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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2003
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 0-26190
US Oncology, Inc.
(Exact name of registrant as specified in its charter)
Delaware 84-1213501
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
16825 Northchase Drive, Suite 1300
Houston, Texas
77060
(Address of principal executive offices)
(Zip Code)
(832) 601-8766
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant (1) is an accelerated filer
(as defined in Rule 12(b)-2 of the Securities Exchange Act of 1934.
Yes [X] No [ ]
As of May 9, 2003, 90,486,607 shares of the Registrant's Common Stock were
outstanding. In addition, as of May 9, 2003, the Registrant had agreed to
deliver 2,976,361 shares of its Common Stock on certain future dates for no
additional consideration.
US ONCOLOGY, INC.
FORM 10-Q
MARCH 31, 2003
TABLE OF CONTENTS PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements............. 3
Condensed Consolidated Balance Sheet ................... 3
Condensed Consolidated Statement of Operations and
Comprehensive Income ................................ 4
Condensed Consolidated Statement of Cash Flows ......... 5
Notes to Condensed Consolidated Financial Statements ... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................. 14
Item 3. Quantitative and Qualitative Disclosures about Market
Risks ............................................... 28
Item 4. Controls and Procedures ................................ 28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ...................................... 29
Item 6. Exhibits and Reports on Form 8-K ....................... 30
SIGNATURES .......................................................... 31
CERTIFICATIONS ...................................................... 32
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands, except par value)
March 31, 2003 December 31, 2002
-------------- -----------------
(unaudited)
ASSETS
Current assets:
Cash and equivalents ................................................. $ 74,884 $ 105,564
Accounts receivable .................................................. 298,321 281,560
Other receivables .................................................... 29,013 42,363
Prepaid expenses and other current assets ............................ 29,075 20,134
Inventories .......................................................... 32,016 31,371
Due from affiliates .................................................. 45,478 47,583
---------- ----------
Total current assets .............................................. 508,787 528,575
Property and equipment, net ............................................. 329,679 327,558
Service agreements, net ................................................. 249,451 252,720
Due from affiliates, long term .......................................... 1,420 7,708
Deferred income taxes ................................................... 41,492 43,214
Other assets ............................................................ 24,634 25,166
---------- ----------
$1,155,463 $1,184,941
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term indebtedness ......................... $ 13,394 $ 15,363
Accounts payable ..................................................... 134,006 193,544
Due to affiliates .................................................... 51,812 32,877
Accrued compensation cost ............................................ 20,248 25,417
Income taxes payable ................................................. 28,611 20,441
Other accrued liabilities ............................................ 40,390 36,379
---------- ----------
Total current liabilities ......................................... 288,461 324,021
Long-term indebtedness .................................................. 264,475 272,042
---------- ----------
Total liabilities ................................................. 552,936 596,063
Minority interest ....................................................... 10,378 10,338
Stockholders' equity:
Preferred Stock, $.01 par value, 1,500 shares authorized, none issued and
outstanding ..........................................................
Series A Preferred Stock, $.01 par value, 500 shares authorized and
reserved, none issued and outstanding ................................
Common Stock, $.01 par value, 250,000 shares authorized, 95,301 and
95,301 issued, 90,245 and 89,553 outstanding ......................... 953 953
Additional paid in capital .............................................. 478,064 479,073
Common Stock to be issued, approximately 3,209 and 3,695 shares ......... 25,903 33,644
Treasury Stock, 5,056 and 5,748 shares .................................. (43,193) (49,302)
Retained earnings ....................................................... 130,422 114,172
---------- ----------
Total stockholders' equity ........................................ 592,149 578,540
---------- ----------
$1,155,463 $1,184,941
========== ==========
The accompanying notes are an integral part of this statement.
-3-
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)
Three Months Ended March 31,
----------------------------
2003 2002
-------- --------
Revenue ........................................... $447,210 $391,285
Operating expenses:
Pharmaceuticals and supplies ................... 246,628 197,595
Field compensation and benefits ................ 87,893 86,101
Other field costs .............................. 46,958 47,859
General and administrative ..................... 15,576 13,562
Depreciation and amortization .................. 18,813 17,871
Restructuring charges .......................... -- 705
-------- --------
415,868 363,693
-------- --------
Income from operations ............................ 31,342 27,592
Other income (expense):
Interest expense, net .......................... (5,132) (5,442)
Loss on early extinguishment of debt ........... -- (13,633)
-------- --------
Income before income taxes ........................ 26,210 8,517
Income tax provision .............................. (9,960) (3,236)
-------- --------
Net income and comprehensive income ............... $ 16,250 $ 5,281
======== ========
Net income per share - basic ...................... $ 0.17 $ 0.05
======== ========
Shares used in per share calculations - basic ..... 92,972 99,848
======== ========
Earnings per share - diluted ...................... $ 0.17 $ 0.05
======== ========
Shares used in per share calculations- diluted .... 94,632 100,305
======== ========
The accompanying notes are an integral part of this statement.
-4-
US ONCOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended March 31,
----------------------------
2003 2002
-------- ---------
Cash flows from operating activities:
Net income ............................................... $ 16,250 $ 5,281
Non cash adjustments:
Depreciation and amortization ............................... 18,813 17,871
Loss on early extinguishment of debt, net of income taxes ... -- 8,452
Deferred income taxes ....................................... 1,722 2,788
Undistributed earnings in joint ventures .................... 49 459
Changes in operating assets and liabilities: ................ (37,957) (54,917)
-------- ---------
Net cash used by operating activities .................... (1,123) (20,066)
-------- ---------
Cash flows from investing activities:
Acquisition of property and equipment ....................... (16,878) (14,713)
-------- ---------
Net cash used by investing activities .................... (16,878) (14,713)
-------- ---------
Cash flows from financing activities:
Proceeds from Credit Facility ............................... -- 24,500
Repayment of Credit Facility ................................ -- (24,500)
Proceeds from Senior Subordinated Notes ..................... -- 175,000
Repayment of other Senior Secured Notes ..................... -- (100,000)
Repayment of other indebtedness ............................. (9,536) (9,010)
Deferred financing costs .................................... -- (7,449)
Proceeds from exercise of options ........................... 339 678
Purchase of Treasury Stock .................................. (3,482) --
Payment of premium upon early extinguishment of debt ........ -- (11,731)
-------- ---------
Net cash (used) provided by financing activities ......... (12,679) 47,488
-------- ---------
Increase (decrease) in cash and equivalents .................... (30,680) 12,709
Cash and equivalents:
Beginning of period ......................................... 105,564 20,017
-------- ---------
End of period ............................................... $ 74,884 $ 32,726
======== =========
Interest paid .................................................. $ 9,708 $ 3,657
Taxes paid ..................................................... $ -- $ 1,920
Non cash transactions:
Delivery of Common Stock in affiliation transactions ........ $ 5,376 $ 5,717
The accompanying notes are an integral part of this statement
-5-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial reporting and in accordance with Form 10-Q and Rule 10.01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the unaudited condensed
consolidated financial statements contained in this report reflect all
adjustments that are normal and recurring in nature and considered necessary for
a fair presentation of the financial position and the results of operations for
the interim periods presented. The preparation of the Company's financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses, as well as disclosures on contingent
assets and liabilities. Because of inherent uncertainties in this process,
actual future results could differ from those expected at the reporting date.
These unaudited condensed consolidated financial statements, footnote
disclosures and other information should be read in conjunction with the
financial statements and the notes thereto included in US Oncology, Inc.'s Form
10-K filed with the Securities and Exchange Commission on March 21, 2003.
Certain reclassifications have been made to the prior year amounts in order to
conform to the current year presentation. Such reclassifications had no effect
on the Company's consolidated earnings or cash flows.
NOTE 2 - Revenue
The Company provides the following services to physician practices: oncology
pharmaceutical services, cancer center services, cancer research services, and
other practice management services. The Company currently earns revenue from
physician practices under two models, the physician practice management (PPM)
model and the service line model. Under the PPM model, the Company enters into
long term agreements with affiliated practices to provide comprehensive
services, including all those described above, and the practices pay the Company
a service fee and reimburse all expenses. Under the service line model, the
first three services described above are offered by the Company under separate
agreements for each service line.
Net operating revenue includes three components - net patient revenue, service
line revenue and the Company's other revenue.
. Net patient revenue. The Company reports net patient revenue for those
business lines under which the Company's revenue is derived from
payments for medical services to patients and the Company is
responsible for billing those patients. Currently, net patient revenue
consists of patient revenue of affiliated practices under the PPM
model. Net patient revenue also will include revenues of practices
that enter into service line agreements for cancer center services
service line.
. Service line revenue. Revenues from pharmaceutical services rendered
by the Company under its oncology pharmaceutical management service
line agreements.
. Other revenue. Other revenue includes revenue from pharmaceutical
research, informational services and activities as a group purchasing
organization.
Net patient revenue is recorded when services are rendered to patients based on
established or negotiated charges reduced by contractual adjustments and
allowances for doubtful accounts. Differences between estimated contractual
adjustments and final settlements are reported in the period when final
settlements are determined.
Service line revenue is recorded when services are rendered to practices based
on established or negotiated charges.
Under the Company's PPM service agreements, amounts retained by the affiliated
physician groups for physician compensation are primarily derived under two
models. Under the first model (the net revenue model), amounts retained by
physician groups are based upon a specified amount (typically 23% of net
revenue) and, if certain
-6-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
financial criteria are satisfied, an incremental performance-based amount. Under
the second model (the earnings model), amounts retained by practices are based
upon a percentage (typically 65% - 75%) of the difference between net patient
revenues less direct expenses, excluding interest expense and taxes. In certain
states the Company's fee is a fixed fee.
