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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
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Washington, D.C. 20549
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FORM 10-K
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(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, 2001
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)
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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: (832) 601-8766
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 21, 2002 was $645,462,369 (based upon the closing
sales price of the Common Stock on The Nasdaq Stock Market on March 21, 2002 of
$8.42 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 93,157,809 shares of the Registrant's Common Stock outstanding
on March 21, 2002. In addition, as of March 21, 2002, the Registrant had agreed
to deliver approximately 6,725,417 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 2002 Annual Meeting of Stockholders are incorporated by reference
into Part III hereof.
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PART I
As used in this report, unless the context otherwise requires, the terms, "US
Oncology," the "Company," "we," "our" and "us" refer to US Oncology, Inc. and
its consolidated subsidiaries.
Item 1. Business
US Oncology is America's premier cancer care services company. We support
the cancer care community by providing practice management, oncology
pharmaceutical management, outpatient cancer center operations and cancer
research and development services. Our 868 network physicians provide care to
patients in over 450 locations, including 77 outpatient cancer centers and 12
Positron Emission Tomography (PET) installations, across 27 states. In 2001, we
estimate that our network physicians provided care to over 500,000 cancer
patients, including approximately 200,000 new patients, representing 15% of the
nation's newly diagnosed cancer cases.
Our network's community-based focus allows our affiliated physicians to
provide to patients locally the latest advances in therapies, research and
technology, often within a single outpatient setting. As a result, patients
access the best possible treatment with the least amount of disruption to their
daily lives. Our nationwide presence enables us to rapidly implement best
practices and share new discoveries, and our network's size affords competitive
advantages in areas such as purchasing, information systems, access to clinical
research and leading edge technology.
On June 15, 1999, a wholly owned subsidiary of US Oncology, Inc. merged
with Physician Reliance Network, Inc. ("PRN"), a cancer management company. As a
result of the merger, PRN became a wholly owned subsidiary of US Oncology, Inc.,
and each holder of PRN common stock received 0.94 shares of our common stock for
each PRN share held. This transaction, which is referred to as the "AOR/PRN
merger," was accounted for under the pooling of interests method of accounting
and treated as a tax-free exchange. Our 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 bases.
US Oncology was incorporated in October 1992 under the laws of the State
of Delaware. Our principal executive offices are located at 16825 Northchase
Drive, Suite 1300, Houston, Texas, and our telephone number is (832) 601-8766.
Our common stock is traded on the Nasdaq Stock Market under the symbol "USON."
Our Operations
We provide our network physicians with a comprehensive set of services
that empowers them to offer to cancer patients in outpatient settings a full
continuum of care, including professional medical services, chemotherapy
infusion, radiation oncology services, stem cell transplantation, clinical
laboratory, diagnostic radiology, pharmacy services and patient education. The
services include:
Oncology Pharmaceutical Management Services. We purchase and manage
specialty oncology pharmaceuticals for our network physicians. We are one of the
largest buyers of oncology pharmaceuticals within the United States, purchasing
more than $700 million in cancer drugs annually on behalf of our network
physicians. In addition, we operate 31 licensed pharmacies and over 400
admixture sites that are staffed with 51 pharmacists and 180 pharmacy
technicians.
Outpatient Cancer Center Operations. We develop and manage comprehensive,
community-based cancer centers, which integrate all forms of outpatient cancer
care, from the most advanced laboratory and radiology diagnostic capabilities to
chemotherapy and radiation therapy. We provide a "turn-key" service, developing
centers from the preliminary feasibility study through full operational status,
including site acquisition, architectural design, construction management,
equipment evaluation and acquisition, physician and technical staff recruiting
and billing and collection services. We have developed and manage 77
comprehensive outpatient cancer centers located in urban, suburban and rural
settings. Overall, we maintain over 1.2 million square feet of medical office
space and an installed base of 112 linear accelerators, 59 Computerized Axial
Tomography (CT) units and 12 PET units.
Cancer Research and Development Services. We facilitate a broad range of
cancer research and development activities through our network. We contract with
pharmaceutical and biotechnology firms to provide a
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comprehensive range of services, from study concept and design to regulatory
approval, including complete Phase I through Phase IV trials, recruitment of
studies, protocol writing and scientific approval process, supported by a single
Clinical Review Advisory Board. Our 1,100 research team members, working in
conjunction with our network of 650 participating physicians in more than 330
research locations, conduct approximately 100 clinical trials each year with
accruals of more than 3,500 patients during 2001.
Other Practice Management Services. We act as the exclusive manager and
administrator of all day-to-day nonmedical business functions connected with our
affiliated practices. As such, we are responsible for physician recruiting, data
management, accounting, systems, compliance and capital allocation to facilitate
growth in practice operations.
Physician Practice Management Model
Currently, we provide all of our services to the practices in our network
under long-term comprehensive service agreements. When we entered into each
agreement, we paid consideration to physicians to purchase the nonmedical assets
of their practices and to enter into service agreements. Utilizing this strategy
(sometimes referred to as the "physician practice management" or "PPM" business
model), we have assembled the nation's largest network of oncologists, who care
for 15 percent of the nation's new cancer cases annually. However, the PPM model
relies on significant and recurring capital investments in intangible assets in
order to expand the network. Going forward we generally do not intend to add
physicians to our network in new markets through the PPM model. Rather, we will
contract with practices to provide our core services on a non-PPM basis. See the
discussion under "--Strategic Repositioning."
Under the PPM model, in connection with affiliating with a practice, we
entered into a service agreement with the practice and purchased the practice's
nonmedical assets. In consideration of these arrangements, we typically
delivered cash and subordinated promissory notes and agreed to deliver shares of
our common stock at specified future dates (typically on the second through
fifth anniversaries of the closing date). In addition, in most of our affiliated
practices, each physician entered into an employment or non-competition
agreement with the practice. We do not provide medical care to patients or
employ any of the affiliated practices' clinical staff who provide medical care.
However, under the terms of the service agreements with the practices, we are
responsible for the compensation and benefits of the practices' non-physician
medical personnel, and our financial statements reflect the costs of such
compensation and benefits.
The service agreements with the practices generally have contractual terms
of 40 years. These agreements provide that they cannot be terminated by the
practices or by us without cause. Each agreement provides for payment to us of a
service fee and reimbursement of all practice costs as consideration for our
services. Some of the service agreements, known as the "earnings model"
agreements, provide that this fee is a percentage of the practice's earnings
before income taxes. In others, known as "net revenue model" agreements, the fee
consists of a fixed fee, a percentage fee (in most states) of the practice's net
revenues and, if certain performance criteria are met, a performance fee. Where
our service agreement follows the net revenue model, the practice is entitled to
retain a fixed portion of net revenue before the service fee (other than
practice operating costs) is paid to us. The effect of this priority of payments
under the net revenue model agreements is that we bear a disproportionate share
of increasing practice costs. This is because if, after payment of operating
expenses, there are not sufficient amounts available to pay both the fixed
management fee and the fixed percentage to be retained by the practice, the
entire amount of such shortfall is a reduction to our management fee. For this
reason, we believe that the net revenue model does not provide adequate
incentives for our practices to manage costs efficiently.
Beginning in the Fall of 2000, we commenced a network-wide initiative to
convert our affiliated practices from the net revenue model to the earnings
model. We believe that the earnings model more appropriately aligns our economic
interests with those of our affiliated practices, particularly in a rising cost
environment. In addition, we have negotiated, and intend to continue to
negotiate, terminations of certain service agreements that we do not believe
will attain satisfactory performance under either model. During 2001, we
successfully converted twelve practices formerly under the net revenue model to
the earnings model. We continue to pursue other conversions. Changing the manner
in which fees are calculated has and will in some cases result in management
fees that are, at least in the short term, lower than those that would have been
received under the net revenue model. For the fourth quarter of 2001, 63% of our
revenue was derived from practices under the earnings model as of March 11,
2002, and several other additional affiliated practices are currently in
negotiations regarding conversion to this model. We
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intend to continue to convert practices under the revenue model to the earnings
model or to allow them to terminate their PPM arrangement and adopt the service
line structure, as described below under "--Strategic Repositioning."
Strategic Repositioning
In September 2001, we announced an initiative to offer our core
cancer-related services nationwide to oncology practices that are outside of our
current network under what we call the "service line structure." Oncology
practices will now be able to contract for our services without entering into
comprehensive service agreements that call for our involvement in all business
aspects of their day-to-day operations. Under the service line structure, we
will no longer pay consideration to physicians in new markets to acquire the
nonmedical assets of their practices. We believe that this new strategic
initiative will enable us to expand our oncology network to meet the growing
demand for cancer care services without the recurring capital investments in
intangible assets, limited return on assets, increased compliance requirements
and reimbursement risks and the delays inherent in expanding under the PPM
model. The service line structure will also allow significant numbers of new
physicians to affiliate with us and utilize our core services while maintaining
complete ownership and control of their oncology practices' assets. In February
of 2002, we executed definitive agreements with the first external practice to
adopt the service line structure and expect to begin providing services to that
practice during the second quarter of 2002.
