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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1999
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 Identification No.)
incorporation or organization)
16825 Northchase Drive, Suite 1300, Houston, Texas 77060
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (281) 873-2674
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock ($.01 par value)
(Title of class)
Series A Preferred Stock Purchase Rights
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
---- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of March 17, 2000 was $396,389,644 (based upon the closing sales
price of the Common Stock on The Nasdaq Stock Market on March 17, 2000 of $4.625
per share). For purposes of this calculation, shares held by non-affiliates
exclude only those shares beneficially owned by executive officers, directors
and stockholders beneficially owning 10% or more of the outstanding Common
Stock.
There were 89,831,290 shares of the Registrant's Common Stock outstanding on
March 17, 2000. In addition, as of March 17, 2000, the Registrant had agreed to
deliver 10,867,525 shares of its Common Stock on certain future dates for no
additional consideration.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement issued in connection with the
Registrant's 2000 Annual Meeting of Stockholders are incorporated by reference
into Part III hereof.
PART I
ITEM 1. BUSINESS
US Oncology, Inc. (together with its subsidiaries, "US Oncology" or
the "Company") is a cancer management company. The Company provides
comprehensive management services under long-term agreements to oncology
practices comprised of over 800 physicians in 26 states. The physicians
affiliated with US Oncology provide all aspects of care related to the diagnosis
and outpatient treatment of cancer, including medical oncology, radiation
oncology, gynecologic oncology, stem cell transplantation, diagnostic radiology
and clinical research. The Company was incorporated in October 1992 under the
laws of the State of Delaware. The Company's principal executive offices are
located at 16825 Northchase Drive, Suite 1300, Houston, Texas, and its telephone
number is (281) 873-2674.
On June 15, 1999, a wholly owned subsidiary of the Company merged with
and into Physician Reliance Network, Inc. ("PRN"), a cancer management company.
As a result of the merger, PRN became a wholly owned subsidiary of US Oncology,
and each holder of PRN common stock received 0.94 shares of the Company's common
stock for each PRN share held. The transaction was accounted for under the
pooling of interests method of accounting and treated as a tax-free exchange.
The Company's financial statements included in this report have been
retroactively restated to combine the accounts of US Oncology (formerly known as
American Oncology Resources, Inc. ("AOR")) and PRN for all periods presented
using their historical basis.
Management Services
The Company is a cancer management company, and its primary business
is providing comprehensive management services to oncology practices, including
the following:
STRATEGIC SERVICES. At each affiliated practice, an operating board
comprised of equal representation from the Company and affiliated physicians is
created to develop and adopt a strategic plan designed to improve the
performance of the practice by (i) outlining physician recruiting goals, (ii)
identifying services and equipment to be added, (iii) identifying desirable
payor relationships and other oncology groups that are possible affiliation
candidates and (iv) facilitating communication with other affiliated physician
groups in the US Oncology network.
FINANCIAL SERVICES. The Company provides comprehensive financial
analysis to each affiliated physician group in connection with managed care
contracting and billing, collection, reimbursement, tax and accounting services.
The Company also implements its cash management system. In addition, the
Company and each affiliated physician group jointly develop a comprehensive
budget that involves the adoption of financial controls and cost containment
measures.
MANAGEMENT INFORMATION SYSTEMS. The Company implements its management
information system to facilitate and organize the exchange of clinical and
operational information among the Company's affiliated physicians. The Company
believes that an integrated information system will enable the Company and its
affiliated physicians to identify effective protocols and manage the costs of
cancer care in future years.
ADMINISTRATIVE SERVICES. The Company manages the facilities used by
the affiliated physicians and, in coordination with the physicians, determines
the number and location of practice sites. The Company provides support for
practice management, billing functions and patient record keeping. The Company
also provides comprehensive purchasing services for drugs, supplies, equipment,
insurance and other practice requirements.
COMPLIANCE PROGRAM. The Company and, more particularly, its
affiliated physician groups are intensely regulated at the federal, state and
local level. To help each affiliated physician group comply with increasingly
complex laws and regulations applicable to oncology practices, the Company has
implemented a comprehensive compliance program.
PERSONNEL MANAGEMENT. The Company employs and manages substantially
all nonmedical personnel of most physician groups, including the executive
director, controller and other administrative personnel. The Company evaluates
these employees, makes staffing recommendations, provides and manages employee
benefits and implements personnel policies and procedures. The Company also
provides similar administrative services to each physician group's employees.
CLINICAL RESEARCH SERVICES. Through its clinical research network,
the Company facilitates and organizes clinical research conducted by its
affiliated physician groups and markets the groups' ability to perform and
manage clinical trials to pharmaceutical and biotechnology companies. Clinical
research conducted by the oncology groups focuses on (i) improving
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cancer survival rates, (ii) enhancing the cancer patient's quality of life,
(iii) reducing the costs of cancer care and (iv) developing new approaches to
cancer diagnosis, treatment and post-treatment monitoring. The Company assists
in a number of aspects in the conduct of clinical trials, including protocol
development, data coordination, institutional review board coordination and
contract review and negotiation.
CLINICAL INITIATIVES AND STANDARDS. The Company organizes clinical
conferences for its affiliated physicians to discuss and identify clinical care,
research and educational strategies for the Company's network of affiliated
physicians. The Company also assists its affiliated physicians in developing
clinical practice guidelines for the different types of cancer and in operating
in accordance with the standards of care required for accreditation by managed
care accreditation bodies. The Company is also implementing a clinical
information system with the goal of facilitating the exchange of information
among affiliated physicians. The Company expects the system will enable the
physicians to share clinical data and treatment patterns and will allow ready
access to current protocols and information regarding cancer therapies and
research developments.
Operations of Oncology Groups
Since the Company's incorporation in October 1992, the Company has
grown rapidly from managing a single practice comprised of six physicians in one
state to managing oncology practices comprised of over 800 physicians in 26
states.
The Company estimates that most of the affiliated physician groups are
among the largest group practices providing cancer care in their markets. The
physician members of these groups have staff privileges at most private
hospitals in their markets and have long-standing relationships with
governmental and private payors.
The oncologists are employed by the affiliated physician groups, not
the Company, and maintain control over all aspects of the provision of medical
care to their patients. The Company does not provide medical care to patients
or employ any of the non-physician personnel of its affiliated physician groups
who provide medical care. However, under the terms of the management agreements
with the affiliated physician groups, the Company is responsible for the
compensation and benefits of the groups' non-physician medical personnel, and
the financial statements of the Company reflect the costs of such compensation
and benefits.
The affiliated physician groups offer a wide array of services to
cancer patients in outpatient settings, including professional medical services,
chemotherapy infusion and radiation oncology services, stem cell
transplantation, clinical laboratory services, diagnostic radiology services,
pharmacy services and patient education. The groups employ a range of personnel
to provide these services, such as medical assistants, nurses (including
oncology certified nurses), radiation therapy technicians, physicists and
laboratory and pharmacy technicians. The practice sites are generally located
in close proximity to other health care providers and typically are equipped to
provide the outpatient services necessary to treat and care for cancer patients
and their families.
Affiliation Structure
The Company's structure enables its affiliated physicians to retain their
autonomy through ownership and participation in their local professional
corporation or other entity, thereby maintaining local authority and control
over medical practice decisions. The Company believes that this local
governance structure is critical to its success.
In connection with affiliating with a physician group, the Company
enters into a management agreement with the group and purchases the group's
nonmedical assets. In consideration of these arrangements, the Company
typically pays cash and subordinated promissory notes and agrees to deliver
shares of its Common Stock at specified future dates (typically on the second
through fifth anniversaries of the closing date). In addition, in most of the
Company's physician group affiliations, each affiliated physician enters into an
employment or noncompetition agreement with the physician group. The Company
believes that the delivery of shares on a delayed basis, the Company's
affiliation structure and the compensation formulas defined in the management
agreements all serve to align the long-term interests of the affiliated
physician groups with those of the Company.
The management service agreements with the affiliated physician groups
generally have contractual terms of 40 years. These agreements cannot be
terminated by the physician groups without cause. As consideration for the
Company's management services, each management agreement provides for payment to
the Company of a management fee. In all of the Company's management agreements,
the Company's management fee includes reimbursement for all practice costs
(other than amounts retained by the physicians). The Company is also paid an
additional management fee. Some of the Company's
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management agreements provide that this additional fee is a percentage of the
practice's earnings before income taxes. In others, the additional fee is
comprised of a fixed fee, plus a percentage fee (in most states) plus, if
certain financial and performance criteria are met, a performance fee.
Competition
The business of providing health care services generally, and of
managing and providing oncology services specifically, is competitive. The
Company's profitability depends on the continued success of its affiliated
physician groups. These physician groups face competition from several sources,
including sole practitioners, single and multi-specialty groups, hospitals and
managed care organizations.
Regulation
General. The health care industry is highly regulated, and there can
be no assurance that the regulatory environment in which the Company and its
affiliated physician groups operate will not change significantly and adversely
in the future. In general, regulation and scrutiny of health care providers and
companies are increasing.
There are currently several federal and state initiatives to amend
regulations relating to the provision of health care services, the legal
structure under which those services are provided, access to health care,
disclosure of health care information, costs of health care and the manner in
which health care providers are reimbursed for their services. It is not
possible to predict whether any such initiatives will be enacted or, if enacted,
what their form, effective dates or impact on the Company will be. The execution
of a management agreement with a physician group currently does not require any
regulatory approval on the part of the Company or the physician group. However,
in connection with the expansion of existing operations and the entry into new
markets, the Company and its affiliated physician groups may become subject to
additional regulation.
