS 144 is effective for the Company in fiscal 2002.
Management does not currently believe that the implementation of SFAS 144 will
have a material impact on the Company's financial condition or results of
operations.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 2001
presentation.
3. Merger and Acquisitions
Acquired Practices: Pooling method
On November 30, 2000, the Company completed a merger transaction with Inform
DX that was accounted for as a pooling-of-interests transaction. The Company
issued 2.6 million common stock shares to Inform DX stockholders and Inform
DX's outstanding stock options were converted into options to purchase
approximately 170,000 AmeriPath common shares. The historical consolidated
financial statements for periods prior to the consummation of the combination
are restated as though the companies had been combined during such periods.
The table below presents a reconciliation of total revenue and net income
available to common stockholders as reported in the accompanying consolidated
financial statements with those previously reported by the Company.
Combining
AmeriPath Inform DX Adjustments (A) Combined
--------- --------- --------------- --------
ELEVEN MONTHS ENDED NOVEMBER 30,
2000
Total revenue $269,865 $ 34,329 -- $304,194
======== ======== ===== ========
Net income (loss) $ 20,514 $ (6,250) -- $ 14,264
======== ======== ===== ========
YEAR ENDED DECEMBER 31, 1999
Total revenue $232,753 $ 24,652 $ 27 $257,432
======== ======== ===== ========
Net income (loss) $ 22,969 $ (31) $(358) $ 22,580
======== ======== ===== ========
- --------
(A) The provision for income taxes has been adjusted by $358,000 in 1999, to
reflect the recordation of acquired net operating loss carry forwards,
related valuation allowances and other various timing differences of
Inform DX in accordance with SFAS No. 109. In addition, certain
reclassifications totaling $27,000 were made to conform to the current
year presentation.
F-14
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
Acquired Practices: Purchase method
During 2001, the Company acquired one anatomic pathology practice. The total
consideration paid by the Company in connection with this acquisition, which
is deemed immaterial, included cash, issuance of common stock and subordinated
debt. In addition, the Company issued additional purchase price consideration
in the form of contingent notes. During 2000, the Company acquired nine
anatomic pathology practices, including the two practices acquired by Inform
DX. The total consideration paid by the Company in connection with these
acquisitions included cash of $32.5 million, 1.5 million shares of common
stock (aggregate value of $12.2 million based upon amounts recorded on the
Company's consolidated financial statements) and subordinated debt of $2.8
million. In addition, the Company issued additional purchase price
consideration in the form of contingent notes.
During the year ended December 31, 2001, the Company made contingent note
payments of $36.1 million, issued $.8 million of contingent stock, and made
other purchase price adjustments of $.6 million in connection with certain
post-closing adjustments and acquisition costs. During the year ended December
31, 2000, the Company made contingent note payments of $26.6 million and other
purchase price adjustments of approximately $2.9 million in connection with
certain post-closing adjustments and acquisition costs.
The acquisitions have been accounted for using the purchase method of
accounting, except for the Inform DX acquisition. The aggregate consideration
paid, and to be paid, is based on a number of factors, including each
practice's demographics, size, local prominence, position in the marketplace
and historical cash flows from operations. Assessment of these and other
factors, including uncertainties regarding the health care environment,
resulted in the sellers of each of the practices and the Company being unable
to reach agreement on the final purchase price. The Company agreed to pay a
minimum purchase price and to pay additional purchase price consideration to
the sellers of the practices in proportion to their respective ownership
interest in each practice. The additional payments are contingent upon the
achievement of stipulated levels of operating earnings (as defined) by each of
the practices over periods of three to five years from the date of the
acquisition as set forth in the respective agreements, and are not contingent
on the continued employment of the sellers of the practices. In certain cases,
the payments are contingent upon other factors such as the retention of
certain hospital contracts for periods ranging from three to five years. The
amount of the payments cannot be determined until the achievement of the
operating earnings levels or other factors during the terms of the respective
agreements. If the maximum specified levels of operating earnings for each
practice are achieved, the Company would make aggregate maximum payments,
including principal and interest, of approximately $150.0 million over the
next three to five years. At the mid-point level, the aggregate principal and
interest would be approximately $77.0 over the next three to five years. A
lesser amount or no payments at all would be made if the mid-point levels of
operating earnings specified in each agreement were not met. Through December
31, 2001, the Company has made contingent note payments aggregating $89.1
million, which represents 66% of the maximum amount available. Additional
payments are accounted for as additional purchase price, which increases the
recorded goodwill.
The accompanying consolidated financial statements include the results of
operations of the acquisitions from the date acquired through December 31,
2001. The following unaudited pro forma information presents the consolidated
results of the Company's operations and the results of operations of the 2000
acquisitions for the year ended December 31, 2000 after giving effect to
amortization of goodwill and identifiable intangible assets, interest expense
on long-term debt incurred in connection with these acquisitions, and the
reduced level of certain specific operating expenses (primarily compensation
and related expenses attributable to former owners) as if the acquisitions had
been consummated on January 1, 2000. Pro-forma information for the year 2001
has not
F-15
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
been calculated due to the immateriality of the one acquisition. Such
unaudited pro forma information is based on historical financial information
with respect to the 2000 acquisitions and does not include operational or
other changes which might have been effected by the Company.
The unaudited pro forma information for the year ended December 31, 2000
presented below is for illustrative information purposes only and is not
necessarily indicative of results which would have been achieved or results
which may be achieved in the future.
Pro Forma
December 31,
------------
2000
------------
Net revenues $357,638
Net income available to common stockholders $ 15,849
--------
Net income per share available to common stockholders (diluted) $ 0.62
========
4. Accounts Receivable
Accounts receivable are recorded at net realizable value. The allowance for
contractual and other adjustments and uncollectible accounts is based on
historical experience and judgments about future events. Accordingly, the
actual amounts experienced could vary significantly from the recorded
allowances. For Managed Practices, terms of the service agreements require the
Company to purchase receivables generated by the physician groups on a monthly
basis. Such amounts are recorded net of contractual allowances and estimated
bad debts. For Managed Practices, accounts receivable are a function of the
net physician group revenue rather than the net revenue of the Company.