Our existing affiliated practices will remain in the network and be given
a choice of maintaining a PPM relationship with us or transitioning to a service
line relationship. We believe that conversion to the service line arrangement
will allow physicians to regain management control of their practices and
effectively increase physician compensation, while allowing them to retain
access to virtually all of our core services at market based rates. If all
affiliated practices transition to the service line structure, we would expect
the potential financial impact could include significant, but largely non-cash,
restructuring and reorganization costs, and a reduction in our earnings related
to those practices. We do not think that all of our practices will transition to
the service line structure in the near future. We also cannot accurately predict
which practices will transition or when they will do so. Thus, we are unable to
more accurately predict the financial impact of this transition until practices
agree to change structures.
Although we will no longer expand into new markets under the PPM model, we
may expand certain practices that continue to operate under the existing PPM
model. Existing affiliated practices that choose to remain under the PPM model
will continue to be managed according to existing agreements, and we will
continue to attempt to convert net revenue model service agreements to the
earnings model. In certain cases, we may acquire the nonmedical assets of
additional physician practices under the PPM model and integrate those
physicians with an existing practice under the PPM model.
While we believe that the service line structure will be attractive to
practices in our existing network, we are not currently able to predict the
number of practices and physicians that may transition to this new model or the
timing of negotiations and implementation of such transitions. As our existing
practices complete their evaluation of the service line structure, we believe
many will elect to make the transition to that structure. At the same time,
however, we are firmly committed to our existing operations and believe that our
repositioning will be successful if our affiliated practices convert to either
the earnings model within the PPM structure or the service line structure.
Service Line Structure
To implement our service line strategy, we will be internally reorganized
into three divisions. We will manage and operate our business under distinct
service lines, and expect to begin segment reporting according to those service
lines in 2002. For management and reporting purposes, our existing PPM
operations will be divided into the various service line offerings included in
the PPM relationship.
Oncology Pharmaceutical Management
This division would offer the pharmaceutical management services we
currently provide to our network physicians. We expect to retain a
market-competitive service fee that is a percentage of the cost of all drugs
purchased on behalf of clients. Based on current network volume, and our
preliminary assumptions with respect to our potential fees, this division would
generate more than $780 million in annual revenues from currently affiliated
practices.
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The oncology pharmaceutical management service line combines all of our
core competencies and service offerings related to oncology drugs into a single,
coordinated business division. We expect the division to provide a
comprehensive, integrated solution to all of the drug needs of an oncology
practice, from purchasing drugs and supplies to mixing and managing drugs for
infusion, to post-use evaluation and data aggregation. The division is aimed at
providing efficient, high quality management of drugs from the manufacturer to
the patient, including the following service offerings:
. Purchasing. Coordination of purchasing for oncology drugs and Group
Purchasing Organization services.
. Inventory Management. Tracking of drug usage and reduction of waste,
implementation of network-wide systems and protocols and
coordination of drug replacement assistance with respect to unused
expired drugs and drugs for indigent patients.
. Admixture Services. Coordination of comprehensive mixing services
for oncology drugs.
. Information Services. Data aggregation and analysis regarding drug
usage for use by physicians, pharmaceutical companies and patients.
. National Network Participation. Coordination of meetings and
discussions among other network physicians regarding treatment
protocols, drug effectiveness and other pharmacy-related issues.
. Retail Pharmacy. In addition to providing pharmaceutical services
for our affiliated practices that allow them to infuse drugs in
their offices, we expect that the oncology pharmaceutical management
division will permit us to participate in the market for retail
pharmaceuticals in the oncology arena. Although most oncology drugs
continue to be administered in the physician's office, in the event
additional self-administered therapies become available, our network
of trained pharmacists, combined with the other core competencies of
the network, will enable us to serve patients in a convenient retail
pharmacy context also.
Under the service line structure, pharmaceutical management services
contracts will have a term of up to five years. We will be responsible for
providing all of the services outlined above and will be paid on a per-dose
basis an amount reflecting our cost per dose plus an agreed upon percentage. In
addition, the practices will pay a per-dose admixture fee. The practices will
also be required to acquire substantially all of their drugs through us and to
use our admixture services. Under all contracts we will bear the costs and risks
of ownership of pharmaceuticals and will be able to capture the benefits of any
drug efficiencies resulting from our mixing operations. We will act as a group
purchasing organization on behalf of the practices and will receive a fee from
pharmaceutical manufacturers for this service. In addition, under the contracts,
we will own data gathered in connection with our pharmaceutical services and
intend to enter into agreements to sell such data to pharmaceutical companies
and to others.
Outpatient Cancer Center Operations
This division will contract with oncology practices and clinics to provide
expertise in outpatient cancer center development and operations and access to
capital for development. The portfolio of service offerings includes the full
range of outpatient cancer center development and management, including
deployment of radiation therapy and diagnostic technology, including PET. Both
the economic arrangement and the types of services offered by this division
under the service line structure remain largely unchanged from the manner in
which we conduct business in this segment today at earnings model practices.
Based on current network performance and our existing affiliated practices, this
division would produce more than $280 million in annual net patient revenues.
The division provides a "turn-key" service, developing centers from the
preliminary feasibility study through full operational status, including site
acquisition, architectural design, construction management, equipment evaluation
and acquisition, and physician and technical staff recruiting. Once a center is
operational, the division provides full operations and facilities management,
including marketing and other related services. Practices benefit from having
access to low-cost capital, operational expertise gained from pioneering
outpatient cancer centers, the latest technology to enhance patient care and
diversified revenue sources.
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We currently manage 77 comprehensive outpatient cancer centers located in
urban, suburban and rural settings under PPM arrangements. We manage over 1.2
million square feet of medical office space, an installed base of 112 linear
accelerators, 59 CT units and 12 PET units.
The Outpatient Cancer Center Operations division manages all aspects of
the development and operation of comprehensive outpatient cancer centers.
Throughout all stages of the process of developing and operating a cancer
center, we and the local physicians collectively make all material decisions and
coordinate strategic and planning activities, including:
. Market Evaluation. Market assessment, including evaluation of
competition, alternative treatment sources, demographic trends,
referral patterns and patient base and assessment of opportunities
for expansion.
. Pre-Construction Analysis and Planning. Site selection, managing
planning and zoning requirements, developing preliminary space
requirements, coordinating certificate of need or similar approval
process, conducting site engineering and environmental studies,
developing a master site plan, preliminary project cost estimates,
financial planning and a preliminary staffing and equipment plan.
. Construction. Coordination and supervision of all aspects of the
construction of the cancer center including analysis of conformity
with project costs and schedule goals.
. Equipment Services. Equipping and furnishing the center,
coordinating installation and in-service training for center staff
and maintaining of equipment.
. Personnel. Setting appropriate staffing levels and evaluating,
retaining and training the necessary technical and other staff to
operate the center, including physicists, dosimetrists, radiation
therapists, nurses, social workers, dieticians, secretaries,
clerical staff, data managers and research staff.
. Operations. Management of all of the day-to-day business operations
of the cancer center, including provision of supplies, management of
necessary information systems, front office operations, billing and
collection, financial planning and reporting, benchmarking and
introduction of network best practices.
. Marketing, Payor Relationships and Strategic Planning. Assistance in
developing competitive fee schedules and negotiations with payors,
monitoring of payor contract compliance, marketing and strategic
planning services, including physician recruitment, strategic
partnerships and new service opportunities.
Under the service line structure, Outpatient Cancer Center Operations will
be conducted pursuant to leases and service agreements with fifteen-year terms.
Under the leases for both equipment and real estate, the affiliated practices
will pay our economic cost related to the property plus, in the case of
radiation assets, an amount sufficient to give us a predetermined return on
invested capital. In addition, we will receive a service fee equal to 30% of net
earnings from radiation operations, subject to a fee rebate to the extent
certain performance criteria are achieved by the practice. The agreements will
include mutual non-competition covenants. In addition, practices will be
required to utilize our pharmaceutical management services within the cancer
centers.
Cancer Research and Development Services
This division will provide a full range of oncology drug development
services, from study concept and design to regulatory approval, including
complete Phase I-IV clinical trials. The division will contract with
pharmaceutical and biotechnology firms and focus on bringing investigational
therapies to cancer patients through our network of community-based oncology
researchers.
The division provides a complete range of research and development support
services, including recruitment of studies, protocol writing and scientific
approval process, supported by a single Clinical Review Advisory Board. A team
of research professionals, which includes the study principal investigator, site
investigator,
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site sub-investigator, research nurse/coordinator, clinical research assistants,
project managers and data coordinator/manager, supervises each research project.
Study management services include study initiation and monitoring, patient
accrual, project management, protocol implementation, data management and
statistical analysis. A single Institutional Review Board provides research
oversight.
We currently supervise 98 clinical trials with accruals of more than 3,500
patients during 2001. We have completed more than 200 trials in conjunction with
our network of 650 participating physicians in more than 330 research locations.
We actively participated in clinical research trials that resulted in nine new
drugs in five years.
The Cancer Research and Development service line provides a range of
services designed to give affiliated practices and their patients access to a
wide selection of the latest clinical trials. This division is also responsible
for our stem cell transplant program. We will contract with pharmaceutical
companies and others needing research services, generally on a per trial basis.
We will pay physicians for each trial based upon economic considerations unique
to each trial.
Other Key Support Services
Under the service line structure, we will continue to offer certain other
services in which we have developed expertise as a result of operating under the
PPM Model. These services include:
. marketing
. recruiting of physicians and staff
. continuing education
. network communications
. public policy and patient advocacy
Transition from PPM Model to Service Line Structure
We believe that the PPM model has afforded us the opportunity to greatly
improve the quality of community-based cancer care in the United States and to
assemble a nationwide network. We have developed core competencies relating to
oncology pharmaceutical management, cancer center development and operations and
cancer research and drug development services. We have also established
ourselves as the market leader in providing these services to oncology practices
in the United States.
