-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AJiY3GVO++466GTACMjneTvy1sl63pacu3ziS23OJL1mgJyZv+hAXMnJFBzB8QTd 7AEM2e6vcbneEXEzVX80pA== 0000950144-00-004312.txt : 20000331 0000950144-00-004312.hdr.sgml : 20000331 ACCESSION NUMBER: 0000950144-00-004312 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: RESPONSE ONCOLOGY INC CENTRAL INDEX KEY: 0000763098 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SPECIALTY OUTPATIENT FACILITIES, NEC [8093] IRS NUMBER: 621212264 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-09922 FILM NUMBER: 588909 BUSINESS ADDRESS: STREET 1: 1775 MORIAH WOODS BLVD CITY: MEMPHIS STATE: TN ZIP: 38117 BUSINESS PHONE: 9017617000 MAIL ADDRESS: STREET 1: 1775 MORIAH WOODS BLVD CITY: MEMPHIS STATE: TN ZIP: 38117 FORMER COMPANY: FORMER CONFORMED NAME: RESPONSE TECHNOLOGIES INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: BIOTHERAPEUTICS INC DATE OF NAME CHANGE: 19891221 10-K405 1 RESPONSE ONCOLOGY, INC. 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10 - K (Mark One) [X] Annual Report Pursuant to Section 13 or 15(d) of Securities Exchange Act of 1934 for the fiscal year ended December 31, 1999 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period: ---------------------- Commission File Number: ------------------------ RESPONSE ONCOLOGY, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) TENNESSEE 62-1212264 ----------------------- ------------------------ (State of incorporation) (I.R.S. Employer ID No.) 1805 MORIAH WOODS BLVD., MEMPHIS, TN 38117 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (901) 761-7000 Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class On Which Registered - ------------------- --------------------- Common Stock, par value $.01 per share...................Nasdaq National Market Securities registered pursuant to Section 12(g) of the Act: NONE ---- Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months 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. [X] As of March 9, 2000, 12,290,406 shares of Common Stock of Response Oncology, Inc. were outstanding and the aggregate market value of such Common Stock held by non-affiliates was $27,512,918 based on the closing sale price of $2.563 as of that date. Portions of registrant's Proxy Statement for use in connection with the Annual Meeting of Shareholders to be held on June 13, 2000 are incorporated by reference into Part III of this report, to the extent set forth therein, if such Proxy Statement is filed with the Securities and Exchange Commission on or before May 1, 2000. If such Proxy Statement is not filed by such date, the information required to be presented in Part III will be filed as an amendment to this report under cover of a Form 8. The exhibits for this Form 10-K are listed on Page 16. 1 2 PART I ITEM 1. BUSINESS THE COMPANY Response Oncology, Inc. (the "Company") is a comprehensive cancer management company. The Company provides advanced cancer treatment services through outpatient facilities known as IMPACT(R) Centers under the direction of practicing oncologists; owns the assets of and manages the nonmedical aspects of oncology practices; and conducts outcomes research on behalf of pharmaceutical manufacturers. Approximately 300 medical oncologists are associated with the Company through these programs. IMPACT SERVICES The Company presently operates 39 IMPACT Centers in 20 states and the District of Columbia which provide high dose chemotherapy with stem cell support to cancer patients on an outpatient basis. Through its IMPACT Centers, the Company has developed extensive medical information systems and databases containing clinical and patient information, analysis of treatment results and side effects and clinical care pathways. These systems and databases support the Company's clinical trials program, which involves carefully planned, uniform treatment regimens administered to a significant group of patients together with the monitoring of outcomes and side effects of these treatments. The clinical trials program allows the Company to develop a rational means of improving future treatment regimens by predicting which patients are most likely to benefit from different treatments. Each IMPACT Center is staffed by, and makes extensive use of, experienced oncology nurses, pharmacists, laboratory technologists, and other support personnel to deliver outpatient services under the direction of independent medical oncologists. IMPACT Center services include preparation and collection of stem cells, administration of high dose chemotherapy, reinfusion of stem cells and delivery of broad-based supportive care. IMPACT Center personnel extend the support mechanism into the patient's home, further reducing the dependence on hospitalization. The advantages of this system to the physician and patient include (i) convenience of the local treatment facility; (ii) specialized on-site laboratory and pharmacy services, including home pharmacy support; (iii) access to the Company's clinical trials program to provide ongoing evaluation of current cancer treatment; (iv) specially trained medical and technical staff; (v) patient education and support materials through computer, video and staff consultation; and (vi) reimbursement assistance. High dose chemotherapy is most appropriate for patients with lymphoma, acute leukemia, multiple myeloma and breast and ovarian cancer. Patients referred to the Company by the treating oncologists are placed on a treatment protocol developed from the cumulative analysis of the Company's approximately 4,000 high dose cases. Cases conducted at the IMPACT Center begin with a drug regimen which allows for the collection and cryopreservation of stem cells. A stem cell is a cell which originates in the bone marrow and is a precursor to white blood cells. At the appropriate time, stem cells capable of restoring immune system and bone marrow functions are harvested over a two to three day period. The harvested stem cells are then frozen and stored at the IMPACT Center, and following confirmation of response to treatment and a satisfactory stem cell harvest, patients receive high dose chemotherapy followed by reinfusion of stem cells. Most patients are then admitted to an affiliated hospital for approximately 8-12 days. After discharge, the patient is monitored in the oncologist's office. The Company believes that the proprietary databases and the information gathering techniques developed from the foregoing programs enable practicing oncologists to cost effectively manage cancer cases while ensuring quality. Clinical research conducted by the Company focuses on (i) improving cancer survival rates; (ii) enhancing the cancer patient's quality of life; (iii) reducing the costs of cancer care; and (iv) developing new approaches to cancer diagnosis, treatment and post-treatment monitoring. In May of 1999, the results of certain breast cancer studies were released at the meeting of the American Society of Clinical Oncology. These studies, involving the use of high dose chemotherapy, sparked controversy among oncologists, and, in the aggregate, caused confusion among patients and physicians about the role of high dose chemotherapy in the treatment of breast cancer. Since the release of these data, the Company's high dose business has slowed, as evidenced by the number of procedures in the six months ended December 31, 1999 at 365, as compared with 622 in the six months ended December 31, 1998. High dose procedures decreased 28% in 1999 as compared to 1998. In addition, the Company closed 12 marginal IMPACT Centers due to decreased patient volumes in 1999. Without further negative clinical data regarding the use of high dose chemotherapy for the treatment of breast cancer, the Company believes that procedure levels will stabilize. However, there can be no assurance that further erosion will not occur in this line of business beyond 1999. The Company anticipates that maturity of existing breast cancer data along with the release of new data will clarify the role of high dose therapies for breast cancer. While the past focus has been 2 3 weighted toward advanced breast cancer, the Company is evaluating new diseases that could potentially be managed through the IMPACT Center network. The Company also provides pharmacy management services for certain medical oncology practices through its IMPACT Center pharmacies. These services include compounding and dispensing pharmaceuticals for a fixed or cost plus fee. ONCOLOGY PRACTICE MANAGEMENT SERVICES During 1996, the Company adopted a strategy of diversification into physician practice management and ultimately consummated affiliations with 12 medical oncology practices, including 43 medical oncologists in Florida and Tennessee. Through these affiliations, the Company believes that it has successfully achieved deep geographic penetration in those markets, believing that significant market share is crucial to achieving efficiencies, revenue enhancements, and marketing of complete cancer services to diverse payors including managed care. Pursuant to management service agreements ("Service Agreements"), the Company provides management services that extend to all nonmedical aspects of the operations of the affiliated practices. The Service Agreements name the Company as the sole and exclusive manager and administrator of all day-to-day business functions connected with the medical practice of an affiliated physician group. The Company is responsible for providing facilities, equipment, supplies, support personnel, and management and financial advisory services. Under the terms of the Service Agreements, the Company (among other things): (i) prepares annual capital and operating budgets; (ii) prepares financial statements; (iii) orders and purchases medical and office inventory and supplies; (iv) bills patients and third party payors as agent for the affiliated practices; (v) maintains accounting, billing, medical, and collection records; (vi) negotiates and administers managed care contracts as agent for affiliated physicians; (vii) arranges for legal and accounting services related to practice operations; (viii) recruits, hires and appoints an executive director to manage and administer all of the day-to-day business functions of each practice; and (ix) manages all non-physician professional support, administrative, clerical, secretarial, bookkeeping and billing personnel. The Company seeks to combine the purchasing power of numerous physicians to obtain favorable pricing and terms for equipment, pharmaceuticals and supplies. In return for its management services, the Company receives a service fee, depending on Service Agreement form, based on net revenue or net operating income of the practice. Pursuant to each Service Agreement, the physicians and the practice agree not to compete with the Company and the practice. Each Service Agreement has an initial term of 40 years and, after the initial term, will be automatically extended for additional five year terms unless either party delivers written notice to the other party 180 days prior to the expiration of the preceding term. The Service Agreement only provides for termination "for cause." If the Company terminates the Service Agreement for cause, the practice is typically obligated to purchase assets (which typically include intangible assets) and pay liquidated damages, which obligations are wholly or partially guaranteed by individual physician owners of the practice for a period of time. Each Service Agreement provides for the creation of an oversight committee, a majority of the members of which are designated by the practice. The oversight committee is responsible for developing management and administrative policies for the overall operation of each practice. In February 1999 and March 1999, respectively, the Company announced that it had terminated its Service Agreements with Knoxville Hematology Oncology Associates, PLLC, and Southeast Florida Hematology Oncology Group, P.A., two of the Company's three underperforming net revenue model relationships. Since these were not "for cause" terminations initiated by the Company, the affiliated practices were not responsible for liquidated damages. In 1998, the Company recorded an impairment charge related to the three Service Agreements in accordance with Financial Accounting Standards Board Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of" ("SFAS No. 121"). The structure of these contracts has failed over time to align the physician and Company incentives, producing deteriorating returns and/or negative cash flows to the Company. The Company currently has no plans to terminate the Service Agreement with the third physician group. In the fourth quarter of 1999, the Company terminated its Service Agreement with one single-physician practice in Florida. This termination was initiated on a "for cause" basis and the Company is seeking recovery of liquidated damages. During the same period, the Company began negotiations to terminate another Service Agreement with a single-physician practice. Since this is not a "for cause" termination initiated by the Company, the affiliated practice is not responsible for liquidated damages. The Company experienced deteriorating returns on this particular Service Agreement and concluded that continuing the relationship was not economically feasible. At December 31, 1999, the Company has recorded an impairment charge related to the Service Agreements and associated assets in accordance with Financial Accounting Standards Board Statement No. 5 "Accounting for Contingencies". The Company anticipates that the second Service Agreement will be terminated in the second quarter of 2000. 3 4 CANCER RESEARCH SERVICES Since 1989, the Company has conducted a clinical trials program pursuant to which carefully planned, uniform treatments administered to a substantial number of IMPACT Center patients have been monitored and studied, with the results being collected in a database and utilized to predict outcomes and determine utilization of high dose chemotherapy as a treatment. In addition, the Company has recorded outcomes from over 4,000 cases in which high dose chemotherapy was utilized as a treatment and has developed and continues to refine treatment pathways, which forecast the best outcome with the lowest possible cost. Pursuant to agreements between the Company and the oncologists who supervise their patients' treatment in IMPACT Centers, such oncologists are obligated to record and monitor outcomes, collect information and report such information to the Company. The Company also utilizes its outcomes database to provide various types of data to pharmaceutical companies regarding the use of their products. The IMPACT Center network and the Company's medical information systems make the Company favorably suited to this process. The Company is currently participating in several projects with leading pharmaceutical manufacturers to furnish data in connection with FDA applications and post-FDA approval marketing studies. Revenue from these contracts helps to underwrite the Company's clinical trials expenses. Such relationships with pharmaceutical companies allow patients and physicians earlier access to drugs and therapies which enhances the Company's role as a leader in oncological developments. Certain financial information relating to each of the Company's reportable segments is included in Note K of the Company's consolidated financial statements. COMPETITION As a result of growing interest among oncologists and the more widely recognized efficacy of high dose chemotherapy treatments, the competitive environment in the field has heightened. Most community hospitals with a commitment to cancer treatment are evaluating their need to provide high dose treatments, and other entities are competing with the Company in providing high dose services similar to those offered by the Company. Such competition has long been contemplated by the Company, and is indicative of the evolution of this field. While the Company believes that the demand for high dose chemotherapy services is sufficiently large to support several significant providers of these services, the Company is subject to increasing competitive risks from these entities. In addition, the Company is aware of at least two competitors specializing in the management of oncology practices and two other physician management companies that manage at least one oncology practice. Several health care companies with established operating histories and significantly greater resources than the Company are also providing at least some management services to oncologists. There are certain other companies, including hospitals, large group practices, and outpatient care centers, that are expanding their presence in the oncology market and may have access to greater resources than the Company. Furthermore, organizations specializing in home and ambulatory infusion care, radiation therapy, and group practice management compete in the oncology market. The Company's profitability depends in significant part on the continued success of its affiliated physician groups. These physician groups face competition from several sources, including sole practitioners, single and multi-specialty groups, hospitals and managed care organizations. GOVERNMENT REGULATION The delivery of healthcare items and services has become one of the most highly regulated of professional and business endeavors in the United States. Both the federal government and individual state governments are responsible for overseeing the activities of individuals and businesses engaged in the delivery of healthcare services. Federal regulation of the healthcare industry is based primarily upon the Medicare and Medicaid programs, each of which is financed, at least in part, with federal funds. State jurisdiction is based upon the state's authority to license certain categories of healthcare professionals and providers, and the state's interest in regulating the quality of healthcare in the state, regardless of the source of payment and the state's level of participation in and funding of its Medicaid program. The Company believes it is in material compliance with applicable healthcare laws. During 1999, the Company adopted a formal compliance program and is currently in the initial stages of implementation. However, the laws and regulations applicable to the Company are subject to significant change and evolving interpretations and, therefore, there can be no assurance that a review of the Company's 4 5 or the affiliated physicians' practices by a court or law enforcement or regulatory authority will not result in a determination that could materially adversely affect the operations of the Company or the affiliated physicians. Furthermore, there can be no assurance that the laws applicable to the Company will not be amended in a manner that could adversely affect the Company, its permissible activities, the relative costs associated with doing business, and the amount of reimbursement by government and other third-party payors. FEDERAL LAW The federal healthcare laws apply in any case in which the Company is providing an item or service that is reimbursable under Medicare, Medicaid or other federally-funded programs ("Federal Reimbursement Programs") or is claiming reimbursement from Federal Reimbursement Programs on behalf of physicians with whom the Company has a Service Agreement. The principal federal laws include those that prohibit the filing of false or improper claims with the Federal Reimbursement Programs, those that prohibit unlawful inducements for the referral of business reimbursable under Federal Reimbursement Programs and those that prohibit the provision