Accounts receivable consisted of the following:
December 31,
------------------
2000 2001
-------- --------
Gross accounts receivable $166,873 $185,618
Less: Allowance for contractual and other adjustments (54,840) (58,712)
Allowance for uncollectible accounts (41,094) (45,311)
-------- --------
Accounts receivable, net $ 70,939 $ 81,595
======== ========
The following table represents the rollforward of the allowances for
contractual adjustments and uncollectible accounts:
Years Ended December 31,
-----------------------------
1999 2000 2001
-------- -------- ---------
Beginning allowance for contractual adjustments
and uncollectible accounts $ 62,512 $ 73,003 $ 95,934
Provision for contractual adjustments 128,585 173,873 236,821
Provision for doubtful accounts 25,289 34,040 48,287
Managed Practice contractual adjustments and
bad debt expense 41,712 44,849 46,428
Write-offs and other adjustments (185,095) (229,831) (323,447)
-------- -------- ---------
Ending allowance for contractual adjustments
and uncollectible accounts $ 73,003 $ 95,934 $ 104,023
======== ======== =========
F-16
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The Company grants credit without collateral to individual patients, most of
whom are insured under third-party payor agreements. The estimated mix of
receivables from patients and third-party payors are as follows:
December
31,
------------
2000 2001
----- -----
Government programs 17.8% 12.9%
Third-party payors 53.3 51.4
Private pay patients 23.8 26.2
Other 5.1 9.5
----- -----
100.0% 100.0%
===== =====
5. Net Revenue
Net patient service revenue consisted of the following:
Years Ended December 31,
-----------------------------
1999 2000 2001
--------- -------- --------
Gross revenue $ 361,854 $482,238 $624,205
Less contractual and other adjustments (128,585) (173,873) (236,821)
--------- -------- --------
Net patient service revenue $ 233,269 $308,365 $387,384
========= ======== ========
Net management service revenue consisted of the following:
Years Ended December 31,
-----------------------------
1999 2000 2001
--------- -------- --------
Gross physician group revenue $ 85,379 $ 86,203 $ 99,338
Contractual adjustments and bad debt expense (41,712) (44,849) (46,428)
--------- -------- --------
Net physician group revenue 43,667 41,354 52,910
Less amounts retained by physician groups (19,504) (19,625) (21,562)
--------- -------- --------
Net management service revenue $ 24,163 $ 21,729 $ 31,348
========= ======== ========
A significant portion of the Company's net revenue is generated by the
hospital-based practices through contracts with various hospitals. HCA--The
Healthcare Company ("HCA") owned approximately 10% to 15% of these hospitals.
For the years ended December 31, 1999, 2000 and 2001, approximately 15%, 13%,
and 12%, respectively, of net patient service revenue was generated directly
from contracts with hospitals owned by HCA. Generally, these contracts and
other hospital contracts have remaining terms of less than five years and
contain renewal provisions. Some of the contracts also contain clauses that
allow for termination by either party with relatively short notice. HCA has
been under government investigation for some time and is evaluating its
operating strategies; including the sale, spin-off or closure of certain
hospitals. Although the Company, through its acquisitions, has had
relationships with these hospitals and national labs for extended periods of
time, the termination of one or more of these contracts could have a material
adverse effect on the Company's financial position and results of operations.
The Company from time to time evaluates the carrying values of identified
intangibles and goodwill and the related useful lives assigned to such assets.
See Note 8 for additional information related to the impairment of certain
hospital contracts.
F-17
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
6. Property and Equipment
Property and equipment and the related accumulated depreciation and
estimated useful lives consisted of the following:
Estimated December 31,
Useful Life ----------------
(Years) 2000 2001
----------- ------- -------
Laboratory, office and data processing equipment 3-7 $27,668 $33,616
Leasehold improvements 5-10 7,984 8,573
Furniture and fixtures 3-7 2,590 3,114
Mobile laboratory units 3 175 200
Automotive vehicles 3-5 1,380 1,499
------- -------
39,797 47,002
Less accumulated depreciation (17,728) (23,930)
Construction in progress 1,511 1,046
------- -------
Property and equipment, net $23,580 $24,118
======= =======
Depreciation expense was $3.6 million, $4.7 million, and $6.6 million for
the years ended December 31, 1999, 2000, and 2001, respectively.
7. Intangible assets
Intangible assets and the related accumulated amortization and amortization
periods are set forth below:
Amortization
Periods
December 31, (Years)
------------------ --------------
Weighted
2000 2001 Range Average
-------- -------- ----- --------
Hospital contracts $211,738 $211,638 25-40 31.5
Physician client lists 71,447 66,646 10-30 19.3
Laboratory contracts 4,543 4,543 10 10.0
Management service agreements 11,214 11,379 25 25.0
-------- --------
298,942 294,206
Accumulated amortization (30,315) (40,644)
-------- --------
Identifiable intangibles, net $268,627 $253,562
======== ========
Goodwill $193,231 $239,361 10-35 29.1
Accumulated amortization (15,968) (23,139)
-------- --------
Goodwill, net $177,263 $216,222
======== ========
In determining the useful lives of the identifiable intangible assets, the
Company considered each practice's operating history, contract renewals,
stability of physician referral lists and industry statistics.
The amortization periods for goodwill were determined by the Company with
consideration given to the lives assigned to the identifiable intangibles, the
reputation of the practice, the length of the practice's operating history,
and the potential of the market in which the acquired practice is located.
F-18
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The weighted average amortization period for identifiable intangible assets
is approximately 27 years. Amortization expense for the years ended December
31, 1999, 2000 and 2001 was $12.8 million, $16.2 million and $18.7 million,
respectively.
8. Asset Impairments and Related Charges
During the second quarter ended June 30, 2000, the Company recorded a pre-
tax non-cash charge of approximately $4.7 million, and related charges of
approximately $.5 million in connection with the impairment of intangible
assets at an acquired practice in Cleveland, Ohio. The Company had provided
services at four hospitals and an ambulatory care facility owned by Primary
Health Systems ("PHS"), a regional hospital network in Cleveland, Ohio. During
the first quarter of 2000, PHS began implementing a plan of reorganization
filed under Chapter 11 with the U.S. Bankruptcy Court for the District of
Delaware, and closed one hospital. During the second quarter, the bankruptcy
court approved the sale of two hospitals and the ambulatory care facility to
local purchasers in the Cleveland area. The Company's contracts with these two
hospitals and the ambulatory care facility were not accepted by the
purchasers, who have elected to employ their own pathologists. One hospital
has not been sold and continues to do business with the Company. As a result,
the Company determined, using the discounted cash flow method, that the
intangible assets, including goodwill, had no remaining fair value. Therefore,
the Company wrote off the unamortized intangible asset balance. In addition,
the Company recorded approximately $.5 million of related charges for
potentially uncollectible accounts receivable, employee termination costs and
legal fees.
During the fourth quarter of 2000, the Company recorded a pre-tax non-cash
charge of approximately $4.3 million related to the impairment of certain
intangible assets. Of this charge, $3.3 million related to Quest Diagnostics'
("Quest") termination of its contract with the Company in South Florida,
effective December 31, 2000. The Company believes that some portion of this
work may be transferred by Quest to other practices owned by the Company and
the Company is implementing a marketing strategy to retain and provide
services directly to these customers in South Florida. In addition, during the
fourth quarter of 2000, a hospital in South Florida where the Company had the
pathology contract, requested proposals for its pathology services, and the
Company was unsuccessful in retaining this contract. Based upon the remaining
projected cash flow from this hospital network, the Company determined that
the intangible assets were impaired and recorded a pre-tax non-cash charge of
approximately $1.0 million.