Nevertheless, management believes that the PPM model has limited growth
opportunities: access to capital is limited because the capital markets perceive
risks in the PPM structure, growth by practice acquisition is capital intensive,
and there are only a limited number of oncology practices available for
acquisition because of valuation difficulties and the perception of many
physicians that a PPM relationship diminishes their local control.
With respect to those practices who elect to transition from the PPM model
to the service line structure, we would be able to eliminate the distractions of
lesser-valued services and reduce indebtedness. In addition, going forward under
the service line structure allows us to:
. increase and accelerate participation in the growing cancer services
market
. reduce capital expenditures necessary to add practices
. improve shareholder value and capital structure through a less
capital-intensive model
. prepare for future reimbursement and technology changes
If all current affiliated practices transitioned to the service line
structure, thus eliminating the medical oncology practice management
responsibilities and related fees, we expect that there would be reduction in
long-term and intangible assets currently reflected on our balance sheet and
transitional and restructuring costs. As practices transition to this service
line structure, we would expect the financial impact to be a reduction in debt,
restructuring and reorganization costs, mostly non-cash related, and a reduction
in our earnings related to those practices. We cannot assess at this time which,
or how many, practices will adopt the service line structure, and the exact
extent of the above-described financial impacts will depend on which practices
convert.
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It is not integral to our strategy that all or any of our currently
affiliated practices adopt the service line structure, and we currently expect
that a large percentage of existing affiliated practices will stay on the PPM
model for the foreseeable future. With respect to continuing PPM relationships,
we will continue to negotiate conversions to the earnings model and otherwise
manage these practices in accordance with their service agreements. We remain
fully committed to those practices with which we have PPM relationships and will
continue to provide the complete range of PPM services to them.
Competition
Some of our competitors have greater financial, technical, marketing and
managerial resources than we have. To the extent that competitors are owned by
pharmaceutical manufacturers, retail pharmacies, insurance companies, HMOs or
hospitals, they may have pricing advantages that are unavailable to us and other
independent companies. While competition is often based primarily on price and
quality of service, it can also be affected by the ability to develop and
maintain relationships with patients and referral sources, depth of product
line, technical support systems, specific patient requirements and reputation.
Pharmaceutical Management. The specialty pharmaceutical industry is highly
competitive and is undergoing consolidation. The industry is fragmented, with
many public and private companies focusing on different product or customer
niches. We are unique in our exclusive focus on oncology pharmaceuticals. Some
of our current and potential competitors include:
. specialty pharmacy distributors, such as Accredo Health,
Incorporated, Caremark Rx, Inc., Priority Healthcare Corporation and
Gentiva Health Services, Inc.;
. specialty pharmacy divisions of national wholesale distributors;
. pharmacy benefit management companies, such as Express Scripts, Inc.
(minority-owned by New York Life Insurance Co.), Merck-Medco Managed
Care, LLC (an affiliate of Merck & Co., Inc.) and AdvancePCS;
. hospital-based pharmacies;
. retail pharmacies;
. home infusion therapy companies;
. group purchasing organizations (GPOs);
. manufacturers that sell their products both to distributors and
directly to users, including clinics and physician offices; and
. hospital-based comprehensive cancer care centers and other alternate
site health care providers.
Outpatient Health Care Centers. Outpatient care is a growing trend, but
the sector is highly fragmented, with no other company focusing exclusively on
comprehensive cancer centers. Many hospitals and regional medical centers
operate outpatient care centers, offering primary care, urgent care, diagnostic
imaging like MRIs and heart scans, minor surgery (known as ambulatory surgery
centers or ASCs), and a range of other specialties including oncology. Although
fragmented and predominantly locally-focused, our strongest competitors are
hospitals or joint ventures between hospitals and oncology practices who
finance, build and operate comprehensive cancer centers adjacent to a large
hospital or as a satellite location within the hospital system. Companies such
as SurgiCare, Inc. (for ASCs) and Outpatient Imaging Affiliates (for diagnostic
radiology imaging) also build and operate outpatient care centers, often in
partnership with hospitals or HMOs. Some of these companies could attempt to
enter or expand their presence in the oncology market.
Affiliated Practices. Our profitability depends in large part on the
continued success of our affiliated practices. The business of providing health
care services is highly competitive. The affiliated practices face
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competition from several sources, including sole practitioners, single- and
multi-specialty practices, 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 we and our affiliated
practices operate will not change significantly and adversely in the future. In
general, regulation and scrutiny of health care providers and related companies
are increasing.
There are currently several federal and state initiatives 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. One of these initiatives being conducted by
the Office of the Inspector General is focusing on, among other issues, clinical
research, physician coding, pharmaceutical relationships, credit balances and
group purchasing organization activities, which may result in government actions
that could negatively impact our operations. It is not possible to predict
whether any such initiatives will result in new or different rules or
regulations or other actions or what their form, effective dates or impact on us
will be.
Our affiliated practices are intensely regulated at the federal, state and
local levels. Although these regulations often do not directly apply to us, if a
practice is found to have violated any of these regulations and, as a result,
suffers a decrease in its revenues or an increase in costs, our results of
operations might be materially and adversely affected.
Licensing and Certificate of Need Requirements. Every state imposes
licensing requirements on clinical staff, individual physicians and on
facilities operated or utilized by health care providers. Many states require
regulatory approval, including certificates of need, before (1) establishing
certain types of health care facilities, (2) offering certain services or (3)
expending amounts in excess of statutory thresholds for health care equipment,
facilities or programs.
Privacy Regulations. The Department of Health and Human Services published
new privacy regulations on December 28, 2000 under the Health Insurance
Portability and Accountability Act of 1996 ("HIPAA"). Currently, the privacy
regulations are subject to further comment or revision by the new executive
administration. When final, the privacy regulations may impact our operations
with respect to the transfer of data between us and the affiliated practices.
Already adopted in final form, and also a part of HIPAA, are security and
electronic signature standards that regulate how we maintain personally
identifiable health information in our databases. We believe we are taking
appropriate measures to comply with these requirements, which will require
significant expenditures by us.
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 US Oncology, 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 limited
judicial and regulatory interpretation. We believe our current and planned
activities do not constitute fee-splitting or the practice of medicine as
contemplated by these laws. However, there can be no assurance that future
interpretations of such laws will not require structural and organizational
modification of our existing relationships with the practices. In addition,
statutes in some states in which we do not currently operate could require us to
modify our 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
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
8
under such programs. In addition to federal criminal penalties, the Social
Security Act provides for civil monetary penalties and exclusion of violators
from participation in the Medicare or Medicaid programs.
A violation of the Anti-Kickback Amendments requires the existence of all
of these 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 any governmental health programs; and (v)
patient coverage under any governmental program. Fulfilling all of the
requirements of the applicable regulatory safe harbors ensures that a party has
not violated the Anti-Kickback Amendments. We believe that all compensation we
receive is for our services. We also believe that we are not in a position to
make or influence referrals of patients or services reimbursed under any
governmental health programs to our affiliated practices. Consequently, we do
not believe that the service fees payable to us 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. To our knowledge, there
have been no case law decisions regarding service agreements similar to ours
that would indicate that such agreements violate the Anti-Kickback Amendments.
Further, we believe that since we are not a provider of medical services, and
are not in a position to refer patients to any particular medical practice, the
remuneration we receive for providing services does not violate the
Anti-Kickback Amendments. Because of the breadth of the Anti-Kickback Amendments
and the government's active enforcement thereof, there can be no assurance,
however, that future interpretations of such laws will not require modification
of our existing relationships with practices.
Prohibitions of 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." The Stark Bill and its current and
future regulations apply directly to physicians, not to us. There can be no
assurance, however, that interpretations of such laws will not indirectly affect
our existing relationships with affiliated practices.
Pharmacy Regulation. Our pharmaceutical service line, and our pharmacies
in particular, are subject to the operating and security standards of the Food
and Drug Administration (the "FDA"), the United States Drug Enforcement
Administration, various state boards of pharmacy and comparable agencies. Such
standards affect the prescribing of pharmaceuticals (including certain
controlled substances), operating of pharmacies (including nuclear pharmacies),
and packaging of pharmaceuticals. Complying with the standards, especially as
they change from time to time, could be extremely costly for us and could limit
the manner in which we implement this segment. Additionally, although the
pharmacies shall seek reimbursement only from the practices and never from any
third party payor, their existence and operation makes us a provider. While we
believe that our arrangements with our affiliated practices comply with the
Anti-Kickback Amendments and any relevant safe harbors as well as the Stark Law
and its exceptions, there can be no assurance that our pharmacy function will
not subject us to additional governmental review or an adverse determination.
Antitrust. We and our affiliated practices are subject to a range of
antitrust laws that prohibit anti-competitive conduct, including price fixing,
concerted refusals to deal and division of markets. We believe we are in
compliance with these laws, but there can be no assurance that a review of US
Oncology or our affiliated practices would not result in a determination that
could adversely affect our operations and the operations of our affiliated
practices.