of certain services by a provider to a patient if the patient was referred by a physician with whom the provider has certain types of financial relationships. FALSE AND OTHER IMPROPER CLAIMS The federal government is authorized to impose criminal, civil and administrative penalties on any person or entity that files a false claim for reimbursement from Federal Reimbursement Programs. Criminal penalties are also available in the case of claims filed with private insurers if the government can show that the claims constitute mail fraud or wire fraud or violate state false claims prohibitions. While the criminal statutes are generally reserved for instances involving fraudulent intent, the civil and administrative penalty statutes are being applied by the government in an increasingly broader range of circumstances. By way of example, the federal government recently has brought suits which maintain that a pattern of claiming reimbursement for unnecessary services where the claimant should have known that the services were unnecessary and that claiming reimbursement for substandard services where the claimant knows the care was substandard are actionable claims. In addition, at least one federal appellate court has affirmed a finding of liability under the false claims statutes based upon reckless disregard of the factual basis of claims submitted, falling short of actual knowledge. Severe sanctions under these statutes, including exclusion from Federal Reimbursement programs, have been levied even in situations not resulting in criminal convictions. The Company believes that its billing activities on behalf of affiliated practices through Service Agreements are in material compliance with such laws, but there can be no assurance that the Company's activities will not be challenged or scrutinized by governmental authorities. A determination that the Company or any affiliated practice has violated such laws could have a material adverse effect on the Company. ANTI-KICKBACK LAW Federal law commonly known as the "Anti-kickback Statute" prohibits the knowing or willful offer, solicitation, payment or receipt of anything of value (direct or indirect, overt or covert, in cash or in kind) which is intended to induce the referral of patients covered by Federal Reimbursement Programs, or the ordering of items or services reimbursable under those programs. The law also prohibits remuneration that is intended to induce the recommendation of, or furnishing, or the arranging for, the provision of items or services reimbursable under Federal Reimbursement Programs. The law has been broadly interpreted by a number of courts to prohibit remuneration which is offered or paid for otherwise legitimate purposes if the circumstances show that one purpose of the arrangement is to induce referrals. Even bona fide investment interests in a healthcare provider may be questioned under the Anti-kickback Statute if the government concludes that the opportunity to invest was offered as an inducement for referrals. The penalties for violations of this law include criminal sanctions and exclusion from the federal healthcare program. In part to address concerns regarding the implementation of the Anti-kickback Statute, the federal government has promulgated regulations that provide exceptions, or "safe harbors," for certain transactions that will not be deemed to violate the Anti-kickback Statute. Among the safe harbors included in the regulations were provisions relating to the sale of physician practices, management and personal services agreements and employee relationships. Subsequently, regulations were published offering safe harbor protection to additional activities, including referrals within group practices consisting of active investors. Further regulatory "safe harbors" relating to the Anti-kickback Statute are under consideration which, if ultimately adopted, may result in substantive changes to existing regulations. The failure to qualify under a safe harbor provision, while potentially subjecting the activity to greater regulatory scrutiny, does not render the activity illegal per se. There are several aspects of the Company's relationships with physicians to which the Anti-kickback Statute may be relevant. In some instances, the Company itself may become a provider of services for which it will claim reimbursement from Federal Reimbursement Programs, and physicians who are investors in the Company may refer patients to the Company for those services. Furthermore, the government may construe some of the marketing and managed care contracting activities of the Company as arranging for the referral of patients to the physicians with whom the Company has a Service Agreement. Finally, at the request of a physician or medical practice with which the Company has a Service Agreement, the Company will manage the provision of ancillary services which the physician desires to make available to his patients in the physician's office. At the present time, the services provided by the Company in its IMPACT Centers are generally not reimbursable by Federal Reimbursement Programs. 5 6 Although neither the investments in the Company by physicians nor the Service Agreements between the Company and physicians qualify for protection under the safe harbor regulations, the Company does not believe that these activities fall within the types of activities the Anti-kickback Statute was intended to prohibit. A determination that the Company had violated or is violating the Anti-kickback Statute would have a material adverse effect on the Company's business. THE STARK SELF-REFERRAL LAW The Stark Self-Referral Law ("Stark Law") prohibits a physician from referring a patient to a healthcare provider for certain designated health services reimbursable by the Medicare or Medicaid programs if the physician has a financial relationship with that provider, including an investment interest, a loan or debt relationship or a compensation relationship. The designated services covered by the law include radiology services, infusion therapy, radiation therapy, outpatient prescription drugs and hospital services, among others. In addition to the conduct directly prohibited by the law, the statute also prohibits "circumvention schemes" that are designed to obtain referrals indirectly that cannot be made directly. The penalties for violating the law include (i) a refund of any Medicare or Medicaid payments for services that resulted from an unlawful referral; (ii) civil fines; and (iii) exclusion from the Medicare and Medicaid programs. The Stark Law contains a number of exceptions potentially applicable to the Company's operations. These include exceptions for a physician's ownership of certain publicly traded securities, certain in-office ancillary services, certain employment relationships and certain personal services arrangements. On January 9, 1998, the Health Care Financing Administration ("HCFA") issued proposed rules (the "Proposed Regulations") regarding the Stark Law as it relates to designated health services other than clinical laboratory services. The Proposed Regulations contemplate that designated health services may be provided by a physician's practice or by any other corporation, including an entity that owns the operation. The Proposed Regulations expand upon the statutory exceptions and propose certain additional exceptions. However, until final regulations are issued, the precise arrangements necessary to qualify for the Stark Law exceptions for services other than clinical laboratory services cannot be assured. It is not known when final regulations relating to the non-clinical laboratory designated health services will be promulgated. The Company believes that in the vast majority of situations it would not be construed as a provider of any designated health service under the Stark Law for which the Company claims reimbursement from Medicare or Medicaid. However, there can be no certainty that the Company will not be deemed to be the provider for designated health services in at least some circumstances. In that event, referrals from the physicians for designated health services will be permissible only if the relevant contractual relationship(s) meets an exception to the Stark Law prohibitions. To qualify for such exception, the payments made under the relevant contract must be set at fair market value as well as meeting other requirements of the relevant exception. The Company intends to structure its arrangements so as to qualify for applicable exceptions under the Stark Law, however, there can be no assurance that a review by courts or regulatory authorities would not result in a contrary determination. A finding of noncompliance with the Stark Law could have a material adverse effect upon the Company and subject it and the Company's affiliated physicians to penalties and sanctions. The Stark Law contains an exception for investment interests by physicians in a health care provider where the health care provider is a company whose securities are traded on a national securities market and which, as of the end of the most recently completed fiscal year, had stockholders' equity exceeding $75 million. The Company's stockholders' equity currently is less than $75 million, thus such exception is not currently available to physicians who own the Company's securities. STATE LAW STATE ANTI-KICKBACK LAWS Many states have laws that prohibit the payment of kickbacks in return for the referral of patients. Some of these laws apply only to services reimbursable under the state Medicaid program. However, a number of these laws apply to all healthcare services in the state, regardless of the source of payment for the service. The Company pays oncologists who supervise their patients' treatment at the IMPACT Centers certain professional fees for collecting and monitoring treatment and outcomes data and reporting such data to the Company. The Company believes such fees reflect the fair market value of the services rendered by such physicians to the Company. However, the laws in most states 6 7 regarding kickbacks have been subjected to limited judicial and regulatory interpretation and, therefore, no assurances can be given that the Company's activities will be found to be in compliance. Noncompliance with such laws could have a material effect upon the Company and subject it and such physicians to penalties and sanctions. STATE SELF-REFERRAL LAWS A number of states have enacted self-referral laws that are similar in purpose to the Stark Law. However, each state law is unique. For example, some states only prohibit referrals where the physician's financial relationship with a healthcare provider is based upon an investment interest. Other state laws apply only to a limited number of designated health services. Finally, some states do not prohibit referrals, but merely require that a patient be informed of the financial relationship before the referral is made. The Company believes that it is in compliance with the self-referral law of any state in which the Company has a financial relationship with a physician. FEE-SPLITTING LAWS Many states prohibit a physician from splitting with a referral source the fees generated from physician services. Other states have a broader prohibition against any splitting of a physician's fees, regardless of whether the other party is a referral source. In most cases, it is not considered to be fee-splitting when the payment made by the physician is reasonable reimbursement for services rendered on the physician's behalf. The Company will be reimbursed by physicians on whose behalf the Company provides management services. The Company intends to structure the reimbursement provisions of its management contracts with physicians in order to comply with applicable state laws relating to fee-splitting. However, there can be no certainty that, if challenged, the Company and its affiliated physicians will be found to be in compliance with each state's fee-splitting laws. Noncompliance would have an adverse impact upon such physician and thus upon the Company. The Florida Board of Medicine recently ruled in a declaratory statement that payments of 30% of a physician group's net income to a practice management company in return for a number of services, including expansion of the practice by increasing patient referrals through the creation of provider networks, affiliation with other networks, and the negotiation of managed care contracts, constituted fee-splitting arrangements in violation of the Florida law prohibiting fee-splitting and could subject the physicians engaged in such arrangements to disciplinary action. This order has been affirmed by a Florida appellate court, though the order itself only applies to the physician practice management company and the individual physicians whose fact situation was presented to the Florida Board of Medicine for a declaratory statement. While the Company believes that its Service Agreements are substantially different from the management services agreement that the Florida Board of Medicine ruled on, there is a risk that the adverse decision by the Florida court on the case presented could have an adverse precedential impact on the Company's Service Agreements with Florida affiliated practices. The Company's Service Agreements contain provisions requiring modification of the Service Agreements in such event in a manner that preserves the economic value of the Service Agreement, but there can be no assurance that Florida courts would specifically enforce such contractual provisions. The adverse determinations of the Florida court could have a material adverse effect on the Company. CORPORATE PRACTICE OF MEDICINE Most states prohibit corporations from engaging in the practice of medicine. Many of these state doctrines prohibit a business corporation from employing a physician. However, states differ with respect to the extent to which a licensed physician can affiliate with corporate entities for the delivery of medical services. Some states interpret the "practice of medicine" broadly to include decisions that have an impact on the practice of medicine, even where the physician is not an employee of the corporation and the corporation exercises no discretion with respect to the diagnosis or treatment of a particular patient. The Company's standard practice under its Service Agreements is to avoid the exercise of any responsibility on behalf of its physicians that could be construed as affecting the practice of medicine. Accordingly, the Company believes that it is not in violation of applicable state laws relating to the corporate practice of medicine. However, because such laws and legal doctrines have been subjected to only limited judicial and regulatory interpretation, there can be no assurance that, if challenged, the Company will be adjudicated to be in compliance with all such laws and doctrines. INSURANCE LAWS Laws in all states regulate the business of insurance and the operation of HMOs. Many states also regulate the establishment and operation of networks of health care providers. While these laws do not generally apply to companies that provide management services to networks of physicians, there can be no assurance that regulatory authorities of the states in which the Company operates would not apply these laws to require licensure of the Company's operations as an insurer, as an HMO or as a provider network. The Company believes that it is in compliance with these laws in the states in which it does business, but there can be no assurance that future interpretations of insurance and health care network laws by regulatory authorities in these states or in the states into which the Company may expand will not require licensure or a restructuring of some or all of the Company's operations. 7 8 STATE LICENSING The Company's laboratories operated in conjunction with certain IMPACT Centers are registered with the U.S. Food & Drug Administration and are certified pursuant to the Clinical Laboratory Improvement Amendments of 1988. In addition, the Company maintains pharmacy licenses for all IMPACT Centers having self-contained pharmacies, and state health care facility licenses, where required. REIMBURSEMENT AND COST CONTAINMENT Approximately 50% of the net revenue of the Company's practice management division and less than 5% of the revenue of the Company's IMPACT division are derived from payments made by government sponsored health care programs (principally Medicare and Medicaid). As a result, any change in reimbursement regulations, policies, practices, interpretations or statutes could adversely affect the operations of the Company. The Company expects that the Federal Government will continue to constrain the growth of spending in the Medicare and Medicaid programs. To the extent the Company's volume adjusted costs increase, the Company will not be able to recover such cost increases from government reimbursement programs. In addition, because of cost containment measures and market changes in non governmental insurance plans, it is increasingly unlikely that the Company will be able to shift cost increases to non governmental payors. Rates paid by private third party payors, including those that provide Medicare supplemental insurance, are based on established physician, clinic and hospital charges and are generally higher than Medicare payment rates. Changes in the mix of the Company's patients among the non-governmental payors and government sponsored health care programs, and among different types of non-government payor sources, could have a material adverse effect on the Company. EMPLOYEES As of March 1, 2000, the Company employed approximately 540 persons, approximately 442 of whom were full-time employees. Under the terms of the Service Agreements with the affiliated physician groups, the Company is responsible for the practice compensation and benefits of the groups' non-physician medical personnel. No employee of the Company or of any affiliated physician group is a member of a labor union or subject to a collective bargaining agreement. The Company believes that its labor relations are good. ITEM 2. PROPERTIES As of March 1, 2000, the Company leased approximately 35,000 square feet of space at 1775 and 1805 Moriah Woods Boulevard, in Memphis, Tennessee, where the Company's headquarters are located. The lease expires in 2002. The Company also leases all facilities housing the Company's operating facilities. Management believes that the Company's properties are well maintained and suitable for its business operations. The Company may lease additional space in connection with the development of future treatment facilities or practice affiliations. ITEM 3. LEGAL PROCEEDINGS No material litigation is currently pending against the Company, and the Company is not aware of any outstanding claims against any affiliated physician group that would have a material adverse effect on the Company's financial condition or results of operations. The Company expects its affiliated physician groups to be involved in legal proceedings incident to their business, most of which are expected to involve claims related to the alleged medical malpractice of its affiliated oncologists. ITEM 4. MATTERS SUBMITTED TO STOCKHOLDERS' VOTE Not applicable. 8 9 PART II ITEM 5. MARKET INFORMATION AND RELATED STOCKHOLDER MATTERS The Company's common stock trades on The Nasdaq Stock Market under the symbol "ROIX." As of March 17, 2000, the Company's common stock was held by approximately 1,971 shareholders of record. The high and low closing sale prices of the Company's common stock, as listed on the Nasdaq National Market System, were as follows for the quarterly periods indicated.