The Company's affiliated physician groups are intensely regulated at
the federal, state and local levels. Although these regulations often do not
directly apply to the Company, to the extent an affiliated physician group is
found to have violated any of these regulations and, as a result, suffers a
decrease in its revenues or an increase in costs, the Company's results of
operations might be materially and adversely affected.
Licensing and Certificate of Need Requirements. Every state imposes
licensing requirements on individual physicians and on facilities and services
operated or provided by physicians. Many states require regulatory approval,
including certificates of need, before (a) establishing certain types of health
care facilities, (b) offering certain services or (c) expending monies in excess
of statutory thresholds for health care equipment, facilities or programs.
Fee-Splitting; Corporate Practice of Medicine. The laws of many
states prohibit physicians from splitting professional fees with non-physicians
and prohibit non-physician entities, such as the Company, from practicing
medicine and from employing physicians to practice medicine. The laws in most
states regarding the corporate practice of medicine have been subjected to
relatively limited judicial and regulatory interpretation. The Company believes
its current and planned activities do not constitute fee-splitting or the
practice of medicine as contemplated by these statutes and interpretations.
However, there can be no assurance that future interpretations of such laws will
not require structural and organizational modification of the Company's existing
relationships with the affiliated physician groups. In addition, statutes in
some states in which the Company does not currently operate could require the
Company to modify its affiliation structure.
Medicare/Medicaid Fraud and Abuse Provisions. Federal law prohibits
the offer, payment, solicitation or receipt of any form of remuneration in
return for the referral of Medicare or state health program patients or patient
care opportunities, or in return for the purchase, lease or order of any item or
service that is covered by Medicare or a state health program. Pursuant to this
law, the federal government has pursued a policy of increased scrutiny of joint
ventures and other transactions among health care providers in an effort to
reduce potential fraud and abuse relating to government health care costs.
The Medicare and Medicaid anti-kickback amendments (the "Anti-Kickback
Amendments") provide criminal penalties for individuals or entities
participating in the Medicare or Medicaid programs who knowingly and willfully
offer, pay, solicit or receive remuneration in order to induce referrals for
items or services reimbursed under such programs. In addition to federal
criminal penalties, the Social Security Act also includes the sanction of
excluding violators from participation in the Medicare or Medicaid programs.
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A violation of the Anti-Kickback Amendments requires several elements:
(i) the offer, payment, solicitation or receipt of remuneration; (ii) the intent
to induce referrals; (iii) the ability of the parties to make or influence
referrals of patients; (iv) the provision of services that are reimbursable
under Medicare or state health programs; and (v) patient coverage under the
Medicare program or a state health program. The Company believes that it is
receiving compensation under the management agreements for management services.
The Company also believes that it is not in a position to make or influence
referrals of patients or services reimbursed under Medicare or state health
programs to its affiliated physician groups. Consequently, the Company does not
believe that the management fees payable to it should be viewed as remuneration
for referring or influencing referrals of patients or services covered by such
programs as prohibited by the Anti-Kickback Amendments.
In 1991, the Inspector General of the United States Department of
Health and Human Services first published "Safe Harbor Regulations," defining
safe harbors for certain arrangements that do not violate the Anti-Kickback
Amendments. One of the safe harbors specifically provided is a safe harbor for
personal services and management contracts. Under this safe harbor,
"remuneration" prohibited by the Anti-Kickback Amendments does not include any
payment made by a principal to an agent as compensation for services of the
agent as long as certain standards are met. To the Company's knowledge, there
have been no agency interpretations or case law decisions of management
agreements similar to the Company's that would indicate that such agreements do
not fall within a safe harbor. Further, the Company believes that since it is
not a provider of medical services, and is not in a position to refer patients
to any particular medical practice, the remuneration it receives for providing
services does not violate the Anti-Kickback Amendments.
Prohibitions on Certain Referrals. The Omnibus Budget Reconciliation
Act of 1993 ("OBRA") includes a provision that significantly expands the scope
of the Ethics in Patient Referral Act, also known as the "Stark Bill." The
Stark Bill originally prohibited a physician from referring a Medicare or
Medicaid patient to any entity for the provision of clinical laboratory services
if the physician or a family member of the physician had an ownership interest
in or compensation relationship with the entity. The revisions to the Stark
Bill prohibit a referral to an entity in which the physician or a family member
has an ownership interest or compensation relationship if the referral is for
any of a list of "designated health services." In January 1998, the Health Care
Financing Administration proposed additional regulations to the Stark Bill. It
is not yet possible to predict whether these proposed regulations will be
adopted or, if adopted, what their final form, effective dates and impact on the
Company will be.
Prohibitions on Certain Compensation Arrangements. The OBRA
legislation also prohibits physician group practices from developing
compensation or bonus arrangements that are directly related to the volume or
value of referrals by a physician in the group for designated health services.
Antitrust. The Company and its affiliated physician groups are
subject to a range of antitrust laws that prohibit anti-competitive conduct,
including price fixing, concerted refusals to deal and division of markets. The
Company believes it is in compliance with these laws, but there can be no
assurance that a review of the Company's or its affiliated physician groups'
business would not result in a determination that could adversely affect the
operations of the Company and its affiliated physician groups.
Reimbursement Requirements. In order to participate in the Medicare
and Medicaid programs, the Company's affiliated physicians must comply with
stringent reimbursement regulations, including those that require many health
care services to be conducted "incident to" a physician's supervision.
Satisfaction of all reimbursement requirements is required under the Company's
compliance program. The Company believes that its affiliated physicians are in
compliance with the reimbursement requirements; however, affiliated physicians'
failure to comply with these requirements could negatively affect the Company's
results of operations.
Enforcement Environment. In recent years, the federal government has
launched several initiatives aimed at uncovering practices that violate the
federal civil and criminal laws regarding false claims and fraudulent billing
and coding practices. Proper billing and coding of medical services is part of
the complex reimbursement requirements to which the Company's affiliated
physicians must adhere, individually and through their group practices, in order
to practice medicine and be compensated for it in accordance with applicable
law. Although the Company's compliance program requires adherence to applicable
law and promotes reimbursement education and training, because the Company
performs administrative services for its affiliated physician groups, it is
likely that governmental investigations or lawsuits regarding affiliated
physician groups' compliance with reimbursement requirements would also
encompass the activities of the Company. A determination that billing and
coding practices are false or fraudulent could have a material adverse effect on
the Company.
4
The Federal False Claims Act has been the most successful vehicle for
identifying and enforcing billing, reimbursement and other regulatory
violations. In addition to the government bringing claims under the Federal
False Claims Act, qui tam, or "whistleblower", actions may be brought by private
individuals on behalf of the government. A violation under the False Claims Act
occurs each time a claim is submitted to the government or each time a false
record is used to get a claim approved, when the claim is false or fraudulent
and the defendant acted knowingly. Under the False Claims Act, defendants face
exclusion from the Medicare/Medicaid programs and monetary damages of $5,000 to
$10,000 for each false claim, as well as treble damages.
Compliance. The Company has implemented a comprehensive compliance
program designed to assist the Company and its affiliated physician groups in
complying with applicable law. In addition, the Company recognizes that health
care regulations will continue to change and, as a result, regularly monitors
developments in health care law. The Company expects to modify its agreements
and operations from time to time as the business and regulatory environment
changes. While the Company believes it will be able to structure all of its
agreements and operations in accordance with applicable law, there can be no
assurance that its arrangements will not be successfully challenged.
Executive Officers of the Registrant
Name, Age, and Position Experience
- -------------------------------------------------- -----------------------------------------------
R. DALE ROSS, age 53 Mr. Ross has been Chairman of the Board and
Chairman of the Board of Directors and Chief Executive Officer since December 1992.
Chief Executive Officer He was self-employed from April 1990 until
joining the Company. From December 1982 until
April 1990, Mr. Ross was employed by HMSS,
Inc., a home infusion therapy company. Mr.
Ross founded HMSS, Inc. and served as its
President and Chief Executive Officer and as a
director.
LLOYD K. EVERSON, M.D., age 56 Dr. Everson has been President of the Company
President since November 1993. He received his medical
degree from Harvard Medical School and his
oncology training at Memorial Sloan Kettering
National Cancer Institute. He is board
certified in medical oncology. Dr. Everson
has published widely in the field of oncology
and is a member of numerous professional
associations. He also has served as President
of the Association of Community Cancer Centers
and as Associate Chairman for Community
Programs for the Eastern Cooperative Oncology
Group.
MARK E. AHERN, age 42 Mr. Ahern joined the Company in 1995 and has
Senior Vice President for Development been involved in various development roles
since that time. Mr. Ahern currently oversees
development activities involving new physician
affiliations and physician recruitment. Prior
to joining the Company, Mr. Ahern was Vice
President, Business Development at Caremark
Oncology Practice Management.
JOSEPH S. BAILES, M.D., age 43 Dr. Bailes joined the Company in June 1999.
Executive Vice President for Clinical Prior to that, he was President of PRN from
Services 1985 to 1999. Dr. Bailes was formerly a
physician at Texas Oncology, P.A., the
Company's largest affiliated physician group.
Dr. Bailes is Board Certified in medical
oncology. He is currently President of The
American Society of Clinical Oncology.
DAVID S. CHERNOW, age 43 Mr. Chernow joined the Company in 1993. He is
President, Physician Services Group currently President of the Physician Services
Group,
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which is responsible for coordinating
the full spectrum of operational and
development services to the US Oncology
network of affiliated physicians, including
new affiliations, cancer center development,
physician recruitment and other development
and strategic initiatives.
ATUL DHIR, M.D.; D. Phil, age 37 Dr. Dhir joined the Company in November 1999.