Reimbursement Requirements. In order to participate in the Medicare and
Medicaid programs, our affiliated practices must comply with stringent
reimbursement regulations, including those that require certain health care
services to be conducted "incident to" or otherwise under a physician's
supervision. Satisfaction of all reimbursement requirements is required under
our compliance program. The practices' failure to comply with these requirements
could negatively affect our results of operations.
Enforcement Environment. In recent years, federal and state governments
have launched several initiatives aimed at uncovering behavior that violates the
federal civil and criminal laws regarding false claims and fraudulent billing
and coding practices. Such laws require physicians to adhere to complex
reimbursement requirements
9
regarding proper billing and coding in order to be compensated for medical
services by governmental payors. Our compliance program requires adherence to
applicable law and promotes reimbursement education and training; however,
because we perform services for our practices, it is likely that governmental
investigations or lawsuits regarding practices' compliance with reimbursement
requirements would also encompass our activities. A determination that billing
and coding practices of the affiliated practices are false or fraudulent could
have a material adverse effect on us.
The Federal False Claims Act is a frequently employed 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 $5,500 to
$11,000 for each false claim, as well as treble damages.
Compliance. We have a comprehensive compliance program designed to assist
us, our employees and our affiliated practices in complying with applicable law.
We regularly monitor developments in health care law and modify our agreements
and operations as changes in the business and regulatory environment require.
While we believe we will be able to structure all of our agreements and
operations in accordance with applicable law, there can be no assurance that our
arrangements will not be successfully challenged.
Employees
As of December 31, 2001, we directly employed 3,581 people. As of December
31, 2001, the affiliated practices employed 4,673 people (excluding the network
physicians). Under the terms of the service agreements with the affiliated
practices, we are responsible for the practice compensation and benefits of the
practices' non-physician medical personnel. No employee of US Oncology or of any
affiliated practice is a member of a labor union or subject to a collective
bargaining agreement. We consider our relations with our employees to be good.
Service Marks
We have registered the service mark "US Oncology" with the United States
Patent and Trademark Office.
Item 2. Properties
We lease our corporate headquarters in Houston, Texas. We or the
affiliated practices own, lease or sublease the facilities where the clinical
staffs provide medical services. In connection with the development of
integrated cancer centers, we have acquired land valued at approximately $21.0
million. We anticipate that, as our affiliated practices grow, expanded
facilities will be required.
In addition to conventional medical office space, we have 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, 2001, we operated 77 integrated cancer centers and had
four cancer centers under development. Of the 77 cancer centers operated by us,
50 are leased and 27 are owned, ranging in size from 4,700 square feet to
112,400 square feet.
Item 3. Legal Proceedings
The provision of medical services by our affiliated practices entails an
inherent risk of professional liability claims. We do not control the practice
of medicine by the clinical staff or their compliance with regulatory and other
requirements directly applicable to practices. In addition, because the
practices purchase and resell pharmaceutical products, they face the risk of
product liability claims. Although we maintain insurance coverage, successful
malpractice, regulatory or product liability claims asserted against us or one
of the practices could have a material adverse effect on us.
In November 1999, we disclosed that we and one of our formerly affiliated
practices were the subject of allegations that the practice's billing practices
may violate the Federal False Claims Act. These allegations are
10
contained in two qui tam complaints, commonly referred to as "whistle-blower"
lawsuits, filed under seal prior to the AOR/PRN merger. The U.S. Department of
Justice has determined that it will not intervene in those qui tam suits. In
these suits, the individual who filed the complaint may choose to continue to
pursue litigation in the absence of government intervention, but has not yet
indicated an intent to do so.
We have become aware that we and certain of our subsidiaries and
affiliated practices are the subject of additional qui tam lawsuits that remain
under seal, meaning that they were filed on a confidential basis with a U.S.
federal court and are not publicly available or disclosable. To date, the United
States has not intervened in any such suit against us. Because the complaints
are under seal, and because the Department of Justice and we are in the process
of investigating the claims, we are unable to assess at this time the
materiality of these lawsuits. Because qui tam actions are filed under seal,
there is a possibility that we could be the subject of other qui tam actions of
which we are unaware. We intend to continue to investigate and vigorously defend
ourselves against any and all such claims, and we continue to believe that we
conduct our operations in compliance with law.
Qui tam suits are brought by private individuals, and there is no minimum
evidentiary or legal threshold for bringing such a suit. However, the Department
of Justice is legally required to investigate the allegations in these suits.
The subject matter of many such claims may relate both to our alleged actions
and alleged actions of an affiliated practice. Because the affiliated practices
are separate legal entities not controlled by us, such claims necessarily
involve a more complicated, higher cost defense, and may adversely impact the
relationship between us and the practices. If the individuals who file
complaints and/or the United States were to prevail in these claims against us,
and the magnitude of the alleged wrongdoing were determined to be significant,
the resulting judgment could have a material adverse financial and operational
effect on us including potential limitations in future participation in
governmental reimbursement programs. In addition, addressing complaints and
government investigations requires us to devote significant financial and other
resources to the process, regardless of the ultimate outcome of the claims.
We and our network physicians are defendants in a number of lawsuits
involving employment and other disputes and breach of contract claims. In
addition, we are involved from time to time in disputes with, and claims by, our
affiliated practices against us. Although we believe the allegations are
customary for the size and scope of our operations, adverse judgments,
individually or in the aggregate, could have a material adverse effect on us.
Forward-Looking Statements and Risk Factors
The following are or may contain forward-looking statements within the
meaning of the U.S. federal securities laws: (i) certain statements, including
possible or assumed future results of operations, contained in "Management's
Discussion and Analysis of Financial Condition and Results of Operations," (ii)
any statements contained herein regarding the prospects for our business or any
of our services; (iii) any statements preceded by, followed by or that include
the words "believes," "expects," "anticipates," "intends," "estimates," "plans"
or similar expressions; and (iv) other statements contained herein regarding
matters that are not historical facts.
Our business and results of operations are subject to risks and
uncertainties, many of which are beyond our ability to control or predict.
Because of these risks and uncertainties, actual results may differ materially
from those expressed or implied by forward-looking statements, and investors are
cautioned not to place undue reliance on such statements, which speak only as of
the date thereof.
In addition to the specific risk factors described below, important
factors that could cause actual results to differ materially include, but are
not limited to, our success in implementing our proposed service line structure
described herein, the degree to which practices currently managed by us convert
to the earnings model or the service line structure rather than terminate their
affiliation, our ability to attract and retain additional physicians and
practices under the service line structure, our ability to obtain financing,
government regulations and enforcement, reimbursement for health care services,
changes in cancer therapy or the manner in which cancer care is delivered, drug
utilization, our ability to create and maintain favorable relationships with
pharmaceutical companies and other suppliers, and the operations of affiliated
practices. Below is a more detailed discussion of certain of these risks and
uncertainties.
The cautionary statements contained or referred to herein should be
considered in connection with any written or oral forward-looking statements
that may be issued by us or persons acting on our behalf. We do not
11
undertake any obligation to release any revisions to or to update publicly any
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
In general, because our revenues depend upon the revenues of our
affiliated practices, any of the risks below that harm the economic performance
of the practices will, in turn, harm us.
Declining reimbursement for pharmaceutical products used by oncologists could
adversely affect us.
We cannot assure you that payments under state or federal government
programs will remain at levels comparable to present levels or will be
sufficient to cover the costs allocable to patients eligible for reimbursement
pursuant to these programs. We also cannot assure you that the services that we
provide and the facilities that we operate meet or will continue to meet the
requirements for participation in these programs.
There is a continued risk of declining reimbursement for pharmaceuticals
used by oncologists as a result of changes in reimbursement methodology.
Currently, Medicare and most Medicaid programs reimburse providers for oncology
drugs based on the Average Wholesale Price (AWP) of the drugs. AWP is determined
by third-party information services using data furnished by pharmaceutical
companies. During 2000, the U.S. Department of Health and Human Services
announced its intention to change the basis of AWP, which would have resulted in
substantially lowered reimbursement from federal government programs for
chemotherapy agents and other pharmaceutical agents used by oncologists, without
any adjustment in reimbursement for services and other costs related to
chemotherapy. This would have resulted in oncologists incurring losses for the
administration of many chemotherapy treatments. Although the federal government
later stated that reimbursement levels for pharmaceuticals used to treat cancer
would not be reduced at that time, the agency responsible for the Medicare
program announced its belief that there is still a need to modify its
reimbursement scheme for pharmaceuticals. As a result of congressional action,
the General Accounting Office and Centers for Medicaid and Medicare Services
(CMS) conducted a comprehensive study to develop a more accurate reimbursement
methodology for outpatient cancer therapy services. The study was completed and
published in September of 2001, and the agencies and Congress continue to
discuss appropriate changes in reimbursement in response to the study. It is not
possible to assess the likely outcome of any change in reimbursement for
oncology services, particularly reimbursement of pharmaceuticals, whether
through federal agency initiatives or through the calculation of AWP from
information supplied by pharmaceutical companies. It is possible that changes in
reimbursement that are ultimately adopted or implemented could have a material
adverse effect on our operations and financial condition, either directly in the
case of our affiliated practices, particularly those on the revenue model, or
indirectly in the case of service line customers as a result of decreased
financial performance of such customers.
If our affiliated practices terminate their agreements with us, we could be
seriously harmed.