YEAR ENDED DECEMBER 31, 1999 YEAR ENDED DECEMBER 31, 1998 - -------------------------------------------------- --------------------------------------------- HIGH LOW HIGH LOW ------ ------ ------ ----- First Quarter $4 3/8 $2 3/8 First Quarter $9 3/4 $6 1/2 Second Quarter $3 1/2 $2 1/2 Second Quarter $8 15/16 $6 1/8 Third Quarter $ 3 $ 23/32 Third Quarter $7 5/8 $3 1/4 Fourth Quarter $ 1 7/8 $ 3/8 Fourth Quarter $5 1/4 $3 1/2
The Company has not paid any cash dividends on the common stock since its inception. The Board of Directors does not intend to pay cash dividends on the common stock in the foreseeable future, but intends to retain all earnings, if any, for use in the Company's business. RECENT SALES OF UNREGISTERED SECURITIES In April 1999, the Company issued 36,870 shares of its common stock and unsecured and subordinated 4% promissory notes in the aggregate principal amount of $244,000, payment of which may be made, at the option of the holders, in shares of common stock at a conversion price equal to 120% of the ten day average closing price per share on the Nasdaq on the election date (collectively, the "Unregistered Securities"), in one acquisition transaction pursuant to which the Company acquired the operating assets of a medical oncology practice from the physician owners ("Physician Owners") thereof. The Unregistered Securities were issued in exchange for certain assets of the professional association owned by the Physician Owners. The Unregistered Securities were offered and issued to the Physician Owners in reliance upon the exemption from registration under Section 4(2) of the Securities Act of 1933. Each of the Physician Owners was an accredited investor, as that term is defined in Rule 501 under Regulation D. 9 10 ITEM 6. SELECTED FINANCIAL DATA (in thousands except per share data) The following table sets forth certain selected consolidated financial data and should be read in conjunction with the Company's consolidated financial statements and related notes appearing elsewhere in this report.
Years Ended December 31, ------------------------------------------------------------------------------ 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------ Net revenue $135,567 $128,246 $101,920 $67,353 $44,298 Net earnings (loss) (1,693) (17,448) 4,202 910 2,314 Net earnings (loss) to common stockholders (1,695) (17,451) 4,199 907 2,310 Total assets 119,645 126,753 149,075 142,950 24,765 Long-term debt and capital lease obligations 36,025 33,252 35,443 62,230 15 Earnings (loss) per common share: Basic ($0.14) ($1.45) $0.36 $0.11 $0.33 ========== ============= ============== ============= ============= Diluted ($0.14) ($1.45) $0.36 $0.11 $0.32 ========== ============= ============== ============= =============
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company is a comprehensive cancer management company. The Company provides advanced cancer treatment services through outpatient facilities known as IMPACT Centers under the direction of practicing oncologists; owns the assets of and manages the nonmedical aspects of oncology practices; and conducts outcomes research on behalf of pharmaceutical manufacturers. Approximately 300 medical oncologists are associated with the Company through these programs. In 1990 the Company began development of a network of specialized IMPACT Centers to provide complex outpatient chemotherapy services under the direction of practicing oncologists. The majority of the therapies provided at the IMPACT Centers entail the administration of high dose chemotherapy coupled with peripheral blood stem cell support of the patient's immune system. At December 31, 1999, the Company's network consisted of 42 IMPACT Centers, including 24 wholly-owned, 15 managed programs, and 3 owned and operated in joint venture with a host hospital. Prior to January 1997, the Company derived substantially all of its revenues from outpatient cancer treatment services through reimbursements from third party payors on a fee-for-service or discounted fee-for-service basis. During 1997, the Company began concentrating its efforts on contracting on a "global case rate" basis where the Company contracts with the appropriate third-party payor to receive a single payment that covers the patient's entire course of treatment at the center and any necessary in-patient care. In May of 1999, the results of certain breast cancer studies were released at the meeting of the American Society of Clinical Oncology. These studies, involving the use of high dose chemotherapy, sparked controversy among oncologists, and, in the aggregate, caused confusion among patients and physicians about the role of high dose chemotherapy in the treatment of breast cancer. Since the release of these data, the Company's high dose business has slowed, as evidenced by the number of procedures in the six months ended December 31, 1999 at 365, as compared with 622 in the six months ended December 31, 1998. High dose procedures decreased 28% in 1999 as compared to 1998. In addition, the Company closed 12 marginal IMPACT Centers due to decreased patient volumes in 1999. Without further negative clinical data regarding the use of high dose chemotherapy for the treatment of breast cancer, the Company believes that procedure levels will stabilize. However, there can be no assurance that further erosion will not occur in this line of business beyond 1999. The Company anticipates that maturity of existing breast cancer data along with the release of new data will clarify the role of high dose therapies for breast cancer. While the past focus has been 10 11 weighted toward advanced breast cancer, the Company is evaluating new diseases that could potentially be managed through the IMPACT Center network. The Company also provides pharmacy management services for certain medical oncology practices through its IMPACT Center pharmacies. These services include compounding and dispensing pharmaceuticals for a fixed or cost plus fee. During 1996, the Company executed a strategy of diversification into physician practice management and subsequently affiliated with 43 physicians in 12 medical oncology practices in Florida and Tennessee. Through these affiliations, the Company believes that it has successfully achieved deep geographic penetration in those markets, believing that significant market share is crucial to achieving efficiencies, revenue enhancements, and marketing of complete cancer services to diverse payors including managed care. Pursuant to Service Agreements, the Company provides management services that extend to all nonmedical aspects of the operations of the affiliated practices. The Company is responsible for providing facilities, equipment, supplies, support personnel, and management and financial advisory services. In its practice management relationships, the Company has predominantly used two models of Service Agreements: (i) an "adjusted net revenue" model; and (ii) a "net operating income" model. Service Agreements utilizing the adjusted net revenue model provide for payments out of practice net revenue, in the following order: (A) physician retainage (i.e. physician compensation, benefits, and perquisites, including malpractice insurance) equal to a defined percentage of net revenue ("Physician Expense"); (B) a clinic expense portion of the management fee (the "Clinic Expense Portion") equal to the aggregate actual practice operating expenses exclusive of Physician Expense; and (C) a base service fee portion (the "Base Fee") equal to a defined percentage of net revenue. In the event that practice net revenue is insufficient to pay all of the foregoing in full, then the Base Fee is first reduced, followed by the Clinic Expense Portion of the management fee, and finally, Physician Expense, therefore effectively shifting all operating risk to the Company. In each Service Agreement utilizing the adjusted net revenue model, the Company is entitled to a Performance Fee equal to a percentage of Annual Surplus, defined as the excess of practice revenue over the sum of Physician Expense, the Clinic Expense Portion, and the Base Fee. Service Agreements utilizing the net operating income model provide for a management fee equal to the sum of a Clinic Expense Portion (see preceding paragraph) plus a percentage (the "Percentage Portion") of the net operating income of the practice (defined as net revenue minus practice operating expenses). Practice operating expenses do not include Physician Expense. In those practice management relationships utilizing the net operating income model Service Agreement, the Company and the physician group share the risk of expense increases and revenue declines, but likewise share the benefits of expense savings, economies of scale and practice enhancements. Each Service Agreement contains a liquidated damages provision binding the physician practice and the principals thereof in the event the Service Agreement is terminated "for cause" by the Company. The liquidated damages are a declining amount, equal in the first year to the purchase price paid by the Company for practice assets and declining over a specified term. Principals are relieved of their individual obligations for liquidated damages only in the event of death, disability, or retirement at a predetermined age. Each Service Agreement provides for the creation of an oversight committee, a majority of whom are designated by the practice. The oversight committee is responsible for developing management and administrative policies for the overall operation of each clinic. However, under each Service Agreement, the affiliated practice remains obligated to repurchase practice assets, typically including intangible assets, in the event the Company terminates the Service Agreement for cause. In February 1999 and April 1999, respectively, the Company announced that it had terminated its Service Agreements with Knoxville Hematology Oncology Associates, PLLC, and Southeast Florida Hematology Oncology Group, P.A., two of the Company's three underperforming net revenue model relationships. Since these were not "for cause" terminations initiated by the Company, the affiliated practices were not responsible for liquidated damages. In 1998 the Company recorded an impairment charge related to the three Service Agreements in accordance with Financial Accounting Standards Board Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of" ("SFAS No. 121"). The structure of these contracts has failed over time to align the physician and Company incentives, producing deteriorating returns and/or negative cash flows to the Company. The Company currently has no plans to terminate the Service Agreement with the third physician group. 11 12 In the fourth quarter of 1999, the Company terminated its Service Agreement with one single-physician practice in Florida. The termination was initiated on a "for cause" basis and the Company is seeking recovery of liquidated damages. During the same period, the Company began negotiations to terminate another Service Agreement with a single-physician practice. Since this not a "for cause" termination initiated by the Company, the affiliated practice is not responsible for liquidated damages. The Company experienced deteriorating returns on this particular Service Agreement and concluded that continuing the relationship was not economically feasible. At December 31, 1999, the Company has recorded an impairment charge related to the Service Agreements and associated assets in accordance with Financial Accounting Standards Board Statement No. 5 "Accounting for Contingencies". The Company anticipates that the second Service Agreement will be terminated in the second quarter of 2000. RESULTS OF OPERATIONS 1999 COMPARED TO 1998 Net revenue increased 6% to $135.6 million for the year ended December 31, 1999, compared to $128.2 million for the year ended December 31, 1998. Practice management service fees were $68.4 million in 1999 compared to $59.5 million in 1998 for a 15% increase. This increase is due to growth in utilization of both non-ancillary and ancillary services. Pharmaceutical sales to physicians increased $10.7 million or 40% from $26.8 million in 1998 to $37.5 million in 1999. Additionally, net patient service revenues from IMPACT services decreased $9.8 million or 26% from $38.0 million in 1998 to $28.2 million in 1999. This decrease in IMPACT services revenues is primarily due to reduced breast cancer patient referrals subsequent to research study data released at the annual meeting of ASCO in May 1999. For further discussion, see IMPACT Services section in Item 1. EBITDA (earnings before interest, taxes, depreciation and amortization) increased $20.4 million or 146% to $6.4 million for the year ended December 31, 1999 in comparison to ($14.0) million for the year ended December 31, 1998. The increase is primarily due to the reserve for the impairment of Service Agreements established in the fourth quarter of 1998. Salaries and benefits increased $.6 million, or 2%, from $25.2 million in 1998 to $25.8 million in 1999. The increase is primarily attributable to the addition of personnel in the practice management division and general increases in salaries and benefits. Salaries and benefits as a percentage of net revenue was 19% and 20% in 1999 and 1998, respectively. Supplies and pharmaceuticals expense increased $12.9 million, or 19%, from 1998 to 1999. The increase is primarily related to greater utilization of new chemotherapy agents with higher costs in the practice management division and increased volume in pharmaceutical sales to physicians. Supplies and pharmaceuticals expense as a percentage of net revenue was 59% and 52% for the years ended 1999 and 1998, respectively. The increase as a percentage of net revenue is due to the lower margin associated with the increased pharmaceutical sales to physicians as well as general price increases in pharmaceuticals used in the practice management division. Other operating expenses decreased $2.4 million, or 17%, from $13.9 million in 1998 to $11.5 million in 1999. Other operating expenses consist primarily of medical director fees, rent expense, and other operational costs. The decrease is primarily due to lower purchased services and physician fees as a result of lower IMPACT and cancer research patient volumes as compared to 1998. General and administrative expenses decreased $.8 million, or 11%, from $7.3 million in 1998 to $6.5 million in 1999. The decrease is primarily due to expenses recognized in 1998 for various aborted mergers and acquisitions and the termination of the Service Agreements with two of the Company's three underperforming net revenue model relationships. Depreciation and amortization decreased $1.1 million from $5.6 million in 1998 to $4.5 million in 1999. The decrease is primarily attributable to the impairment of management service agreements recognized in the fourth quarter of 1998. 1998 COMPARED TO 1997 Net revenue increased 26% to $128.2 million for the year ended December 31, 1998, compared to $101.9 million for the year ended December 31, 1997. Practice management service fees were $59.5 million in 1998 compared to $46.5 million 12 13 in 1997 for a 28% increase. This increase was due to growth in patient volumes, pharmaceutical utilization, and the acquisition of a physician practice. Additionally, pharmaceutical sales to physicians increased $8.5 million or 46% from $18.3 million in 1997 to $26.8 million in 1998. EBITDA (earnings before interest, taxes, depreciation and amortization) decreased $28.6 million or 195% to ($14.0) million for the year ended December 31, 1998 in comparison to $14.6 million for the year ended December 31, 1997. The decrease was primarily due to the increase in reserve for impairment of management service agreements and associated assets of $24.9 million recognized in the fourth quarter of 1998. Salaries and benefits costs increased $4.4 million, or 21%, from $20.8 million in 1997 to $25.2 million in 1998. The increase was primarily due to the addition of employed physicians and their support personnel in the practice management division and general increases in salaries and benefits. Salaries and benefits expense as a percentage of net revenue was 20% in the years 1998 and 1997. Supplies and pharmaceuticals expense increased $18.2 million, or 37%, from 1997 to 1998. The increase was primarily related to greater utilization of new chemotherapy agents with higher costs in the practice management division and increased volume in pharmaceutical sales to physicians. Supplies and pharmaceuticals expense as a percentage of net revenue was 52% and 48% for the years ended 1998 and 1997, respectively. The increase as a percentage of net revenue was due to the lower margin associated with the increased pharmaceutical sales to physicians as well as general price increases in pharmaceuticals used in the practice management division. Other operating expenses increased $2.9 million, or 26%, from $11.0 million in 1997 to $13.9 million in 1998. Other operating expenses consist primarily of medical director fees, purchased services related to global case rate contracts, rent expense, and other operational costs. The increase was primarily due to increased volume in the practice management division in 1998. General and administrative expense increased $3.0 million, or 70%, from $4.3 million in 1997 to $7.3 million in 1998. The increase was primarily due to a consolidation of certain of the Company's business office functions at the Company's headquarters during the year, expenses recognized for various aborted mergers and acquisitions during 1998, as well as general corporate expense increases. Depreciation and amortization increased $.9 million from $4.7 million in 1997 to $5.6 million in 1998. Based on guidance from the Securities and Exchange Commission, the Company announced a change in the amortization period of Service Agreements acquired in practice management affiliations to 25 years from 40 years beginning July 1, 1998. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1999, the Company's working capital was $23.4 million with current assets of $48.5 million and current liabilities of $25.1 million. Cash and cash equivalents represented $7.2 million of the Company's current assets. Cash provided by operating activities was $12.8 million in 1999 as compared to cash provided by operating activities of $2.8 million in 1998. The increase in operating cash flow is primarily the result of improved accounts receivable collections, tempered by a slowdown in IMPACT revenues in 1999. Cash used in investing activities was $.7 million and $2.7 million in 1999 and 1998, respectively. This decrease is the result of lower expenditures for equipment. In addition, there were no payments for the acquisition of affiliated physician groups in 1999. Cash used in financing activities was $5.9 million in 1999 and $1.4 million in 1998. This increase is primarily attributable to additional payments on notes payable in 1999 as compared to 1998. The Company has a $42.0 million Credit Facility which matures June 2002, to fund the Company's working capital needs. The Credit Facility, comprised of a $35.0 million Term Loan Facility and a $7.0 million Revolving Credit Facility, is collateralized by the assets of the Company and the common stock of its subsidiaries. The Credit Facility bears interest at a variable rate equal to LIBOR plus a spread between 1.375% and 2.5%, depending upon borrowing levels. The Company is also obligated to a commitment fee of .25% to .5% of the unused portion of the Revolving Credit Facility. At December 13 14 31, 1999, $36.7 million aggregate principal was outstanding under the Credit Facility with a current interest rate of approximately 9.3%. The Company is subject to certain affirmative and negative covenants which, among other things, require the Company to maintain certain financial ratios, including minimum fixed charge coverage, funded debt to EBITDA and minimum net worth. In June 1999, the Company entered into a LIBOR based interest rate swap agreement ("Swap Agreement") effective July 1, 1999 with the Company's lender as required by the terms of the Credit Facility. Amounts hedged under the Swap Agreement accrue interest at the difference between 5.93% and the ninety-day LIBOR rate and are settled quarterly. The Company is committed to hedge $18.0 million under the terms of the Swap Agreement. The Swap Agreement matures on July 1, 2000. In November 1999, the Company and its lenders amended certain terms of the Credit Facility. As a result of this amendment, the Revolving Credit Facility was reduced from $7.0 million to $6.0 million and the interest rate was adjusted to LIBOR plus a spread of 3.25%. The Company's obligation for commitment fees was adjusted from a maximum of .5% to .625% of the unused portion of the Revolving Credit Facility. Repayment of the January 1, 2000 quarterly installment was accelerated. In addition, certain affirmative and negative covenants were added or modified, including minimum EBITDA requirements for the fourth quarter of 1999 and the first quarter of 2000. Certain covenants were also waived for the quarters ending September 30, 1999 and December 31, 1999. On March 30, 2000, the Company and its lenders amended various terms of he Credit Facility. As a result of this amendment, certain affirmative and negative covenants were added (including minimum quarterly cash flow requirements through March 2001), and certain other existing covenants were modified. Additionally, certain principal repayment terms were modified and certain future and current compliance with specific covenants was waived. Finally, the maturity date of the Credit Facility was accelerated to June 2001. The Company expects to have a longer-term facility in place prior to the June 2001 maturity date, but there can be no assurances that such facility will in fact be consummated. Long-term unsecured amortizing promissory notes bearing interest at rates from 4% to 9% were issued as partial consideration for the practice management affiliations consummated in 1996. Principal and interest under the long-term notes may, at the election of the holders, be paid in shares of common stock of the Company based upon conversion rates ranging from $13.75 to $17.50. The unpaid principal amount of the long-term notes was $2.5 million at December 31, 1999. The Company is committed to future minimum lease payments under operating leases of $17.7 million for administrative and operational facilities. HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 The federal Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), required that standards be developed for the privacy and protection of individually identifiable health information. As directed by HIPAA, the federal government recently proposed detailed regulations to protect individual health information that is maintained or transmitted electronically from improper access, alteration or loss. Final regulations are expected sometime this year. The Company expects that health care organizations will be required to comply with the new standards 24 months after the date of adoption. The Company expects to begin to address HIPAA issues during fiscal year 2000. Because the HIPAA regulations have not been finalized, the Company has not been able to determine the impact of the new standards on it financial position or results. The Company does expect to incur costs to evaluate and implement the rules, and will be actively evaluating such costs and their impact on financial position and operations. IMPACT OF YEAR 2000 The Year 2000 Issue exists because many computer systems and applications currently use two-digit date fields to designate a year. The Company developed a Year 2000 Plan to address all of its Year 2000 issues. The Company's primary focus was on its own internal information technology systems, including all types of systems in use by the Company in its operations, finance and human resources departments, and to deal with the most critical systems first. The Company has not experienced any significant disruptions to its financial or operating systems caused by failure of computerized systems resulting from Year 2000 issues. Furthermore, the Company does not expect Year 2000 issues to have a material adverse effect on the Company's operations or financial results in 2000. Although the Company has no information that indicates any significant Year 2000 issues, management recognizes and is attentive to future financial and operational risk associated with Year 2000 computer system failures. FORWARD-LOOKING STATEMENTS With the exception of historical information, the matters discussed in this filing are forward-looking statements that involve a number of risks and uncertainties. The actual future results of the Company could differ significantly from those statements. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to; (i) a continued decline in high dose chemotherapy referrals due to the high dose chemotherapy breast cancer results; (ii) difficulty in transitioning operating responsibilities to new members of senior management; (iii) continued decline in margins for cancer drugs; (iv) reductions in third-party reimbursement from managed care plans and private insurance resulting from stricter utilization and reimbursement standards; (v) the inability of the Company to recover all or a portion of the carrying amounts of the cost of service agreements, resulting in an additional charge to earnings; (vi) the Company's dependence upon its affiliations with physician practices, given that there can be no assurance that the practices will remain successful or that key members of a particular practice will remain actively employed; (vii) changes in government regulations (as discussed elsewhere in this report); (viii) risk of professional malpractice and other similar claims inherent in the provision of medical services; (ix) the Company's dependence on the ability and experience of its executive officers; (x) the Company's inability to raise additional capital or refinance existing debt; and (xi) potential volatility in the market price of the Company's common stock. The Company cautions that any forward-looking statement reflects only the beliefs of the Company or its management at the time the statement is made. The Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement was made. 14 15 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary market risk exposure is to changes in interest rates obtainable on its Credit Facility. The Company's interest rate risk objective is to limit the impact of interest rate fluctuations on earnings and cash flows and to lower its overall borrowing costs by selecting favorable interest periods for tranches of the Credit Facility based on the current market interest rates. The Company has the option of fixing current interest rates for interest periods of 1, 2, 3 or 6 months. The Company is also a party to a LIBOR based interest rate swap agreement ("Swap Agreement") with an affiliate of one of the Company's lenders as required by the terms of the Credit Facility. Amounts hedged under the Swap Agreement accrue interest at the difference between 5.93% and the ninety-day LIBOR rate and are settled quarterly. As of December 31, 1999, approximately 49% of the Company's outstanding principal balance under the Credit Facility was hedged under the Swap Agreement. The Swap Agreement matures in July 2000. The Company does not enter into derivative or interest rate transactions for speculative purposes. At December 31, 1999, $36.7 million aggregate principal was outstanding under the Credit Facility with a current interest rate of approximately 9.3%. The Company does not have any other material market-sensitive financial instruments. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA This item is submitted in a separate section of this report (see pages 20 through 38). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 15 16 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The information required by this item with respect to the executive officers and directors of the Company is incorporated herein by reference to the sections entitled "Executive Officers" and "Nominees for Election as Directors" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held June 13, 2000. ITEM 11. EXECUTIVE COMPENSATION The information required by this item with respect to executive compensation is incorporated herein by reference to the section entitled "Executive Compensation" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held June 13, 2000. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item with respect to executive compensation is incorporated herein by reference to the section entitled "Security Ownership of Certain Beneficial Owners, Directors and Management" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held June 13, 2000. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference to the section entitled "Certain Transactions" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held June 13, 2000. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) and (2) -- The response to this portion of Item 14 is submitted as a separate section of this report (a)(3) LISTING OF EXHIBITS 2(a) Stock Purchase Agreement between the Registrant and stockholders of Oncology Hematology Group of South Florida (filed as Exhibit 10(m) to Registrant's Form 8-K filed January 17, 1996 (File No. 0-15416) and incorporated herein by reference) 2(b) Purchase and Sale Agreement between the Registrant, Knoxville Hematology Oncology Associates and Partners of Knoxville Hematology Oncology Associates (filed as Exhibit 10(q) to Registrant's Form 8-K filed April 15, 1996 (File No. 0-15416) and incorporated herein by reference) 2(c) Stock Purchase Agreement between the Registrant and stockholders of Jeffrey L. Paonessa, M.D., P.A. (filed as Exhibit 10(s) to Registrant's Form 8-K filed July 5, 1996 (File No. 0-15416) and incorporated herein by reference) 2(d) Stock Purchase Agreement between the Registrant and stockholders of Southeast Florida Hematology Oncology Group, P.A. (filed as Exhibit 2(d) to Registrant's Form 8-K filed July 15, 1996 (File No. 0-15416) and incorporated herein by reference) 2(e) Asset Purchase Agreement by and among the Registrant, stockholders of The Center for Hematology-Oncology, P.A. and the Registrant's Form 8-K filed October 21, 1996 (File No. 1-09922) and incorporated herein by reference 2(f) Stock Purchase Agreement by and among the Registrant, stockholders of Hematology Oncology Associates of the Treasure Coast, P.A., and Hematology Oncology Associates of the Treasure Coast, P.A. (filed as Exhibit 10(z) to the Registrant's Form 8-K filed November 5, 1996 (File No 1-09922) and incorporated herein by reference) 3(a) Charter (1) 3(b) Bylaws (2) 4 Trust Indenture, Deed of Trust and Security Agreement dated April 3, 1990 (3) 10(a) Registrant's 1985 Stock Option Plan, as amended (4) 16 17 10(b)* Registrant's 1990 Non-Qualified Stock Option Plan, as amended** (6)(8) 10(c)* Employment agreement between the Registrant and William H. West, M.D. dated January 1, 1995* 10(d)* Employment agreement between the Registrant and Joseph T. Clark dated July 1, 1995**(7) 10(e) Service Agreement between the Registrant and stockholders of Oncology Hematology Group of South Florida (filed as Exhibit 10(n) to Registrant's Form 8-K filed January 17, 1996 (File No. 0-15416) and incorporated herein by reference) 10(f)** Amendment to 1990 Registrant's Non-Qualified Stock Option Plan adopted April 20, 1995 (7) 10(g) Service Agreement between the Registrant and stockholders of Jeffrey L. Paonessa, M.D., P.A. (filed as Exhibit 10(t) to Registrant's Form 8-K filed July 5, 1996 (File No. 0-15416) and incorporated herein by reference) 10(h) Service Agreement between the Registrant and stockholders of Southeast Florida Hematology Oncology Group, P.A. (filed as Exhibit 10(u) to Registrant's Form 8-K filed July 15, 1996 (File No 0-15416) and incorporated herein by reference) 10(i)** Amendment No. 3 to 1990 Registrant's Non-qualified Stock Option Plan adopted December 16, 1995 (8) 10(j) Service Agreement between the Registrant, Rosenberg & Kalman, M.D., P.A., and stockholders of R&K, M.D., P.A. (filed as Exhibit 10(x) to Registrant's Form 8-K filed September 18, 1996 (File No. 1-09922) and incorporated herein by reference) 10(k) Loan Agreement dated April 21, 1997 between Registrant, NationsBank of Tennessee, N.A., AmSouth Bank of Tennessee and Union Planters National Bank (10) 10(l) Registrant's 1996 Stock Incentive Plan (9) 10(m) Second amendment to First Amended and Restated Loan Agreement dated March 31, 1999 between Registrant, NationsBank of Tennessee, N.A., AmSouth Bank of Tennessee and Union Planters National Bank (11) 10(n) First Amendment to Revolving Credit Note dated March 31, 1999 between Registrant, NationsBank of Tennessee, N.A., AmSouth Bank of Tennessee and Union Planters National Bank (11) 10(o) Credit Agreement dated June 10, 1999 between Registrant, AmSouth Bank, Union Planters National Bank and NationsBank, N.A. (12) 10(p) Swap Agreement dated June 25, 1999 between Registrant and NationsBank, N.A. (12) 10(q) Employment Agreement between Registrant and Anthony M. LaMacchia (filed as an exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999 and incorporated herein by reference) 10(r) First Amendment to Credit Agreement dated September 30, 1999, between Registrant, AmSouth Bank, Union Planters Bank, N.A. and Bank of America, N.A. 11 Statement regarding Computation of Per Share Earnings 13 Annual Report to Shareholders for the year ended December 31, 1999 -- to be filed 21 List of Subsidiaries 23 Consent of Independent Auditors 27 Financial Data Schedule - ------------------ * These documents may be obtained by stockholders of Registrant upon written request to: Response Oncology, Inc., 1805 Moriah Woods Blvd., Memphis, Tennessee 38117 ** Management Compensatory Plan (1) Incorporated by reference to the Registrant's 1989 10-K, dated July 31, 1989 (2) Incorporated by reference to the Registrant's Registration Statement on Form S-1 under the Securities Act of 1933 (File No. 33-5016) effective April 21, 1986 (3) Incorporated by reference in the initial filing of the Registrants' 1990 10-K, dated July 18, 1990, filed July 20, 1990 and amended on September 19, 1990 (4) Incorporated by reference to the Registrant's Registration Statement on Form S-8 under the Securities Act of 1933 (File No. 33-21333) effective April 26, 1988 (5) Incorporated by reference to the Registrant's 1991 10-K, dated July 26, 1991 (6) Incorporated by reference to the Registrant's Registration Statement on Form S-8 under the Securities Act of 1933 (File No. 33-45616) effective February 11, 1992 (7) Incorporated by reference to the Registrant's 1995 10-K, dated March 29, 1996 (8) Incorporated by reference to the Registrant's Registration Statement on Form S-8 under the Securities Act of 1933 (File No. 333-14371) effective October 11, 1996 17 18 (9) Incorporated by reference to the Registrant's Statement on Form S-8 under the Securities Act of 1933 (File No. 333-28973) effective June 11, 1997 (10) Incorporated by reference to the Registrant's 1997 10-K dated March 31, 1998 (11) Incorporated by reference to the Registrant's 1998 10-K dated March 31, 1999 (12) Filed as an exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999 and incorporated herein by reference. (b) Reports on Form 8-K filed in the fourth quarter of 1999 - None (c) Exhibits - The response to this portion of Item 14 is submitted as a separate section of this report (d) Financial Statement Schedules - The response to this portion of Item 14 is submitted as a separate section of this report 18 19 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Response Oncology, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. RESPONSE ONCOLOGY, INC. By: /s/ Anthony M. LaMacchia ----------------------------- Anthony M. LaMacchia President, Chief Executive Officer, and Director Date: March 30, 2000 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated. By: /s/ Frank M. Bumstead By: /s/ Peter A. Stark ------------------------------ ----------------------------- Frank M. Bumstead Peter A. Stark Vice-Chairman of the Board Vice President, Finance Date: March 30, 2000 Date: March 30, 2000 By: /s/ Anthony M. LaMacchia By: /s/ P. Anthony Jacobs ------------------------------ ----------------------------- Anthony M. LaMacchia P. Anthony Jacobs President, Chief Executive Director Officer, and Director Date: March 30, 2000 Date: March 30, 2000 By: /s/ James R. Seward By: /s/ William H. West, M.D. ------------------------------ ----------------------------- James R. Seward William H. West, M.D. Director Chairman of the Board Date: March 30, 2000 Date: March 30, 2000 19 20 Independent Auditors' Report The Board of Directors Response Oncology, Inc.: We have audited the accompanying consolidated balance sheets of Response Oncology, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1999. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index at Item 14. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Response Oncology, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG LLP Memphis, Tennessee March 10, 2000, except as to the fourth Paragraph of Note E, which is as of March 30, 2000 20 21 PART I - FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollar amounts in thousands except for share data)