President, Cancer Information and As President of Cancer Information and
Research Group Research Group, he is responsible for the
Company's clinical trial activities, cancer
information services and transplant
initiatives. Prior to joining the Company,
Dr. Dhir was a Vice President at Monsanto
Corporation from 1996 to 1998; President of
Health Strategies Partners, a company he
founded that provided consulting services to
hospitals and physicians from 1994 until 1996;
and a health care consultant with McKinsey &
Company from 1989 until 1993. Dr. Dhir holds
a D. Phil. in molecular biology from Oxford
University, where he was a Rhodes Scholar.
MARC I. KERLIN, age 36 Mr. Kerlin joined the Company in 1994. As
Senior Vice President of Managed Care Senior Vice President of Managed Care,
Mr. Kerlin's primary area of responsibility is
managed care contracting.
WILLIAM F. MCKEON, age 40 Mr. McKeon joined the Company in 1997. He is
Senior Vice President for Marketing and primarily responsible for the Company's
eCommerce marketing, eCommerce and eHealth initiatives.
Prior to joining the Company, Mr. McKeon was
involved in marketing at Stanford University
Medical Center from 1991 until 1997.
R. ALLEN PITTMAN, age 52 Mr. Pittman joined the Company in 1993. As
Chief Administrative Officer chief administrative officer, he oversees the
corporate services functions of the Company,
including human resources, real estate and
general administrative services.
L. FRED POUNDS, age 52 Mr. Pounds joined the Company in January 1993
Chief Financial Officer and Treasurer as its Chief Financial Officer. On December
13, 1999, Mr. Pounds resigned as the Company's
Chief Financial Officer, effective March 31,
2000.
LEO E. SANDS, age 52 Mr. Sands joined the Company in November 1992.
Chief Compliance Officer and Secretary He is primarily responsible for the Company's
compliance program, including all aspects of
regulatory and health care compliance and
governmental relations.
PHILLIP H. WATTS, age 34 Mr. Watts joined the Company in January 1998
General Counsel as its General Counsel. He has primary
responsibility for overseeing all legal
operations of the Company. From September
1991 until December 1997, Mr. Watts was an
attorney at Mayor, Day, Caldwell & Keeton,
L.L.P., a law firm in Houston, Texas that is
the Company's primary outside legal counsel.
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Employees
As of December 31, 1999, the Company employed 3,202 people. In
addition, as of December 31, 1999, the affiliated physician groups employed
3,980 people (excluding the affiliated physicians). Under the terms of the
management agreements with the affiliated physician groups, the Company is
responsible for the practice compensation and benefits of the groups' non-
physician medical personnel. No employee of the Company or of any affiliated
group is a member of a labor union or subject to a collective bargaining
agreement. The Company considers its relations with its employees to be good.
Service Marks
The Company has registered the service mark "US Oncology" with the
United States Patent and Trademark Office.
ITEM 2. PROPERTIES
The Company leases its corporate offices in Houston, Texas, where the
Company's headquarters are located. The Company or its affiliated physician
groups also own, lease, sublease or occupy the facilities where the affiliated
physician groups provide medical services. In connection with the development
of integrated cancer centers, the Company has acquired land valued at
approximately $18.1 million. The Company anticipates that, as its affiliated
group practices grow, expanded facilities will be required.
In addition to conventional physician office space, in several markets
the Company has developed comprehensive cancer centers that are generally free-
standing facilities in which a full range of outpatient cancer treatment
services is offered in one facility. At December 31, 1999, the Company operated
60 cancer centers and had ten cancer centers under development. Of the 60
cancer centers operated by the Company, 35 are leased by the Company and 25 are
owned, ranging in size from 3,300 Sq. Ft. to 15,700 Sq. Ft.
ITEM 3. LEGAL PROCEEDINGS
The provision of medical services by the Company's affiliated
physicians entails an inherent risk of professional liability claims. The
Company does not control the practice of medicine by physicians or the
compliance with regulatory and other requirements directly applicable to
physicians and physician groups. Because the Company's affiliated physician
groups purchase and resell pharmaceutical products, they face the risk of
product liability claims. The Company maintains insurance coverage that it
believes to be adequate both as to risks and amounts. In addition, pursuant to
the management services agreements with the affiliated physician groups, the
affiliated practices and the Company are required to maintain comprehensive
professional liability insurance. Successful malpractice claims asserted
against the Company or one of the affiliated physician groups could, however,
have a material adverse effect on the Company.
The Company has been informed that the Company and an affiliated
physician group are the subject of allegations that their billing practices may
violate the Federal False Claims Act. The allegations are the result of two qui
tam complaints filed under seal prior to the merger of PRN with a subsidiary of
US Oncology. The U.S. Department of Justice is currently investigating the
allegations in order to determine if the United States will intervene and pursue
the claims on behalf of the plaintiffs. If the United States does not intervene,
the plaintiffs may continue to pursue the claims individually. Because the
complaints are under seal, and because the Department of Justice is in the
process of investigating the claims, the Company is unable to fully assess at
this point in time the nature or magnitude of these allegations. If the
plaintiffs and/or the United States were to prevail in these claims, the
resulting judgment could have a material adverse effect on the Company. In
addition, addressing the complaints and government investigation will require
the Company to devote significant financial and other resources to the process,
regardless of the ultimate outcome of the claims. Because qui tam actions are
filed under seal, there is a possibility that the Company could be the subject
of other qui tam actions of which it is unaware.
In addition to the legal proceedings described in the prior paragraph,
the Company and its affiliated physicians are defendants in a number of lawsuits
involving employment disputes and breach of contract claims. Although the
Company believes the allegations are customary for the Company's size and scope
of operations, adverse judgments, individually or in the aggregate, could have a
material adverse effect on the Company.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1999.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on The Nasdaq Stock Market under the
symbol "USON". The high and low closing sale prices of the Common Stock, as
reported by The Nasdaq Stock Market, were as follows for the quarterly periods
indicated.
Year Ended December 31, 1998 High Low
------- -------
Fiscal Quarter Ended March 31, 1998 $17.38 $12.38
Fiscal Quarter Ended June 30, 1998 $15.75 $11.13
Fiscal Quarter Ended September 30, 1998 $13.75 $ 8.13
Fiscal Quarter Ended December 31, 1998 $15.00 $ 8.63
Year Ended December 31, 1999
Fiscal Quarter Ended March 31, 1999 $15.06 $ 7.56
Fiscal Quarter Ended June 30, 1999 $12.63 $ 6.56
Fiscal Quarter Ended September 30, 1999 $12.75 $ 9.06
Fiscal Quarter Ended December 31, 1999 $ 9.44 $ 3.94
As of March 17, 2000, there were approximately 8,750 holders of the
Common Stock. The Company has not declared or paid any cash dividends on its
Common Stock. The payment of cash dividends in the future will depend on the
Company's earnings, financial condition, capital needs and other factors deemed
pertinent by the Company's board of directors, including the limitations, if
any, on the payment of dividends under state law and then-existing credit
agreements. It is the present policy of the Company's board of directors to
retain earnings to finance the operations and expansion of the Company's
business. The Company's credit facilities currently prohibit the payment of
cash dividends. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources."
8
RECENT SALES OF UNREGISTERED SECURITIES
In connection with each affiliation transaction between the Company
and an oncology group, the Company purchases the nonmedical assets of, and
enters into a long-term management agreement with, that oncology group. In
consideration for that arrangement, the Company typically pays cash, issues
subordinated promissory notes (in general, payable on each of the second through
seventh anniversaries of the closing date at an annual interest rate of seven
percent) and unconditionally agrees to deliver shares of Common Stock at
specified future dates (in general, on each of the second through fifth
anniversaries of the closing date).
The following table describes private placements by the Company in
connection with physician transactions of its securities during 1999. Each sale
was a private placement made in connection with a physician transaction,
described in general in the preceding paragraph, to affiliated oncologists, the
overwhelming majority of whom are accredited investors. No underwriter was
involved in any such sale, and no commission or similar fee was paid with
respect thereto. Each sale was not registered under the Securities Act of 1933
in reliance on Section 4(2) of such Act and Rule 506 enacted thereunder.
Number of Shares of Aggregate Principal
Date of Transaction Number of Physicians Common Stock/1/ Amount of Notes
- --------------------------- ---------------------------- ---------------------------- -----------------------------
(in dollars)
1/99 8 819,665 6,316,000
1/99 4 283,568 2,558,000
1/99 2 47,611 233,000
1/99 1 24,426 640,000
1/99 1 18,609 186,000
1/99 1 96,366 680,000
1/99 6 156,165 3,200,000
2/99 1 12,881 217,000
3/99 1 33,381 686,000
6/99 10 402,209 2,990,000
7/99 1 20,724 322,000
8/99 4 64,642 745,000
8/99 2 18,421 400,000
9/99 2 36,186 560,000
9/99 1 34,430 540,000
10/99 1 47,059 450,000
10/99 3 93,176 1,782,000
12/99 2 74,776 730,000
12/99 3 202,020 1,500,000
12/99 1 145,471 2,632,000
____________________
/1/ In connection with each affiliation transaction, the Company unconditionally
agrees to deliver shares of Common Stock at specified future dates (typically on
each of the second through fifth anniversaries of the closing date).
In November 1999, the Company issued $100 million in senior secured
notes to a group of institutional investors. The notes bear interest at 8.42%,
mature in 2006 and rank equal in right of payment with all current and future
senior indebtedness of the Company. The placement was not registered under the
Securities Act of 1933 in reliance on Section 4(2) of such Act. Banc One
Securities Corporation and First Union Securities acted as placement agents.
