10-Q 1 e10-q.txt RESPONSE ONCOLOGY 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) (X) Quarterly report pursuant to Section 13 or 15(d) of the Securities --- Exchange Act of 1934 For the quarterly period ended June 30, 2000 or Transition report pursuant to Section 13 or 15(d) of the Securities --- Exchange Act of 1934 For the transition period from to --------- Commission file number 0-15416 --------- RESPONSE ONCOLOGY, INC. ----------------------- (Exact name of registrant as specified in its charter) Tennessee 62-1212264 --------- ---------- (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 1805 Moriah Woods Blvd., Memphis, TN 38117 ------------------------------------ ----- (Address of principal executive offices) (Zip Code) (901) 761-7000 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $.01 Par Value, 12,290,406 shares as of August 8, 2000. 2 INDEX
PART I. FINANCIAL INFORMATION Item 1. Financial Statements Page Consolidated Balance Sheets, June 30, 2000 and December 31, 1999------------------------------- 3 Consolidated Statements of Operations for the Three Months Ended June 30, 2000 and June 30, 1999----------------------------------- 4 Consolidated Statements of Operations for the Six Months Ended June 30, 2000 and June 30, 1999------------------------------------------------- 5 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2000 and June 30, 1999 ---------------------------------- 6 Notes to Consolidated Financial Statements---------------------------------------------- 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations---------------------------------------------------- 13 Item 3. Quantitative and Qualitative Disclosures About Market Risk ----------------------------------------------- 19 PART II. OTHER INFORMATION Item 1. Legal Proceedings------------------------------------------------ 20 Item 2. Changes in Securities and Use of Proceeds------------------------ 20 Item 3. Defaults Upon Senior Securities---------------------------------- 20 Item 4. Submission of Matters to a Vote of Security Holders-------------- 20 Item 5. Other Information------------------------------------------------ 21 Item 6. Exhibits and Reports on Form 8-K -------------------------------- 21 Signatures ----------------------------------------------------------------- 22
- 2 - 3 PART I - FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollar amounts in thousands except for share data)
June 30, 2000 December 31, 1999 (Unaudited) (Note 1) ------------- ----------------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 6,777 $ 7,195 Accounts receivable, less allowance for doubtful accounts of $2,597 and $2,632 16,164 16,007 Pharmaceuticals and supplies 3,519 3,485 Prepaid expenses and other current assets 3,845 4,778 Due from affiliated physician groups 16,926 16,884 Deferred income taxes 344 114 --------- --------- TOTAL CURRENT ASSETS 47,575 48,463 Property and equipment, less accumulated depreciation and amortization of $13,093 and $12,366 3,927 4,222 Deferred charges, less accumulated amortization of $190 and $86 287 380 Management service agreements, less accumulated amortization of $9,645 and $8,206 63,891 66,113 Other assets 513 467 --------- --------- TOTAL ASSETS $ 116,193 $ 119,645 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 15,648 $ 15,665 Accrued expenses and other liabilities 4,060 5,440 Current portion of notes payable 36,262 3,745 Current portion of capital lease obligations 268 267 --------- --------- TOTAL CURRENT LIABILITIES 56,238 25,117 Notes payable, less current portion 1,292 35,445 Capital lease obligations, less current portion 444 580 Deferred income taxes 9,512 9,802 Minority interest 1,314 924 STOCKHOLDERS' EQUITY Series A convertible preferred stock, $1.00 par value (aggregate involuntary liquidation preference $183) authorized 3,000,000 shares; issued and outstanding 16,631 shares at each period end 17 17 Common stock, $.01 par value, authorized 30,000,000 shares; issued and outstanding 12,290,406 and 12,270,406 shares, respectively 123 123 Paid-in capital 102,011 101,979 Accumulated deficit (54,758) (54,342) --------- --------- 47,393 47,777 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 116,193 $ 119,645 ========= =========
See accompanying notes to consolidated financial statements. - 3 - 4 RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Dollar amounts in thousands except for share data)