December 31, -------------------------- 1999 1998 ---------- ---------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 7,195 $ 1,083 Accounts receivable, less allowance for doubtful accounts of $2,632 and $2,772 16,007 22,844 Supplies and pharmaceuticals 3,485 3,406 Prepaid expenses and other current assets 4,778 6,276 Due from affiliated physician groups 16,884 18,630 Deferred income taxes 114 -- --------- --------- TOTAL CURRENT ASSETS 48,463 52,239 Property and equipment, net 4,222 5,273 Deferred charges, less accumulated amortization of $86 and $496 380 50 Management service agreements, less accumulated amortization of $8,206 and $5,160 66,113 68,087 Other assets 467 1,104 --------- --------- TOTAL ASSETS $ 119,645 $ 126,753 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 15,665 $ 16,528 Accrued expenses and other liabilities 5,440 7,350 Current portion of notes payable 3,745 11,107 Current portion of capital lease obligations 267 357 Deferred income taxes -- 473 --------- --------- TOTAL CURRENT LIABILITIES 25,117 35,815 Notes payable, less current portion 35,445 32,290 Capital lease obligations, less current portion 580 962 Deferred income taxes 9,802 7,295 Minority interest 924 981 STOCKHOLDERS' EQUITY Series A convertible preferred stock, $1.00 par value (aggregate liquidation preference $183), authorized 3,000,000 shares; issued and outstanding 16,631 and 26,631 shares, respectively 17 27 Common stock, $.01 par value, authorized 30,000,000 shares; issued and outstanding 12,270,406 and 12,049,331 shares, respectively 123 120 Paid-in capital 101,979 101,912 Accumulated deficit (54,342) (52,649) --------- --------- 47,777 49,410 ========= ========= TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 119,645 $ 126,753 ========= =========
See accompanying notes to consolidated financial statements. 21 22 RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollar amounts in thousands except for share data)
Years Ended December 31, -------------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ NET REVENUE $ 135,567 $ 128,246 $ 101,920 COSTS AND EXPENSES Salaries and benefits 25,810 25,227 20,828 Pharmaceuticals and supplies 80,210 67,290 49,132 Other operating costs 11,529 13,887 10,955 General and administrative 6,487 7,315 4,278 Depreciation and amortization 4,509 5,579 4,704 Interest 3,305 2,946 3,125 Provision for doubtful accounts 2,625 2,947 1,529 Impairment of management service agreements and associated assets 1,840 24,877 -- ------------ ------------ ------------ 136,315 150,068 94,551 ------------ ------------ ------------ EARNINGS (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST (748) (21,822) 7,369 Minority owners' share of net earnings (700) (749) (591) ------------ ------------ ------------ EARNINGS (LOSS) BEFORE INCOME TAXES (1,448) (22,571) 6,778 Income tax provision (benefit) 245 (5,123) 2,576 ------------ ------------ ------------ NET EARNINGS (LOSS) (1,693) (17,448) 4,202 Common stock dividend to preferred stockholders (2) (3) (3) ------------ ------------ ------------ NET EARNINGS (LOSS) TO COMMON STOCKHOLDERS $ (1,695) $ (17,451) $ 4,199 ============ ============ ============ EARNINGS (LOSS) PER COMMON SHARE: Basic $ (0.14) $ (1.45) $ 0.36 ============ ============ ============ Diluted $ (0.14) $ (1.45) $ 0.36 ============ ============ ============ Weighted average number of common shares: Basic 12,014,153 12,039,480 11,505,775 ============ ============ ============ Diluted 12,014,153 12,039,480 11,662,157 ============ ============ ============
See accompanying notes to consolidated financial statements. 22 23 RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollar amounts in thousands except for share data)
Series A Convertible Preferred Stock Common Stock ----------------------- ---------------------- Par Value Par Value Total $1.00 Per $.01 Per Paid-In Accumulated Stockholders' Shares Share Shares Share Capital Deficit Equity ---------- ---------- ----------- --------- -------- ----------- ------------- Balances at December 31, 1996 27,233 $ 27 8,947,018 $ 89 $ 77,454 $(39,403) $38,167 Net earnings 4,202 4,202 Exercise of common stock options 4,498 1 26 27 Conversion of note payable to parent 3,020,536 30 23,922 23,952 Dividend on preferred stock 306 -------- -------- ----------- ------- -------- -------- ------- Balances at December 31, 1997 27,233 27 11,972,358 120 101,402 (35,201) 66,348 Net loss (17,448) (17,448) Exercise of common stock options 54,164 320 320 Common stock issued in connection with practice affiliations 22,406 190 190 Conversion of preferred stock (602) 110 Dividend on preferred stock 293 -------- ----------- ---------- ------- -------- -------- ------- Balances at December 31, 1998 26,631 27 12,049,331 120 101,912 (52,649) 49,410 Net loss (1,693) (1,693) Common stock issued in connection with practice affiliations 36,870 1 112 113 Common stock issued under compensation plan 300,000 3 297 300 Common stock received in connection with practice termination (117,811) (1) (352) (353) Conversion of preferred stock (10,000) (10) 1,833 10 Dividend on preferred stock 183 -------- -------- ---------- ------- -------- -------- ------- Balances at December 31, 1999 16,631 $ 17 12,270,406 $ 123 $101,979 $(54,342) $47,777 ======== ======== ========== ======= ======== ======== =======
See accompanying notes to consolidated financial statements. 23 24 RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollar amounts in thousands)
Years Ended December 31, -------------------------------------- 1999 1998 1997 -------- -------- -------- OPERATING ACTIVITIES Net earnings (loss) $ (1,693) $(17,448) $ 4,202 Adjustments to reconcile net earnings (loss) to net cash provided by operating activities: Depreciation and amortization 4,509 5,579 4,704 Impairment of management service agreements and associated assets 1,840 24,877 -- Deferred income taxes 1,979 (5,800) 988 Provision for doubtful accounts 2,625 2,947 1,529 Minority owners' share of net earnings 700 749 591 Changes in operating assets and liabilities net of effect of acquisitions: Accounts receivable 4,212 (8,881) (4,141) Supplies and pharmaceuticals, prepaid expenses and other current assets 1,359 (2,624) (2,408) Deferred charges and other assets (178) (175) (1,958) Due from affiliated physician groups (108) (4,955) (3,783) Accounts payable and accrued expenses (2,450) 8,512 6,849 -------- -------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 12,795 2,781 6,573 -------- -------- -------- INVESTING ACTIVITIES Purchase of equipment (741) (1,702) (978) Investment in joint venture -- -- 73 Acquisition of nonmedical assets of affiliated physician groups -- (1,011) (332) -------- -------- -------- NET CASH USED IN INVESTING ACTIVITIES (741) (2,713) (1,237) -------- -------- -------- FINANCING ACTIVITIES Financing costs incurred (416) -- (388) Proceeds from exercise of stock options and warrants -- 320 27 Distributions to joint venture partners (757) (805) -- Proceeds from notes payable 1,734 8,191 12,724 Principal payments on notes payable (6,202) (8,907) (16,623) Proceeds from note payable to parent -- -- 1,006 Principal payments on capital lease obligations (301) (209) (72) -------- -------- -------- NET CASH USED IN FINANCING ACTIVITIES (5,942) (1,410) (3,326) -------- -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 6,112 (1,342) 2,010 Cash and cash equivalents at beginning of period 1,083 2,425 415 -------- -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,195 $ 1,083 $ 2,425 ======== ======== ========
Continued: 24 25
Years Ended December 31, ----------------------------------- 1999 1998 1997 ------- -------- ------- Supplemental schedule of noncash investing and financing activities Effect of practice affiliations: Intangible assets $ 1,036 $ 1,040 $ 281 Property and equipment 15 20 42 Acquired accounts receivable, net -- 139 29 Other assets (695) -- 22 ------- ------- ------- Total assets acquired, net of cash 356 1,199 374 ------- ------- ------- Liabilities assumed -- -- (42) Issuance of notes payable (244) -- -- Issuance of common stock (112) (188) -- ------- ------- ------- Payments for practice affiliation operating assets -- $ 1,011 $ 332 ======= ======= ======= Cash paid for interest $ 3,831 $ 3,010 $ 3,408 ======= ======= ======= Cash paid for income taxes $ 55 $ 2,202 $ 1,821 ======= ======= =======
See accompanying notes to consolidated financial statements. 25 26 RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999 NOTE A--ORGANIZATION AND DESCRIPTION OF BUSINESS Response Oncology, Inc. (the "Company") is a comprehensive cancer management company which owns and/or operates a network of outpatient treatment centers ("IMPACT(R) Centers"), that provide stem cell supported high dose chemotherapy and other advanced cancer treatment services under the direction of practicing oncologists; owns the assets of and manages oncology practices; and conducts outcomes research on behalf of pharmaceutical manufacturers. Prior to July 25, 1997, the Company was a subsidiary of Seafield Capital Corporation ("Seafield"). On July 1, 1997, Seafield's Board of Directors declared a dividend to its shareholders of record on July 11, 1997, of all shares of common stock of the Company owned by Seafield. On July 25, 1997, 1.2447625 shares of the Company's common stock were distributed for each share of Seafield common stock outstanding. The Seafield shareholders paid no consideration for any shares of the Company's stock received in the distribution. NOTE B--SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and majority-owned or controlled joint ventures. All significant intercompany accounts and transactions have been eliminated in consolidation. CASH EQUIVALENTS: All highly liquid investments with an original maturity of three months or less when purchased are considered to be cash equivalents. ACCOUNTS RECEIVABLE: Accounts receivable primarily consists of receivables from patients, insurers, government programs and other third-party payors for medical services provided. Such amounts are reduced by an allowance for contractual adjustments and other uncollectible amounts. Contractual adjustments result from the differences between the amounts charged for services performed and the amounts allowed by the Medicare and Medicaid programs and other public and private insurers. DUE FROM AFFILIATED PHYSICIANS: Due from affiliated physicians consists of management fees earned and due pursuant to related Service Agreements. In addition, the Company may also fund certain working capital needs of affiliated physicians from time to time. A significant portion of the affiliated physicians' medical service revenues are related to third-party reimbursement agreements, primarily Medicare and other governmental programs. Medicare and other governmental programs reimburse physicians based on fee schedules which are determined by the related governmental agency. In the ordinary course of business, affiliated physicians receiving reimbursement from Medicare and other governmental programs are potentially subject to a review by regulatory agencies concerning the accuracy of billings and sufficiency of supporting documentation of procedures performed. SUPPLIES AND PHARMACEUTICALS: Supplies and pharmaceuticals are recorded at lower of cost (first-in, first-out) or market. PROPERTY AND EQUIPMENT: Property and equipment are stated at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives which range from three to ten years. Equipment under capital lease obligations is amortized using the straight-line method over the shorter of the lease term or the estimated useful life of the equipment. Such amortization is included in depreciation and amortization in the consolidated financial statements. MANAGEMENT SERVICE AGREEMENTS: The recorded value of Service Agreements results from the excess of the purchase price over the fair value of net assets of acquired practices. The Service Agreements are noncancelable except for 26 27 performance defaults, as defined. In the event a practice breaches the agreement, or if the Company terminates with cause, the practice is required to purchase all tangible assets at fair market value and pay substantial liquidated damages. At each reporting period, the Company reviews the carrying value of Service Agreements on a practice-by-practice basis to determine if facts and circumstances exist which would suggest that the value of the Service Agreements may be impaired or that relevant amortization periods need to be modified. Among the factors considered by the Company in making the evaluation are changes in the practices' market position, reputation, profitability and geographical penetration. Using these factors, if circumstances are present which may indicate impairment is probable, the Company will prepare a projection of the undiscounted cash flows before interest charges of the specific practice and determine if the Service Agreements are recoverable based on these undiscounted cash flows. If impairment is indicated, then an adjustment will be made to reduce the carrying value of intangible assets to fair value. Certain Service Agreements were determined to be impaired during 1999 and 1998, as more fully discussed in Note C. Based on guidance from the Securities and Exchange Commission, the Company announced a change in the amortization period of Service Agreements acquired in practice management affiliations to 25 years from 40 years beginning July 1, 1998. The Company estimates that the change in the amortization period will result in additional annual amortization expense of approximately $1,200,000 in subsequent years, exclusive of the amortization expense associated with the impaired Service Agreements discussed in Note C. DEFERRED CHARGES: Deferred charges includes costs capitalized in connection with obtaining long-term financing and are being amortized using the interest method over the terms of the related debt. NET REVENUE: The Company's revenue from practice management affiliations includes reimbursement of practice operating expenses (other than amounts retained by physicians) and a management fee either fixed in amount or equal to a percentage of each affiliated oncology group's adjusted net revenue or net operating income. In certain affiliations, the Company may also be entitled to a performance fee if certain financial criteria are satisfied. Pharmaceutical sales to physicians are recorded based upon the Company's contracts with physician groups to manage the pharmacy component of the groups' practice. Revenue recorded for these contracts represents the cost of pharmaceuticals plus a fixed or percentage fee. Clinical research revenue is recorded based on contracts with various pharmaceutical manufacturers to provide clinical data regarding the use of their products. The following table is a summary of net revenue by source.