During the third quarter of 2001, two pathologists in the Birmingham,
Alabama practice terminated their employment with the Company and opened their
own pathology laboratory. During the fourth quarter of 2001, the Company was
unable to retain most of these customers. Consequently, the Company recorded a
non-cash asset impairment charge of $3.8 million in the aggregate.
9. Marketable Securities
The Company accounts for investments in certain debt and equity securities
under the provisions of Statement of Financial Accounting Standards No. 115
("SFAS No. 115"), "Accounting for Certain Debt and Equity Securities". Under
SFAS No. 115, the Company must classify its debt and marketable equity
securities in one of three categories: trading, available-for-sale, or held-
to-maturity.
In September 2000, the Company made a $1.0 million investment in Genomics
Collaborative, Inc. ("GCI") for which it received 333,333 shares of Series D
Preferred Stock, par value $0.01. The shares of GCI Series D Preferred Stock
are convertible into shares of GCI common stock on a one-for-one basis and are
redeemable after 2005 at $3.00 per share at the option of the holder. GCI is a
privately held, start-up, company which has a history of operating losses. As
of December 31, 2001, it appears that GCI has sufficient cash to fund
operations
F-19
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
for the next twelve months. In the event that they are unable to become
profitable and/or raise additional funding, it could result in an impairment
of the Company's investment. This available for sale security is recorded at
its estimated fair value, which approximates cost, and is classified as other
assets on the Company's consolidated balance sheets. At December 31, 2001,
there were no unrealized gains or losses associated with this investment.
10. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consisted of the following:
December 31,
---------------
2000 2001
------- -------
Accounts payable $12,034 $21,249
Accrued compensation 12,604 16,564
Accrued acquisition costs 2,332 1,617
Accrued interest 1,283 338
Income taxes payable 1,822 753
Other accrued expenses 5,637 2,355
------- -------
$35,712 $42,876
======= =======
11. Merger-Related Charges
In connection with the Inform DX merger and other previous acquisitions, the
Company has recorded reserves for transaction costs, employee-related costs
(including severance agreement payouts) and various exit costs associated with
the consolidation of certain operations, including the elimination of
duplicate facilities and certain exit and restructuring costs. During the
first quarter of 2001, the Company recorded merger-related costs totaling $7.1
million ($4.3 million, net of tax) related to the Inform DX merger. During the
fourth quarter of 2000, the Company recorded merger-related costs totaling
$6.2 million ($5.1 million, net of tax). As part of the Inform DX acquisition,
the Company is closing or consolidating certain facilities. In 1999, the
Company paid $1.7 million of costs in connection with the May 1998 American
Pathology Resource, Inc. ("APR") acquisition. Payments were for various exit
costs associated with the disposal of certain operations of APR and the
shutdown of the APR corporate office.
A reconciliation of the activity for the years ended December 31, 2000 and
2001 with respect to the merger-related reserves is as follows:
Balance Balance Statement of Balance
December 31, Sheet Operations December 31,
2000 Charges Charges Payments 2001
------------ ------- ------------ -------- ------------
Transaction costs $1,726 $ -- $1,109 $(2,719) $ 116
Employee termination
costs 1,417 -- 5,150 (3,135) 3,432
Lease commitments 2,128 -- 844 (807) 2,165
Other exit costs 263 -- -- (103) 160
------ ---- ------ ------- ------
Total 5,534 $ -- $7,103 $(6,764) 5,873
==== ====== =======
Less: portion included
in current liabilities (3,165) (3,183)
------ ------
Total included in other
liabilities $2,369 $2,690
====== ======
F-20
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
Balance Balance Statement of Balance
December 31, Sheet Operations December 31,
1999 Charges Charges Payments 2000
------------ ------- ------------ -------- ------------
Transaction costs $ -- $1,160 $4,348 $(3,782) $1,726
Employee termination
costs 78 1,200 1,861 (1,722) 1,417
Lease commitments 394 1,974 -- (240) 2,128
Other exit costs 715 -- -- (452) 263
----- ------ ------ ------- ------
Total 1,187 $4,334 $6,209 $(6,196) 5,534
====== ====== =======
Less: portion included
in current liabilities (275) (3,165)
----- ------
Total included in other
liabilities $ 912 $2,369
===== ======
12. Long-term Debt
Long-term debt consisted of the following:
December 31,
------------------
2000 2001
-------- --------
Revolving loan $197,216 $ 90,000
Note payable 210 248
Capital leases 683 431
Subordinated notes issued and assumed in connection with
acquisitions, payable in varying amounts through 2005,
with interest at rates of 6.5% and 9.5% 3,638 2,643
-------- --------
201,747 93,322
Less: current portion (1,055) (469)
-------- --------
Long-term debt, net of current portion $200,692 $ 92,853
======== ========
At December 31, 2001 maturities of long-term debt were as follows:
2002 $ 469
2003 330
2004 103
2005 2,420
2006 90,000
-------
Total $93,322
=======
Since 1997, the Company maintained a revolving line of credit (the "former
credit facility") with a syndicate of banks led by Fleet National Bank,
formerly BankBoston, N.A. as lender and agent. The former credit facility had
been amended at various times to provide for increased borrowings to $287.5
million as well as restrictions on how the funds could be utilized to fund
acquisitions and for general working capital purposes.
All outstanding advances under the former credit facility were due and
payable on December 16, 2004. Interest was payable monthly at variable rates
based, at the Company's option, on the Agents' base rate or the Eurodollar
rate plus a premium based on the Company's quarterly ratio of total debt to
cash flow. The former credit facility also required a commitment fee to be
paid quarterly equal to 0.50% of the annualized unused portion of the total
commitment.
In November 2001, the Company entered into a new credit facility with a
syndicate of financial institutions led by Bank of America, N.A., First Union
National Bank, and Citibank and extinguished the debt outstanding
F-21
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
under the former credit facility. The write-off of the unamortized debt costs
related to the former credit facility resulted in an extraordinary charge, net
of tax, of approximately $1.0 million.
The new credit facility provides for up to $200 million for a term of five
years. Under the new credit facility, the Company has committed funding of
$175 million. The interest rate at December 31, 2001, based on the Company's
leverage ratio, is LIBOR plus 150 basis points. The facility also requires a
commitment fee to be paid quarterly equal to 0.375% of the annualized unused
portion of the total commitment. In addition, the new facility requires the
Company to maintain certain financial operating ratios and imposes certain
limitations or prohibitions on the Company with respect to the incidence,
guaranty or assumption of indebtedness, the payment of dividends, cash
distributions, new debt issuance, sale of assets, leasing commitments and
annual capital expenditures, and contains provisions which preclude mergers
and acquisitions under certain circumstances. All of the Company's assets are
pledged as collateral under the new credit facility. The Company believes that
it is in compliance with all of the covenants at December 31, 2001.