The Company's revenue is equal to net operating revenue minus amounts retained
by the practices under the Company's PPM service agreements.
The following presents the amounts included in the determination of the
Company's revenue (in thousands):
Three Months Ended March 31,
----------------------------
2003 2002
--------- ---------
Net operating revenue ........................... $ 574,128 $ 500,882
Amounts retained by practices ................ (126,918) (109,597)
--------- ---------
Revenue ......................................... $ 447,210 $ 391,285
========= =========
The Company's most significant service agreement, which is the only service
agreement that represents more than 10% of revenues to the Company, is with
Texas Oncology, P.A. (TOPA), which is managed under the earnings model. TOPA
accounted for approximately 25% and 24%, respectively, of the Company's total
revenue for the first quarter of 2003 and 2002.
NOTE 3 - Stock-Based Compensation
At December 31, 2002, the Company has eight stock-based employee compensation
plans. The Company accounts for those plans under the recognition and
measurement principles of Accounting Principles Board Opinion No. 25, "
Accounting for Stock Issued to Employees," and related Interpretations. Stock
based employee compensation costs for options granted under those plans with
exercise prices less than the market value of the underlying Common Stock on the
date of the grant are insignificant for the three months ended March 31, 2003
and 2002.
The Company also provides a benefit plan to non-employee affiliates which is
accounted for using fair value based accounting with compensation expense being
recognized over the respective vesting period. The Company recognized $0.4
million and $0.6 million in compensation cost during the three months ended
March 31, 2003 and 2002, respectively.
-7-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
The following table illustrates the effect on net income (loss) and earnings
(loss) per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation,"
to stock-based employee compensation:
Three Months Ended March 31,
----------------------------
2003 2002
------- ------
Net income, as reported .................................... $16,250 $5,281
Total stock-based employee compensation expense included in
reported net income, net of related tax effects ......... 266 352
Less: total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related income taxes ............................. (1,724) (1,663)
------- ------
Pro forma net income ....................................... $14,792 $3,970
======= ======
Earnings per share:
Basic, as reported ......................................... $ 0.17 $ 0.05
======= ======
Basic, pro forma ........................................... $ 0.16 $ 0.04
======= ======
Diluted, as reported ....................................... $ 0.17 $ 0.05
======= ======
Diluted, pro forma ......................................... $ 0.16 $ 0.04
======= ======
NOTE 4 - Restructuring Charges
During the first quarter of 2002, the Company recognized charges of $0.7 million
consisting of: (i) $0.3 million in costs related to personnel reductions, and
(ii) $0.4 million in consulting fees related to the Company's conversion to the
service line model. There were no such charges recorded during the first quarter
of 2003.
NOTE 5 - Reclassification of Extraordinary Loss to Other Income (Expense)
During the first quarter of 2002, the Company recorded an extraordinary loss of
$13.6 million, before income taxes of $5.3 million, in connection with the early
extinguishment of the $100 million Senior Secured Notes due 2006 and the
previously existing credit facility. The loss consists of a payment of a
prepayment penalty of $11.7 million on the Senior Secured Notes and a write-off
of unamortized deferred financing costs of $1.9 million related to the
terminated debt agreements.
In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS No.
145, "Rescission of FASB Statements No. 4,44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections". This statement provides guidance
on the classification of gains and losses from the extinguishment of debt and on
the accounting for certain specified lease transactions. The provisions of this
statement related to the rescission of FASB Statement No.4, were effective for
the Company beginning on January 1, 2003. In accordance with the transition
provisions, the first quarter 2002 extraordinary item has been reclassified in
the statement of operations to interest expense, net beginning in the quarter
ended March 31, 2003.
-8-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
NOTE 6 - Indebtedness
As of March 31, 2003 and December 31, 2002, respectively, the Company's
long-term indebtedness consisted of the following (in thousands):
March 31, 2003 December 31, 2002
-------------- -----------------
Credit facility ........................... $ -- $ --
9.625% Senior Subordinated Notes due
2012 ................................... 175,000 175,000
Synthetic lease facility .................. 70,312 72,018
Notes Payable ............................. -- 818
Subordinated Notes ........................ 32,065 38,869
Capital lease obligations and other ....... 492 700
-------- --------
277,869 287,405
Less: current maturities .................. (13,394) (15,363)
-------- --------
$264,475 $272,042
======== ========
Credit Facility
From June 1999 until February 2002, the Company utilized a $175 million
syndicated revolving credit facility for working capital and other corporate
purposes expiring in June 2004.
On February 1, 2002, the Company terminated its $175 million revolving facility
and entered into a new $100 million five-year revolving credit facility (Credit
Facility), which expires in February 2007. Proceeds from loans under the Credit
Facility may be used to finance development of cancer centers and new Positron
Emission Tomography (PET) facilities, to provide working capital or for other
general business uses. Costs incurred in connection with the extinguishment of
the Company's previous credit facility were expensed during the first quarter of
2002 and recorded as other expense in the Company's condensed consolidated
statement of operations and comprehensive income. Costs incurred in connection
with establishing the Credit Facility are being capitalized and amortized over
the term of the Credit Facility.
Borrowings under the Credit Facility are collateralized by substantially all of
the Company's assets. At the Company's option, funds may be borrowed at the base
interest rate or the London Interbank Offered Rate (LIBOR), plus an amount
determined under a defined formula. The base rate is selected by First Union
National Bank (First Union) and is defined as its prime rate or Federal Funds
Rate plus 1/2%. No amounts were borrowed or outstanding under the Credit
Facility during 2002 and the first quarter of 2003.
Senior Subordinated Notes
On February 1, 2002, the Company issued $175 million in 9.625% senior
subordinated notes (Senior Subordinated Notes) to various institutional
investors in a private offering pursuant to Rule 144A. The notes were
subsequently exchanged for substantially identical notes in an offering
registered under the Securities Act of 1933. The notes are unsecured, bear
interest at 9.625% annually and mature in February 2012. Payments under the
Senior Subordinated Notes are subordinated, in substantially all respects, to
the Company's Credit Facility and other "Senior Indebtedness," as defined in the
indenture governing the Senior Subordinated Notes.
Proceeds from the Senior Subordinated Notes were used to pay off the $100
million in borrowings under the existing Senior Secured Notes, an $11.7 million
prepayment penalty on the early termination of the Senior Secured Notes and
facility fees and related expenses associated with establishing the Senior
Subordinated Notes and Credit Facility of $4.8 million and $2.7 million,
respectively. Costs incurred in connection with extinguishment of the Company's
previous Senior Secured Notes, including the prepayment penalty were expensed in
the first quarter of 2002 and reflected as other expenses in the Company's
condensed consolidated statement of operations and
-9-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
comprehensive income. Costs incurred in connection with establishing the Senior
Subordinated Notes, including facility fees, were capitalized, and are being
amortized over the term of those notes.
Leasing Facility
The Company entered into a leasing facility in December 1997, under which a
special purpose entity has constructed and owns certain of the Company's cancer
centers and leases them to the Company. The facility was funded by a syndicate
of financial institutions and is collateralized by the property to which it
relates and matures in June 2004.
As of March 31, 2003, the Company had $70.3 million outstanding under the
leasing facility, and no further amounts are available under that facility. The
annual lease cost of the lease is approximately $3.2 million, based on interest
rates in effect as of March 31, 2003. At March 31, 2003, the lessor under the
leasing facility held real estate assets (based on original acquisition and
construction costs) of approximately $55.5 million and equipment of
approximately $16.8 million (based on original acquisition cost) at seventeen
locations.
The lease is renewable in one-year increments, but only with the consent of the
financial institutions that are parties thereto. In the event the lease is not
renewed at maturity, or is earlier terminated for various reasons, the Company
must either purchase the properties under the lease for the total amount
outstanding or market the properties to third parties. Effective December 31,
2002, the Company increased its residual value guarantee from 85% to 100% of the
amounts advanced under the lease, and as a result of this guarantee the Company
reflects amounts advanced under the leasing facility of $70.2 million as a
long-term indebtedness on its balance sheet. The Company increased its guaranty
to provide greater ability to sell, move or transfer the assets in the lease. In
January 2003, the Company sold two properties under the lease in connection with
practice disaffiliations.
As a result of this amendment, the Company recorded $72.0 million outstanding
under the lease as indebtedness in its consolidated balance sheet. The Company
also included assets under the lease as assets in its consolidated balance sheet
based upon the Company's determination of fair values of those properties at
December 31, 2002, and recognized an impairment charge of $20.0 million in the
fourth quarter of 2002 related to these cancer centers. Prior to December 31,
2002, and increase to the Company's guarantee, the lease was recorded as an
operating lease and, accordingly neither the debt nor the assets were recorded
on its consolidated balance sheet.
Notes payable
The notes payable bear interest, which is payable annually, at rates ranging
from 5.3% to 10% and were paid off at maturity in the first quarter of 2003. The
notes were payable to physicians with whom the Company entered into long-term
service agreements and related to affiliation transactions. The notes payable
were unsecured.