Years Ended December 31, (In thousands) ----------------------------------------------- 1999 1998 1997 -------- ------- --------- Net patient service revenue $28,179 $37,957 $ 34,249 Practice management service fees 68,413 59,527 46,476 Pharmaceutical sales to physicians 37,530 26,849 18,302 Clinical research revenue 1,445 3,913 2,893 -------- -------- -------- $135,567 $128,246 $101,920 ======== ======== ========
Revenue is recognized when earned. Sales and related cost of sales are generally recognized upon delivery of goods or performance of services. INCOME TAXES: The asset and liability method is used whereby deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. EARNINGS (LOSS) PER COMMON SHARE: Earnings (loss) per common share has been computed based upon the weighted average number of shares of common stock outstanding during the period, plus (in periods in which they have a dilutive effect) common stock equivalents, primarily stock options and warrants. 27 28 FAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying amounts of all asset and liability financial instruments approximate their estimated fair values at December 31, 1999 and 1998. Fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties. USE OF ESTIMATES: Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. NOTE C - IMPAIRMENT OF MANAGEMENT SERVICE AGREEMENTS AND ASSOCIATED ASSETS The Company recognized a pretax impairment charge during the fourth quarter of 1998, based on the criteria described in Note B, totaling $24,877,000. This charge was principally related to the poor performance of three specific Physician Practice Management Service Agreements as further described below. Of the total charge, $22,482,000 related to the impairment of Service Agreement assets and $2,395,000 related to the write-off of certain net tangible assets associated with the individual physician practices. Certain significant economic issues, especially the introduction of new and more costly cancer drugs and the Company's related inability to convert the subject physician practices to a more equitable revenue sharing model, began to materially and negatively impact these practices during 1998. Practice operating losses and other factors led the Company to evaluate the recoverability of related Service Agreements and other assets. This evaluation and the factors described in the following paragraph led to the recognition of impairment charges in the accompanying 1998 financial statements, which included the complete write-off of the subject Service Agreement assets. Given the results of the evaluation described above, the Company began actively negotiating with the subject physician practices, principally regarding potential exit strategies and/or Service Agreement modifications. On February 1, 1999, and March 31, 1999, the Company executed termination agreements with two of the three physician practices. The terms of the agreements provided for the termination of the Service Agreements and return of certain net tangible assets to the physician practices. The Company currently has no plans to terminate the Service Agreement with the third physician group. In the fourth quarter of 1999, the Company terminated its Service Agreement with one single-physician practice in Florida. During the same period, the Company began negotiations to terminate another Service Agreement with a single-physician practice. The Company experienced deteriorating returns on this particular Service Agreement and concluded that continuing the relationship was not economically feasible. At December 31, 1999, the Company recorded an impairment charge, based on similar evaluation processes as described above, related to the Service Agreements and associated assets. The Company anticipates that the second Service Agreement will be terminated in the second quarter of 2000. NOTE D--PROPERTY AND EQUIPMENT Balances of major classes of property and equipment at December 31, 1999 and 1998 are as follows: (In thousands)
1999 1998 ------- ------- Lab and pharmacy equipment $ 5,423 $ 5,329 Furniture and office equipment 5,666 5,318 Equipment under capital leases 2,597 2,827 Leasehold improvements 2,902 2,949 ------- ------- 16,588 16,423 Less accumulated depreciation and amortization 12,366 11,150 ------- ------- $ 4,222 $ 5,273 ======= =======
28 29 NOTE E--NOTES PAYABLE Notes payable at December 31, 1999 and 1998 consist of the following: (In thousands)
1999 1998 ------- ------- Credit Facility (see below) $36,667 $37,777 Various subordinated notes payable to affiliated physicians and physician practices, bearing interest ranging from 4% to 9%, with maturity dates through 2003 2,457 5,478 Other notes payable collateralized by furniture and equipment, with interest rates between 8% and 10%, payable in monthly installments of principal and interest through 2005 66 142 ------- ------- Total notes payable 39,190 43,397 Less current portion 3,745 11,107 ======= ======= $35,445 $32,290 ======= =======
The Company has a $42.0 million Credit Facility, which matures June 2002, to fund the Company's working capital needs. The Credit Facility, comprised of a $35.0 million Term Loan Facility and a $7.0 million Revolving Credit Facility, is collateralized by the assets of the Company and the common stock of its subsidiaries. The Credit Facility bears interest at a variable rate equal to LIBOR plus a spread between 1.375% and 2.5%, depending upon borrowing levels. The Company is also obligated to a commitment fee of .25% to .5% of the unused portion of the Revolving Credit Facility. At December 31, 1999, $36.7 million aggregate principal was outstanding under the Credit Facility with a current interest rate of approximately 9.3%. The Company is subject to certain affirmative and negative covenants which, among other things, require the Company to maintain certain financial ratios, including minimum fixed charge coverage, funded debt to EBITDA and minimum net worth. In June 1999, the Company entered into a LIBOR based interest rate swap agreement ("Swap Agreement") effective July 1, 1999 with the Company's lender as required by the terms of the Credit Facility. Amounts hedged under the Swap Agreement accrue interest at the difference between 5.93% and the ninety-day LIBOR rate and are settled quarterly. The Company is committed to hedge $18.0 million under the terms of the Swap Agreement. The Swap Agreement matures on July 1, 2000. In November 1999, the Company and its lenders amended certain terms of the Credit Facility. As a result of this amendment, the Revolving Credit Facility was reduced from $7.0 million to $6.0 million and the interest rate was adjusted to LIBOR plus a spread of 3.25%. The Company's obligation for commitment fees was adjusted from a maximum of .5% to .625% of the unused portion of the Revolving Credit Facility. Repayment of the January 1, 2000 quarterly installment was accelerated. In addition, certain affirmative and negative covenants were added or modified, including minimum EBITDA requirements for the fourth quarter of 1999 and the first quarter of 2000. Certain covenants were also waived for the quarters ending September 30, 1999 and December 31, 1999. On March 30, 2000, the Company and its lenders amended various terms of the Credit Facility. As a result of this amendment, certain affirmative and negative covenants were added (including minimum quarterly cash flow requirements through March 2001), and certain other existing covenants were modified. Additionally, certain principal repayment terms were modified and certain future and current compliance with specific covenants was waived. Finally, the maturity date of the Credit Facility was accelerated to June 2001. The Company expects to have a longer-term facility in place prior to the June 2001 maturity date, but there can be no assurances that such facility will in fact be consummated. The installment notes payable to affiliated physicians and physician practices were issued as partial consideration for the practice management affiliations. Principal and interest under the long-term notes may, at the election of the holders, be paid in shares of common stock of the Company based on conversion prices ranging from $11.50 to $17.50. The aggregate maturities of long-term debt at December 31, 1999 are as follows: (In thousands) 2000 $3,745 2001 34,966 2002 236 2003 227 2004 9 Thereafter 7 -------------- $39,190 ============== 29 30 NOTE F -- LEASES The Company leases certain office facilities and equipment under lease agreements with original terms ranging from one to forty years that generally provide for one or more renewal options. Interest has been imputed on capital leases at rates of 6% to 12%. Accumulated amortization of assets recorded under capital leases totaled $1,821,000 and $1,595,000 at December 31, 1999 and 1998, respectively. Amortization of leased assets is included in depreciation and amortization expense. Total rental expense under operating leases amounted to $3,838,000, $3,527,000 and $2,619,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The Company is generally obligated to the lessors for its proportionate share of operating expenses of the leased premises. At December 31, 1999, future minimum lease payments under capital and operating leases with initial terms of one year or more are as follows (in thousands):
Capital Leases Operating Leases ------------------- -------------------- Year ending December 31: 2000 $316 $ 2,589 2001 307 2,050 2002 283 1,631 2003 31 1,333 2004 -- 1,134 Thereafter -- 8,941 ---- ------- Total minimum payments 937 $17,678 ======= Less imputed interest 90 ---- Present value of minimum rental payments 847 Less current portion 267 ---- Capital lease obligations, less current portion $580 ====
NOTE G --- INCOME TAXES The components of the actual expense or benefit for the years ended 1999, 1998 and 1997 are as follows (in thousands):
1999 1998 1997 -------- ------- ------- Federal current tax expense (benefit) $(1,734) $ 545 $ 1,334 State current tax expense -- 132 254 Deferred federal tax expense (benefit) 1,934 (4,885) 883 Deferred state tax expense (benefit) 45 (915) 105 ======= ======= ======= $ 245 ($5,123) $ 2,576 ======= ======= =======
The actual tax expense or benefit for the years ended December 31, 1999, 1998, and 1997, respectively, differs from the expected tax expense or benefit for those years (computed by applying the federal corporate tax rate of 34% to earnings or loss before income taxes) as follows (in thousands):
1999 1998 1997 ------- ------- ------- Computed expected tax expense (benefit) $ (490) $(7,674) $ 2,304 Non-deductible expenses 197 1,206 23 Utilization of net operating loss carryforwards -- -- 12 State tax expense (benefit) -- (893) 237 Valuation allowance 779 2,238 -- Other (241) -- -- ======= ======= ======= Actual income tax expense (benefit) $ 245 ($5,123) $ 2,576 ======= ======= =======
30 31 The approximate tax effects of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax assets and deferred tax liabilities are as follows (in thousands): 1999 1998 -------- -------- Deferred tax assets: Net operating loss carryforwards $ 3,974 $ 1,317 Reserve for bad debts 105 (473) Excess book depreciation/amortization 620 1,093 Other (35) -- Impairment of management service agreements and associated assets 3,541 7,401 -------- -------- Total deferred assets 8,205 9,338 Valuation allowance (3,017) (2,238) -------- -------- Net deferred tax assets 5,188 7,100 Deferred tax liability: Management service agreements 14,876 14,868 -------- -------- Net deferred tax liability $ 9,688 $ 7,768 ======== ======== The valuation allowance for the deferred tax assets as of December 31, 1999 is $3,017,000. Management believes that a valuation allowance is necessary with respect to the impairment of physician practices. This is due to the nature of a loss currently attributed to one of the five practices. The valuation allowance as of December 31, 1998 was $2,238,000. Thus, the net change in the total valuation allowance for the year ended December 31, 1999, was an increase of $779,000. Section 1502 of the Internal Revenue Code requires that certain adjustments be considered in determining the allowable loss on the worthless stock of a subsidiary. These adjustments were considered in determining the valuation allowance. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, income taxes paid in prior years eligible to be offset by net operating loss carrybacks, and tax planning strategies in making this assessment. In order to fully realize the deferred tax asset, the Company will need to generate future ordinary taxable income of $13,664,000 (after considering taxable income in previous years available for carryback) and future capital gain income of $7,948,000. Based upon the level of historical ordinary taxable income, management believes it is more likely than not the Company will realize the benefits of ordinary deductible differences. However, based upon the historical level of capital gain taxable income, management believes that it is less likely the Company will realize the entire deferred tax asset related to the impaired physician practices. The amount of income that the Company may offset in future years by the net operating loss carryforwards incurred prior to an ownership change in 1990 will be limited, by the application of Internal Revenue Code Section 382, to $473,000 annually through the year 2005. The unused portion of the net operating losses may be carried forward and realized in future years subject to this limitation. The net operating loss incurred in 1999 is not limited by IRC Section 382, and will be carried forward and utilized in future years. As of December 31, 1999, the Company had available for federal income tax purposes net operating loss carryforwards totaling $9,655,000. Of this amount, $2,997,000 of the net operating loss carryforward is subject to the annual limitations discussed above. In addition, as of December 31, 1999, the Company had $14,808,000 in state net operating loss carryforwards available. The difference between the federal and state net operating loss carryforwards is a result of the losses being carried back to the previous two years for federal purposes. The use of net operating loss carryforwards, for income tax purposes, is also dependent upon future taxable income. 