9
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial information of the Company set
forth below is qualified by reference to, and should be read in conjunction
with, "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Consolidated Financial Statements and notes thereto
included elsewhere in this report.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1999 1998 1997 1996 1995
----------- ----------- --------- --------- ---------
(in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Revenue........................................... $ 1,092,941 $ 836,596 $ 625,413 $432,749 $227,964
Operating expenses:
Pharmaceuticals and supplies................... 521,087 357,766 250,425 155,743 69,173
Practice compensation and benefits............. 215,402 172,298 143,210 104,174 55,072
Other practice costs........................... 134,635 107,671 87,232 57,414 34,964
General and administrative..................... 39,490 38,325 31,809 22,508 14,918
Write-off of accounts receivable............... - - 37,841 - -
Merger, restructuring and integration costs.... 29,014 - - - -
Depreciation and amortization.................. 65,072 48,463 35,194 25,237 12,308
----------- ---------- --------- -------- --------
Income from operations............................ 88,241 112,073 39,702 67,673 41,529
Interest income (expense), net.................... (22,288) (15,908) (12,474) (5,184) (2,355)
Other income, net................................. 14,431/1/ - - - 1,600/2/
------------ ---------- --------- -------- --------
Income before taxes............................... 80,384 96,165 27,228 62,489 40,774
Income taxes...................................... 32,229 36,184 11,593 24,343 15,042
----------- ---------- --------- -------- --------
Net income........................................ $ 48,155 $ 59,981 $ 15,635 $ 38,146 $ 25,732
=========== ========== ========== ======== ========
Net income per share - basic...................... $ .48 $ .61 $ .17 $ .43 $ .35
Shares used in per share computation - basic...... 100,183 97,647 93,168 88,072 73,593
Net income per share - diluted.................... $ .47 $ .60 $ .16 $ .41 $ .33
Shares used in per share computations - diluted... 101,635 99,995 97,198 92,136 77,869
December 31,
------------------------------------------------------------------
1999 1998 1997 1996 1995
------- ---------- ------------ -------- --------
(in thousands)
BALANCE SHEET DATA:
Working capital................................. $ 280,793 $ 178,262 $ 121,221 $121,741 $112,350
Management service agreements, net.............. 537,130 467,214 431,068 326,417 193,710
Total assets.................................... 1,298,477 1,033,528 883,430 694,741 476,992
Long-term debt/3/............................... 360,191 234,474 189,377 96,368 78,668
Stockholders' equity............................ 707,164 629,798 554,298 516,630 336,914
- ------------------
/1/ Unrealized gain on investment in common stock.
/2/ Consists of gain from life insurance proceeds of $2,090 less lease
termination costs of $490.
/3/ Excludes current maturities of long-term debt.
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
US Oncology, Inc. provides comprehensive management services under
long-term agreements to oncology practices that provide a broad range of medical
services to cancer patients, integrating the specialties of medical and
gynecologic oncology, hematology, radiation oncology, diagnostic radiology and
stem cell transplantation. The Company has grown rapidly since inception and
now manages over 800 affiliated physicians in 26 states.
MARCH 17, DECEMBER 31,
--------- --------------------
2000 1999 1998 1997
---- ---- ---- -----
Affiliated physicians............... 821 806 719 630
States............................ 26 26 25 23
The Company enters into management agreements with, and purchases the
nonmedical assets of, oncology practices. Under the terms of the management
agreements, the Company provides comprehensive management services to its
affiliated physician groups, including operational and administrative services,
and furnishes personnel, facilities, supplies and equipment. The physician
groups, in return, agree to practice medicine exclusively in affiliation with
the Company under the management agreements. Substantially all of the Company's
revenue consists of management fees paid under the terms of the management
agreements. In all of the Company's management agreements, the Company's
management fee includes reimbursement for all practice costs (other than amounts
retained by physicians). The Company is also paid an additional management fee.
Some of the Company's management agreements provide that this additional fee is
a percentage of the practice's earnings before income taxes. In others, the
additional fee is comprised of a fixed fee, a percentage fee (in most states)
and, if certain financial and performance criteria are met, a performance fee.
For the years ended December 31, 1999, 1998 and 1997, one of the Company's
affiliated physician groups, Texas Oncology, P.A., contributed more than 10% of
the Company's revenue, contributing 25%, 32% and 37%, in 1999, 1998 and 1997,
respectively.
Medicare and Medicaid are the Company's affiliated groups' largest
payor. During 1999, 1998 and 1997, approximately 35% of the Company's revenue
was derived from Medicare and Medicaid payments. This percentage varies among
physician groups. No other single payor accounted for more than 10% of the
Company's revenues in 1999, 1998 or 1997.
RESULTS OF OPERATIONS
The following table sets forth the percentages of revenue represented
by certain items reflected in the Company's Statement of Operations and
Comprehensive Income. The information that follows should be read in
conjunction with the Company's Consolidated Financial Statements and notes
thereto included elsewhere herein.
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
------ ----- -----
Revenue................................. 100.0% 100.0% 100.0%
----- ----- -----
Operating expenses:
Pharmaceuticals and supplies....... 47.7 42.8 40.0
Practice compensation and benefits. 19.7 20.6 22.9
Other practice costs............... 12.3 12.9 13.9
General and administrative......... 3.6 4.5 5.1
Write-off of accounts receivable... 6.1
Merger, restructuring and
integration costs................. 2.7
Depreciation and amortization...... 6.0 5.8 5.6
Net interest............................ 2.0 1.9 2.0
Other income............................ 1.3 __
----- ----- -----
Income before income taxes.............. 7.3 11.5 4.4
Income taxes............................ 2.9 4.3 1.9
----- ----- -----
Net income.............................. 4.4% 7.2% 2.5%
===== ===== =====
11
1999 Compared to 1998
The Company affiliated with 20 and 21 physician groups in 1999 and 1998,
respectively, the results of which are included in the Company's operating
results from the dates of affiliation. Changes in results of operations year to
year were caused in part by affiliations with these oncology practices.
Overall, the Company experienced a decrease in operating margins from 1998
to 1999, with earnings before taxes, interest, depreciation and amortization,
excluding merger, restructuring and integration costs as well as other income
("EBITDA"), as a percentage of revenue, declining from 19.2% to 16.8%. A number
of factors contributed to the decrease in operating margins, including (i)
increases in the acquisition cost of pharmaceuticals, (ii) shifts in the mix of
pharmaceuticals to lower margin products, (iii) increases in practice personnel
costs due to numerous network-wide initiatives (such as information system
conversions) and (iv) higher occupancy costs due to expansion into new cancer
centers and additional sites of service.
Revenue. Revenue increased from $836.6 million in 1998 to $1,092.9 million
in 1999, an increase of $256.3 million or 30.6%. Revenue for markets under
management in 1998 and 1999 increased $204.5 million or 25.7% over the same
period from the prior year, as calculated by comparing 1998 revenue and 1999
revenue for all practices within a metropolitan service area in which the
Company had operations in both periods. This growth was the result of increased
use of anticancer pharmaceuticals, expansion of services, increases in patient
volume, recruitment of or affiliation with additional physicians and, to a
lesser extent, increases in charges for certain physician services. The
remaining $51.8 million increase in total revenues was attributable to
affiliations with oncology practices in new markets.
Pharmaceuticals and Supplies. Pharmaceuticals and supplies, which include
drugs, medications and other supplies used by affiliated physician groups,
increased from $357.8 million for 1998 to $521.1 million for 1999, an increase
of $163.3 million, or 45.6%. This increase was principally attributable to the
same factors that caused revenue to increase. As a percentage of revenue,
pharmaceutical and supply costs increased from 42.8% for 1998 to 47.7% for 1999.
This increase was primarily due to a shift in the revenue mix to a higher
percentage of drug revenue relative to total revenue. In addition, the
affiliated practices experienced an increase in the use of lower margin drugs,
as well as increases in the acquisition cost of pharmaceuticals. The Company
employs an aggressive contracting strategy for negotiating discounts on
pharmaceuticals. However, the effectiveness of this strategy has been offset by
the loss of one pharmaceutical purchasing agreement in 1999 as well as the
inability to obtain discounted pricing on a number of the most frequently
prescribed anticancer agents.
Practice Compensation and Benefits. Practice compensation and benefits,
which include the salaries, wages and benefits of the affiliated physician
groups' employees (excluding affiliated physicians) and the Company's employees
located at the affiliated physician practice sites and business offices,
increased from $172.3 million in 1998 to $215.4 million in 1999, an increase of
$43.1 million or 25.0%. This increase was principally attributable to the same
factors that caused revenue to increase. As a percentage of revenue, practice
compensation and benefits decreased from 20.6% for 1998 to 19.7% for 1999,
primarily as a result of increases in pharmaceutical revenue which did not
require proportional increases in the number of personnel.
Other Practice Costs. Other practice costs, which consist of rent,
utilities, repairs and maintenance, insurance and other direct practice costs,
increased from $107.7 million in 1998 to $134.6 million in 1999, an increase of
$26.9 million or 25.0%. This increase was principally attributable to the same
factors that caused revenue to increase as well as new cancer center
development. As a percentage of revenue, other practice costs decreased from
12.9% for 1998 to 12.3% for 1999.
General and Administrative. General corporate expenses increased from
$38.3 million in 1998 to $39.5 million in 1999, an increase of $1.2 million or
3.1%. As a percentage of revenue, general and administrative expenses decreased
from 4.5% for 1998 to 3.6% for 1999, primarily as a result of economies of scale
attributable to the Merger with PRN and the limited increase in general and
administrative costs needed to support pharmaceutical revenue growth.