Subordinated notes
The subordinated notes are issued in substantially the same form in different
series and are payable to the physicians with whom the Company entered into
service agreements. Substantially all of the notes outstanding at March 31, 2003
bear interest at 7%, are due in installments through 2007 and are subordinated
to senior bank and certain other debt. If the Company fails to make payments
under any of the notes, the respective practice can terminate the related
service agreement
Capital lease obligations and other indebtedness
Leases for medical and office equipment are capitalized using effective interest
rates between 6.5% and 11.5% with original lease terms between two and seven
years. Other indebtedness consists principally of installment notes and bank
debt, with varying interest rates, assumed in affiliation transactions.
NOTE 7 - Capitalization
In November 2002, the Board of Directors of the Company authorized the
repurchase of up to $50 million in shares of Common Stock in public or private
transactions. During the first quarter of 2003, the Company purchased 399,000
shares of Common Stock at an average price of $8.72 per share. Cumulatively
through March 31, 2003, the
-10-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
Company has purchased 1,283,000 shares of Common Stock an average price of $8.76
per share under this authorization.
The table below sets forth the Company's Treasury Stock activity for the three
months ended March 31, 2003 (in thousands):
Shares
------
Treasury Stock shares as of January 1, 2003........................... 5,748
Treasury Stock purchases.............................................. 399
Treasury Stock issued in connection with affiliation
transactions and exercise of employee stock options................ (1,091)
------
Treasury Stock shares as of March 31, 2003............................ 5,056
======
NOTE 8 - Earnings Per Share
The Company computes earnings per share and discloses basic and diluted earnings
per share (EPS). The computation of basic EPS is based on a weighted average
number of outstanding shares of Common Stock and Common Stock to be issued
during the periods. The Company includes Common Stock to be issued in both basic
and diluted EPS as there are no foreseeable circumstances that would relieve the
Company of its obligation to issue these shares. The computation of diluted EPS
is based on a weighted average number of outstanding shares of Common Stock and
Common Stock to be issued during the periods as well as all potentially dilutive
potential Common Stock calculated under the treasury stock method.
The table below summarizes the determination of shares used in per share
calculations (in thousands):
Three Months Ended March 31,
----------------------------
2003 2002
------ -------
Outstanding at end of period:
Common Stock .................................................. 90,245 94,982
Common Stock to be issued ..................................... 3,209 6,344
------ -------
93,454 101,326
Effect of weighting and Treasury Stock ........................ (482) (1,478)
------ -------
Shares used in per share calculations-basic ...................... 92,972 99,848
Effect of weighting and assumed share equivalents for outstanding
stock options at less than the weighted average stock price ... 1,660 457
------ -------
Shares used in per share calculations-diluted .................... 94,632 100,305
====== =======
Anti-dilutive stock options not included above ................... 5,837 5,521
====== =======
NOTE 9 - Segment Financial Information
The Company has adopted the provisions of FASB Statement of Financial Accounting
Standards No. 131, "Disclosure About Segments of an Enterprise and Related
Information" (FAS 131). FAS 131 requires the utilization of a "management
approach" to define and report the financial results of operating segments. The
management approach defines operating segments along the lines used by
management to assess performance and make operating and resource allocation
decisions.
The Company has determined that its reportable segments are those that are based
on the Company's method of internal reporting, which disaggregates its business
by service line, and that sufficient information is now available to permit such
reporting. The Company's reportable segments are oncology pharmaceutical
services, other practice
-11-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
management services, cancer center services, and cancer research services. The
oncology pharmaceutical services segment purchases and manages specialty
oncology pharmaceuticals for the Company's affiliated practices. Management of
the administrative aspects of affiliated medical oncology practices is included
in the other practice management services segment. The cancer center services
segment develops and manages comprehensive, community-based cancer centers,
which integrate all aspects of outpatient cancer care, from laboratory and
radiology diagnostic capabilities to chemotherapy and radiation therapy. The
cancer research services segment contracts with pharmaceutical and biotechnology
firms to provide a comprehensive range of services relating to clinical trials.
The operating results of this segment are reflected in the "other" category. The
Company's business is conducted entirely in the United States.
The financial results of the Company's segments are presented on the accrual
basis. For the first quarter of 2003, 97.4% of the Company's oncology
pharmaceutical services revenue and cancer center services revenue was derived
from the PPM model with the remainder derived under service line model
agreements providing oncology pharmaceutical services. To determine results of
the oncology pharmaceutical services segment with respect to practices managed
under the Company's PPM model, management has assumed that the pharmaceuticals
purchased and pharmacy management services under this segment are provided at
rates consistent with the rates at which the Company is currently offering those
services outside of the PPM model. Therefore, the financial results of that
segment include inter-segment revenues while other practice management services
reflects PPM results after the effect of removing the oncology pharmaceutical
services results and cancer center services results (which are actual results of
that service line within the PPM model) disclosed below. As such, the combined
operating results of the oncology pharmaceutical services segment and other
practice management segments for the quarters ended March 31, 2003 and 2002
represent the operating results under the Company's PPM activities relative to
the management of the non-medical aspects of affiliated medical oncology
practices plus the results under oncology pharmaceutical services for practices
under service line model agreements.
Asset information by reportable segment is not reported since the Company does
not produce such information internally.
The table below presents information about reported segments for the quarter
ended March 31, 2003:
Oncology Other Practice
Pharmaceutical Management Cancer Center
Services Services Services Other Total
-------------- -------------- ------------- -------- ---------
Net operating revenue ...................... $ 262,788 $ 217,880 $ 79,292 $ 14,168 $ 574,128
Amounts retained by affiliated practices ... (254) (100,590) (24,987) (1,087) (126,918)
--------- --------- -------- -------- ---------
Revenue .................................... 262,534 117,290 54,305 13,081 447,210
Operating expenses ......................... (236,793) (95,935) (42,782) (40,358) (415,868)
--------- --------- -------- -------- ---------
Income (loss) from operations .............. $ 25,741 $ 21,355 $ 11,523 $(27,277) $ 31,342
========= ========= ======== ======== =========
The table below presents information about reported segments for the quarter
ended March 31, 2002:
Oncology Other Practice
Pharmaceutical Management Cancer Center
Services Services Services Other Total
-------------- -------------- ------------- -------- ---------
Net operating revenue ...................... $ 205,632 $201,234 $ 77,735 $ 16,281 $ 500,882
Amounts retained by affiliated practices ... 621 (84,303) (24,677) (1,238) (109,597)
--------- -------- -------- -------- ---------
Revenue .................................... 206,253 116,931 53,058 15,043 391,285
Operating expenses ......................... (188,170) (93,511) (42,272) (53,373) (377,326)
--------- -------- -------- -------- ---------
Income (loss) from operations .............. $ 18,083 $ 23,420 $ 10,786 $(38,330) $ 13,959
========= ======== ======== ======== =========
-12-
US Oncology, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued
(unaudited)
The Company evaluates the performance of its segments based on, among other
things, earnings before interest, taxes, depreciation, amortization and loss on
early extinguishment of debt (EBITDA).
The following is a reconciliation of consolidated income (loss) from operations
to EBITDA for the quarter ended March 31, 2003:
Oncology Other Practice
Pharmaceutical Management Cancer Center
Services Services Services Other Total
-------------- -------------- ------------- -------- -------
Income from operations .................... $25,741 $21,355 $11,523 $(27,277) $31,342
Depreciation and amortization ............. 20 -- 5,836 12,957 18,813
------- ------- ------- -------- -------
EBITDA .................................... $25,761 $21,355 $17,359 $(14,320) $50,155
======= ======= ======= ======== =======
The following is a reconciliation of consolidated income (loss) from operations
to EBITDA for the quarter ended March 31, 2002:
Oncology Other Practice
Pharmaceutical Management Cancer Center
Services Services Services Other Total
-------------- -------------- ------------- -------- -------
Income (loss) from operations ............. $18,083 $23,420 $10,786 $(38,330) $13,959
Loss on early extinguishment of debt ...... -- -- -- 13,633 13,633
Depreciation and amortization ............. 191 -- 5,197 12,483 17,871
------- ------- ------- -------- -------
EBITDA .................................... $18,274 $23,420 $15,983 $(12,214) $45,463
======= ======= ======= ======== =======
NOTE 10 - Commitments and Contingencies
As disclosed in Part II, Item 1, under the heading "Legal Proceedings," the
Company is aware that it and certain of its subsidiaries and affiliated
practices have in the past been subject of in qui tam lawsuits filed under seal
alleging healthcare law violations. Although the suits of which the Company is
aware have been dismissed, because qui tam actions are filed under seal, there
is a possibility that the Company could be the subject of other qui tam actions
of which it is unaware.
NOTE 11 - Recent Pronouncements
In April 2002, the FASB issued Statement of Financial Accounting Standards No.
145, "Rescission of FASB Statements Nos. 4, 44 and 64, Amendment of FASB
Statement No. 13 and Technical Corrections" (FAS 145). FAS 145 rescinds SFAS 4,
"Reporting Gains and Losses from Extinguishment of Debt". By rescinding FASB
Statement No. 4, gains or losses from extinguishment of debt that do not meet
the criteria of APB No. 30 should no longer be reported as an extraordinary item
and should be reclassified to income from continuing operations in all periods
presented. APB No. 30 states that extraordinary items are events and
transactions that are distinguished by their unusual nature and by the
infrequency of their occurrence. FAS 145 is effective for all fiscal years
beginning after May 15, 2002, including all prior year presentations. Upon
adoption of FAS 145 in January 2003, the Company reclassified the $13.6 million
extraordinary loss on early extinguishment of debt in the first quarter of 2002
as a separate component of other income (expense) in its condensed consolidated
statement of operations.