31 32 NOTE H -- COMMON STOCK, CONVERTIBLE PREFERRED STOCK, WARRANTS, AND OPTIONS COMMON STOCK: On February 26, 1997, a $23.5 million note payable to Seafield and accrued interest thereon was converted into 3,020,536 shares of the Company's common stock at a rate of $8 per share. Seafield subsequently distributed all of the Company's common stock owned by Seafield to its shareholders as discussed in Note A. In November 1999, 300,000 shares of common stock were sold to an executive of the Company in accordance with the terms of his employment contract. The shares were purchased at market value through the issuance of a note. The note is payable in full on its fifth anniversary and bears interest at the applicable federal mid-term rate in effect on the date of such loan. CONVERTIBLE PREFERRED STOCK: The shares of Series A Convertible Preferred Stock have the following rights and restrictions: (a) a preference in the event of liquidation equal to $11.00 per share; (b) the right to convert into the number of shares of common stock equal to the stated value of shares surrendered ($11.00) divided by the conversion price of $60.00 -- subject to certain adjustments; (c) the right to receive dividends in the form of common stock at the rate of .011 share of common stock per annum per share payable annually each year commencing January 15, 1988; (d) the shares are redeemable at the Company's option at $11.00 per share; and (e) holders of the preferred stock will not be entitled to vote. During the years ended December 31, 1999 and 1998, 10,000 and 602 shares of Series A Convertible Preferred Stock were converted into 1,833 and 110 shares of common stock, respectively. In December 1999, 1998, and 1997, the Board of Directors approved a common stock dividend of 183, 293 and 306 shares to the holders of the Series A Convertible Preferred Stock of record as of December 15, 1999, 1998, and 1997, respectively, that was paid January 2000, 1999, and 1998, respectively. The market value of the common stock distributed was approximately $2,000 at December 15, 1999 and $3,000 at December 15, 1998 and 1997. The dividends have been reflected in the "Statement of Operations," and the weighted average number of common shares in the determination of net earnings (loss) to common stockholders and the earnings (loss) per common share calculations. The par value of the common stock distributed was charged to paid-in capital. OPTIONS: The 1985 Stock Option Plan (the "1985 Plan"), as amended in fiscal year 1988, allows for granting of incentive stock options, non qualified stock options, and stock appreciation rights for up to 122,000 shares of common stock to eligible officers and key employees of the Company at an exercise price of not less than the fair market value of the common stock on the date of grant for an incentive stock option and not less than 85% of the fair market value of the common stock on the date of grant for a non qualified stock option. The 1985 Plan expired in 1995; no additional shares are available for grant. The 1990 Non Qualified Stock Option Plan (the "1990 Plan"), as amended in 1995, allows for the granting of up to 1,125,000 non qualified stock options to eligible officers, directors, key employees, and consultants of the Company at an exercise price of not less than the market price of the common stock on the date of grant with an option period up to 10 years. The 1996 Incentive and Non Qualified Stock Option Plan (the "1996 Plan"), as amended in 1997, allows for the granting of up to 1,130,000 options to eligible officers, directors, advisors, medical directors, consultants, and key employees of the Company at an exercise price of not less than the market price of the common stock on the date of grant with an option period up to 10 years. 32 33 A summary status of the 1985 Plan as of December 31, 1999, 1998, and 1997 and changes during the years then ended is presented below:
1999 1998 1997 ------------------------- ----------------------- ----------------------- Weighted Weighted Weighted Average Average Average Number Exercise Number Exercise Number Exercise Fixed Options of shares Price of shares Price of shares Price ------------- --------- --------- --------- -------- --------- -------- Outstanding at beginning of year 60,203 $3.85 61,203 $3.81 71,100 $ 5.76 Exercised -- -- (1,000) 1.88 (300) 3.12 Forfeited (9,103) 3.59 -- -- (9,597) 17.12 ====== ====== ====== Outstanding at end of year 51,100 3.79 60,203 3.85 61,203 3.81 ====== ====== ====== Options exercisable end of year 51,100 60,006 60,485 ====== ====== ======
A summary status of the 1990 Plan as of December 31, 1999, 1998, and 1997 and changes during the years then ended is presented below:
1999 1998 1997 --------------------------- ----------------------- ----------------------- Weighted Weighted Weighted Average Average Average Number Exercise Number Exercise Number Exercise Fixed Options of shares Price of shares Price of shares Price ------------- --------- -------- --------- --------- --------- --------- Outstanding at beginning of year 779,108 $6.34 810,034 $6.75 1,053,150 $11.24 Granted 220,000 .69 54,500 6.75 658,779 6.44 Exercised -- -- (47,103) 6.00 (721) 6.00 Forfeited (215,136) 5.96 (38,323) 6.00 (901,174) 11.66 ========= ======= ========= Outstanding at end of year 783,972 4.86 779,108 6.34 810,034 6.75 ========= ======= ========= Options exercisable end of year 569,609 754,420 741,054 ========= ======= =========
A summary status of the 1996 Plan for the years ended December 31, 1999, 1998 and 1997 and changes during the years then ended is presented below:
1999 1998 1997 ------------------------- ----------------------- --------------------------- Weighted Weighted Weighted Average Average Average Number Exercise Number Exercise Number Exercise Fixed Options of shares Price of shares Price of shares Price ------------- --------- -------- --------- --------- --------- ---------- Outstanding at beginning of year 1,101,690 $6.54 1,086,989 $6.55 570,400 $11.81 Granted 579,000 .85 61,000 6.62 1,025,467 6.06 Exercised -- -- (8,061) 6.00 (3,478) 6.00 Forfeited (660,757) 5.98 (38,238) 6.97 (505,400) 10.30 ========= ========= ========= Outstanding at end of year 1,019,933 3.67 1,101,690 6.54 1,086,989 6.55 ========= ========= ========= Options exercisable end of year 665,601 1,017,146 535,846 ========= ========= =========
33 34 The following table summarizes information about fixed stock options outstanding at December 31, 1999:
Options Outstanding Options Exercisable -------------------------------------------------- ------------------------------ Weighted Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life (Years) Price Exercisable Price ---------------- ----------- ---------------- --------- ----------- --------- $0.69 - $0.69 720,000 9.84 $ 0.69 170,000 $ 0.69 $0.94 - $5.63 191,400 4.75 $ 2.46 188,067 $ 2.41 $6.00 - $6.00 508,505 7.40 $ 6.00 501,507 $ 6.00 $6.25 - $10.00 302,650 7.33 $ 7.59 294,286 $ 7.65 $10.63 - $16.50 131,450 5.72 $13.00 131,450 $12.90 $16.88 - $16.88 1,000 5.75 $16.88 1,000 $16.88
The Company accounts for stock options in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations (APB 25). As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. On December 31, 1995, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (SFAS 123), which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternately, SFAS 123 allows entities to continue to apply the provisions of APB 25 and provide pro forma net earnings and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS 123 had been applied. The Company has elected to continue to apply the provisions of APB 25 and provide the pro forma disclosures required by SFAS 123. The per share weighted average fair value of stock options granted during 1999, 1998 and 1997 was $.61, $4.47 and $6.21 on the date of grant. The fair values were calculated by using the "Black Scholes" option-pricing model with the following average assumptions: 1999 - expected dividend yield of 0%, risk-free interest rate of 6.5%, expected volatility factor of 100% and an expected life of five years, 1998 - expected dividend yield of 0%, risk-free interest rate of 5.5%, expected volatility factor of 80% and an expected life of five years; 1997 - - expected dividend yield of 0%, risk-free interest rate of 5.5%, expected volatility factor of 80% and an expected life of five years. Since the Company applies APB 25 in accounting for its plans, no compensation cost has been recognized for its stock options in the financial statements. Had the Company recorded compensation cost based on the fair value at the grant date for its stock options under SFAS 123, the Company's net earnings (loss) and earnings (loss) per common share would have been reduced by the proforma amounts indicated below (in thousands except for per share data):
1999 1998 1997 ------ ------ ------ Net earnings (loss) $ 517 $1,767 $5,338 Basic earnings (loss) per common share $ 0.04 $ 0.15 $ 0.46 Diluted earnings (loss) per common share $ 0.04 $ 0.15 $ 0.46
Pro forma net earnings (loss) reflect only options granted subsequent to 1995. Therefore, the full impact of calculating compensation cost for stock options under SFAS 123 is not reflected in the pro forma net earnings (loss) amounts presented above because compensation costs are reflected over the options' vesting period of five years for the 1999, 1998 and 1997 options. NOTE I -- BENEFIT PLAN The Company established a 401(k) Profit Sharing Plan (the "Plan") which allows qualifying employees electing participation to defer a portion of their income on a pretax basis through contributions to the Plan. For each dollar of employee contributions, the Company makes a discretionary percentage matching contribution to the Plan. In addition, eligible employees share in any additional discretionary contributions which are based upon the profitability of the 34 35 Company. All contributions made by the Company are determined by the Company's Board of Directors. For the Plan year ended December 31, 1999, the approved matching percentage is 35% up to a maximum of $1,750 per employee. Expense recognized for the Company's contributions to the plan amounted to $177,000, $130,000 and $120,000 in 1999, 1998, and 1997, respectively. NOTE J - PROFESSIONAL AND LIABILITY INSURANCE With respect to professional and general liability risks, the Company currently maintains an insurance policy that provides coverage during the policy period ending August 1, 2000, on a claims-made basis, for $1,000,000 per claim in excess of the Company retaining $25,000 per claim, and $3,000,000 in the aggregate. Costs of defending claims are in addition to the limit of liability. In addition, the Company maintains a $10,000,000 umbrella policy with respect to potential professional and general liability claims. Since inception, the Company has incurred no professional or general liability losses. As of December 31, 1999 the Company was not aware of any pending professional or general liability claims that would have a material adverse effect on the Company's financial condition or results of operations. NOTE K - SEGMENT INFORMATION The Company's reportable segments are strategic business units that offer different services. The Company has three reportable segments: IMPACT Services, Physician Practice Management and Cancer Research Services. The IMPACT Services segment provides stem cell supported high dose chemotherapy and other advanced cancer treatment services under the direction of practicing oncologists and pharmacy management services for certain medical oncology practices through IMPACT Center pharmacies. The Physician Practice Management segment owns the assets of and manages oncology practices. The Cancer Research Services segment conducts clinical cancer research on behalf of pharmaceutical manufacturers. The accounting policies of the segments are the same as those described in the summary of significant accounting policies except that the Company does not allocate interest expense, taxes or corporate overhead to the individual segments. The Company evaluates performance based on profit or loss from operations before income taxes and unallocated amounts. 35 36 (In thousands)
Physician IMPACT Practice Cancer Research Services Management Services Total -------- ---------- --------------- -------- For the year ended December 31, 1999: Net revenue $ 65,709 $ 68,413 $ 1,445 $135,567 Total operating expenses 59,120 59,280 1,438 119,838 Impairment of management service agreements and associated assets -- 1,840 -- 1,840 -------- -------- -------- -------- Segment contribution 6,589 7,293 7 13,889 Depreciation and amortization 536 3,777 -- 4,313 ======== ======== ======== ======== Segment profit $ 6,053 $ 3,516 $ 7 $ 9,576 ======== ======== ======== ======== Segment assets $ 18,448 $ 87,483 $ 1,669 $107,600 ======== ======== ======== ======== Capital expenditures $ 112 $ 741 $ -- $ 853 ======== ======== ======== ========
Physician IMPACT Practice Cancer Research Services Management Services Total -------- ---------- --------------- -------- For the year ended December 31, 1998: Net revenue $ 64,806 $ 59,527 $ 3,913 $ 128,246 Total operating expenses 53,806 53,570 2,059 109,435 Impairment of management service agreements and associated assets -- 24,877 -- 24,877 --------- --------- -------- --------- Segment contribution 11,000 (18,920) 1,854 (6,066) Depreciation and amortization 921 4,208 -- 5,129 ========= ========= ======== ========= Segment profit (loss) $ 10,079 ($ 23,128) $ 1,854 $ (11,195) ========= ========= ======== ========= Segment assets $ 26,448 $ 91,291 $ 2,279 $ 120,018 ========= ========= ======== ========= Capital expenditures $ 340 $ 2,711 $ 18 $ 3,069 ========= ========= ======== =========
Physician IMPACT Practice Cancer Research Services Management Services Total -------- ---------- --------------- -------- For the year ended December 31, 1997: Net revenue $ 52,551 $ 46,476 $ 2,893 $101,920 Total operating expenses 42,596 37,918 1,217 81,731 -------- -------- -------- -------- Segment contribution 9,955 8,558 1,676 20,189 Depreciation and amortization 1,610 2,950 -- 4,560 ======== ======== ======== ======== Segment profit $ 8,345 $ 5,608 $ 1,676 $ 15,629 ======== ======== ======== ======== Segment assets $ 19,850 $120,719 $ 1,493 $142,062 ======== ======== ======== ======== Capital expenditures $ 221 $ 676 $ 11 $ 908 ======== ======== ======== ========
Reconciliation of profit (loss):
Years Ended ------------------------------------------ 1999 1998 1997 -------- -------- -------- Segment profit (loss) $ 9,576 ($11,195) $ 15,629 Unallocated amounts: Corporate general and administrative 7,755 7,980 5,582 Corporate depreciation and amortization 195 450 144 Corporate interest expense 3,074 2,946 3,125 -------- -------- -------- Earnings (loss) before income taxes ($ 1,448) ($22,571) $ 6,778 ======== ======== ========
36 37 Reconciliation of consolidated assets:
Years Ended ------------------------------------------ 1999 1998 1997 -------- -------- -------- Segment assets $107,600 $120,018 $142,062 Unallocated amounts: Cash and cash equivalents 7,195 1,083 2,425 Prepaid expenses and other assets 3,966 4,782 3,644 Property and equipment, net 884 870 944 -------- -------- -------- Consolidated assets $119,645 $126,753 $149,075 ======== ======== ========
37 38 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES (Dollar amounts in thousands)
Col A Col B Col C - Additions Col D Col E -------------- ------------ ---------------------------- ----------- ------------- Charged to Balance at Charged to Other Deductions Beginning of Costs and Accounts - - Describe Balance at Classification Period Expenses Describe (1) End of Period --------------- ------------ ---------- ----------- ----------- ------------- Year ended December 31, 1999: Deducted from asset accounts: Allowance for doubtful accounts - accounts receivable $2,772 $2,625 $2,765 $2,632 ====== ====== ====== ====== Year ended December 31, 1998: Deducted from asset accounts: Allowance for doubtful accounts - accounts receivable $3,130 $2,947 $3,305 $2,772 ====== ====== ====== ====== Year ended December 31, 1997: Deducted from asset accounts: Allowance for doubtful accounts - accounts receivable $1,774 $1,529 $ 173 $3,130 ====== ====== ====== ======