Merger, Restructuring and Integration. In connection with the Merger
between AOR and PRN, the Company incurred total costs of $29.0 million to
consummate the Merger, restructure operating activities and integrate the two
organizations. These costs were expensed during 1999. Costs directly related
to the consummation of the Merger totaled $14.6 million. Restructuring costs
relating to severance and relocation of employees and asset impairments totaled
$7.2 million. Incremental costs incurred to assist in integrating the AOR's and
PRN's operations totaled $7.2 million.
Depreciation and Amortization. Depreciation and amortization expenses
increased from $48.5 million in 1998 to $65.1 million in 1999, an increase of
$16.6 million or 34.2%. As a percentage of revenue, depreciation and
amortization
12
expenses increased from 5.8% for 1998 to 6.0% for 1999. This increase is
primarily attributable to decreasing the amortization period for management
services agreements from 40 years to 25 years effective July 1, 1998, as well as
amortization relating to new physician groups affiliations and investments in
new cancer centers and management information systems during 1999.
Interest. Net interest expense increased from $15.9 million in 1998 to
$22.3 million in 1999, an increase of $6.4 million or 40.3%. The increase was
the result of higher levels of debt, principally incurred to finance
transactions with 20 oncology groups during 1999, as well as construction of 20
cancer centers. As a percentage of revenue, net interest expense was 1.9% and
2.0% in 1998 and 1999, respectively. Indebtedness to physicians increased from
approximately $81.5 million at December 31, 1998 to approximately $98.9 million
at December 31, 1999.
Other Income. Other income increased from zero in 1998 to $14.4 million in
1999. Other income in 1999 represents the recognition of an unrealized gain on
the shares of common stock of ILEX Oncology, Inc. owned by the Company. The
gain was recognized as a result of the Company's reclassification of the ILEX
stock as a trading security. The stock was sold during the first quarter of
2000.
Income Taxes. Income tax expense decreased from the prior year as a result
of the Company's decreased profitability. For 1999, the Company recognized a
tax provision of $32.2 million resulting in an effective rate of 40.1% as
compared to 37.6% for 1998. The increase in the effective tax rate was due to
certain nondeductible professional fees and other costs in connection with the
completion of the Merger
Net Income. Net income decreased from $60.0 million in 1998 to $48.2
million in 1999, a decrease of $11.8 million or 19.7%. As a percentage of
revenue, net income declined from 7.2% to 4.4%, principally as a result of
Merger, restructuring and integration costs incurred in 1999 of $29.0 million.
1998 COMPARED TO 1997
The Company affiliated with 21 and 23 physician groups in 1998 and 1997,
respectively, the results of which are included in the Company's operating
results from the dates of affiliation. Changes in results of operations year to
year were caused in part by affiliations with these oncology practices.
Overall, the Company experienced an increase in operating margins
(excluding one-time write-off of accounts receivable) from 1997 to 1998, with
earnings before taxes, interest, depreciation and amortization ("EBITDA"), as a
percentage of revenue, improving from 18.1% to 19.2%. This increase was
primarily attributable to the non-recurrence in 1998 of certain litigation, loan
and consulting expenses from 1997.
Revenue. Revenue increased from $625.4 million in 1997 to $836.6 million
in 1998, an increase of $211.2 million or 33.8%. This growth was the result of
expansion of services, increases in patient volume, recruitment of or
affiliation with additional physicians and, to a lesser extent, increases in
charges for certain physician services.
Pharmaceuticals and Supplies. Pharmaceuticals and supplies increased from
$250.4 million for 1997 to $357.8 million for 1998, an increase of $107.4
million, or 42.9%. This increase was principally attributable to the same
factors that caused revenue to increase. As a percentage of revenue,
pharmaceutical and supply costs increased from 40.0% for 1997 to 42.8% for 1998.
This increase was primarily due to a shift in the revenue mix to a higher
percentage of drug revenue, the introduction of a number of new chemotherapy
agents and, to a lesser extent, lower reimbursement from payors.
Practice Compensation and Benefits. Practice compensation and benefits
increased from $143.2 million in 1997 to $172.3 million in 1998, an increase of
$29.1 million or 20.3%. This increase was principally attributable to the same
factors that caused revenue to increase. As a percentage of revenue, practice
compensation and benefits decreased from 22.9% for 1997 to 20.6% for 1998,
primarily as a result of economies of scale.
Other Practice Costs. Other practice costs increased from $87.2 million in
1997 to $107.7 million in 1998, an increase of $20.5 million or 23.5%. This
increase was principally attributable to the same factors that caused revenue to
increase. As a percentage of revenue, other practice costs decreased from 13.9%
for 1997 to 12.9% for 1998, primarily as a result of economies of scale.
General and Administrative. General corporate expenses increased from
$31.8 million in 1997 to $38.3 million in 1998, an increase of $6.5 million or
20.4%. This increase was primarily attributable to the addition of personnel
and greater
13
support costs associated with the Company's growth since 1997. As a percentage
of revenue, general and administrative expenses decreased from 5.1% for 1997 to
4.5% for 1998, primarily as a result of economies of scale, as well as the non-
recurrence in 1998 of certain litigation, loan refinancing and consulting costs
from 1997.
Depreciation and Amortization. Depreciation and amortization expenses
increased from $35.2 million in 1997 to $48.5 million in 1998, an increase of
$13.3 million or 37.8%. This increase was primarily attributable to the
amortization expenses relating to new physician group affiliations, as well as
investments in new cancer centers and management information systems during
1997. As a percentage of revenue, depreciation and amortization increased from
5.6% for 1997 to 5.8% for 1998. This increase is primarily attributable to
decreasing the amortization period for management services agreements from 40
years to 25 years effective July 1, 1998, as well as amortization relating to
new physician groups affiliations and investments in new cancer centers and
management information systems during 1998.
Interest. Net interest expense increased from $12.5 million in 1997 to
$15.9 million in 1998, an increase of $3.4 million or 27.2%. The increase was
the result of higher levels of debt, principally incurred to finance
transactions with 21 oncology groups during 1998. As a percentage of revenue,
net interest expense decreased from 2.0% in 1997 to 1.9% in 1998.
Income Taxes. Income tax expense increased from the prior year as a result
of the Company's increased profitability. For 1998, the Company recognized a
tax provision of $36.2 million resulting in an effective rate of 37.6% as
compared to a rate of 42.6% for 1997. The decrease in the effective rate is due
primarily to a change in the Company's composition of revenue by state since
1996.
Net Income. Net income increased from $15.6 million in 1997 to $60.0
million in 1998, an increase of $44.4 million or 284.6%. As a percentage of
revenue, net income improved from 2.5% to 7.2%. This improvement is due
primarily to the non-recurrence in 1998 of certain receivable write-offs from
1997. (See Notes to Consolidated Financial Statements - Note 1 - Organization
and Summary of Significant Accounting Policies - Accounts Receivable.)
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
The following statements are or may constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995: (i)
certain statements, including possible or assumed future results of operations
of US Oncology, contained in "Business" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and including any
statements contained herein regarding the prospects for any of the Company's
services; (ii) any statements preceded by, followed by or that include the words
"believes," "expects," "anticipates," "intends" or similar expressions; and
(iii) other statements contained herein regarding matters that are not
historical facts.
Because such statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by such forward-
looking statements. Factors that could cause actual results to differ
materially include, but are not limited to, those discussed below under "Risk
Factors." US Oncology stockholders are cautioned not to place undue reliance on
such statements, which speak only as of the date thereof.
The cautionary statements contained or referred to herein should be
considered in connection with any subsequent written or oral forward-looking
statements that may be issued by US Oncology or persons acting on its behalf.
US Oncology does not undertake any obligation to release any revisions to or to
update publicly any forward-looking statements to reflect events or
circumstances after the date thereof or to reflect the occurrence of
unanticipated events.
There are continued risks relating to the merger with PRN
Effective June 15, 1999, a wholly-owned subsidiary of the Company merged
with PRN (the "Merger"). The Merger could result in synergies and operating
efficiencies. To date, most of the potential benefits have not been, and may
never be, achieved. Whether we ultimately realize these benefits will depend on
a number of factors, many of which are beyond our control. To attain the
benefits of the Merger, we will have to continue to integrate the operations of
AOR and PRN. In particular, we must continue to integrate our management and
other personnel, our information systems and our financial, accounting and other
operational procedures. This process has required us and will continue to
require us to bring together nationwide operations and different corporate and
physician cultures, at significant expense and with management disruption. As
management and other key personnel continue to focus on integration efforts,
management will continue to be distracted from implementing and executing other
strategic and operational objectives. In addition, because of different
cultures of affiliated physician groups, these groups may elect not to implement
the strategic and operational objectives recommended by the Company.
14
Loss of revenues or a decrease in income of our affiliated physician groups
would impact the Company's results of operations
US Oncology's revenue depends on revenue generated by affiliated physician
groups. Loss of revenue by the affiliated physician groups could seriously harm
the Company. It is possible that our affiliated physician groups will not be
able to maintain successful medical practices. In addition, the management fees
payable to the Company depend upon the profitability of the affiliated physician
groups. (Even under those management agreements where the management fee is
based on the revenues, and not net income, of the affiliated physician groups,
those agreements contain a priority of payments, with US Oncology being paid
last, thereby incentivizing the Company to contain costs.) Any failure by the
physician groups to effectively contain costs will adversely impact the
Company's results of operations. Because the Company does not control the
manner in which its affiliated physician groups conduct their medical practice
(including drug utilization), the Company's ability to control costs related to
the provision of medical care is limited.