In March 2003, the FASB issued Statement of Financial Accounting Standards No.
149, "Accounting for Certain Financial Instruments with Characteristics of
Liabilities and Equity" (FAS 149). This statement establishes standards for
classification of certain financial instruments that have characteristics of
both liabilities and equity in the statement of financial position. This
Statement is effective for all contracts created or modified after the date the
Statement was issued and otherwise effective at the beginning of the first
interim period beginning after June 15, 2003. Management does not expect the
adoption of SFAS 149 to have a material impact on its financial conditions or
results of operations.
-13-
US Oncology, Inc.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
The following discussion should be read in conjunction with the financial
statements, related notes, and other financial information appearing elsewhere
in this report. In addition, see "Forward-Looking Statements and Risk Factors"
included in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission (SEC).
General
We provide comprehensive services to our network of affiliated practices, made
up of more than 875 affiliated physicians in over 440 sites, with the mission of
expanding access to and improving the quality of cancer care in local
communities and advancing the delivery of care. The services we offer include:
. Oncology Pharmaceutical Services. We purchase and manage specialty
oncology pharmaceuticals for our affiliated practices. We are
responsible for purchasing, delivering and managing nearly $1 billion
of pharmaceuticals annually through a network of 36 licensed
pharmacies, 121 pharmacists and 239 pharmacy technicians.
. Cancer Center Services. We develop and manage comprehensive,
community-based cancer centers which integrate a broad array of
outpatient cancer care services, from laboratory and diagnostic
radiology capabilities to chemotherapy and radiation therapy. We have
developed and operate 76 integrated community-based cancer centers and
manage over one million square feet of medical office space. We have
installed and manage 17 Positron Emission Tomography (PET) units and
107 Linear Accelerators, as well as 50 Computerized Axial Tomography
(CT) units.
. Cancer Research Services. We facilitate a broad range of cancer
research and development activities through our network. We contract
with pharmaceutical and biotechnology firms to provide a comprehensive
range of services relating to clinical trials. We currently manage 66
clinical trials, supported by our network of over 500 participating
physicians in more than 170 research locations.
. Other Practice Management Services. Under our physician practice
management arrangements, we act as the exclusive manager and
administrator of all day-to-day non-medical business functions
connected with our affiliated practices. As such, we are responsible
for billing and collecting for medical oncology services, physician
recruiting, data management, accounting, systems, and capital
allocation to facilitate growth in practice operations.
We offer these services through two business models, the Physician Practice
Management ("PPM") model, under which we provide all of the above services under
a single contract with a single fee based on overall practice performance, and
the service line model, under which practices contract with us to purchase only
certain of the above services, each under a separate contract, with a separate
fee methodology for each service.
Under the PPM model, we are reimbursed for all expenses and receive a fee
generally based on one of two models. Under some agreements, the fees are based
on practice earnings before taxes - known as the "earnings model." In others,
the fee consists of a fixed fee, a percentage of the practice's revenues (in
most states) and, if certain performance criteria are met, a performance fee -
known as the "net revenue model." Under the net revenue model, the practice is
entitled to retain a fixed portion of its net revenue before any service fee is
paid, provided that all operating expenses have been reimbursed. In certain
states our fee is a fixed fee.
-14-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
We believe that the earnings model properly aligns ours and our affiliated
practices' priorities with respect to appropriate business operations and cost
control, since practice profitability is shared proportionately, while the net
revenue model results in us disproportionately bearing the impact of increases
or declines in operating margins. For this reason, we have, since 2001, been
negotiating with practices under the net revenue model to convert to the
earnings model. Since the beginning of 2001 and through March 31, 2003, eighteen
practices accounting for 27.0% of our net operating revenue in 2002 have
converted to the earnings model. 67.9% of net operating revenue in the first
quarter of 2003 is attributable to practices on the earnings model as of March
31, 2003. Excluding disaffiliated practices, 73.0% of the net operating revenue
in the first quarter of 2003 is attributable to practices that are either on the
earnings model or the service line model as of March 31, 2003.
In certain net revenue model markets where we have not been successful in
transitioning the practice away from a net revenue model agreement, we have
recognized charges for impairments of the service agreement as a result of our
projection of future results under those agreements, given declining performance
trends. We may in the future be required to recognize additional such
impairments in such under performing markets.
In September 2001, we announced an initiative to offer our core cancer-related
services nationwide to oncology practices that are outside of our current
network under what we call the "service line structure," which allows oncology
practices to obtain our services without entering into comprehensive service
agreements that would call for our involvement in all business aspects of their
day-to-day operations. Under the service line structure, we do not pay
consideration to physicians in new markets to acquire the non-medical assets of
their practices. We believe that the service line structure, when compared to
the PPM model, allows us to expand more rapidly into new markets without
incurring capital investments in intangible assets, with a higher return on
assets and lower compliance and reimbursement risks. During 2002, we refined the
service line structure significantly and believe it will appeal to large numbers
of oncologists outside our network, since new physicians may affiliate with us
and utilize our core services while maintaining complete ownership and control
of their oncology practices' assets.
To implement this service line strategy, we have organized the company in three
divisions, and manage and operate our business under distinct service lines.
This report includes segment financial information which reflects a division of
our existing PPM operations into the various service line offerings in the PPM
relationship. As we enter into new service line model agreements, we will report
revenue from those agreements in the appropriate segment.
Under the service line model, we are offering physician groups three service
lines, each with a separate agreement. Those agreements are structured as
follows:
Oncology Pharmaceutical Services. The oncology pharmaceutical services
service line combines all of our core competencies and service offerings
related to oncology drugs into a single, coordinated business division. The
division provides a comprehensive, integrated solution to all of the drug
needs of an oncology practice, from purchasing drugs and supplies to mixing
and managing drugs for infusion, to post-use evaluation and data
aggregation. We offer a variety of contract options under which practices
may contract to purchase only selected services under this service line,
with an option to upgrade to a fully integrated pharmacy solution. We also
act as a group purchasing organization and will receive a fee from
pharmaceutical manufacturers for this service, as well as for providing
data and informational services to pharmaceutical companies.
Cancer Center Services. We agree to develop outpatient cancer centers under
development agreements and leases with physician practices. Under the
leases, we expect to receive our economic costs of the property plus an
amount sufficient to give us a predetermined rate of return on invested
capital. In addition, we provide management services and expect to receive
an additional fee of 30% of net earnings from radiation and diagnostic
operations, subject to adjustments.
Cancer Research Services. We contract with pharmaceutical companies and
others needing research services on a per trial basis. Our contracts with
physician groups outline the terms of access to clinical trials and provide
for research related services. We will pay physicians for each trial based
on economic considerations relating to that trial.
-15-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
We are continuing to operate under the PPM model, but in connection with our
introduction of the service line model we offered our PPM practices the
opportunity to terminate their existing service agreements, repurchase certain
of their operating assets, and enter into new service line model agreements. For
those practices that remain on the PPM model, we will continue to negotiate with
"net revenue model" practices to move to the "earnings model," and otherwise to
manage those practices pursuant to existing agreements.
During 2002, three of our PPM practices, comprising 34 physicians, converted to
the service line model, and during the first quarter of 2003, one additional PPM
practice, comprising eleven physicians, converted to the service line model. As
practices transition to this service line model or otherwise terminate PPM
agreements, we would expect the financial impact to be receipt of cash payments,
recognition of restructuring and reorganization costs (which are mainly non-cash
charges), and a reduction in our revenues and earnings related to those
practices. We currently expect one additional net revenue model PPM practice to
transition to the service line model, but anticipate that a large majority of
our PPM practices will remain on the PPM model for the foreseeable future.
In addition to converting four PPM practices to the service line model, through
March 31, 2003, we have entered into service line model agreements with seven
practices, comprising 33 physicians, in new markets during that time, including
thirteen physicians during the first quarter of 2003. Effective April 2003, we
have entered into a service line model agreement with one additional practice
comprising four physicians in a new market. 2.6% of net operating revenue in the
first quarter of 2003 is attributable to practices on the service line model as
of March 31, 2003, an increase from 1.4% as of December 31, 2002.
We terminated service agreements with four oncology practices during 2002 and
with ten physicians from one oncology practice in the first quarter of 2003. For
purposes of the following discussion and analysis, same practice revenues and
expense exclude the results of these disaffiliated practices.
Forward-looking Statements and Risk Factors
The following statements are or may constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995: (i) certain
statements, including possible or assumed future results of operations contained
in "Management's Discussion and Analysis of Financial Condition and Results of
Operations," (ii) any statements contained herein regarding the prospects for
any of our business or services and our development activities relating to the
service line model, cancer centers and PET installations; (iii) any statements
preceded by, followed by or that include the words "believes", "expects",
"anticipates", "intends", "estimates", "plans" or similar expressions; and (iv)
other statements contained herein regarding matters that are not historical
facts.
US Oncology's business and results of operations are subject to risks and
uncertainties, many of which are beyond the Company's ability to control or
predict. Because of these risks and uncertainties, actual results may differ
materially from those expressed or implied by such forward-looking statements,
and investors are cautioned not to place undue reliance on such statements,
which speak only as of the date thereof. Factors that could cause actual results
to differ materially include, but are not limited to, reimbursement rates for
pharmaceutical products, the success of the service line model, transition of
existing practices, our ability to attract and retain additional physicians and
practices under the service line model, expansion into new markets, our ability
to develop and complete cancer centers and PET installations, our ability to
maintain good relationships with our affiliated practices, our ability to
recover the cost of our investment in cancer centers, government regulation and
enforcement, reimbursement for healthcare services, particularly including
reimbursement for pharmaceuticals, changes in cancer therapy or the manner in
which cancer care is delivered, drug utilization, our ability to create and
maintain favorable relationships with pharmaceutical companies and other
suppliers, and the operations of the Company's affiliated physician groups.