Our practices may attempt to terminate their agreements with us. If any of
our larger practices were to succeed in such a termination, other than in
connection with a transition to the service line structure, we could be
seriously harmed. From time to time, we have disputes with physicians and
practices which could result in harmful changes to our relationship with them or
a termination of a service agreement if adversely determined. We are also aware
that some practices affiliated with other health care companies have attempted
to end or restructure their affiliations, although they do not have a
contractual right to do so, by arguing that their affiliations violate some
aspect of health care law. For example, some physicians have claimed that the
fee arrangements violate federal or state prohibitions on splitting fees with
physicians. If some of our network physicians or affiliated practices were able
to successfully make such arguments and terminate their affiliation with us,
there could be a materially adverse effect on us.
If a significant number of physicians leave our affiliated practices, we could
be seriously harmed.
Our affiliated practices usually enter into employment or non-competition
agreements with their physicians that provide some assurance to both the
practice and to us with respect to continuing revenues. We and our affiliated
practices try to maintain such contracts. However, if a significant number of
physicians terminate their relationships with our affiliated practices, we could
be seriously harmed.
12
Our affiliated practices may be unable to enforce non-competition provisions
with departed physicians.
Most of the employment agreements between the 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 non-competition covenants in the agreements. If
practices are unable to enforce the non-competition provisions of their
employment agreements, we could be seriously harmed.
Our repositioning is placing significant stress on our network and on our
relationships with physicians.
Our repositioning is placing significant stress on our network and on our
relationships with physicians. Conversions to the service line structure and the
net income model require that the physicians devote significant time and
resources to learning about and assessing the value of our new models. In
addition, physicians may be anxious about taking part in a new and untested
business model for us. To the extent we are not successful in developing new
relationships and maintaining our current relationships with physicians because
of these additional pressures, our business and results of operations could be
harmed.
We may encounter difficulties in managing our network of affiliated practices.
We do not control the practice of medicine by the physicians or their
compliance with regulatory and other requirements directly applicable to
practices. At the same time, an affiliated practice may have difficulty in
effectively influencing the practices of its individual physicians. In addition,
we have only limited control over the business decisions of the practices even
under the PPM model. As a result, it is difficult to implement standardized
practices across the network, and this could have an adverse effect on cost
controls, regulatory compliance, our profitability and the strength of our
network.
Continued review of pharmaceutical companies and their pricing and marketing
practices could result in lowered reimbursement for pharmaceuticals.
Continued review of pharmaceutical companies by government payors could
result in lowered reimbursement for pharmaceuticals, which could harm us. As
indicated above, the federal government is reconsidering the manner in which
health care providers, including oncologists, are reimbursed for the
pharmaceutical agents they use to treat patients. In addition, we are aware of
various investigations and lawsuits filed against manufacturers of oncology
drugs. These investigations relate to the manner in which those companies report
data used in determining AWP and to marketing and other practices. As a result
of these investigations, a number of pharmaceutical manufacturers have entered
into or are discussing settlements with the government that could result in
lower reimbursement. Furthermore, possibly in response to such scrutiny, some
pharmaceutical manufacturers could alter AWP and pricing to reduce the margin
between reported AWP and the sales price of some oncology drugs. Any such change
could have an adverse effect on oncologists, which in turn could adversely
affect us. Finally, as a group purchasing organization that is a significant
purchaser of pharmaceutical agents paid for by government programs, we and our
network of affiliated practices could become involved in these investigations or
lawsuits, or may become a target of such pharmaceutical-related scrutiny. Any of
these events could have a material adverse effect on us.
Our service fee arrangements with many of our affiliated practices subject us to
disproportionate economic risk.
Currently, each service agreement provides for payment to us of a service
fee plus reimbursement of all practice costs, and the economic arrangements in
our service agreements with affiliated practices fall into two principal
categories. Some of our agreements, known as the "earnings model" agreements,
provide that the service fee is a percentage of the practice's earnings before
income taxes. In others, known as "net revenue model" agreements, the fee
consists of a fixed fee, a percentage fee (in most states) of the practice's net
revenues and, if certain performance criteria are met, a performance fee. Where
the service agreement follows the net revenue model, the practice retains a
fixed portion of net revenue before any service fee (other than practice
operating costs) is paid to us. Under these net revenue agreements, therefore,
we disproportionately bear the economic impact of increasing or declining
margins. Our costs of operations have increased, primarily due to an increase in
expensive, single-source drugs and compensation and benefits, which has resulted
in a disproportionate decline in our operating margin, even as practice
profitability continues to grow. We are seeking to convert practices to the
earnings model
13
or the service line structure, which eliminates this disproportionate economic
risk. If we are not successful, then continuing to provide services under the
net revenue model agreements could have a material adverse effect on us.
Increased governmental regulation could adversely affect our operating results
or financial condition.
The health care industry is highly regulated and there can be no assurance
that the regulatory environment in which we operate will not change
significantly and adversely in the future. State and federal governments have
increasingly undertaken efforts to control growing health care costs through
legislation, regulation and voluntary agreements with medical care providers and
pharmaceutical companies. If future government cost containment efforts limit
the profits that can be derived on new drugs, then profit margins on
pharmaceutical products could decrease and clinical research spending on
pharmaceutical products may also decrease, which could decrease the business
opportunities available to us and affect our results of operations and financial
condition.
Our pharmaceutical segment is subject to the operating and security
standards of the Food and Drug Administration (the "FDA"), the United States
Drug Enforcement Administration, various state boards of pharmacy and comparable
agencies. Such standards affect the prescribing of pharmaceuticals (including
certain controlled substances), operating of pharmacies (including nuclear
pharmacies), and packaging of pharmaceuticals. Complying with those standards,
especially as they change from time to time, could be extremely costly for us
and could limit the manner in which we implement this segment.
The laws of many states prohibit unlicensed, non-physician-owned entities
or corporations (such as US Oncology) from performing medical services, or in
certain instances, prohibit physicians from splitting fees with non-physicians,
including US Oncology. We do not believe that we engage in the unlicensed
practice of medicine or the delivery of medical services in any state, and are
not licensed to practice medicine in states which permit such licensure. In many
jurisdictions, however, the laws restricting the corporate practice of medicine
and fee-splitting have been subject to limited judicial and regulatory
interpretation and, therefore, there is no assurance that upon review some of
our activities would not be found to be in violation of such laws. If such a
claim were successfully asserted against us, we could be subject to civil and
criminal penalties, the imposition of which could have a material adverse effect
on our operations, cash flows and financial condition.
In general, regulation and scrutiny of health care providers and related
companies are increasing. In addition, we may be adversely affected by aspects
of some other health care proposals, including cutbacks in Medicare and Medicaid
programs, containment of health care costs on an interim basis by means that
could include a freeze on rates paid to health care providers, greater
flexibility to the states in the administration of Medicaid, and developments in
federal and state health information requirements, including the standardization
of electronic transmission of some administrative and financial information.
The current regulatory environment in the health care industry continues to
negatively impact us.
Because of the complexity and uncertainty of the regulations that govern
companies and individuals in the health care sector, we expend significant
resources in our comprehensive compliance program. In addition, the government
is empowered to investigate all business activities of health care companies,
including lawful ones, and exerts considerable leverage in such investigations
as a result of the significant penalties that may apply in the event of any
violation of health care law. Furthermore, government programs often are
administered and enforced by multiple agencies and entities that may themselves
have differing interpretations of health care regulations, and enforcement
authorities have taken the position that complying with specific instructions of
such entities may not, by itself, be determinative of the lawfulness of any
actions. Because of these factors and the high cost of defending or addressing
any investigation or allegation regarding health care law violations, we must
from time to time forego business opportunities that we believe to be lawful, if
there is a possibility that such activities could be perceived or later
interpreted as inappropriate or unlawful or could invite government
investigation.
Loss of revenues or a decrease in income of our affiliated practices could
adversely affect our results of operations.
Our revenue currently depends on revenue generated by affiliated
practices. Loss of revenue by the practices could seriously harm us. It is
possible that our affiliated practices will not be able to maintain successful
medical practices. In addition, under our current service agreements and under
the outpatient cancer center
14
operations service line, the fees payable to us depend upon the profitability of
the practices. Even under those service agreements where the service fee is
based on the revenues of the practices, and not on their earnings, a priority of
payments provision mandates that we will be paid last. Any failure by the
practices to contain costs effectively will adversely impact our results of
operations in those areas. Because we do not control the manner in which our
practices conduct their medical practice (including drug utilization), our
ability to control costs related to the provision of medical care is limited.
Furthermore, the affiliated practices face competition from several sources,
including solo practitioners, single- and multi-specialty practices, hospitals
and managed care organizations. Although we are offering our affiliated
practices the option of converting to the service line structure, which would
eliminate our direct risk related to practice profitability with respect to
medical oncology, we have limited ability to discontinue or alter our service
arrangements with practices, even where continuing to manage such practices
under existing arrangements is economically detrimental to us.
Our business could be adversely affected if relations with any of our
significant pharmaceutical suppliers are terminated or modified.
Our ability to purchase pharmaceuticals, or to expand the scope of
pharmaceuticals purchased, from a particular supplier is largely dependent upon
such supplier's assessment of the value of our network. To the extent that our
transition to the service line structure causes pharmaceutical suppliers to
perceive our network as less valuable, our relationships with such suppliers
could be harmed. Our inability to purchase pharmaceuticals from any of our
significant suppliers could have a material adverse effect on our business,
results of operations and financial condition because many suppliers own
exclusive patent rights and are the sole manufacturers of certain
pharmaceuticals. If we were unable to purchase patented products from any such
supplier on favorable terms or at all, we could be required to purchase such
products from other distributors on less favorable terms, and our profit margin
on such products could be eliminated.