If our operations are deemed by regulators not to comply with applicable
regulations, or if restrictive new regulations are passed, we may be seriously
harmed
There can be no assurance that a review of our business or our affiliated
physician groups by courts or by regulatory authorities would not result in
determinations that could seriously harm our operations. Further, the health
care regulatory environment could change and restrict our existing operations or
potential for expansion. The health care industry is highly regulated. We
believe our businesses and the practices of our affiliated physician groups
operate in material compliance with these regulations. However, the
relationships between us and our affiliated physician groups are unique. Many
aspects of these relationships have not been subject to judicial or regulatory
interpretation. There are currently several federal and state initiatives
designed to amend regulations relating to health care. However, we cannot
predict whether any such initiatives will be enacted as legislation or, if
enacted, what their form, effective dates or impact on us will be.
We face the risk of qui tam litigation relating to regulations governing billing
for medical services.
The Company is currently aware of two qui tam lawsuits in which a
subsidiary of the Company and an affiliated physician group are named as
defendants. Because qui tam lawsuits are typically filed under seal, the
Company could be named in other such suits of which it is not aware. In
addition, as the federal government intensifies its focus on billing,
reimbursement and other healthcare regulatory violations, private individuals
are also bringing more qui tam lawsuits, because of the potential of financial
rewards for such individuals. This trend increases the risk that the Company
may become subject to additional qui tam lawsuits.
If our physician groups terminated their management agreements, we would be
seriously harmed
Our affiliated physician groups may attempt to terminate their management
agreements. If any of our larger groups were to succeed in such a termination,
we could be seriously harmed. We are aware that some physician groups have
attempted to end or restructure their affiliations with other practice
management companies when they do not have a contractual right to do so. Such
groups argue that their affiliations violate some aspect of health care law. For
example, some physician groups affiliated with other physician practice
management companies have claimed that the management fee arrangements violate
federal or state prohibitions on splitting fees with physicians. If our
affiliated physicians or practices were able to successfully make such an
argument, the effect on our affiliations could harm us.
If a significant number of physicians leaves our affiliated practices, the
Company could be seriously harmed
Our affiliated practices usually enter into employment or noncompetition
agreements with their physicians. We and our affiliated practices try to
maintain such contracts. However, if a significant number of physicians
terminate their relationships with our affiliated practices, the Company could
be seriously harmed.
Our affiliated practices may be unable to enforce noncompetition provisions with
departed physicians
Most of the employment agreements between the affiliated practices and
their physicians include a clause that prevents the physician from competing
with the practice for a period after termination of employment. We cannot
predict whether a court will enforce the noncompetition covenants of the
affiliated practices. If practices are unable to enforce the noncompetition
provisions of their employment agreements, the Company could be seriously
harmed.
15
We may have additional financing needs
Our expansion, cancer center development and management plans require
substantial capital resources. Operations of the affiliated physician groups
require recurring capital expenditures for renovation, expansion, and the
purchase of costly medical equipment and technology. It is likely that our
capital needs in the next several years will exceed the capital generated from
our operations. Thus, we may incur additional debt or issue additional debt or
equity securities from time to time. This may include the issuance of common
stock or notes in connection with physician affiliations. Capital available for
health care companies, whether raised through the issuance of debt or equity
securities, is quite limited. As a result, we may be unable to obtain
sufficient financing on terms satisfactory to us or at all. In particular, the
Company currently is a party to a $100 million 364-day revolving credit
facility which matures in June 2000 and is renewable at the option of the
lenders under that facility. Although we intend to renew this facility, there
can be no assurance that we will be able to do so on terms satisfactory to us or
at all.
Loss of revenue by affiliated physician groups caused by the cost containment
efforts of third-party payors, including the government, could seriously harm us
Loss of revenue by affiliated physician groups caused by the cost
containment efforts of third-party payors could seriously harm us. Physician
groups typically bill various third-party payors, such as governmental programs
like Medicare and Medicaid, private insurance plans and managed care plans, for
the health care services provided to their patients. These third-party payors
negotiate the prices charged for medical services and supplies to lower the cost
of health care services and products paid for by them. Third-party payors also
try to influence legislation to lower costs. Third-party payors can also deny
reimbursement for medical services and supplies if they determine that a
treatment was not appropriate. Our affiliated practices also derive a
significant portion of their revenues from governmental programs. Reimbursement
by governmental programs generally is not subject to negotiation and is
established by governmental regulation.
If the reimbursement rate for pharmaceuticals is reduced, we would be seriously
harmed
The Company's profitability depends heavily on the reimbursement rate for
pharmaceuticals. Recently, several new chemotherapy agents have been introduced
that have lower profit margins to the Company than other agents. If this trend
continues, the Company's results of operations could be harmed. Payors are also
intensely negotiating the reimbursement rate for pharmaceuticals. Recently, the
executive branch of the federal government proposed to significantly reduce the
reimbursement rate for chemotherapy agents covered by the federal government.
If the proposal is enacted, the Company's results of operations would be
seriously harmed.
We and our affiliated practices may become subject to harmful lawsuits
Successful malpractice or products liability claims asserted against the
physician groups or us could seriously harm us. We and our affiliated physician
groups are at risk of malpractice and other lawsuits because they provide health
care services to the public. In addition, managed care providers and physician
practice management companies are increasingly subject to liability claims
arising from physician compensation arrangements and other activities designed
to control costs by reducing services. A successful claim on this basis against
us or an affiliated physician group could harm us. Lawsuits, if successful,
could result in damage awards in excess of the limits of our insurance coverage.
Insurance against losses related to claims of this type is expensive and the
cost varies widely from state to state. In addition, our affiliated physicians
prescribe and dispense pharmaceuticals and, therefore, could be subject to
products liability claims. We and our affiliated physician groups maintain
liability insurance in amounts and coverages we consider appropriate.
We may not be able to successfully affiliate with new physician groups or
integrate the operations of new affiliations
US Oncology has grown by affiliating with new physician groups and
expanding the operations of existing affiliated physician groups. We intend to
continue to pursue this growth strategy. Identifying appropriate physician
groups and negotiating affiliations with them can be costly. We may not be able
to affiliate with additional physician groups on desirable terms. We may
encounter difficulties integrating and expanding the operations of additional
physician groups. Our failure to successfully integrate newly affiliated
physician groups could harm us.
Our development of new cancer centers could be delayed or result in serious
liabilities, and the centers may not be profitable
16
Another growth strategy of US Oncology is to develop integrated cancer
centers. The development of integrated cancer centers is subject to a number of
risks, including obtaining regulatory approval, delays that often accompany
construction of facilities and environmental liabilities that attach to
operating cancer centers. Any failure or delay in successfully building and
operating integrated cancer centers or in avoiding liabilities from operations
could seriously harm the Company. In addition, in order for cancer centers to
be operated profitably, our affiliated physician groups must consolidate their
operations within the facilities. If our affiliated physician groups elect not
to close other offices to consolidate operations within a cancer center, our
real estate and occupancy costs would increase, which would harm our operations.
Managed care and capitation can adversely impact our business
A loss in revenues, or a failure to contain costs, by our affiliated
practices under managed care and capitated arrangements, or by payors with which
our affiliated practices have such arrangements, could cause our revenues to be
substantially diminished. Under capitation arrangements, health care providers
do not receive a fee for each medical service provided but instead receive an
aggregate fee for treating a defined population of patients. As a result, health
care providers bear the risk that the costs of providing medical services to the
determined population will exceed the payments received. The ability of the
providers to effectively manage the per patient costs affects profitability.
Although the majority of the revenues of our affiliated practices come from non-
capitated services, capitated arrangements might become a bigger part of our
business in the future.
We could become subject to costly insurance regulations
The Company and its affiliated physician groups may enter into capitation
contracts or other "risk-sharing" arrangements with managed care organizations.
The Company and our affiliated groups would assume risk in connection with
providing healthcare services under these arrangements. If we or our affiliated
groups are considered to be in the business of insurance as a result of entering
into these capitation or other arrangements, we and our affiliated groups could
become subject to a variety of regulatory and licensing requirements applicable
to insurance companies that could harm the Company.
Our business, and the business of our affiliated practices, could be harmed by
competition with other businesses
Our business, and the business of our affiliated practices, could be harmed
by competition with other businesses. The business of providing health care
related services and facilities is competitive. Our revenues depend on the
continued success of our affiliated physician groups. The physician groups face
competition from several sources, including sole practitioners, single- and
multi-specialty groups, hospitals and managed care organizations.
Our success depends on our key personnel, and we may not be able to hire enough
qualified personnel to meet our hiring needs
We will be harmed if we cannot hire and retain suitable executives and
other personnel. The Merger and related integration efforts have placed, and
will continue to place, significant strain on management and key personnel,
which may make it more difficult to retain and attract such personnel. We
believe that our success will depend on continued employment of our management
team and other key personnel. If one or more members of our management team
become unable or unwilling to continue in their present positions, we could be
harmed.
The amortization period for our intangible assets may be reduced, which would
reduce our earnings
In connection with our affiliations with physician practices, US Oncology
records an intangible amount for the price paid for assets less the value of the
tangible assets acquired. US Oncology has amortized, and we will continue to
amortize, these intangible assets. This results in periodic non-cash charges to
our earnings. During 1998, US Oncology shortened the amortization period of its
intangible assets to 25 years. However, if the amortization period is
successfully challenged by regulatory authorities or there is a change in
accounting treatment for such intangibles, we would likely be required to reduce
further the number of years that the intangibles are amortized against our
earnings. This would increase the amount of amortization expense charged against
earnings each year. This increased charge, while non-cash in nature, could
significantly reduce our earnings and seriously harm our business. We expect
these non-cash amortization charges to increase in the future as we continue our
affiliation strategy. In the event that we determine that the value of the
intangible assets related to any specific affiliation is impaired, we could be
required to reduce the value of that asset, which would result in a charge to
earnings.