Please refer to the Company's Annual Report on Form 10-K for the year ended
December 31, 2002 and subsequent filings with the SEC, particularly the section
entitled "Risk Factors," for a more detailed discussion of certain of these
risks and uncertainties.
The cautionary statements contained or referred to herein should be considered
in connection with any written or oral forward-looking statements that may be
issued by US Oncology or persons acting on its behalf. US Oncology
-16-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
does not undertake any obligation to release any revisions to or to update
publicly any forward-looking statements to reflect events or circumstances after
the date thereof or to reflect the occurrence of unanticipated events.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires management to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, we evaluate these estimates, including
those related to service agreements, accounts receivable, income taxes, and
contingencies and litigation. We base our estimates on historical experience and
on various other assumptions that we believe to be reasonable under the
circumstances. These estimates form the basis for making judgments about the
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from those estimates under different
assumptions or conditions.
Management believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
condensed financial statements. These critical accounting policies include our
policy of non-consolidation, revenue recognition (including calculation of
physician compensation), general estimates of accruals and intangible asset
amortization and impairment. Please refer to the "Critical Accounting Policies"
section of our Annual Report on Form 10-K for the year ended December 31, 2002
for a more detailed discussion of such policies.
Discussion of Non-GAAP Information
In this report, we use certain measurements of our performance that are not
calculated in accordance with Generally Accepted Accounting Principles ("GAAP").
These non-GAAP measures are derived from relevant items in our GAAP financials.
A reconciliation of the non-GAAP measure to our income statement is included in
this report.
Management believes that the non-GAAP measures we use are useful to investors,
since they can provide investors with additional information that is not
directly available in a GAAP presentation. In all events, these non-GAAP
measures are not intended to be a substitute for GAAP measures, and investors
are advised to review such non-GAAP measures in conjunction with GAAP
information provided by us. The following is a discussion of these non-GAAP
measures.
"Net operating revenue" is our revenue, plus amounts retained by our affiliated
physicians. We believe net operating revenue is useful to investors as an
indicator of the overall performance of our network, since it represents the
total revenue of all of our PPM practices, without taking into account what
portion of that is retained as physician compensation. In addition, by comparing
trends in net operating revenue to trends in our revenue, investors are able to
assess the impact of trends in physician compensation on our overall
performance.
"Net patient revenue" is the net revenue of our affiliated practices under the
PPM model for services rendered to patients by those affiliated practices. Net
patient revenue will also include the net revenue relating to radiation
operations of practices that enter into our cancer center services agreement.
Net patient revenue is the largest component (94.3% in the first quarter of
2003) of net operating revenue. It is a useful measure because it gives
investors a sense of the overall operations of our PPM network and other
business lines in which our revenue is derived from payments for medical
services to patients and in which we are responsible for billing and collecting
such amounts.
"EBITDA" is earnings before taxes, interest, depreciation and amortization, and
loss on early extinguishment of debt. We believe EBITDA is a commonly applied
measurement of financial performance. We believe EBITDA is useful to investors
because it gives a measure of operational performance without taking into
account items that we do not believe relate directly to operations - such as
depreciation and amortization, which are typically based on predetermined asset
lives, and thus not indicative of operational performance, or that are subject
to variations that
-17-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
are not caused by operational performance - such as tax rates or interest rates.
EBITDA is a key tool used by management in assessing our business performance
both as a whole and with respect to individual sites or product lines.
"Field EBITDA" is EBITDA plus physician compensation and corporate general and
administrative expenses. Like net operating revenue, Field EBITDA provides an
indication of our overall network operational performance, without taking into
account the effect of physician compensation and corporate general and
administrative expense.
Results of Operations
The Company was affiliated (including under the service line) with the following
number of physicians by specialty:
March 31,
-----------
2003 2002
---- ----
Medical oncologists ............................................. 693 671
Radiation oncologists ........................................... 115 127
Other oncologists ............................................... 39 30
---- ----
Total oncologists ............................................ 847 828
Diagnostic radiologists ......................................... 38 39
---- ----
Total physicians ............................................. 885 867
==== ====
The Company was affiliated with the following number of physicians by business
model:
March 31,
-----------
2003 2002
---- ----
PPM ............................................................. 817 867
Service line .................................................... 68 --
--- ---
885 867
=== ===
The following table sets forth the sources for growth in the number of
physicians affiliated with the Company:
March 31,
-----------
2003 2002
---- ----
Affiliated physicians, beginning of period ...................... 884 868
Physician practice affiliations ................................. 13 --
Recruited physicians ............................................ 9 7
Physician practice separations .................................. (10) --
Retiring/Other .................................................. (11) (8)
---- ----
Affiliated physicians, end of period ............................ 885 867
==== ====
-18-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
The following table sets forth the number of cancer centers and PET units
managed by the Company:
March 31,
-----------
2003 2002
---- ----
Cancer centers .................................................. 76 77
PET units ....................................................... 17 13
The following table sets forth the key operating statistics as a measure of the
volume of services provided by our PPM practices:
Three Months Ended
March 31,
------------------
2003 2002
------- -------
Medical oncology visits .................................. 585,686 617,213
Radiation treatments ..................................... 165,542 163,011
PET scans ................................................ 4,154 2,924
New patients enrolled in research studies ................ 874 848
The following table sets forth the percentages of revenue represented by certain
items reflected in the Company's Condensed Consolidated Statement of Operations
and Comprehensive Income. The following information should be read in
conjunction with our unaudited condensed consolidated financial statements and
notes thereto included elsewhere herein.
Three Months Ended
March 31,
------------------
2003 2002
----- -----
Revenue .................................................. 100.0% 100.0%
Operating expenses:
Pharmaceuticals and supplies .......................... 55.1 50.5
Field compensation and benefits ....................... 19.7 22.0
Other field costs ..................................... 10.5 12.2
General and administrative ............................ 3.5 3.5
Restructuring charge .................................. -- 0.2
Depreciation and amortization ......................... 4.2 4.6
----- -----
Income from operations ................................... 7.0 7.0
Interest expense, net .................................... (1.2) (1.4)
Loss on early extinguishment of debt ..................... -- (3.5)
----- -----
Income before income taxes ............................... 5.8 2.1
Income tax provision ..................................... (2.2) (0.8)
----- -----
Net income ............................................... 3.6% 1.3%
===== =====
Net Operating Revenue. Net operating revenue includes three components - net
patient revenue, service line revenue and our other revenue:
. Net patient revenue. We report net patient revenue for those business
lines under which our revenue is derived from payments for medical
services to patients and we are responsible for billing those
patients. Currently, net patient revenue consists of patient revenue
of affiliated
-19-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
practices under the PPM model. Net patient revenue also will include
revenues of practices that enter into service line agreements for
Cancer Center Services.
. Service line revenue. Revenues from pharmaceutical services rendered
by us under our Oncology Pharmaceutical Services service line
agreement.
. Other revenue. Other revenue includes revenue from pharmaceutical
research, informational services and activities as a group purchasing
organization.
The following table shows the components of our net operating revenue for the
three months ended March 31, 2003 and 2002 (in thousands):
Three Months Ended
March 31,
-------------------
2003 2002
-------- --------
Net patient revenue ...................................... $541,142 $483,190
Other revenue ............................................ 32,986 17,692
-------- --------
Net operating revenue .................................... $574,128 $500,882
======== ========
Net patient revenue is recorded when services are rendered based on established
or negotiated charges reduced by contractual adjustments and allowances for
doubtful accounts. Differences between estimated contractual adjustments and
final settlements are reported in the period when final settlements are
determined. Net operating revenue is reduced by amounts retained by the
practices under our services agreement to arrive at the amount we report as
revenue in our financial statements.
Net operating revenue increased from $500.9 million in the first quarter of 2002
to $574.1 million in the first quarter of 2003, an increase of $73.2 million, or
14.6%. Same practice net operating revenue (which excludes the results of
practices with which we disaffiliated since January 1, 2002 increased from
$479.4 million for the first quarter of 2002) to $571.9 million for the quarter
of 2003, an increase of $92.5 million, or 19.3%. Revenue growth was attributable
to increases in pharmaceutical revenue and, to a lesser extent, diagnostic
revenue. Other revenue increased from $17.7 million in the first quarter of 2002
to $33.0 million in the first quarter of 2003, an increase of $15.3 million, or
86.4%. This increase was attributable to $14.7 million of operating revenue
under the new service line agreements, as well as an increase in group
purchasing organization revenues, offset by a decline in research revenues.
The following table shows our net operating revenue by segment for the three
months ended March 31, 2003 and 2002 (in thousands):
Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
------------------ ------------------
Oncology pharmaceutical management services ... $262,788 $205,632
Other practice management services ............ 217,880 201,234
-------- --------
Medical oncology ........................... 480,668 406,866
Cancer center services ........................ 79,292 77,735
Other segment revenue ......................... 14,168 16,281
-------- --------
$574,128 $500,882
======== ========
-20-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
Our medical oncology net operating revenue is comprised of (i) our oncology
pharmaceutical services revenue, which represents the revenue attributable to
our providing drugs to medical oncologists under either the PPM model or the
service line model, plus (ii) our other practice management services revenue,
since this represents our PPM model revenue derived from providing other
services to medical oncologists. A portion of the other practice management
services revenue is attributable to revenues of affiliated practices derived
from pharmaceuticals. Revenue attributable to services provided in connection
with radiation oncology and diagnostic radiology under either the PPM model or
the service line model appears as cancer center services revenue.