On February 2, 1998, the Company entered into a revolving line of credit
agreement with Nations Bank providing available borrowings up to $5.0 million
that were used for general corporate purposes including working capital and
the funding of cash for acquisitions or affiliations with pathology practices.
This revolving line of credit was increased to $9.0 million in September 2000.
The balance of this revolving line of credit was paid in full on December 1,
2000.
Note Payable to Bank
In October 1999, the Company assumed a long-term obligation pursuant to a
promissory note agreement with a bank in connection with a managed practice
acquisition in Tennessee. The obligation is evidenced by an installment note
bearing interest at fixed rate of 9.75% and maturing in 2004. The note is
secured by certain assets of the acquired practice.
Letters of Credit
As of December 31, 2001, the Company had letters of credit outstanding
totaling $1.6 million. The letters of credit secure payments under certain
operating leases and expire at various dates in 2002 and 2003. Some of the
letters of credit automatically decline in value over various lease terms. The
letters of credit have annual fees averaging 1.5%.
13. Interest Rate Risk Management
The Company utilizes interest rate swap contracts to effectively convert a
portion of its floating-rate obligations to fixed-rate obligations. Under SFAS
133, the Company accounts for its interest rate swap contracts as cash flow
hedges whereby the fair value of the related interest rate swap agreement is
reflected in other comprehensive income/loss with the corresponding
asset/liability being recorded as a component of other assets or other
liabilities in the consolidated balance sheet. During 2001, the Company had no
ineffectiveness with regard to its interest rate swap contracts as each
interest rate swap agreement meets the criteria for accounting under the
short-cut method as defined in SFAS 133 for cash flow hedges of debt
instruments. The Company used derivative financial instruments to reduce
interest rate volatility and associated risks arising from the floating rate
structure of its former credit facility. Such derivative financial instruments
were not held or issued for trading purposes. The Company was required by the
terms of its former credit facility to keep some form of interest rate
protection in place.
In May 2000, the Company entered into three interest rate swaps transactions
with an effective date of October 5, 2000, variable maturity dates, and a
combined notional amount of $105 million. These interest rate
F-22
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
swap transactions involve the exchange of floating for fixed rate interest
payments over the life of the agreement without the exchange of the underlying
principal amounts. The differential to be paid or received is accrued and is
recognized as an adjustment to interest expense. These agreements were indexed
to 30 day LIBOR. The following table summarizes the terms of the swaps:
Notional
Amount Fixed Term in
(in Rate Months Maturity
millions) ----- ------- --------
$45.0 7.604% 24 10/07/02
$30.0 7.612% 36 10/06/03
$30.0 7.626% 48 10/05/04
In connection with the termination of the former credit facility, the
Company terminated the three interest rate swaps with a combined notional
amount of $105 million and recorded a special charge of approximately $10.4
million.
14. Lease Commitments
The Company leases various office and laboratory space, and certain
equipment pursuant to operating lease agreements. The following information
includes the related party leases discussed in Note 20. Future minimum lease
commitments under noncancellable operating leases consisted of the following
at December 31, 2001:
2002 $ 3,980
2003 3,419
2004 2,597
2005 2,516
2006 2,130
Thereafter 4,088
-------
$18,730
=======
In addition, certain owners of the Managed Practices are lessees of various
equipment, auto and facility operating leases that are used in the operations
of the business. Future payments under these leases are $2.2 of which the
Company is responsible for their corresponding share as defined in the
management service agreements. The Company's obligations, based upon their
management fee percentage, are $.4 million. In the event of termination of a
management service agreement, any related lease obligations are also
terminated or assumed by the Managed Practice.
The Company has entered into certain noncancellable subleases that reduce
its total commitments under operating leases by $.2 million.
Owned Practices' rent expense under operating leases for the years ended
December 31, 1999, 2000, and 2001 was $2.2 million, $4.1 million, and $5.2
million, respectively.
15. Option Plan
The Company's 1996 and 2001 Stock Option Plans (the "Option Plans") provide
for the grant of options to purchase shares of common stock to key employees
and others. The plan provides that the option price shall not be less than the
fair market value of the shares on the date of the grant. All options granted
under the Option Plans have 10-year terms and vest and generally become
exercisable at the rate of 20% a year, following the date of grant. As part of
the Inform DX acquisition, the Company assumed two additional option plans
("Additional Plans"). Options granted under the Additional Plans have varying
exercisable rates.
F-23
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The Company's Director Option Plan provides for the grant of options to
purchase shares of common stock to Directors who are not employees of the
Company. All options granted under the Director Option Plan have 10 year terms
and are exercisable during the period specified in the agreement evidencing
the grant of such Director Option. At December 31, 2001, 35,000 options have
been granted under the Director Option Plan.
At December 31, 2001, 1,948,413 shares of common stock are reserved for
issuance pursuant to options granted under the Option Plans, the Director
Option Plan and the Additional Plans.
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25"), and the related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under SFAS
No. 123, "Accounting for Stock-Based Compensation," requires use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, because the exercise price of the Company's employee
stock options approximates the fair value of the underlying stock on the date
of grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using the Black-Scholes Option Pricing Model with the following weighted-
average assumptions for 1999, 2000, and 2001:
1999 2000 2001
------- ------ -------
Risk free interest rate 6.5% 6.5% 3.3%
Dividend yield -- -- --
Volatility factors 120.0% 137.0% 148.0%
Weighted average life
(years) 4.1 4.2 4.2
Using the Black-Scholes Option Pricing Model, the estimated weighted-average
fair value per option granted in 1999, 2000, and 2001 were $6.28, $6.92, and
$22.51, respectively.
The pro forma net income available to common stockholders assuming the
amortization of the estimated fair values over the option vesting period and
diluted earnings per common share, had the fair value method of accounting for
stock options been used, would have been as follows:
1999 2000 2001
------- ------ -------
Pro forma net income
available to common
stockholders $19,612 $8,018 $15,163
Pro forma diluted earn-
ings per common share $ 0.87 $ 0.33 $ 0.56
The Black-Scholes Option Pricing Model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different than those of traded options, and because changes in the assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models may not necessarily provide a reliable single measure of the
fair value of its employee stock options.