17
Our stock price may fluctuate significantly, which may make it difficult to
resell your shares when you want to at prices you find attractive
The market price of US Oncology common stock has been highly volatile. This
volatility may adversely affect the price of our common stock in the future. You
may not be able to resell your shares of common stock following periods of
volatility because of the market's adverse reaction to this volatility. We
anticipate that this volatility, which frequently affects the stock of health
care service companies, will continue. Factors that could cause such volatility
include:
. Our quarterly operating results,
. Deviations in results of operations from estimates of securities analysts
(which estimates the Company neither endorses nor accepts the
responsibility for),
. General economic conditions or economic conditions specific to the health
care services industry,
. Regulatory or reimbursement changes and
. Other developments affecting competitors or us.
On occasion the equity markets, and in particular the markets for physician
management company stocks, have experienced significant price and volume
fluctuations. These fluctuations have affected the market price for many
companies' securities even though the fluctuations are often unrelated to the
companies' operating performance.
Our shareholder rights plan and anti-takeover provisions of the certificate of
incorporation, bylaws and Delaware law could adversely impact a potential
acquisition by third parties
Our shareholder rights plan and anti-takeover provisions of the certificate
of incorporation, bylaws and Delaware law could adversely impact a potential
acquisition by third parties. The Company has a staggered board of directors,
with three classes each serving a staggered three-year term. This classification
has the effect of generally requiring at least two annual stockholder meetings,
instead of one, to replace a majority of the members of the board of directors.
The Company's certificate of incorporation also provides that stockholders may
act only at a duly called meeting and that stockholders' meetings may not be
called by stockholders. These provisions could discourage potential acquisition
proposals and could delay or prevent a change in control of the Company. These
provisions are intended to increase the likelihood of continuity and stability
in our board of directors and in the policies formulated by them and to
discourage certain types of transactions that may involve an actual or
threatened change of control of the Company, reduce our vulnerability to an
unsolicited acquisition proposal and discourage certain tactics that may be used
in proxy fights. However, these provisions could have the effect of discouraging
others from making tender offers for our shares, and, as a consequence, they
inhibit fluctuations in the market price of the Company's shares that could
result from actual or rumored takeover attempts. Such provisions also may have
the effect of preventing changes in the management of the Company.
In addition, other provisions of the Company's certificate of incorporation
and certain provisions of Delaware law may make it difficult to change control
of the Company and to replace incumbent management. For example, the Company's
certificate of incorporation permits the board of directors, without stockholder
approval, to issue additional shares of common stock or to establish one or more
classes or series of preferred stock with characteristics determined by the
board. US Oncology has also adopted a shareholder rights plan, which would
significantly inhibit the ability of another entity to acquire control of the
Company through a tender offer or otherwise without the approval of the
Company's board of directors. These provisions could limit the price that
certain investors might be willing to pay in the future for shares of common
stock.
We have not paid dividends and do not expect to in the future, which means that
the value of our shares cannot be realized except through sale
US Oncology has never declared or paid cash dividends. We currently expect
to retain earnings for our business and do not anticipate paying dividends on
our common stock at any time in the foreseeable future. Because we do not
anticipate paying dividends, it is likely that the only opportunity to realize
the value of our common stock will be through a sale of those shares. The
decision whether to pay dividends on common stock will be made by the board of
directors from time to time in the exercise of its business judgment. The
Company is currently precluded from paying dividends by the terms of its credit
facilities.
18
We cannot be sure that the year 2000 problem will not affect our business
Thus far, we have had no significant problems related to year 2000 issues
associated with the computer systems, software, other property and equipment we
use. However, we cannot guarantee that the year 2000 problem will not adversely
affect our business, operating results or financial condition at some point in
the future. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Year 2000 Implications."
19
SUMMARY OF OPERATIONS BY QUARTER
The following table represents unaudited quarterly results for 1999 and
1998. The Company believes that all necessary adjustments have been included in
the amounts stated below to present fairly the quarterly results when read in
conjunction with the Consolidated Financial Statements and that all adjustments
are of a normal recurring nature. Results of operations for any particular
quarter are not necessarily indicative of operations for a full year or
predictive of future periods.
1999 QUARTER ENDED 1998 QUARTER ENDED
------------------------------------------ -----------------------------------------
DEC 31 SEP 30 JUN 30 MAR 31 DEC 31 SEP 30 JUN 30 MAR 31
-------- -------- --------- -------- -------- -------- -------- --------
(In thousands, except per share data)
Net revenue.................... $299,526 $277,789 $266,412 $249,214 $227,299 $216,916 $204,744 $187,637
Income from operations......... 20,836 26,991 9,338 31,076 29,459 27,898 28,681 26,035
Other income................... 14,431
Net income..................... 17,871 14,983 (1,214) 16,515 15,843 15,045 15,504 13,589
Net income per share-basic..... .18 .15 (.01) .17 .16 .15 .16 .14
Net income per share-diluted... .18 .15 (.01) .16 .16 .15 .15 .14
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital primarily to enter into management services
agreements with, and to purchase the nonmedical assets of, oncology medical
practices. During 1999, the Company paid total consideration of $95.4 million in
connection with affiliations with 20 physician groups, including cash and
transaction costs of $43.5 million. During 1998, the Company paid total
consideration of $54.5 million in connection with affiliations with 21 physician
groups, including cash and transaction costs of $32.2 million.
To fund its growth and development, the Company has satisfied its
transaction and working capital needs through debt and equity financings and
borrowings under a $275 million syndicated revolving credit facility ("Credit
Facility") with First Union National Bank ("First Union"), as agent for the
various lenders. The Credit Facility is comprised of two parts: a $175 million
revolving credit facility which matures in 2004 and a $100 million 364-revolving
credit facility which matures in June 2000 and is renewable at the option of the
Lenders under that facility. The Company presently intends to seek renewal of
the 364-day facility. In addition, in connection with the Credit Facility the
Company has available a $75 million leasing facility used by the Company in
connection with developing its integrated cancer centers. In November 1999, the
Company sold an aggregate of $100 million of Senior Secured Notes to a group of
institutional investors. The notes are secured by the same collateral as the
Credit Facility and rank equally in right of payment with the Credit Facility.
The notes bear interest at 8.42% per annum with a final maturity in 2006 and an
average life of five years.
During 1999, the Company borrowed $118.0 million, net, under the Credit
Facility and Senior Secured Notes to fund medical practice transactions and the
development of integrated cancer centers. Borrowings under the Credit Facility
bear interest at a rate equal to a rate based on prime rate or the London
Interbank Offered Rate, based on a defined formula. The Credit Facility
contains affirmative and negative covenants, including the maintenance of
certain ratios, restriction on sales, leases or other dispositions of
properties, restrictions on other indebtedness and on the payment of dividends.
The Company's management services agreements and the capital stock of the
Company's subsidiaries are pledged as security under the Credit Facility. The
Company is currently in compliance with the Credit Facility covenants, with
additional capacity under the Credit Facility of $101.0 million at December 31,
1999.
In connection with the merger of AOR and PRN, the combined company incurred
substantial costs. The Company incurred costs directly related to its efforts
to consummate the merger ("merger costs"), costs related to restructuring
certain duplicative operating costs ("restructuring costs") and costs related to
its efforts to integrate the operations of the two companies ("integration
costs"). These costs totaled $29.0 million and have been summarized in the
accompanying consolidated statement of operations and comprehensive income as
Merger, restructuring and integration costs in the year ended December 31, 1999.
The Company's merger costs totaled $14.6 million and include professional
fees and expenses incurred in connection with the due diligence, negotiation and
solicitation of shareholder approval for the transaction, as well as incremental
travel costs and contractual change of control payments of approximately $5.0
million to the executive management of PRN.
20
The Company's management made decisions to restructure its operations to
reduce overlapping personnel and duplicative facilities. The costs of personnel
reductions include severance pay for terminated employees and payments
attributable to stay bonuses paid before December 31, 1999 for employees
providing transition assistance services. The Company also determined that
certain furniture, fixtures, leasehold improvements, computer equipment and
software were impaired as a result of personnel terminations, facility closings
and decisions to harmonize certain information systems. The Company's
restructuring costs recognized in the year ended December 31, 1999 totaled $7.2
million.
The Company also incurred specifically identified costs related to its
efforts to integrate the two companies totaling $7.2 million during the year
ended December 31, 1999. These integration costs include costs for a physician
conference to address combined Company operating strategies, employee
orientation meetings, consulting fees related to integration activities and
adoption of common employee benefit programs. These costs have been recognized
as incurred and do not include costs related to inefficiencies incurred as the
Company has attempted to integrate the operating activities of AOR and PRN.
The Company has relied primarily on management fees received from its
affiliated physician groups to fund its operations. While the obligation of the
affiliated practice groups to pay these fees is unsecured, to the extent
permitted by law, the Company is entitled to purchase the accounts receivable of
the practice for an amount that is net of such management fee. Since the
Company typically effects these purchases frequently, the amounts due to the
Company from its affiliated physician groups and to such groups from the Company
are each short-term obligations.
Cash provided by operating activities was $31.5 million in 1999, a decrease
of $48.2 million, or 60.4%, from 1998. The decrease was due to merger related
costs of $26.6 million and the timing of receivables collection and the
settlement of such amounts with affiliated physician groups. Cash used in
investing activities was $133.5 million in 1999, compared to $94.2 million in
1998. This increase was attributable to a higher level of medical practice
transactions in 1999 as well as cancer center development. Cash provided by
financing activities was $99.7 million in 1999 compared to $20.4 million in
1998. This increase was due to a lower level of medical practice transactions
in 1998 offset by increased repayments of other indebtedness and purchases of
the Company's common stock. Repurchased shares of the Company's common stock
are used primarily to fulfill commitments for delivery of the Company's common
stock under medical practice transactions.