Medical oncology net operating revenue increased from $406.9 million in the
first quarter of 2002 to $480.7 million for the first quarter of 2003, an
increase of $73.7 million or 18.1%. The growth in medical oncology revenue is
primarily attributable to more expensive chemotherapy agents and additional
supportive care drugs, rather than increased patient volume. During the first
quarter of 2003, medical oncology visits decreased by 5.1% compared to the same
prior year period as a result of PPM practice disaffiliations and conversions to
the service line model since service line model visits are not included in our
patient volume statistics. Same practice medical oncology visits for the first
quarter of 2003 increased 2.6% over the same prior year period. Also
contributing to the increase in medical oncology revenue is the addition of our
new service line agreements of $14.7 million and increased group purchasing
organization revenues of $2.3 million.
Cancer center services net operating revenue increased from $77.7 million in the
first quarter of 2002 to $79.3 million for the first quarter of 2003, an
increase of $1.6 million, or 2.0%. This increase is attributable to increased
radiology revenue from PET services partially offset by our disaffiliation with
a radiation oncology facility during the third quarter of 2002 and our sale of
technical radiology assets during the second quarter of 2002. Diagnostic
revenues increased over the prior year period as a result of an increase in PET
services. PET scans increased from 2,924 in the first quarter of 2002 to 4,154
in the first quarter of 2003, an increase of 42.1%. The increase in the number
of PET scans is attributable to our opening four PET units since March 31, 2002,
as well as growth of 21.7% in the number of treatments on the thirteen PET units
that were operational during the first quarter of 2002. Radiation treatments
increased from 163,011 in the first quarter of 2002 to 165,542 in the first
quarter of 2003, or 1.6%. Since March 31, 2002, we have disaffiliated with three
radiation oncology practices with operations in five cancer centers and closed
two other cancer centers. In addition, we have opened five cancer centers since
March 31, 2002. Same practice radiation treatments increased from 158,360 in the
first quarter of 2002 to 160,909 in the first quarter of 2003, or 1.6%. We
currently have nine cancer centers and six PET installations in various stages
of development.
Other segment net operating revenue decreased from $16.3 million in the first
quarter of 2002 to $14.2 million for the first quarter of 2003, a decrease of
$2.1 million, or 12.8%. The decrease is primarily attributable to a decrease in
research revenue.
95.2% of our net operating revenue for the first quarter of 2003 was derived
from practices under the PPM model as of March 31, 2003. The following table
shows the amount of operating revenue we derived under each type of service
agreement at the end of the respective period for the three months ended March
31, 2003 and 2002 (in thousands):
Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
------------------ ------------------
Revenue % Revenue %
-------- ----- -------- -----
Earnings model ...................... $389,630 67.9% $312,198 62.3%
Net revenue model ................... 156,864 27.3% 174,915 34.9%
Service line model .................. 14,733 2.6% -- 0.0%
Other ............................... 12,901 2.2% 13,769 2.8%
-------- ----- -------- -----
$574,128 100.0% $500,882 100.0%
======== ===== ======== =====
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US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
During the first quarter of 2003, one net revenue model practice accounting for
0.8% of our net operating revenue for 2002 converted to the earnings model.
Since the beginning of 2001 and through March 31, 2003, eighteen practices
accounting for 27.0% of net operating revenue in 2002 have converted from the
net revenue model to the earnings model. As of March 31, 2003, twenty-six
service agreements were on the earnings model and twelve service agreements were
on the net revenue model. In addition during the first quarter of 2003, we
transitioned one PPM practice from the revenue model to the service line model
and commenced operations at three new practices under the service line model.
Also during the first quarter of 2003, we disaffiliated with ten physicians who
practiced at the net revenue model practice that converted to the earnings
model.
Revenue. Our revenue is net operating revenue, less the amount of net operating
revenue retained by our affiliated physician practices under PPM service
agreements.
The following presents the amounts included in determination of our revenue (in
thousands):
Three Months Ended
March 31,
-------------------
2003 2002
-------- --------
Net operating revenue ................................... $574,128 $500,882
Amounts retained by the practices ....................... (126,918) (109,597)
-------- --------
Revenue .............................................. $447,210 $391,285
======== ========
Amounts retained by practices increased from $109.6 million in the first quarter
of 2002 to $126.9 million in the first quarter of 2003, an increase of $17.3
million, or 15.8%. Such increase in amounts retained by practices is directly
attributable to the growth in net patient revenue combined with the increase in
profitability of affiliated practices. Amounts retained by practices as a
percentage of net operating revenue increased from 21.9% to 22.1% for the first
quarters of 2002 and 2003, respectively.
Revenue increased from $391.3 million for the first quarter of 2002 to $447.2
million for the first quarter of 2003, an increase of $55.9 million, or 14.3%.
Revenue growth was caused by increases in revenues attributable to
pharmaceuticals, and to a lesser extent, an increase in other revenues.
The following table shows our revenue by segment for the three months ended
March 31, 2003 and 2002 (in thousands):
Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
------------------ ------------------
Oncology pharmaceutical management services ... $262,534 $206,253
Other practice management services ............ 117,290 116,931
-------- --------
Medical oncology ........................... 379,824 323,184
Cancer center services ........................ 54,305 53,058
Other segment revenue ......................... 13,081 15,043
-------- --------
$447,210 $391,285
======== ========
Medicare and Medicaid are the practices' largest payors. During the first three
months of 2003 approximately 43% of the PPM practices' net patient revenue was
derived from Medicare and Medicaid payments, and 42% was derived from those
sources in the comparable period last year. This percentage varies among
practices. No other single payor accounted for more than 10% of our revenues in
the first three months of 2003 or 2002.
Pharmaceuticals and Supplies. Pharmaceuticals and supplies expense, which
includes drugs, medications and other supplies used by the practices, increased
from $197.6 million in the first quarter of 2002 to
-22-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
$246.6 million in the same period of 2003, an increase of $49.0 million, or
24.8%. As a percentage of revenue, pharmaceuticals and supplies increased from
50.5% in the first quarter of 2002 to 55.1% in the same period in 2003. The
increase was attributable to more expensive drugs and to a lesser extent the
conversion of four affiliated practices to, and the addition of seven practices
in new markets under, the service line model since March 31, 2002.
We expect that third-party payors will continue to negotiate or mandate the
reimbursement rates for pharmaceuticals and supplies, with the goal of lowering
reimbursement rates, and that such lower reimbursement rates together with
shifts in revenue mix may continue to adversely impact our margins with respect
to such items. In both regulatory and litigation activity, federal and state
governments are focusing on decreasing the amount governmental programs pay for
drugs. Current governmental focus on average wholesale price (AWP) as a basis
for reimbursement could also lead to a wide-ranging reduction in the
reimbursement for pharmaceuticals by both governmental and commercial payors.
Commercial payors also continue to try to implement both voluntary and mandatory
programs in which the practice must obtain drugs they administer to patients
from a third party and that third party, rather than the practice, receives
payment for the drugs directly from the payor, and to otherwise reduce drug
expenditures. We continue to believe that single-source drugs, possibly
including oral drugs, will continue to be introduced at a rapid pace, thus
further negatively impacting margins. In response to this decline in margin
relating to certain pharmaceutical agents, we have adopted several strategies.
The successful conversion of net revenue model practices to the earnings model
will help reduce the impact of the increasing cost of pharmaceuticals and
supplies and the effect of reduced levels of reimbursement. Likewise, the
implementation of the service line structure should have a similar effect, since
our revenues and earnings are not directly dependent on pharmaceutical margins
of practices under that model. In addition, we have numerous efforts under way
to reduce the cost of pharmaceuticals by negotiating discounts for volume
purchases and by streamlining processes for efficient ordering and inventory
control and are assessing other strategies to address this trend. We also
continue to seek to expand into areas that are less affected by lower
pharmaceutical margins, such as radiation oncology and diagnostic radiology.
However, as long as pharmaceuticals continue to become a larger part of our
revenue mix as a result of changing treatment patterns (rather than growth of
our business), we believe that our overall margins could continue to be
adversely impacted. In addition, the pharmacy service line is a lower-margin
business than our PPM model. Although we believe it reduces risk in certain
respects, to the extent we add additional service line practices under the
pharmacy service line, we would expect our overall margin percentages to be
adversely impacted.
Field Compensation and Benefits. Field compensation and benefits, which includes
salaries and wages of our field-level employees and the practices' employees
(other than physicians), increased from $86.1 million in the first quarter of
2002 to $87.9 million in the first quarter of 2003, an increase of $1.8 million,
or 2.1%. As a percentage of revenue, field compensation and benefits decreased
from 22.0% in the first quarter of 2002 to 19.7% in the first quarter of 2003.
The decrease as a percentage of revenue is attributable to pharmaceutical
revenues increasing at a more rapid rate than compensation and benefits. Same
practice field compensation and benefits increased 7.9% in the first quarter of
2003 as compared to the same prior year period.