Our development of new cancer centers could be delayed or result in serious
liabilities, and the centers may not be profitable.
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 arise from
operating cancer centers. Any failure or delay in successfully building and
operating integrated cancer centers or in avoiding liabilities from operations
could seriously harm us. In addition, new cancer centers may incur significant
operating losses during their initial operations, which could materially
adversely affect our operating results, cash flows and financial condition.
We rely on the ability of our affiliated practices to grow and expand.
We rely on the ability of our affiliated practices to grow and expand. Our
affiliated practices may encounter difficulties attracting additional physicians
and expanding their operations. The failure of practices to expand their patient
base and increase revenues could harm us.
We operate in a highly competitive industry.
We may have existing competitors, as well as a number of potential new
competitors, that have greater name recognition and significantly greater
financial, technical and marketing resources than we do. This may permit our
competitors to devote greater resources than we can to the development and
promotion of their services. These competitors may also undertake more
far-reaching marketing campaigns, adopt more aggressive pricing policies and
make more attractive offers to existing and potential employees. In addition,
implementation of our service line structure will bring us into competition with
numerous additional competitors, including specialty pharmacy companies, medical
facilities operators and a variety of clinical research entities.
We also expect our competitors to develop strategic relationships with
providers, pharmaceutical companies and payors, which could result in increased
competition. The introduction of new and enhanced services, acquisitions,
industry consolidation and the development of strategic relationships by our
competitors could cause price competition, a decline in sales or a loss of
market acceptance of our services, or make our services less attractive. In
addition, in developing cancer centers, we compete with a number of tax-exempt
non-profit
15
organizations that can finance acquisitions and capital expenditures on a
tax-exempt basis or receive charitable contributions unavailable to us.
With respect to research activities, the contract research organization
industry is fragmented, with several hundred small limited-service providers and
several large full-service contract research organizations with global
operations. We compete against large contract research organizations that may
have access to more financial resources than we do.
We expect that industry forces will have an impact on us and our
competitors. In recent years, the health care industry has undergone significant
changes driven by various efforts to reduce costs, including national health
care reform, trends toward managed care, limits in Medicare coverage and
reimbursement levels, consolidation of health care services companies and
collective purchasing arrangements by office-based health care practitioners.
The changes in our industry have caused greater competition among us and similar
businesses. Our inability to predict accurately, or react competitively to,
changes in the health care industry could adversely affect our operating
results. We cannot assure you that we will be able to compete successfully
against current or future competitors or that competitive pressures will not
have a material adverse effect on our business, financial condition and results
of operations.
Our success depends on our ability to attract and retain highly qualified
technical staff and other key personnel, and we may not be able to hire enough
qualified personnel to meet our hiring needs.
Our ability to offer and maintain high quality service is dependent upon
our ability to attract and maintain arrangements with qualified professional and
technical staff, and with executives on our management team. There is a high
level of competition for such skilled personnel among other health care
providers, research and academic institutions, government entities and other
organizations. We cannot assure you that our contractual arrangements with such
staff can be maintained on terms advantageous to us. In addition, if one or more
members of our management team become unable or unwilling to continue in their
present positions, we could also be harmed.
Our failure to remain technologically competitive could adversely affect our
business.
Rapid technological advancements have been made in the radiation oncology
and diagnostic imaging industry. Although we believe that our equipment and
software can generally be upgraded as necessary, the development of new
technologies or refinements of existing technologies might make existing
equipment technologically obsolete. If such obsolescence were to occur, then we
may be compelled to incur significant costs to replace or modify the equipment,
which could have a material adverse effect on our financial condition, results
of operations and cash flow. In addition, some of our cancer centers compete
against local centers which may contain more advanced imaging or radiation
therapy equipment or provide additional technologies. Our performance is
dependent upon physician and patient confidence in the superiority of our
technology and equipment over those of our competitors.
Advances in other cancer treatment methods, such as chemotherapy, surgery
and immunotherapy, or in cancer prevention techniques, could reduce demand or
eliminate the need for the radiation therapy services provided at the cancer
centers we operate. The development and commercialization of new radiation
therapy technologies could have a material adverse effect on our business,
operating results and financial condition.
We may be unable to satisfy our additional financial needs.
Continuing to expand our lines of business in accordance with our business
growth plan and expected capital needs will require substantial capital
resources. Operation of the cancer centers will 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 wish to incur additional debt or issue additional debt or equity securities
from time to time. Capital available for health care companies, whether raised
through the issuance of debt or equity securities, has recently been quite
limited and may continue to be difficult to obtain. Consequently, we may be
unable to obtain sufficient financing on terms satisfactory to us or at all. If
additional funds are raised through the incurrence of debt, then we may become
subject to restrictions on our operations and finances.
16
Our working capital could be impacted by delays in reimbursement for services.
The health care industry is characterized by delays that typically range
from three to six months between when services are provided and when the
reimbursement or payment for these services is received. Under our existing
service agreements and the new cancer center operations service line, our
working capital is dependent on such collections. This makes working capital
management, including prompt and diligent billing and collection, an important
factor in our results of operations and liquidity in those areas. We cannot
assure you that trends in the industry will not further extend the collection
period and negatively impact our working capital.
We may be unsuccessful at negotiating contracts with third-party payors on
behalf of our practices, which could result in lower operating margins.
We are responsible for negotiating payor contracts on behalf of our
network physicians under the PPM model and will also be responsible for such
contracting activities for radiation oncologists and diagnostic radiologists
under the cancer center operations service line. Commercial payors, such as
managed care organizations and traditional indemnity insurers, are increasingly
requesting fee structures and other arrangements that require health care
providers to assume all or a portion of the financial risk of providing care.
The lowering of reimbursement rates, increasing review of bills for services and
negotiating for reduced contract rates could have a material adverse effect on
our results of operations and liquidity with respect to our existing service
agreements and cancer center operations under the service line structure.
Loss of revenue by our affiliated practices caused by the cost containment
efforts of third-party payors could harm us.
Physician practices typically bill third-party payors for the health care
services provided to their patients. Third-party payors such as private
insurance plans and commercial managed care plans negotiate the prices charged
for medical services and supplies in order to lower the cost of the health care
services and products they pay for, thus increasing their own profits.
Third-party payors also try to influence legislation to lower costs. Third-party
payors can also deny reimbursement for medical services and supplies by stating
that they believe a treatment was not appropriate, and these reimbursement
denials are difficult to appeal or reverse. 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. In addition, Medicare
reimbursement rates for services our network physicians provide (other than for
chemotherapy agents or lab services) declined effective April 1, 2002 as a
result of the application of a statutory formula designed to link growth in
government health care spending to growth in the economy generally. There is a
risk that other payors could reduce rates of reimbursement to match this
decline. Our management fees under the PPM model, as well as our operating fees
for cancer center operations under the service line structure, are dependent on
the financial performance of the practices and would be adversely affected by a
reduction in reimbursement. In addition, to the extent oncologists, as our
customers, are impacted adversely by reduced reimbursement levels, our business
could be harmed generally.
We face the risk of qui tam litigation relating to regulations governing billing
for medical services.
We are currently aware of various qui tam lawsuits in which we and/or our
subsidiaries or affiliated practices are named as defendants. Because qui tam
lawsuits are filed under seal, we could be named in other such suits of which we
are not aware. In addition, as the federal government intensifies its focus on
billing, reimbursement and other health care regulatory areas, private
individuals are also bringing more qui tam lawsuits because of the potential
financial rewards for such individuals. For the past several years, the number
of qui tam suits filed against health care companies and the aggregate amount of
recoveries under such suits have increased significantly. This trend increases
the risk that we may become subject to additional qui tam lawsuits.
Although we believe that our operations comply with law and intend to
vigorously defend ourselves against allegations of wrongdoing, the costs of
addressing such suits, as well as the amount of any recovery in the event of a
finding of wrongdoing on our part, could be significant. The existence of qui
tam litigation involving us may also strain our relationships with
pharmaceutical suppliers or our network physicians, particularly those
physicians or practices named in such suits. Furthermore, our involvement in
those qui tam lawsuits, and the uncertainty such suits create, may adversely
affect our ability to raise capital.
17
Our services could give rise to liability from clinical trial participants and
the parties with whom we contract.
In connection with clinical research programs, we provide several services
that are involved in bringing new drugs to market, which is time consuming and
expensive. Such clinical research involves the testing of new drugs on human
volunteers. The provision of medical services entails an inherent risk of
professional malpractice and other similar claims. If we do not perform our
services to contractual or regulatory standards, the clinical trial process and
the participants in such trials could be adversely affected. Clinical research
involves the inherent risk of liability for personal injury or death to patients
resulting from, among other things, unforeseen adverse side effects or improper
administration of the new drugs by physicians. In certain cases, these patients
are already seriously ill and are at risk of further illness or death. These
events would create a risk of liability to us from either the pharmaceutical
companies with which we contract or the study participants.