(1) Accounts written off, net of recoveries 38 EX-10.R 2 FIRST AMENDMENT TO CREDIT AGREEMENT 1 Exhibit 10(r) FIRST AMENDMENT TO CREDIT AGREEMENT THIS AMENDMENT TO CREDIT AGREEMENT dated as of September 30, 1999 ("this Amendment") is entered into by RESPONSE ONCOLOGY, INC., a Tennessee corporation ("Response"), RESPONSE ONCOLOGY MANAGEMENT OF SOUTH FLORIDA, INC., a Tennessee corporation ("Management"), RESPONSE ONCOLOGY OF TAMARAC, INC., a Florida corporation ("Tamarac") and RESPONSE ONCOLOGY OF FORT LAUDERDALE, INC., a Florida corporation ("Fort Lauderdale"; Response, Management, Tamarac and Fort Lauderdale are sometimes together referred to as the "Borrowers"), AMSOUTH BANK, an Alabama banking corporation ("AmSouth"), UNION PLANTERS BANK NATIONAL ASSOCIATION, a national banking association ("UP"), and BANK OF AMERICA, N.A., a national banking association and formerly known as NationsBank, N.A. (collectively, the "Lenders"), and AMSOUTH BANK, an Alabama banking corporation, as agent for the Lenders (the "Agent"). Recitals A. The Borrowers, the Agent and the Lenders are parties to that certain Credit Agreement dated as of June 10, 1999 (the "Agreement") pursuant to which the Lenders have made available to the Borrowers (i) a revolving credit facility in an aggregate principal amount outstanding not to exceed $7,000,000, and (ii) a term loan facility in the principal amount of $35,000,000. B. The Borrowers have applied to the Lenders for modifications to certain provisions of the Agreement. C. The Lenders are willing to make such modification as requested only if, among other things, the Borrowers enter into this Amendment. Agreement NOW, THEREFORE, in consideration of the foregoing Recitals, the Borrowers, the Lenders and the Agent hereby agree as follows: 1. Capitalized terms used in this Amendment and not otherwise defined herein have the respective meanings attributed thereto in the Agreement. 2. The definition of "Applicable Commitment Fee." "Applicable LIBO Rate Margin," and "Applicable Prime Rate Margin" shall be amended to read, in its entirety, as follows: "Applicable Commitment Fee," "Applicable LIBO Rate Margin," and "Applicable Prime Rate Margin" mean, with respect to any Loan and the commitment 1 2 fee respecting the Revolving Credit Loan, during any Effective Period, the percentage rate per annum set forth below: Prime Rate LIBOR Commitment Fee Margin Margin in Basis Points 1.00% 3.25% 62.5 bps 3. The reference in Section 2.1 of the Agreement to "$7,000,000" shall be amended to read "$6,000,000". 4. The repayment grid set forth in Section 2.10 of the Agreement is hereby amended to read, in its entirety, as follows: Date Quarterly Payment ---- ----------------- July 1, 1999 1,250,000 October 1, 1999 1,250,000 November 15, 1999 416,667 December 1, 1999 416,667 January 1, 2000 416,667 April 1, 2000 1,250,000 July 1, 2000 1,500,000 October 1, 2000 1,500,000 January 1, 2001 1,500,000 April 1, 2001 1,500,000 July 1, 2001 1,500,000 October 1, 2001 1,500,000 January 1, 2002 1,500,000 April 1, 2002 1,500,000 June 10, 2002 Balance Due in Full 5. The "Revolving Credit Commitment" for AmSouth and UP is hereby amended as set forth on the attached signature page for such financial institution. 6. Section 6.1.7 of the Agreement is hereby amended to read, in its entirety, as follows: 6.1.7 Purchase Money Debt. Purchase Money Debt, including Assumed Debt, existing on the date of this Amendment and set forth on Schedule 6.1.7 attached hereto. 2 3 7. Section 6.11 of the Agreement is hereby amended to read, in its entirety, as follows: 6.11 Advances. No Consolidated Entities shall extend any loans to any other Persons except for the loans (including Provider Loans) existing on the date of this Agreement and set forth on Schedule 6.11 attached hereto. 8. Section 7.2 of the Agreement is hereby amended to read, in its entirety, as follows: 7.2 Total Funded Debt to Consolidated EBITDA. Borrower shall maintain a ratio of Total Funded Debt divided by Consolidated EBITDA, measured as of the end of each fiscal quarter for the previous four consecutive fiscal quarters, of no greater than 4.0:1.0 through the fiscal quarter ending September 30, 1999, of no greater than 4.25:1.0 through the fiscal quarter ended December 31, 1999 and of no greater than 3.00:1.00 thereafter. 9. Section 7.5 of the Agreement is hereby amended to read, in its entirety, as follows: 7.5 Capital Expenditures. Borrower shall not incur Capital Expenditures for any fiscal year without the prior written consent of the Lenders, other than those Capital Expenditures listed on Exhibit A. 10. The Lenders agree to waive (a) the failure by the Borrowers to comply with the financial covenants set forth in Sections 7.3 and 7.4 for the fiscal quarters ending September 30, 1999 and December 31, 1999 and (b) any and all Defaults, Events of Default and remedies the Lenders and Agent may have that arise from Borrowers' failure to comply with the above-referenced financial covenants. 11. The following Section 7.7 is hereby added to the Agreement and shall read as follows: 7.7 Minimum EBITDA. EBITDA for the Borrower shall not be less than (a) $1,464,000 for the three months ending September 30, 1999, (b) $500,000 for the months of October, November and December, 1999, provided, however, any excess EBITDA above the minimum set forth in this subparagraph (b) may be carried forward to the next succeeding month for October, November and December so long as EBITDA for the three months ending December 31, 1999 exceeds $1,500,000, and (c) $600,000 for the months of January, February and March, 2000; provided, however, any excess EBITDA above the minimum set forth in this subparagraph (c) may be carried forward to the next succeeding month for January, February and March so long as EBITDA for the three months ending March 31, 2000 exceeds $1,800,000. 12. Section 8.1.1 of the Agreement is hereby amended to read, in its entirety, as follows: 3 4 8.1.1 Payments. Borrowers' failure to make payment of any amount of the Obligations. 13. Section 8.1.5 of the Agreement is hereby amended to read, in its entirety, as follows: 8.1.5 Reporting Requirements. The failure of Borrowers or any other party to timely perform any covenant in the Credit Documents requiring the furnishing of notices, financing reports or other information to Lenders; and provided, however, that during any period of time that a report is delinquent, Agent may at its option increase the Pricing Values to their highest levels permitted under this Agreement. 14. As consideration for the Lenders' agreement to make the modification set forth in this Amendment, the Borrowers shall pay a fee in the amount of $19,250 to the Agent for the account of each of the Lenders. This fee shall be due and payable upon the execution of this Amendment and shall be fully earned and non-refundable. 15. Notwithstanding the execution of this Amendment, all of the indebtedness evidenced by each of the Notes shall remain in full force and effect, as modified hereby, and nothing contained in this Amendment shall be construed to constitute a novation of the indebtedness evidenced by any of the Notes or to release, satisfy, discharge, terminate or otherwise affect or impair in any manner whatsoever (a) the validity or enforceability of the indebtedness evidenced by any of the Notes; (b) the liens, security interests, assignments and conveyances affected by the Agreement or the Loan Documents, or the priority thereof; (c) the liability of any maker, endorser, surety, guarantor or other person that may now or hereafter be liable under or on account of any of the Notes or the Agreement or the Loan Documents; or (d) any other security or instrument now or hereafter held by the Agent or the Lenders as security for or as evidence of any of the above-described indebtedness. 16. All references in the Loan Documents to "Credit Agreement" shall refer to the Agreement as amended by this Amendment, and as the Agreement may be further amended from time to time. 17. The Borrowers hereby certify that the organizational documents of the Borrowers have not been amended since June 10, 1999. 18. The Borrowers hereby represent and warrant to the Agent and the Lenders that all representations and warranties contained in the Agreement are true and correct as of the date hereof, and the Borrowers hereby certify that no Event of Default nor any event that, upon notice or lapse of time or both, would constitute an Event of Default, has occurred and is continuing. 19. Except as hereby amended, the Agreement shall remain in full force and effect as written. This Amendment may be executed in one or more counterparts, each of which shall be deemed an original, and all of which when taken together shall constitute one and the same instrument. The covenants and agreements contained in this Amendment shall apply to and inure 4 5 to the benefit of and be binding upon the parties hereto and their respective successors and permitted assigns. 20. Nothing contained herein shall be construed as a waiver, acknowledgment or consent to any breach of or Event of Default under the Agreement and the Loan Documents not specifically mentioned herein. 21. This Amendment shall be governed by the laws of the State of Alabama. [Remainder of this page intentionally blank] 5 6 IN WITNESS WHEREOF, each of the Borrowers, the Lenders and the Agent has caused this Amendment to be executed and delivered by its duly authorized corporate officer as of the day and year first above written. RESPONSE ONCOLOGY, INC. By: /s/ ----------------------------------- Its: CFO RESPONSE ONCOLOGY MANAGEMENT OF SOUTH FLORIDA, INC. By: /s/ ----------------------------------- Its: CFO RESPONSE ONCOLOGY OF TAMARAC, INC. By: /s/ ----------------------------------- Its: CFO RESPONSE ONCOLOGY OF FORT LAUDERDALE, INC. By: /s/ ----------------------------------- Its: CFO 6 7 AMSOUTH BANK By: /s/ ----------------------------------- Its: Vice President Revolving Credit Commitment: $3,692,400 UNION PLANTERS BANK NATIONAL ASSOCIATION By: /s/ ----------------------------------- Its: Vice President Revolving Credit Commitment: $2,307,600 BANK OF AMERICA, N.A. (formerly known as NationsBank, N.A.) By: /s/ ----------------------------------- Its: Senior Vice President AMSOUTH BANK, as Agent By: /s/ ----------------------------------- Its: Vice President 7 8 RESPONSE ONCOLOGY, INC. CAPITAL EXPENDITURES Through January 31, 2000 Exhibit A
LOCATION DESCRIPTION AMOUNT -------- ----------- -------- Oncology & Hematology Consultants, PLLC Chemistry Analyzer $ 57,000 Hematology Oncology Associates of the Treasure Coast PA Server 4,000 J. Paonessa, M.D., PA Satellite Office Build Out 20,350 J. Paonessa, M.D., PA Server/PC's/Cabling 22,233 J. Paonessa, M.D., PA Medical Manager Software/Installation 22,935 Oncology & Hematology Group of South Florida, PA AVI Pumps (14 Refurbished) 4,550 Oncology & Hematology Group of South Florida, PA Computers(3) 3,000 IMPACT Center of Hollywood CBC Analyzer 18,500 IMPACT Center of Lehigh Valley iMac/Router 2,500 IMPACT Center of Youngstown iMac/Router 2,500 IMPACT Center of St. Joseph iMac/Router 2,500 IMPACT Center of Colorado Springs iMac/Router 2,500 IMPACT Center of Pensacola iMac/Router 2,500 IMPACT Center of Albuquerque iMac/Router 2,500 Tampa Pharmacy iMac/Router 2,500 Bayonne Hospital iMac/Router 2,500 Mercy Hospital Cancer Center iMac/Router 2,500 North Shore Hematology Oncology iMac/Router 2,500 IMPACT Center of Washington iMac/Router 2,500 IMPACT Center of Little Rock iMac/Router 2,500 IMPACT Center of Nashville iMac 1,000 Corporate Notebook/Docking Station 3,300 Corporate PC's(3) 3,000 -------- Total $189,868 ========
EX-11 3 STATEMENT REGUARDING COMPUTATION PER SHARE EARNING 1 EXHIBIT 11 STATEMENT RE: COMPUTATION OF DILUTED COMMON EARNINGS (LOSS) PER SHARE (In thousands)
Years Ended December 31, ------------------------------------------- 1999 1998 1997 -------- -------- -------- Weighted average number of shares 12,014 12,039 11,506 Net effect of dilutive stock options and warrants based on the treasury stock method (1) -- -- 156 -------- -------- -------- Weighted average number of common shares and common stock equivalents 12,014 12,039 11,662 -------- -------- -------- Net earnings (loss) $ (1,693) $(17,448) $ 4,202 Common stock dividend to preferred shareholders (2) (2) (3) (3) -------- -------- -------- Net earnings (loss) to common stockholders $ (1,695) $(17,451) $ 4,199 ======== ======== ======== Diluted earnings (loss) per share amount (3) $ (0.14) $ (1.45) $ 0.36 ======== ======== ========
(1) Stock options and warrants are excluded from the weighted average number of common shares due to their anti-dilutive effect. (2) In December 1999, 1998, and 1997, the Board of Directors approved a Common Stock dividend of 183, 293 and 306 shares to the stockholders of record of Series A Convertible Preferred Stock as of December 15, 1999, 1998, and 1997 that was paid January 2000, 1999, and 1998 respectively. The market value of the common stock distributed was approximately $2,000 at December 15, 1999 and $3,000 at December 15, 1998 and 1997. (3) The assumed conversion of the preferred stock would have an immaterial effect (less than 1/10 of $.01) in all periods, and therefore that calculation has been omitted. EX-21 4 LIST OF SUBSIDIARIES 1 EXHIBIT 21 LIST OF SUBSIDIARIES Company State of Organization - ------- --------------------- IMPACT Center of Albany, LLC Tennessee IMPACT Center of Bayonne, LLC New Jersey IMPACT Center of Billings, LLC Montana IMPACT Center of Fort Smith, LLC Tennessee IMPACT Center of Glendale, LLC Tennessee IMPACT Center of Mobile, LLC Tennessee IMPACT Center of Mt. Diablo, LLC Tennessee IMPACT Center of Northridge, LLC Tennessee IMPACT Center of St. Johns, LLC Tennessee IMPACT Center of Tri-City Medical Center, LLC Tennessee IMPACT Center of Washington, D.C., LLC Tennessee Response Oncology of Fort Lauderdale, Inc. Florida Response Oncology of Tamarac, Inc. Florida Response Oncology Management of South Florida, Inc. Tennessee EX-23 5 CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23 ACCOUNTANTS' CONSENT The Board of Directors Response Oncology, Inc.: We consent to incorporation by reference in the Registration Statement (No. 33-45616) on Form S-8, the Registration Statement (NO. 33-21333) on Form S-8 and the Registration Statement (No. 333-14371) on Form S-8 of Response Oncology, Inc. of our report dated March 10, 2000, except as to the fourth Paragraph of Note E, which is as of March 30, 2000, relating to the consolidated balance sheets of Response Oncology, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1999, and the related schedule, which report appears in the December 31, 1999, annual report on Form 10-K of Response Oncology, Inc. KPMG LLP Memphis, Tennessee March 30, 2000 EX-27 6 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 7,195 0 18,639 2,632 3,485 48,463 16,588 12,366 119,645 25,117 0 0 17 123 47,637 119,645 135,567 135,567 80,210 136,315 0 2,625 3,305 (1,448) 245 (1,693) 0 0 0 (1,693) (.14) (.14)
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