F-24
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
A summary of the status of the option plans as of and for the changes during
each of the three years in the period ended December 31, 2001 is presented
below:
Option Price Per Share
Number of -----------------------
Shares Low High Weighted
--------- ------ ------- --------
Outstanding December 31, 1998 1,459,356 $ 1.11 $ 40.46 $ 7.46
Granted in 1999 26,000 9.31 9.31 9.31
Granted in 1999 259,500 7.63 7.63 7.63
Granted in 1999 5,000 9.56 9.56 9.56
Granted in 1999 2,000 9.16 9.16 9.16
Granted in 1999 2,000 9.06 9.06 9.06
Granted in 1999 9,000 7.75 7.75 7.75
Granted in 1999 49,727 15.56 15.56 15.56
Granted in 1999 3,736 40.46 40.46 40.46
Cancelled in 1999 (41,800) 10.00 16.75 10.58
Exercised in 1999 (8,000) 1.11 1.11 1.11
---------
Outstanding December 31, 1999 1,766,519 1.11 40.46 7.76
Granted in 2000 50,000 8.13 8.13 8.13
Granted in 2000 356,000 7.63 7.63 7.63
Granted in 2000 17,000 16.88 16.88 16.88
Granted in 2000 73,703 41.58 41.58 41.58
Cancelled in 2000 (42,250) 7.63 14.06 9.64
Exercised in 2000 (260,521) 1.11 15.56 5.96
---------
Outstanding December 31, 2000 1,960,451 1.11 41.58 9.30
---------
Granted in 2001 20,000 18.75 18.75 18.75
Granted in 2001 769,750 24.95 24.95 24.95
Granted in 2001 135,621 30.03 30.03 30.03
Granted in 2001 11,000 30.48 30.48 30.48
Cancelled in 2001 (83,434) 7.63 41.58 14.77
Exercised in 2001 (564,449) 1.11 18.67 6.05
---------
Outstanding December 31, 2001 2,248,939 $ 1.67 $ 41.58 $ 14.27
=========
F-25
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The following table summarizes the information about options outstanding at
December 31, 2001:
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------- ----------------------------
Weighted Average
Range of Number Remaining Contractual Life Weighted Average Number Weighted Average
Exercisable Prices Outstanding (in years) Exercise Price Exercisable Exercise Price
- ------------------ ----------- -------------------------- ---------------- ----------- ----------------
$ 1.67 210,011 4.1 $ 1.67 210,011 $ 1.67
3.74 3,370 6.1 3.74 2,280 3.74
7.63 474,600 8.0 7.63 87,500 7.63
7.75 6,000 7.9 7.75 600 7.75
8.13 50,000 8.0 8.13 10,000 8.13
8.33 69,340 4.5 8.33 69,340 8.33
9.31 26,000 7.2 9.31 10,400 9.31
9.56 3,000 7.6 9.56 -- --
10.00 143,400 5.6 10.00 96,800 10.00
11.20 803 6.4 11.20 -- --
11.65 400 6.5 11.65 -- --
12.45 6,829 8.7 12.45 1,371 12.45
14.06 162,120 6.4 14.06 84,000 14.06
15.56 28,757 7.9 15.56 13,202 15.56
16.13 2,000 6.4 16.13 1,200 16.13
16.63 2,400 5.9 16.63 1,200 16.63
16.75 31,800 5.9 16.75 23,100 16.75
16.88 17,000 8.8 16.88 3,400 16.88
18.75 20,000 9.2 18.75 -- --
24.95 767,250 9.3 24.95 -- --
30.03 135,621 9.6 30.03 483 30.03
30.48 11,000 10.0 30.48 -- --
40.46 15,103 6.9 40.46 11,929 40.46
41.58 62,135 7.5 41.58 62,135 41.58
--------- -------
$1.67-$41.58 2,248,939 7.8 $16.70 688,951 $11.21
========= =======
As of December 31, 1999 and 2000, exercisable options were 860,366 and
902,454, respectively.
Warrants to purchase 38,867, 16,226 and 6,202 shares of common stock were
outstanding at December 31, 1999, 2000 and 2001, respectively, at exercise
prices ranging from $0.01 to $0.30 per share. These warrants were issued in
conjunction with certain indebtedness incurred by the Company. Holders of
warrants do not have voting rights or any other rights as a shareholder of the
Company.
In connection with indebtedness issued by the Company in 1997 (the "Junior
Notes"), the Company issued warrants to purchase 16,066 shares of the
Company's common stock to the holders of the Junior Notes. For each $10,000
Junior Note, the holder was issued a warrant to purchase 161 shares of common
stock at $0.01 per share (the "Junior Warrants"). The Junior Warrants expire
on December 24, 2002. A value of approximately $58,000 was allocated to these
warrants which was included in deferred financing costs and additional paid-in
capital in the accompanying consolidated financial statements.
F-26
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
17. Redeemable Preferred Stock
This footnote describes the transactions regarding Inform DX's Series A
Redeemable Preferred Stock (the "Preferred Stock"). All share amounts have
been converted using the conversion ratio for the pooling transaction.
In 1998, Inform DX issued 395,471 shares of Preferred Stock at $40.46 per
share. The Preferred Stock was convertible into common stock at the option of
the holder. The conversion rate for the Preferred Stock was one share of
common stock per share of Preferred Stock. The Preferred Stock was redeemable
after May 20, 2003 at $40.46 per share. Net proceeds from the Preferred Stock
sale were approximately $15,298 and were used to repay long-term obligations
of the Inform DX and certain indebtedness assumed, including accrued interest.
Proceeds received in excess of retired indebtedness were used to provide
general working capital and funding for Company acquisitions.
Offering costs and expenses of approximately $.7 million were recorded
against the aggregate preference value of the Preferred Stock and were being
accreted over five years. Accretion for the period ended December 31, 2000 and
1999 was approximately $.1 million in each year.
The Preferred Stock voted on an as converted basis with the holders of
Inform DX's common stock. The Preferred Stock contained a liquidation
preference over all other classes of Inform DX's capital stock. Furthermore,
holders of the Preferred Stock may have elected to treat certain transactions
as liquidation events. Subject to certain conditions, the Preferred Stock also
contained anti-dilution and preemptive rights. Each holder of shares of the
Preferred Stock was entitled to receive, when and as declared by the Board of
Directors, if at all, dividends on a parity with each holder of shares of
common stock.
On June 30, 2000, Inform DX acquired Pathsource, Inc. in a stock for stock
transaction accounted for as a purchase business combination. In connection
with this acquisition, Inform DX provided for an induced conversion of the
Preferred Stock. The induced conversion resulted in the issuance of 642,640
shares of common stock. Inform DX estimated, based on a third party valuation,
the fair market value of its common stock at June 30, 2000 to be $6.22 per
share. Based on this valuation, Inform DX recorded a charge for the induced
conversion of approximately $1.5 million, or $6.22 per share times the
additional common shares issued of 247,169 in 2000.