We also contract with physicians to serve as investigators in conducting
clinical trials. Third parties could possibly claim that we should be held
liable for losses arising from any professional malpractice of the investigators
with whom we contract or in the event of personal injury to or death of persons
for the medical care rendered by third-party investigators, and we would
vigorously defend any such claims. Nonetheless it is possible that we could be
held liable for such types of losses.
We could be subject to malpractice claims and other harmful lawsuits not fully
covered by insurance.
We could also be implicated in claims related to medical services provided
by our network physicians. We cannot assure you that claims, suits or complaints
relating to services delivered by a network physician will not be assessed
against us in the future. In addition, because network physicians prescribe and
dispense pharmaceuticals and we will maintain pharmacy operations, we and our
network physicians could be subject to product liability claims.
Although we maintain insurance believed to be adequate both as to risks
and amounts, there can be no assurance that any claim asserted against us for
professional or other liability will be covered by, or will not exceed the
coverage limits of, such insurance. The availability and cost of professional
liability insurance varies widely from state to state and is affected by various
factors, many of which are beyond our control. There can be no assurance that we
will be able to maintain insurance in the future at a cost that is acceptable to
us, or at all. Therefore, successful malpractice, regulatory or product
liability claims asserted against us that are not fully covered by insurance
could have a material adverse effect on our operating results. During February
2002, PHICO Insurance Company, which had been our and our affiliated practices'
primary malpractice insurer, was placed in liquidation. Although state guaranty
associations provide some coverage for insured claims in the event of insurer
insolvency, if we or our affiliated practices are unable to receive sufficient
coverage as a result of the insolvency, we could be harmed.
Proposed and final confidentiality laws and regulations may create a risk of
liability, increase the cost of our business or limit our service offerings.
The confidentiality of patient-specific information and the circumstances
under which such records may be released for inclusion in our databases or used
in other aspects of our business are subject to substantial governmental
regulation. Legislation governing the possession, use and dissemination of
medical information and other personal health information has been proposed or
adopted at both the federal and state levels. Such regulations may require us to
implement new security measures, which may require substantial expenditures or
limit our ability to offer some of our products or services, thereby negatively
impacting the business opportunities available to us. A risk of civil or
criminal liability exists if we are found to be responsible for any violation of
applicable laws, regulations or duties relating to the use, privacy or security
of health information.
On December 28, 2000, the Secretary of the Department of Health and Human
Services issued the final rule on Standards for Privacy of Individually
Identifiable Health Information to implement the privacy requirements for the
Health Insurance Portability and Accountability Act of 1996. These regulations
generally impose standards for covered entities transmitting or maintaining
protected data in an electronic, paper or oral form with respect to the rights
of individuals who are the subject of protected health information. They also
establish limitations on and procedures for the exercise of those individuals'
rights and the uses and disclosures of protected health information. Such
regulations could inhibit third-party processors in using, transmitting or
disclosing health data (even if the data
18
has been de-identified) for purposes other than facilitating payment or
performing other clearinghouse functions, which would restrict our ability to
obtain and use data in our services. In addition, these regulations could
require us to establish uniform specifications for obtaining de-identified data
so that de-identified data obtained from different sources could be aggregated.
While the impact of developments in legislation, regulations or the demands of
third-party processors is difficult to predict, each could materially adversely
affect our business.
If we cannot effectively market and implement the service line structure, it
would materially and adversely affect our business and results of operations.
Because the service line structure is an untested business model, we
cannot assure you that it will attain broad market acceptance or that we will be
able to effectively market it to, and implement it for, new practices outside of
our existing network on terms acceptable to us or at all. We will incur
significant costs to attract and negotiate such arrangements and to develop our
infrastructure in advance of revenues being produced by such arrangements.
Delays or failures to effectively market the service lines to new practices and
implement service line operations with them could harm us. In addition,
non-competition covenants in our existing service agreements with practices may
limit our ability to offer the service line structure to other practices within
markets that we already serve.
Under the service line structure, we anticipate a decline in operating cash
flow, which could harm us.
If practices currently managed by us terminate their existing service
agreements with us and we instead provide services to them under the service
line structure, we expect to generate less operating cash flow than we currently
do with respect to most such practices. Such reduction in cash flow could
materially adversely affect us and our results of operations.
Each conversion of an affiliated practice to the service line structure
could represent a significant reduction in our cash flow. In addition,
conversions to the earnings model may adversely impact cash flow. We cannot be
sure how many practices will convert and the timing of such conversions.
Although we have some control over the timing, we cannot assure you when these
conversions will occur. As a result, during the transition, our cash flow may be
subject to unpredictable fluctuations.
The nature of our receivables will change with respect to the oncology
pharmaceutical management service line.
Currently, our accounts receivable consist principally of payments that we
bill and collect from third party payors on behalf of our affiliated practices.
Under the pharmaceutical management service line, we will instead bill and
collect payments from the practices. We have no experience in billing and
collecting from affiliated practices. The practices will have responsibility for
billing and collecting from third party payors with respect to the drugs. If we
are not successful in billing and collecting from affiliated practices or if
such practices are not successful in managing their billing and collections from
third-party payors, we may have decreased cash flow from pharmaceutical sales.
Under the service line structure, our agreements with affiliated practices will
have shorter terms than our existing agreements, and we will have less input
with respect to the business operations of the practices.
Currently, we provide management services to practices under long-term
agreements that generally have 40-year terms and that are not terminable except
under specified circumstances. These agreements allow us to be the exclusive
provider of management services, including each of the services contemplated
under the service line structure, to each of the practices. In addition, under
those agreements, the practices are required to bind their physicians to
specified employment terms and restrictive covenants. Under the service line
structure, our agreements with affiliated practices will have shorter terms,
between five to fifteen years, and may be terminable in the event of certain
performance deficiencies based on market standards. A number of the other input
mechanisms that we currently have with respect to affiliated practices will also
be eliminated. This loss of input may increase the extent to which affiliated
practices may change their internal composition to our detriment and may result
in arrangements that are easier for individual physicians and practices to exit,
exposing us to increased competition from other firms, especially in the
pharmacy management sector. Departure of a significant number of physicians or
practices from participation in our service line structure could harm us.
19
If we are not successful in transitioning our existing affiliated practices that
wish to move to the new service line structure, our business and results of
operations could be harmed.
As part of the implementation of the service line structure, we intend to
offer to our existing affiliated practices the ability to terminate their
existing service agreements, purchase their medical oncology operating assets
from us, and adopt the service line structure. While we believe that the service
line structure will be attractive to our existing network and that the
transition will be desirable, we do not have the unilateral right to cause the
termination of existing service agreements and the related transition to our
service line structure. We intend to continue to manage practices that do not
wish to adopt the service line structure, which will prevent us from realizing
certain of the operating efficiencies that could be gained from a complete
transition to the service line structure. Transitioning those affiliated
practices that wish to adopt the service line structure also entails significant
implementation and execution risk, including returning to the affiliated
practices certain operating functions such as information technology, employee
benefits, insurance and other local management functions. A failure to
successfully implement this transition may create significant management
distractions and otherwise limit the success of the service line structure. For
these reasons, failure to successfully transition currently affiliated practices
that wish to move to the service line structure could harm us.
In order to adopt the service line structure, our existing affiliated
practices will require substantial capital resources. Although we are attempting
to facilitate the financing by negotiating with a single source for all
practices that wish to transition, there is no assurance that the practices will
be successful in implementing new financing arrangements. Failure of the
practices to obtain financing would adversely affect our ability to transition
to the service line structure and could materially and adversely affect our
business and results of operations.
The process of negotiating with existing affiliated practices that want to
move to the service line as to the termination of service agreements and the
signing of new agreements could take longer than anticipated. In addition, we
could face unanticipated difficulties in transitioning the practices, including
system conversion problems, lawsuits and other logistical hurdles, and also be
subject to duplicative costs during the transition process.
Under the service line structure, we will significantly increase our ownership
and operation of licensed pharmacies, which will subject us to various new state
and federal regulations.
Our pharmaceutical segment is subject to the laws and regulations of the
Food and Drug Administration (the "FDA"), the United States Drug Enforcement
Administration, various state boards of pharmacy and comparable agencies. Such
laws, regulations and regulatory interpretations affect the prescribing of
pharmaceuticals, purchasing, storing and dispensing of controlled substances,
operating of pharmacies (including nuclear pharmacies), and packaging of
pharmaceuticals. Violations of any of these laws and regulations could result in
various penalties, including suspension or revocation of our licenses or
registrations or monetary fees. As a health care provider, we will, under the
service line structure, subject our affiliated physicians to the federal "Stark
Self-Referral Laws," which prohibit a referral to an entity in which the
physician or the physician's family member has an ownership interest or
compensation relationship if the referral is for any of a list of "designated
health services." Further, while the PPM model currently subjects us to scrutiny
under the federal Medicare and Medicaid anti-kickback law, that provides
criminal penalties for individuals or entities participating in the Medicare or
Medicaid programs that knowingly and willfully offer, pay, solicit or receive
remuneration in order to induce referrals for items or services reimbursed under
such programs, the law will apply to the service line structure in additional
ways as a result of our becoming a pharmacy provider. Complying with those
standards, especially as they change from time to time, could be extremely
costly for us and could limit the manner in which we implement the service line
structure. In addition, we cannot assure you that we will be successful in
obtaining all necessary pharmaceutical licenses in a timely manner or at all.