Other Field Costs. Other field costs, which consist of rent, utilities, repairs
and maintenance, insurance and other direct field costs, decreased from $47.9
million in the first quarter of 2002 to $47.0 million in the first quarter of
2003, a decrease of $0.9 million, or 1.9%. As a percentage of revenue, other
field costs decreased from 12.2% in the first quarter of 2002 to 10.5% in the
first quarter of 2003. The decrease for the first quarter is attributable to the
closure of two cancer centers and the sale of five cancer centers resulting from
the disaffiliation of two radiation oncology practices since March 31, 2002.
Same practice other field costs increased 3.3% in the first quarter of 2003 as
compared to the same prior year period.
-23-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
General and Administrative. General and administrative expenses increased from
$13.6 million in the first quarter of 2002 to $15.6 million in the first quarter
of 2003, an increase of $2.0 million, or 14.9%. Throughout 2002, several new
personnel positions had been created to help manage and support our introduction
of the service line model. As a percentage of revenue, general and
administrative costs remained steady at 3.5% in the first quarters of both 2002
and 2003.
Overall, we experienced a decline in operating margins with earnings before
taxes, interest, depreciation and amortization, and loss on early extinguishment
of debt (EBITDA), as a percentage of revenue, decreasing from 11.8% in the first
quarter of 2002 to 11.2% in the first quarter of 2003.
The following is the EBITDA of our operations by operating segment for the three
months ended March 31, 2003 and 2002 (in thousands):
Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
------------------ ------------------
Oncology pharmaceutical services ..... $ 25,761 $ 18,274
Other practice management services ... 21,355 23,420
-------- --------
Medical oncology .................. 47,116 41,694
Cancer center services ............... 17,359 15,983
Other segment EBITDA ................. 1,256 1,348
-------- --------
65,731 59,025
General and administrative expenses .. (15,576) (13,562)
-------- --------
$ 50,155 $ 45,463
======== ========
EBITDA for the first quarter of 2002 includes $0.7 million in restructuring
charges. The decrease in EBITDA for the other practice management services is
attributable to our disaffiliation with five oncology practices since March 31,
2002.
Medical oncology EBITDA margin decreased from 10.2% in the first quarter of 2002
to 9.8% in the first quarter of 2003. This decrease is attributable to an
increase in lower margin pharmaceuticals.
Cancer center services EBITDA margin increased from 20.6% in the first quarter
of 2002 to 21.9% in the first quarter of 2003. This increase is attributable to
exiting from unprofitable sites, investment in technology such as intensity
modulated radiation therapy (IMRT) and growth in same practice treatments.
Interest. Net interest expense decreased from $5.4 million in the first quarter
of 2002 to $5.1 million in the first quarter of 2003, a decrease of $0.3
million, or 5.3%. As a percentage of revenue, net interest expense decreased
from 1.4% for the first quarter of 2002 to 1.2% for the first quarter of 2003.
Such decreases are due to lower borrowing levels during the first quarter of
2003 and to a lesser extent, an increase in interest income resulting from
improved operating cash flows since March 31, 2002. On February 1, 2002, we
refinanced our indebtedness by issuing $175 million in 9.625% Senior
Subordinated Notes due 2012 and repaying in full our existing senior secured
notes and terminating our existing credit facility. Our previously existing $100
million senior secured notes bore interest at a fixed rate of 8.42% and would
have matured as to $20 million in each of 2002-2006. Lower levels of debt during
the first three months of 2003, as compared to the same period in 2002,
partially offset by the increased rate of interest contributed to the decrease
of interest expense.
Loss on Early Extinguishment of Debt. During the first quarter of 2002, we
recorded a loss of $13.6 million, before income taxes of $5.2 million, in
connection with the early extinguishment of our $100 million Senior Secured
Notes due 2006 and our existing credit facility. The loss consisted of payment
of a prepayment penalty of $11.7 million on the Senior Secured Notes and a
write-off of unamortized deferred financing costs of $1.9 million related to the
terminated debt agreements.
-24-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
The Company adopted Statement of Financial Accounting Standards No. 145,
"Rescission of FASB Statements No. 4,44, and 64, Amendment of FASB Statement No.
13, and Technical Corrections" (SFAS 145) effective January 1, 2003. Among other
matters, SFAS 145 rescinds Statement of Financial Accounting Standards No. 4,
"Reporting Gains and Losses from Extinguishment of Debt," which required all
gains and losses from extinguishment of debt to be aggregated and, if material,
classified as an extraordinary item, net of the related income tax effect. In
connection with its adoption, gains and losses from extinguishments of debt are
no longer classified as extraordinary items in the Company's statement of
operations. In addition prior period financial statements were reclassified to
reflect the new standard. As such, the Company reclassified the $13,633
extraordinary loss on early extinguishment of debt recorded in the three months
ended March 31, 2002 as a component of interest expense, net, in its condensed
consolidated statement of operations.
Income Taxes. We recognized an effective tax rate of 38.0% for the first quarter
of 2003 and for the same prior year period.
In September 2001, we announced in a press release that our introduction of the
service line structure and transition away from the net revenue model, and the
related realignment of our business would cause us to record unusual charges for
write-offs of service agreements and other assets and other charges. These
charges include the impairment, restructuring and other charges and loss on
early extinguishment of debt we have recorded during 2002. Throughout 2002, we
had recorded $10.3 million in unusual cash charges and $153.4 million in unusual
non-cash charges in connection with our transition process. We have not
recognized any unusual charges in the first quarter of 2003.
The principal category of those prior charges related to the impairment of
service agreements. Service agreements were impaired either because of a
termination of the agreement (both in disaffiliations and conversions to the
service line) or because we determined that the agreement was impaired based on
expected future cash flow under the agreement. The latter category of impairment
related exclusively to net revenue model practices. Currently, our balance sheet
reflects $23.5 million in service agreements under the net revenue model and
$226.0 million under the earnings model. Based upon the potential for continued
declining performance, we would anticipate that the net revenue model
agreements, if not converted to the earnings model, could become impaired in the
future. At present, we would not expect earnings model agreements to become
impaired, except in the case of disaffiliations or service line conversions.
Accordingly, management currently expects that the total amount of charges in
connection with our transition is unlikely to exceed $200 million, absent
additional disaffiliations or conversions.
Net Income. Net income increased from $5.3 million, or $0.05 per diluted share,
in the first quarter of 2002 to $16.3 million, or $0.17 per share, in the first
quarter 2003, an increase of $11.0 million or 207.7%. Net income as a percentage
of revenue increased from 1.3% in the first quarter of 2002 to 3.6% in the first
quarter of 2003. Included in net income for the first quarter of 2002 are
restructuring charges of $0.7 million and a loss on early extinguishment of debt
of $13.6 million. Excluding these charges, net income for the first quarter of
2002 would have been $14.2 million, which represents earnings per share of
$0.14.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2003, we had net working capital of $220.3 million, including
cash and cash equivalents of $74.9 million. We had current liabilities of $288.5
million, including $13.4 million in current maturities of long-term debt, and
$264.5 million of long-term indebtedness. During the first quarter of 2003, we
used $1.1 million in net operating cash flow, invested $16.9 million, and used
cash from financing activities in the amount of $12.7 million. As of April 30,
2003, we had cash and cash equivalents of $109.3 million.
Cash Flows from Operating Activities
During the first quarter of 2003, we used $1.1 million in cash flows from
operating activities as compared to $20.1 million in the comparable prior year
period. The decrease in cash flow is primarily attributable to payments of $33.1
million for advance purchases of certain pharmaceutical products during the
first quarter of 2003 in order to obtain favorable pricing and qualify for
certain volume rebates.
-25-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
Cash Flows from Investing Activities
During the first quarter of 2003 and 2002, we expended $16.9 million and $14.7
million in capital expenditures, including $12.8 million and $7.4 million on the
development and construction of cancer centers, respectively. Maintenance
capital expenditures were $3.8 million and $6.9 million in the first quarters of
2003 and 2002, respectively. For all of 2003, we anticipate expending a total of
approximately $30-$35 million on maintenance capital expenditures and
approximately $55-$60 million on development of new cancer centers and PET
installations.
Cash Flows from Financing Activities
During the first quarter of 2003, we used cash from financing activities of
$12.7 million as compared to cash provided of $47.5 million in the quarter of
2002. Such decrease in cash flow is primarily attributed to the proceeds in 2002
from the issuance of our Senior Subordinated Notes due 2012, net of the cash
payments for the retirement of our previously existing indebtedness, including a
prepayment premium paid as a result of early extinguishment of our Senior
Secured Notes due 2006. In addition, we expended $3.5 million to repurchase
399,000 shares of our Common Stock during the first quarter of 2003.
On February 1, 2002, we entered into a five-year $100 million syndicated
revolving credit facility and terminated our existing syndicated revolving
credit facility. Proceeds under that credit facility may be used to finance the
development of cancer centers and new PET facilities, to provide working capital
or for other general business purposes. No amounts have been borrowed under that
facility. Our credit facility bears interest at a variable rate that floats with
a referenced interest rate. Therefore, to the extent we have amounts outstanding
under the credit facility in the future, we would be exposed to interest rate
risk under our credit facility.
On February 1, 2002, we issued $175 million in 9.625% Senior Subordinated Notes
due 2012 to various institutional investors in a private offering under Rule
144A under the Securities Act of 1933. The notes were subsequently exchanged for
substantially identical notes in an offering registered under the Securities Act
of 1933. The notes are unsecured, bear interest at 9.625% annually and mature in
February 2012. Payments under those notes are subordinated in substantially all
respects to payments under our new credit facility and certain other debt.