18. Employee Benefit Plans
Effective July 1, 1997, the Company consolidated its previous 401(k) plans
into a new qualified 401(k) retirement plan (the "401(k) Plan") covering
substantially all eligible employees as defined in the 401(k) plan. The new
401 (k) Plan requires employer matching contributions equal to 50% (25% prior
to July 1, 2000) of the employees' contributions up to a maximum of one
thousand dollars per employee. The Company expensed matching contributions
aggregating $.5 million, $.6 million, and $.9 million to the new plan in 1999,
2000, and 2001, respectively. Also, in connection with acquisitions, the
Company assumes the obligations under certain defined contribution plans which
cover substantially all eligible employees of the acquired practices. The
Company has not made any contributions from the dates of acquisition through
December 31, 2001.
During 1999, the Company introduced a Supplemental Employee Retirement Plan
("SERP") which covers only selected employees. The SERP is a non-qualified
deferred compensation plan which was established to aid in the retention of
the non-selling physicians and other key employees. In 1999, the eligible
participants were allowed to defer up to ten thousand dollars of compensation
and/or eligible bonuses. If the subscription to the plan fell below an
established deferral range, the participating individuals were allowed to
defer additional funds. The Company may also make discretionary contributions
to the SERP. Employee and employer contributions to the SERP for the years
ended December 31, 2000 and 2001, were $.5 million and $.5 million, and $.1
million and $.3 million, respectively.
F-27
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The Company also sponsors certain defined contribution plans for
substantially all employees of the former Inform DX who are at least 21 years
old, have been employed by the Company for at least one year and have
completed 1,000 hours of service. These plans include a 401(k)/profit sharing
plan and a money purchase pension plan. Under the 401(k)/profit sharing plan,
employees may contribute up to 15% of their qualifying salary on a pre-tax
basis, subject to Federal income tax limitations. In 1999, the Company matched
100% of the first 3% of employee contributions and 50% of employee
contributions between 3% and 5%. The amount expensed under all plans for
Company contributions was approximately $.8 million and $1.6 million in 2000
and 2001, respectively.
19. Commitments and Contingencies
During the ordinary course of business, the Company has become and may in
the future become subject to pending and threatened legal actions and
proceedings. The Company may have liability with respect to its employees and
its pathologists as well as with respect to hospital employees who are under
the supervision of the hospital based pathologists. The majority of the
pending legal proceedings involve claims of medical malpractice. Most of these
relate to cytology services. These claims are generally covered by insurance.
Based upon current information, the Company believes the outcome of such
pending legal actions and proceedings, individually or in the aggregate, will
not have a material adverse effect on the Company's financial condition,
results of operations or liquidity. If the Company is ultimately found liable
under these medical malpractice claims, there can be no assurance that the
Company's medical malpractice insurance coverage will be adequate to cover any
such liability. The Company may also, from time to time, be involved with
legal actions related to the acquisition of and affiliation with physician
practices, the prior conduct of such practices, or the employment (and
restriction on competition of) physicians. There can be no assurance any costs
or liabilities for which the Company becomes responsible in connection with
such claims or actions will not be material or will not exceed the limitations
of any applicable indemnification provisions or the financial resources of the
indemnifying parties.
Liability Insurance -- The Company is insured with respect to general
liability on an occurrence basis and medical malpractice risks on a claims
made basis. The Company records an estimate of its liabilities for claims
incurred but not reported. Such liabilities are not discounted. Effective July
1, 2000, the Company changed its medical malpractice carrier and the Company
is currently in a dispute with its former insurance carrier on an issue
related to the applicability of surplus insurance coverage. The Company
believes that an unfavorable resolution, if any, of such dispute will not have
a material adverse effect on the Company's financial position or results of
operations.
The Company was recently notified by its medical malpractice carrier that
they will no longer be underwriting medical malpractice insurance and has
placed the Company on non-renewal status effective July 1, 2002. The Company
is currently evaluating other potential carriers for medical malpractice
coverage and conducting a feasibility study of a captive insurance company.
There can be no assurance the Company will be able to obtain medical
malpractice insurance on terms consistent with our current coverage, which may
increase our cost.
Healthcare Regulatory Environment and Reliance on Government Programs -- The
healthcare industry in general, and the services that the Company provides,
are subject to extensive federal and state laws and regulations. Additionally,
a significant portion of the Company's net revenue is from payments by
government-sponsored health care programs, principally Medicare and Medicaid,
and is subject to audit and adjustments by applicable regulatory agencies.
Failure to comply with any of these laws or regulations, the results of
increased regulatory audits and adjustments, or changes in the interpretation
of the coding of services or the amounts payable for the Company's services
under these programs could have a material adverse effect on the Company's
financial position and results of operations. The Company's operations are
continuously subject to review and inspection by regulatory authorities.
F-28
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
In August 2001, we received two letters from the United States Attorney for
the Southern District of Ohio (the "U.S. Attorney") requesting information
regarding billing practices and documentation of gross descriptions on skin
biopsy reports. We provided documentation to the U.S. Attorney regarding the
tests that were the subject of its requests for information. Requests for
information such as these are often the result of a qui tam, or whistleblower,
action filed by a private party. In February 2002, we received notification
that the U.S. Attorney would not pursue this matter any further. In addition,
we were notified that there were then no presently pending lawsuits in the
Southern District of Ohio against the Company relating to the request by any
private party relator bringing a qui tam action.
Internal Revenue Service Examination -- The Internal Revenue Service (the
"IRS") conducted an examination of the Company's federal income tax returns
for the tax years ended December 31, 1996 and 1997 and concluded during 2000
that no changes to the tax reported needed to be made. Although the Company
believes it is in compliance with all applicable IRS rules and regulations, if
the IRS should determine the Company is not in compliance in any other years,
it could have a material adverse effect on the Company's financial position
and results of operations.
Employment Agreements -- The Company has entered into employment agreements
with certain of its management employees, which include, among other terms,
noncompetition provisions and salary continuation benefits.
20. Related Party Transactions
Operating Leases -- The Company leases laboratory and administrative
facilities used in the operations of eight practices from entities
beneficially owned by some of the Company's common stockholders. The terms of
the leases expire from 2002 to 2006 and some contain options to renew for
additional periods. Lease payments made under leases with related parties were
$.6 million, $1.1 million and $.8 million in 1999, 2000, and 2001,
respectively.