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 our 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:
20
. Our quarterly operating results,
. Deviations in results of operations from estimates of securities
analysts (which estimates we neither endorse nor accept the
responsibility for),
. General economic conditions or economic conditions specific to the
health care services industry,
. Regulatory or reimbursement changes and
. Other developments affecting us, our competitors, vendors such as
pharmaceutical companies or others in the health care industry.
On occasion, the equity markets 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.
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.
We have 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. We are currently precluded
from paying dividends by the terms of our credit facilities.
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 a third party. We have 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.
Our 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. Furthermore, our 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. We have also adopted a shareholder
rights plan, which would significantly inhibit the ability of another entity to
acquire control of US Oncology through a tender offer or otherwise without the
approval of our board of directors. These provisions could discourage potential
acquisition proposals and could delay or prevent a change in control. These
provisions are intended to increase the likelihood of continuity and stability
in our board of directors and in the policies formulated by it and to discourage
certain types of transactions that may involve an actual or threatened change of
control, 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 our shares that could result from actual or rumored takeover
attempts. In addition, these provisions could limit the price that certain
investors might be willing to pay in the future for shares of common stock. Such
provisions also may have the effect of preventing changes in our management.
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 2001.
21
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our 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, 2000 High Low
---- ---
Fiscal Quarter Ended March 31, 2000 $ 6.81 $ 3.81
Fiscal Quarter Ended June 30, 2000 $ 5.47 $ 3.25
Fiscal Quarter Ended September 30, 2000 $ 5.59 $ 3.88
Fiscal Quarter Ended December 31, 2000 $ 7.00 $ 4.14
Year Ended December 31, 2001 High Low
---- ---
Fiscal Quarter Ended March 31, 2001 $10.94 $ 6.27
Fiscal Quarter Ended June 30, 2001 $ 9.24 $ 7.47
Fiscal Quarter Ended September 30, 2001 $ 8.97 $ 6.55
Fiscal Quarter Ended December 31, 2001 $ 8.04 $ 3.95
As of March 21, 2002, there were approximately 15,500 holders of the
common stock. We have not declared or paid any cash dividends on our common
stock. The payment of cash dividends in the future will depend on our earnings,
financial condition, capital needs and other factors deemed pertinent by our
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 our board of directors to retain earnings to finance the operations
and expansion of business. Our 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."
22
Recent Sales of Unregistered Securities
Under the PPM model, in connection with each affiliation transaction
between a practice and us, we purchased the nonmedical assets of, and entered
into a long-term service agreement with, that practice. In consideration for
that arrangement, we typically paid cash, issued 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
agreed 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 us in connection with
affiliation transactions of its securities during 2001. Each sale was a private
placement made in connection with a transaction, described in general in the
preceding paragraph, to affiliated physicians, 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)
January 2001 3 31,206 $ 330,000
February 2001 1 12,223 277,000
March 2001 2 6,165 538,000
July 2001 1 8,899 102,000
September 2001 1 28,016 541,000
- ----------
/1/ In connection with each affiliation transaction, we unconditionally agree
to deliver shares of common stock at specified future dates (typically on
each of the second through fifth anniversaries of the closing date).
23
Item 6. Selected Financial Data
The selected consolidated financial information 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,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(in thousands, except per share data)
Statement of Operations Data:
Revenue ............................................. $ 1,505,024 $ 1,324,154 $ 1,092,941 $ 836,596 $ 625,413
Operating expenses:
Pharmaceuticals and supplies ................... 780,072 651,214 521,087 357,766 250,425
Field compensation and benefits ................ 322,473 277,962 215,402 172,298 143,210
Other field costs .............................. 179,479 161,510 134,635 107,671 87,232
General and administrative ..................... 47,988 54,723 39,490 38,325 31,809
Bad debt expense ............................... -- 10,198 -- -- 37,841
Impairment, restructuring and other charges .... 5,868 201,846 29,014 -- --
Depreciation and amortization .................. 71,929 75,148 65,072 48,463 35,194
----------- ----------- ----------- ----------- ---------
1,407,809 1,432,601 1,004,700 724,523 585,711
----------- ----------- ----------- ----------- ---------
Income (loss) from operations ....................... 97,215 (108,447) 88,241 112,073 39,702
Interest income (expense), net ...................... (22,511) (26,809) (22,288) (15,908) (12,474)
Gain on investment in common stock
(unrealized in 1999) ............................. -- 27,566 14,431 -- --
----------- ----------- ----------- ----------- ---------
Income (loss) before income taxes ................... 74,704 (107,690) 80,384 96,165 27,228
Income tax provision (benefit) ...................... 28,388 (35,047) 32,229 36,184 11,593
----------- ----------- ----------- ----------- ---------
Net income (loss) ................................... $ 46,316 $ (72,643) $ 48,155 $ 59,981 $ 15,635
=========== =========== =========== =========== =========
Net income (loss) per share - basic ................. $ 0.46 $ (0.72) $ 0.48 $ 0.61 $ 0.17
Shares used in per share computation - basic ........ 100,063 100,589 100,183 97,647 93,168
Net income (loss) per share - diluted ............... $ 0.46 $ (0.72) $ 0.47 $ 0.60 $ 0.16
Shares used in per share computations - diluted ..... 100,319 100,589 101,635 99,995 97,198
December 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(in thousands)
Balance Sheet Data:
Working capital .............................. $ 110,741 $ 194,484 $ 280,793 $ 178,262 $ 121,221
Service agreements, net ...................... 379,249 398,397 537,130 467,214 431,068
Total assets ................................. 1,092,962 1,197,467 1,298,477 1,033,528 883,430
Long-term debt, excluding current maturities . 128,826 300,213 360,191 234,474 189,377
Stockholders' equity ......................... 676,768 624,338 707,164 629,798 554,298
24
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation
Introduction
The following discussion should be read in conjunction with the financial
statements, related notes and other financial information appearing elsewhere in
this report. In addition, see "Forward-Looking Statements and Risk Factors."
General
We provide comprehensive services in the oncology field, with the mission
of expanding access to and improving the quality of cancer care in local
communities and advancing the delivery of care. We offer the following services:
. Purchase and manage the inventory of cancer related drugs for
affiliated practices. Annually, we are responsible for purchasing,
delivering and managing more than $700 million of pharmaceuticals
through a network of more than 400 admixture sites, 31 licensed
pharmacies, 51 pharmacists and 180 pharmacy technicians.
. Construct and manage free standing cancer centers that provide
treatment areas and equipment for medical oncology, radiation
therapy and diagnostic radiology. We operate 77 integrated
community-based cancer centers and manage over one million square
feet of medical office space.
. Expand diagnostic capabilities of practices through installation and
management of PET technology, typically in a cancer center setting.
We have installed and continue to manage 12 PET units, as well as 59
Computerized Axial Tomography (CT) units.
. Coordinate and manage cancer drug research trials for pharmaceutical
and biotechnology companies. We currently manage 98 clinical trials,
with accruals of more than 3,500 patients during 2001, supported by
our network of over 650 participating physicians in more than 330
research locations.
Our network provides these services to oncology practices comprising over
450 sites, with over 8,000 employees and 868 physicians. We are not a provider
of medical services, but we provide comprehensive services to oncology
practices, including management and capital resources, data management,
accounting, compliance and other administrative services. The affiliated
practices offer comprehensive and coordinated medical services to cancer
patients, integrating the specialties of medical and gynecologic oncology,
hematology, radiation oncology, diagnostic radiology, and blood and marrow stem
cell transportation.
Our revenue consists primarily of service fees paid by the oncology
practices. We and our affiliated practices have entered into long-term
agreements under which we provide services, and the practices pay a fee and
reimburse us for all practice costs. Under some agreements, the fees are based
on practice earnings before income taxes (known as the "earnings model"). In
others, the fee consists of a fixed fee, a percentage fee (in most states) of
the practice's net revenues and, if certain performance criteria are met, a
performance fee (known as the "net revenue model"). Where our service agreements
follow the net revenue model, the practice is entitled to retain a fixed portion
of net revenue before any service fee (other than practice operating costs) is
paid to us.
Conversion to Earnings Model
We believe that the earnings model properly aligns practice priorities
with respect to appropriate business operations and cost control, with us and
the practice sharing proportionately in practice profitability, while the net
revenue model results in us disproportionately bearing the impact of increases
or declines in operating margins. For this reason, we have, during 2001, been
negotiating with practices under the net revenue model to convert to the
earnings model. Since the beginning of 2001 and through March 11, 2002, fourteen
practices accounting for 21.7% of our affiliated practices' total net patient
revenue in 2001 have converted to the earnings model. In addition, we continue
to sever our non-strategic practice relationships. During 2001, we negotiated
separations with four such
25
practices comprising 21 physicians and accounting for 3.5% of 2000 net patient
revenue. 60% of our revenue in 2001 is attributable to practices on the earnings
model as of December 31, 2001.
Implementation of Service Line Structure
On October 1, 2001, we commenced a strategy to focus our operations on
three core service lines: oncology pharmaceutical management, outpatient cancer
center operations, and cancer research and development services. We have begun
marketing these core services outside our network through a non-PPM (physician
practice management) model. All of our affiliated practices are being afforded
the opportunity to terminate their existing service agreements and enter into
new arrangements under the service line structure. We cannot assure you as to
how many practices will take this opportunity, and we currently expect that a
large percentage of existing affil