We entered into a leasing facility in December 1997, under which a lessor entity
acquired properties and paid for construction of certain of our cancer centers
and leased them to us. It matures in June 2004. As of March 31, 2003, we had
$70.2 million outstanding under the facility and no further amounts are
available under that facility. The annual rent under the lease is approximately
$3.2 million, based on interest rates in effect as of March 31, 2003.
Since December 31, 2002, we guarantee 100% of the residual value of the
properties in the lease and therefore, include the $70.2 million outstanding
under the lease as indebtedness on our financial statements. We also include
assets under the lease as assets on our balance sheet based upon our
determination of fair values of those properties at December 31, 2002 and
recognized an impairment charge of $20.0 million. During the first quarter we
began to recognize a depreciation charge in respect of the assets in the leasing
facility amounting to $0.9 million. We did not recognize depreciation expense
for those off-balance-sheet assets prior to December 31, 2002.
The lease is renewable in one-year increments with the consent of the financial
institutions that are parties thereto. If the lease is not renewed at maturity
or otherwise terminates, we must either purchase the properties under the lease
for the total amount outstanding or market the properties to third parties.
Defaults under the lease, which include cross-defaults to other material debt,
could result in such a termination, and require us to purchase or remarket the
properties. If we sell the properties to third parties, we have guaranteed a
residual value of 100% of the total amount outstanding for the properties. The
guarantees are collateralized by substantially all of our assets.
Because the lease payment floats with a referenced interest rate, we are also
exposed to interest rate risk under the leasing facility. A 1% increase in the
referenced rate would result in an increase in lease payments of $0.7 million
annually.
Borrowings under the revolving credit facility and advances under the
leasing facility bear interest at a rate equal to a rate based on prime rate or
the London Interbank Offered Rate, based on a defined formula. The credit
-26-
US Oncology, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - continued
facility, leasing facility and Senior Subordinated Notes contain affirmative and
negative covenants, including the maintenance of certain financial ratios,
restrictions on sales, leases or other dispositions of property, restrictions on
other indebtedness and prohibitions on the payment of dividends. Events of
default under our credit facility, leasing facility and Senior Subordinated
Notes include cross-defaults to all material indebtedness, including each of
those financings. Substantially all of our assets, including certain real
property, are pledged as collateral under the credit facility and the guarantee
obligations of our leasing facility.
We are currently in compliance with covenants under our leasing facility,
revolving credit facility and Senior Subordinated Notes, with no borrowings
currently outstanding under the revolving credit facility. We have relied
primarily on cash flows from our operations to fund working capital and capital
expenditures for our fixed assets.
We currently expect that our principal use of funds in the near future will be
in connection with the purchase of medical equipment, investment in information
systems and the acquisition or lease of real estate for the development of
integrated cancer centers and PET centers, possible repurchases of our common
stock, as well as implementation of the service line structure, with less
emphasis than in past years on transactions with medical oncology practices. It
is likely that our capital needs in the next several years will exceed the cash
generated from operations. Thus, we may incur additional debt or issue
additional debt or equity securities from time to time. Capital available for
health care companies, whether raised through the issuance of debt or equity
securities, is quite limited. As a result, we may be unable to obtain sufficient
financing on terms satisfactory to management or at all.
-27-
US Oncology, Inc.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCUSSION ABOUT MARKET RISKS
In the normal course of business, our financial position is routinely subjected
to a variety of risks. We regularly assess these risks and have established
policies and business practices to protect against the adverse effects of these
and other potential exposures.
Among these risks is the market risk associated with interest rate movements on
outstanding debt. Our borrowings under the credit facility and leasing facility
contain an element of market risk from changes in interest rates. We currently
have no outstanding borrowings under our credit facility. Historically, we have
managed this risk, in part, through the use of interest rate swaps; however, no
such agreements have been entered into in during the first quarter of 2003. We
do not enter into interest rate swaps or hold other derivative financial
instruments for speculative purposes. We were not obligated under any interest
rate swap agreements during the first quarter of 2003.
For purposes of specific risk analysis, we use sensitivity analysis to determine
the impact that market risk exposures may have on us. The financial instruments
included in the sensitivity analysis consist of all of our cash and equivalents,
long-term and short-term debt and all derivative financial instruments.
To perform sensitivity analysis, we assess the risk of loss in fair values from
the impact of hypothetical changes in interest rates on market sensitive
instruments. The market values for interest rate risk are computed based on the
present value of future cash flows as impacted by the changes in the rates
attributable to the market risk being measured. The discount rates used for the
present value computations were selected based on market interest rates in
effect at March 31, 2003. The market values that result from these computations
are compared with the market values of these financial instruments at March 31,
2003. The differences in this comparison are the hypothetical gains or losses
associated with each type of risk. A one percent increase or decrease in the
levels of interest rates on variable rate debt with all other variables held
constant would not result in a material change to our results of operations or
financial position or the fair value of our financial instruments.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in our periodic SEC filings.
The CEO and CFO note that, since the date of the evaluation to the date of this
report, there have been no significant changes in internal controls or in other
factors that could significantly affect internal controls, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
-28-
US Oncology, Inc.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The provision of medical services by our affiliated practices entails an
inherent risk of professional liability claims. We do not control the practice
of medicine by the clinical staff or their compliance with regulatory and other
requirements directly applicable to practices. In addition, because the
practices purchase and prescribe pharmaceutical products, they face the risk of
product liability claims. Although we and our practices maintain insurance
coverage, successful malpractice, regulatory or product liability claims
asserted against us or one of the practices in excess of insurance coverage
could have a material adverse effect on us.
We have become aware that we and certain of our subsidiaries and affiliated
practices are the subject of qui tam lawsuits (commonly referred to as
"whistle-blower" suits) that remain under seal, meaning they were filed on a
confidential basis with a U.S. federal court and are not publicly available or
disclosable. The United States has determined not to intervene in any of the qui
tam suits we are aware of and all but one of such suits has been dismissed, but
the individuals who filed the remaining claim of which we are aware may still
pursue the litigation, although none of those individuals has indicated an
intent to do so. Because qui tam actions are filed under seal, there is a
possibility that we could be the subject of other qui tam actions of which we
are unaware. We intend to continue to investigate and vigorously defend
ourselves against any and all such claims, and we continue to believe that we
conduct our operations in compliance with law.
Qui tam suits are brought by private individuals, and there is no minimum
evidentiary or legal threshold for bringing such a suit. The Department of
Justice is legally required to investigate the allegations in these suits. The
subject matter of many such claims may relate both to our alleged actions and
alleged actions of an affiliated practice. Because the affiliated practices are
separate legal entities not controlled by us, such claims necessarily involve a
more complicated, higher cost defense, and may adversely impact the relationship
between us and the practices. If the individuals who file complaints and/or the
United States were to prevail in these claims against us, and the magnitude of
the alleged wrongdoing were determined to be significant, the resulting judgment
could have a material adverse financial and operational effect on us including
potential limitations in future participation in governmental reimbursement
programs. In addition, addressing complaints and government investigations
requires us to devote significant financial and other resources to the process,
regardless of the ultimate outcome of the claims.
We and our network physicians are defendants in a number of lawsuits involving
employment and other disputes and breach of contract claims. In addition, we are
involved from time to time in disputes with, and claims by, our affiliated
practices against us. Although we believe the allegations are customary for the
size and scope of our operations, adverse judgments, individually or in the
aggregate, could have a material adverse effect on us.
-29-
US Oncology, Inc.
Item 6. Exhibits And Reports On Form 8-K
(a) Exhibits
Exhibit
Number Description
- ------- -----------
3.1 Amended and Restated Certificate of Incorporation (filed as Exhibit
3.1 to the Company's Form 8-K/A filed June 17, 1999 and incorporated
herein by reference)
3.2 Amended and Restated By-Laws (filed as Exhibit 3.2 to the Company's
Form 10-K filed March 21, 2003 and incorporated herein by reference)
4.1 Rights Agreement between the Company and American Stock Transfer &
Trust Company (incorporated by reference from the Company's Form 8-A
filed June 2, 1997).
4.2 Indenture dated February 1, 2002 among US Oncology, Inc., the
Guarantors named therein, and JP Morgan Chase Bank as Trustee
(filed as Exhibit 3 to, and incorporated by reference from, the
Company's Form 8-K filed February 5, 2002).
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
(b) Reports on Form 8-K
None.
-30-
US Oncology, Inc.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
US ONCOLOGY, INC.
Date: May 14, 2003: By: /s/ R. Dale Ross
----------------------------------------
R. Dale Ross, Chief Executive Officer
(duly authorized signatory)
Date: May 14, 2003: By: /s/ Bruce D. Broussard
----------------------------------------
Bruce D. Broussard, Chief Financial Officer
(principal financial and accounting officer)
-31-
US Oncology, Inc.
CERTIFICATION
I, R. Dale Ross, Chief Executive Officer of US Oncology, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of US Oncology, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ R. Dale Ross
--------------------------------------------
R. Dale Ross
Chief Executive Officer of US Oncology, Inc.
-32-
US Oncology, Inc.
CERTIFICATION
I, Bruce D. Broussard, Chief Financial Officer of US Oncology, Inc., certify
that:
1. I have reviewed this quarterly report on Form 10-Q of US Oncology, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation,to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ Bruce D. Broussard
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Bruce D. Broussard
Chief Financial Officer of US Oncology, Inc.
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