21. Income Taxes
The provision for income taxes for the years ended December 31, 1999, 2000
and 2001 consists of the following:
Year ended December 31,
-------------------------
1999 2000 2001
------- ------- -------
Current:
Federal $17,465 $20,958 $21,701
State 2,015 2,227 2,306
------- ------- -------
Total current provision 19,480 23,185 24,007
------- ------- -------
Deferred:
Federal (1,799) (8,242) (5,423)
State (207) (875) (576)
------- ------- -------
Total deferred benefit (2,006) (9,117) (5,999)
------- ------- -------
Total provision for income taxes $17,474 $14,068 $18,008
======= ======= =======
F-29
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
The effective tax rate on income before income taxes is reconciled to the
statutory federal income tax rate as follows:
Year ended
December 31,
-------------------
1999 2000 2001
----- ----- -----
Statutory federal rate 35.0% 35.0% 35.0%
State income taxes, net of federal income tax benefit 4.0 3.7 3.7
Non-deductible items, primarily amortization of goodwill 3.3 8.6 5.0
Non-deductible items, merger-related charges 0.0 4.8 0.0
Other 1.2 (0.3) (1.2)
----- ----- -----
43.5% 51.8% 42.5%
===== ===== =====
The following is a summary of the deferred income tax assets, classified in
other current assets on the balance sheet, and deferred tax liabilities as of
December 31, 2000 and 2001:
December 31,
------------------
2000 2001
-------- --------
Deferred tax assets (short term):
Allowance for doubtful accounts $ 8,479 $ 12,946
Accrued liabilities 1,499 887
-------- --------
Deferred tax assets (short term) 9,978 13,833
-------- --------
Deferred tax liabilities (short term):
481 (a) adjustment (1,385) (813)
Other -- --
-------- --------
Deferred tax liabilities (short term) (1,385) (813)
-------- --------
Net short term deferred tax assets 8,593 13,020
-------- --------
Deferred tax assets (long-term):
Net operating loss 6,955 8,165
Other 1,255 2,250
-------- --------
Deferred tax assets (long-term) 8,210 10,415
Less: valuation allowance (3,548) (5,535)
-------- --------
Net deferred tax assets (long-term) 4,662 4,880
-------- --------
Deferred tax liabilities (long-term):
Change from cash to accrual basis of accounting by the
acquisitions (1,178) (289)
Intangible assets acquired (67,059) (66,586)
Property and equipment (471) (479)
-------- --------
Deferred tax liabilities (long-term) (68,708) (67,354)
-------- --------
Net long-term deferred tax liability (64,046) (62,474)
-------- --------
Net deferred tax liabilities $(55,453) $(49,454)
======== ========
F-30
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
22. Earnings Per Share
Earnings per share is computed and presented in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share". Basic
earnings per share, which excludes the effects of any dilutive common
equivalent shares that may be outstanding, such as shares issuable upon the
exercise of stock options and warrants, is computed by dividing net income
attributable to common stockholders by the weighted average number of common
shares outstanding for the respective periods. Diluted earnings per share
gives effect to the potential dilution that could occur upon the exercise of
certain stock options and warrants that were outstanding at various times
during the respective periods presented. The dilutive effects of stock options
and warrants are calculated using the treasury stock method.
Basic and diluted earnings per share for the respective periods are set forth
in the table below:
Years ended December 31,
--------------------------
1999 2000 2001
------- -------- -------
Earnings Per Common Share:
Net income attributable to common stockholders $22,580 $ 11,488 $23,352
======= ======== =======
Basic earnings per common share $ 1.03 $ 0.49 $ 0.90
======= ======== =======
Diluted earnings per common share $ 1.00 $ 0.47 $ 0.86
======= ======== =======
Basic weighted average shares outstanding 21,984 23,473 25,974
Effect of dilutive stock options and warrants 532 764 1,075
------- -------- -------
Diluted weighted average shares outstanding 22,516 24,237 27,049
======= ======== =======
Options to purchase 774,590 shares, 453,818 shares, and 223,859 of common
stock which were outstanding at December 31, 1999, 2000 and 2001,
respectively, have been excluded from the calculation of diluted earnings per
share for the respective years because their effect would be anti-dilutive. In
addition, 395,471 shares of Preferred Stock were excluded from the calculation
of diluted earnings per share for the years ended December 31, 1999 because
the effect would be anti-dilutive. Warrants to purchase shares of 38,867 for
the year December 31, 1999 were excluded from the calculation of diluted
earnings per share because the effect would be anti-dilutive.
23. Supplemental Cash Flow Information
The following supplemental information presents the non-cash impact on the
balance sheet of assets acquired and liabilities assumed in connection with
acquisitions consummated during the years ended December 31, 1999, 2000 and
2001:
Years Ended December 31,
--------------------------
1999 2000 2001
------- -------- -------
Assets acquired $74,745 $ 64,633 $ 8,050
Liabilities assumed (19,850) (19,996) (665)
Common stock issued (3,149) (12,180) (2,153)
------- -------- -------
Cash paid for acquisitions 51,746 32,457 5,232
Less cash acquired (1,541) (6,955) (752)
------- -------- -------
Net cash paid for acquisitions 50,205 25,502 4,480
Costs related to completed and pending acquisi-
tions 1,438 (573) 565
------- -------- -------
Cash paid for acquisitions and acquisition
costs, net of cash acquired $51,643 $ 24,929 $ 5,045
======= ======== =======
F-31
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
24. Preferred Share Purchase Rights Plan
On April 8, 1999, the Board of Directors of the Company adopted a Preferred
Share Purchase Rights Plan (the "Rights Plan") and, in connection therewith,
declared a dividend distribution of one preferred share purchase right
("Right") on each outstanding share of the Company's common stock to
shareholders of record at the close of business on April 19, 1999. The Rights
will expire on April 8, 2009. The adoption of the Rights Plan and the
distribution of the Rights is not dilutive, does not affect reported earnings
per share, and is not taxable to shareholders.
Subject to the terms of the Rights Plan, each Right entitles the registered
holder to purchase from the Company one one-thousandth of a share of the
Company's Series A Junior Participating Preferred Stock (the "Preferred
Shares"). Each Right has an initial exercise price of $45.00 for one one-
thousandth of a Preferred Share (subject to adjustment). The Rights will be
exercisable only if a person or group acquires 15% or more of the Company's
common stock or announces a tender or exchange offer the consummation of which
would result in ownership by a person or group of 15% or more of the common
stock. Upon any such occurrence, each Right will entitle its holder (other
than such person or group of affiliated or associated persons) to purchase, at
the Right's then current exercise price, a number of the Company's common
shares having a market value of twice such price.
25. Segment Reporting
The Company has two reportable segments, Owned practices and Managed
practices. The segments were determined based on the type of service and
customer. Owned practices provide anatomic pathology services to hospitals and
referring physicians, while under the management relationships the Company
provides management services to the affiliated physician groups. The
accounting policies of the segments are the same as those described in the
summary of accounting policies. The Company evaluates performance based on
revenue and income before amortization of intangibles, merger-related charges,
asset impairment related charges, interest expense, other income and expense
and income taxes ("Segment Operating Income"). In addition to the business
segments above, the Company evaluates certain corporate expenses which are not
allocated to the business segments.
The following is a summary of the financial information for the business
segments and corporate.