At December 31, 1999, the Company had working capital of $280.8 million,
including cash and equivalents of $11.4 million. The Company had $195.4 million
of current liabilities, including $26.7 million of long-term indebtedness
maturing before December 31, 2000. The Company's accounts receivable and
accounts payable have increased significantly during the past several years with
the growth of its business. The Company has not experienced, however, any
significant change in the quality of its accounts receivable and, as a result,
its increasing working capital has resulted in greater liquidity.
In March 2000, the Company sold its equity investment in ILEX Oncology,
Inc. in a private sale transaction and realized proceeds of $54.8 million, or
$39.1 million net of tax. These proceeds were used to reduce outstanding
borrowings under the Credit Facility. Also in March 2000, the Company's Board
of Directors authorized the purchase by the Company of up to 10 million shares
of the Company's Common Stock.
The Company currently expects that its principal use of funds in the near
future will be in connection with future transactions with oncology groups, the
purchase of medical equipment, investment in information systems and the
acquisition or lease of real estate for the development of integrated cancer
centers. It is likely that our capital needs in the next several years will
exceed the capital generated from our operations. Thus, we may incur additional
debt or issue additional debt or equity securities from time to time. This may
include the issuance of common stock or notes in connection with physician
affiliations. Capital available for health care companies, whether raised
through the issuance of debt or equity securities, is quite limited. As a
result, we may be unable to obtain sufficient financing on terms satisfactory to
us or at all. In particular, although the Company intends to renew its $100
million 364-day revolving credit facility that matures in June 2000, there can
be no assurance that we will be able to do so on terms satisfactory to us or at
all.
YEAR 2000 IMPLICATIONS
Many currently installed computer systems, software programs, and embedded
data chips are programmed using a 2-digit date field and are therefore unable to
distinguish dates beyond the 20th century. A failure to identify and correct any
mission-critical internal or third party year 2000 processing problem could have
a material adverse operational or financial consequence to us. We established a
Year 2000 Project Team that, together with external consultants, developed a
process for addressing the year 2000 issue including performing an inventory, an
assessment, remediation procedures (to the extent necessary) and testing
procedures of all mission-critical information systems and equipment and
machinery that contain
21
embedded technology, as well as obtaining assurances from all mission-critical
third parties as to their own year 2000 preparedness.
As of the date of this report, we have not experienced any significant year
2000 problems with our own mission-critical systems or any mission-critical
third parties. Although we have not experienced any significant year 2000
problems to date, we plan to continue to monitor the situation. We cannot be
sure the year 2000 issue has been adequately addressed or that problems arising
from the year 2000 issue will not cause a material adverse effect on our
operating results or financial condition. We believe, however, that our most
reasonably likely worst-case scenario would relate to problems with the systems
of third parties rather than with our internal systems. Although we have
developed contingency plans for third party failures, we cannot guarantee that
the contingency plans will adequately address all circumstances that may disrupt
operations or that such planning will prevent circumstances that may cause a
material adverse effect on our operating results or financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
In the normal course of business, the financial position of the Company is
routinely subjected to a variety of risks. Among these risks is the market risk
associated with interest rate movements on outstanding debt. The Company
regularly assesses these risks and has established policies and business
practices to protect against the adverse effects of these and other potential
exposures.
The Company's borrowings under its credit facilities and subordinated notes
due to affiliated physicians contain an element of market risk from changes in
interest rates. The Company managed this risk, in part, through the use of
interest rate swaps until August 1999. The Company does not enter into interest
rate swaps or hold other derivative financial instruments for speculative
purposes.
For purposes of specific risk analysis, the Company uses sensitivity
analysis to determine the impact that market risk exposures may have on the
Company. The financial instruments included in the sensitivity analysis consist
of all of the Company's cash and equivalents, long-term and short-term debt and
all derivative financial instruments.
To perform sensitivity analysis, the Company assesses the risk of loss in
fair values from the impact of hypothetical changes in interest rates on market
sensitive instruments. The market values for interest rate risk is 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 December 31, 1999. The market values that result from these
computations are compared with the market values of these financial instruments
at December 31, 1999. The differences in this comparison are the hypothetical
gains or losses associated with each type of risk. A one percent increase or
decrease in the levels of interest rates on variable rate debt with all other
variables held constant would not result in a material change to the Company's
results of operations or financial position or the fair value of its financial
instruments.
22
US ONCOLOGY, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Financial Statements as of December 31, 1999 and 1998 and for each
of the three years ended December 31, 1999:
Page
----
Report of Independent Accountants........................................ 24
Consolidated Balance Sheet............................................... 26
Consolidated Statement of Operations and Comprehensive Income............ 27
Consolidated Statement of Stockholders' Equity........................... 28
Consolidated Statement of Cash Flows..................................... 29
Notes to Consolidated Financial Statements............................... 30
Financial statement schedules have been omitted because they are not applicable
or the required information is shown in the consolidated financial statements or
notes thereto.
23
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of US Oncology, Inc.
We have audited the consolidated balance sheet of US Oncology, Inc. and its
subsidiaries as of December 31, 1999 and 1998 and the related consolidated
statements of operations and comprehensive income, of stockholders' equity and
of cash flows for each of the three years in the period ended December 31, 1999.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits. We did not audit the financial statements of Physician Reliance
Network, Inc., which statements reflect total assets constituting 45 percent at
December 31, 1998 and total revenues of 48 and 47 percent for the years ended
December 31, 1998 and 1997, respectively, of the related consolidated totals.
Those statements were audited by other auditors whose report has been furnished
to us, and our opinion, insofar as it relates to the amounts included for
Physician Reliance Network, Inc., is based solely on the report of the other
auditors.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit and the report of
the other auditors provide reasonable basis for our opinion.
In our opinion, based on our audit and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of US Oncology, Inc. and
it subsidiaries at December 31, 1999, and 1998 and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1999 in conformity with accounting principles generally
accepted in the United States.
PRICEWATERHOUSECOOPERS LLP
Houston, Texas
March 21, 2000
24
[ARTHUR ANDERSEN LOGO APPEARS HERE]
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Physician Reliance Network, Inc.:
We have audited the consolidated balance sheets of Physician Reliance Network,
Inc. (a Texas corporation) and subsidiaries as of December 31, 1998 and 1997,
and the related consolidated statements of income, stockholders' equity, and
cash flows for the years then ended. These consolidated financial statements are
included in the restated consolidated financial statements of US Oncology, Inc.
and are not separately presented in the 1999 Form 10-K of US Oncology, Inc.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on theses financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Physician Reliance Network,
Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Dallas, Texas
February 19, 1999
US ONCOLOGY, INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except per share data)
DECEMBER 31,
------------------------
1999 1998
----------- ----------
ASSETS
Current assets:
Cash and equivalents............................................. $ 11,381 $ 13,691
Investment in common stock....................................... 27,258 6,975
Accounts receivable.............................................. 331,361 243,390
Prepaids and other current assets................................ 42,655 20,924
Inventories...................................................... 24,692 14,682
Due from affiliated physicians groups............................ 38,894 22,354
---------- ----------
Total current assets.......................................... 476,241 322,016
Property and equipment, net......................................... 254,289 220,944
Management service agreements, net of accumulated amortization of
$59,845 and $36,899.............................................. 537,130 467,214
Other assets........................................................ 30,817 23,354
---------- ----------
$1,298,477 $1,033,528
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term indebtedness..................... $ 26,693 $ 22,426
Accounts payable................................................. 107,937 80,729
Due to affiliated physician groups............................... 2,584 6,606
Accrued compensation costs....................................... 6,252 10,118
Income taxes payable............................................. 9,322 4,066
Other accrued liabilities........................................ 42,660 19,809
---------- ----------
Total current liabilities..................................... 195,448 143,754
Deferred income taxes............................................... 33,224 23,537
Long-term indebtedness.............................................. 360,191 234,474
---------- ----------
Total liabilities............................................ 588,863 401,765
Minority interest................................................... 2,450 1,965
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,
87,253 and 81,205 shares issued and 87,253 and 80,830
shares outstanding............................................. 873 812
Additional paid-in capital....................................... 428,533 404,749
Common Stock to be issued, approximately 13,982 and 16,947 shares. 91,330 89,142
Treasury Stock, 0 and 375 shares................................. (3,696)
Accumulated other comprehensive income........................... 269
Retained earnings................................................ 186,428 138,522
---------- ----------
Total stockholders' equity................................... 707,164 629,798
---------- ----------
Commitments and contingencies.......................................
---------- ----------
$1,298,477 $1,033,528
========== ==========
The accompanying notes are an integral part of this statement.
26
US ONCOLOGY, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
(in thousands, except per share data)
YEAR ENDED DECEMBER 31,
---------------------------------------
1999 1998 1997
----------- ---------- ----------
Revenue................................. $1,092,941 $836,596 $625,413
Operating expenses:
Pharmaceuticals and supplies.......... 521,087 357,766 250,425
Practice compensation and benefits.... 215,402 172,298 143,210
Other practice costs.................. 134,635 107,671 87,232
General and administrative............ 39,490 38,325 31,809
Write-off of accounts receivable...... 37,841
Merger, restructuring and integration
costs................................ 29,014
Depreciation and amortization......... 65,072 48,463 35,194
---------- -------- --------
1,004,700 724,523 585,711
---------- -------- --------
Income from operations.................. 88,241 112,073 39,702
Other income (expense):
Interest, net......................... (22,288) (15,908) (12,474)
Unrealized gain on investment in
common stock......................... 14,431
---------- -------- --------
Income before income taxes.........