Owned 1999 2000 2001
- ----- -------- -------- --------
Net patient service revenue $233,269 $308,365 $387,384
Segment operating income 73,676 94,346 118,580
Segment assets 139,791 250,814 380,238
Managed
- -------
Net management service revenue $ 24,163 $ 21,729 $ 31,348
Segment operating income (loss) 4,299 (304) 4,454
Segment assets 15,533 18,723 25,494
Corporate
- ---------
Segment operating loss $(15,676) $(19,789) $(24,547)
Segment assets 351,138 330,143 228,816
Elimination of Intercompany Accounts (27,566) (37,514) (30,086)
F-32
AMERIPATH, INC. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED)
26. Subsequent Events
Contingent Note Payments -- Subsequent to December 31, 2001, the Company
paid approximately $17.6 million on contingent notes issued in connection with
previous acquisitions as additional purchase price.
Acquisition -- In addition, during the first quarter of 2002, the Company
announced the acquisition of an operation located in Denver, Colorado. The
acquisition represented a conversion from an existing management contract to a
wholly-owned entity. The operation includes three exclusive hospital
contracts, a physician referral base and a 20,000 square foot state-of-the-art
laboratory.
27. Quarterly Results of Operations (unaudited)
The following table presents certain unaudited quarterly financial data for
each of the quarters in the years ended December 31, 2000 and 2001. This
information has been prepared on the same basis as the Consolidated Financial
Statements and includes, in the opinion of the Company, all adjustments
(consisting of only normal recurring adjustments) necessary to present fairly
the quarterly results when read in conjunction with the Consolidated Financial
Statements and related Notes thereto. The operating results for any quarter
are not necessarily indicative of results for any future period or for the
full year. Adjustments have been made to the quarterly financial statements to
reflect the acquisition of Inform DX, which was accounted for as a pooling of
interest, as more further described in Note 3, Mergers and Acquisitions. These
adjustments are reflected in the first three quarters of 2000.
F-33
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
2000 Calendar Quarters 2001 Calendar Quarters
----------------------------------- -----------------------------------
First Second Third Fourth First Second Third Fourth
------- ------- ------- -------- ------- ------- ------- --------
Net patient service
revenue $68,888 $74,372 $79,650 $ 85,455 $91,724 $97,335 $97,555 $100,770
Management service
revenue 6,155 6,562 6,871 2,141 7,021 7,717 8,503 8,107
------- ------- ------- -------- ------- ------- ------- --------
Net revenue 75,043 80,934 86,521 87,596 98,745 105,052 106,058 108,877
------- ------- ------- -------- ------- ------- ------- --------
OPERATING COSTS AND
EXPENSES:
Cost of services 36,950 38,826 42,415 45,199 48,432 49,390 50,921 51,359
Selling, general and
administrative
expense 13,141 14,285 15,234 15,751 17,218 18,168 18,089 18,381
Provision for doubtful
accounts 7,103 8,349 8,868 9,720 10,658 12,548 12,617 12,464
Amortization expense 3,837 3,897 4,043 4,395 4,526 4,654 4,677 4,802
Merger-related charges
(1) -- -- -- 6,209 7,103 -- -- --
Asset impairment and
related
charges (2) -- 5,245 -- 4,317 -- -- -- 3,809
------- ------- ------- -------- ------- ------- ------- --------
Total 61,031 70,602 70,560 85,591 87,937 84,760 86,304 90,815
Income from operations 14,012 10,332 15,961 2,005 10,808 20,292 19,754 18,062
Interest expense (3,418) (3,558) (3,657) (4,743) (4,742) (4,695) (4,443) (2,470)
Other income (expense),
net 63 50 91 22 24 120 (74) 75
Termination of interest
swap (3) -- -- -- -- -- -- -- (10,386)
------- ------- ------- -------- ------- ------- ------- --------
Income (loss) before
income taxes and
extraordinary loss 10,657 6,824 12,395 (2,716) 6,090 15,717 15,237 5,281
Provision for income
taxes 4,559 3,852 5,159 498 2,849 6,570 6,369 2,220
------- ------- ------- -------- ------- ------- ------- --------
Income (loss) before
extraordinary loss 6,098 2,972 7,236 (3,214) 3,241 9,147 8,868 3,061
Extraordinary loss, net
(4) -- -- -- -- -- -- -- (965)
------- ------- ------- -------- ------- ------- ------- --------
Net income 6,098 2,972 7,236 (3,214) 3,241 9,147 8,868 2,096
Induced conversion and
accretionof redeemable
preferred stock (34) (1,570) -- -- -- -- -- --
------- ------- ------- -------- ------- ------- ------- --------
Net income available to
common stockholders $ 6,064 $ 1,402 $ 7,236 $ (3,214) $ 3,241 $ 9,147 $ 8,868 $ 2,096
======= ======= ======= ======== ======= ======= ======= ========
PER SHARE DATA:
Basic earnings per
common share $ .27 $ .06 $ .30 $ (.13) $ .13 $ .36 $ .35 $ .07
======= ======= ======= ======== ======= ======= ======= ========
Diluted earnings per
common share $ .27 $ .06 $ .29 $ (.13) $ .12 $ .35 $ .34 $ .07
======= ======= ======= ======== ======= ======= ======= ========
- --------
(1) In connection with the Inform DX merger, the Company recorded $6.2 million
and $7.1 million in the fourth quarter of 2000 and the first quarter of
2001, respectively, of costs related to transaction fees, change in
control payments and various exit costs associated with the consolidation
of certain operations.
(2) In connection with the loss of two hospital contracts and an ambulatory
care facility contract in Cleveland, Ohio, the Company recorded a non-
recurring charge of $5.2 million in the second quarter of 2000. In
connection with Quest Diagnostics termination of its contract in South
Florida and the loss of a renewable contract with a hospital in South
Florida, the Company recorded a non-recurring charge of $4.3 million in
the fourth quarter of 2000. In the fourth quarter of 2001, two
pathologists in the Birmingham, AL practice terminated their employment
agreement with the Company and opened their own pathology laboratory. As a
result, the Company was unable to retain most of these customers and
therefore, recorded an impairment charge of $3.8 million. The impairment
charges were based upon the remaining projected cash flows from these
contracts and customers in which the Company determined that the
intangible assets that were recorded from acquisitions in these areas had
been impaired.
(3) In connection with the extinguishment of the Company's former credit
facility, the Company made a one-time pre-tax payment of $10.4 million to
terminate the Company's interest rate swap agreements.
(4) The Company terminated its former credit facility and recorded an
extraordinary loss, net of tax, of $1.0 million, in connection with the
write-off of previously deferred financing costs.
Certain reclassifications have been made to the quarterly consolidated
statements of operations to conform to the annual presentations.
F-34