Three Months Ended ------------------------------- June 30, June 30, 2000 1999 ------------ ------------ NET REVENUE $ 34,639 $ 34,053 COSTS AND EXPENSES Salaries and benefits 5,310 6,442 Pharmaceuticals and supplies 23,901 19,756 Other operating costs 2,192 2,691 General and administrative 1,240 1,687 Depreciation and amortization 1,147 1,119 Interest 830 843 Provision for doubtful accounts 76 504 ------------ ------------ 34,696 33,042 ------------ ------------ EARNINGS (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST (57) 1,011 Minority owners' share of net earnings (135) (274) ------------ ------------ EARNINGS (LOSS) BEFORE INCOME TAXES (192) 737 Income tax provision (benefit) (69) 280 ------------ ------------ NET EARNINGS (LOSS) $ (123) $ 457 ============ ============ EARNINGS (LOSS) PER COMMON SHARE: Basic $ (0.01) $ 0.04 ============ ============ Diluted $ (0.01) $ 0.04 ============ ============ Weighted average number of common shares: Basic 12,290,406 11,931,731 ============ ============ Diluted 12,290,406 11,961,986 ============ ============
See accompanying notes to consolidated financial statements. - 4 - 5 RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Dollar amounts in thousands except for share data)
Six Months Ended ------------------------------- June 30, June 30, 2000 1999 ------------ ------------ NET REVENUE $ 70,225 $ 70,362 COSTS AND EXPENSES Salaries and benefits 10,823 13,008 Pharmaceuticals and supplies 48,067 40,243 Other operating costs 4,670 6,120 General and administrative 2,714 3,368 Depreciation and amortization 2,283 2,236 Interest 1,657 1,706 Provision for doubtful accounts 286 695 ------------ ------------ 70,500 67,376 ------------ ------------ EARNINGS (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST (275) 2,986 Minority owners' share of net earnings (390) (386) ------------ ------------ EARNINGS (LOSS) BEFORE INCOME TAXES (665) 2,600 Income tax provision (benefit) (249) 988 ------------ ------------ NET EARNINGS (LOSS) $ (416) $ 1,612 ============ ============ EARNINGS (LOSS) PER COMMON SHARE: Basic $ (0.03) $ 0.13 ============ ============ Diluted $ (0.03) $ 0.13 ============ ============ Weighted average number of common shares: Basic 12,286,272 11,990,206 ============ ============ Diluted 12,286,272 12,023,887 ============ ============
See accompanying notes to consolidated financial statements. - 5 - 6 RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Dollar amounts in thousands)
Six Months Ended ---------------------- June 30, June 30, 2000 1999 ----------- --------- OPERATING ACTIVITIES Net earnings (loss) $ (416) $ 1,612 Adjustments to reconcile net earnings (loss) to net cash provided by operating activities: Depreciation and amortization 2,283 2,236 Deferred income taxes (249) -- Provision for doubtful accounts 286 695 Gain on sale of property and equipment (31) -- Minority owners' share of net earnings 390 386 Changes in operating assets and liabilities: Accounts receivable (444) 1,562 Pharmaceuticals and supplies, prepaid expenses and other current assets 894 1,296 Deferred charges and other assets 41 54 Due from affiliated physician groups (457) (179) Accounts payable and accrued expenses (595) (2,226) ------- ------- NET CASH PROVIDED BY OPERATING ACTIVITIES 1,702 5,436 INVESTING ACTIVITIES Proceeds from sale of property and equipment 36 -- Purchase of equipment (496) (500) ------- ------- NET CASH USED IN INVESTING ACTIVITIES (460) (500) FINANCING ACTIVITIES Proceeds from exercise of stock options 32 -- Distributions to joint venture partners -- (353) Financing costs incurred -- (416) Principal payments on notes payable (1,557) (1,136) Principal payments on capital lease obligations (135) (166) ------- ------- NET CASH USED IN FINANCING ACTIVITIES (1,660) (2,071) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (418) 2,865 Cash and cash equivalents at beginning of period 7,195 1,083 ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 6,777 $ 3,948 ======= =======
See accompanying notes to consolidated financial statements. - 6 - 7 RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2000 NOTE 1 -- BASIS OF PRESENTATION The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required for complete financial statements by generally accepted accounting principles. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2000 are not necessarily indicative of the results that may be expected for the year ending December 31, 2000. For further information, refer to the consolidated financial statements and footnotes thereto included in Response Oncology, Inc. and Subsidiaries' (the "Company's") annual report on Form 10-K for the year ended December 31, 1999. Net Revenue: The Company's net patient service revenue includes charges to patients, insurers, government programs and other third-party payers for medical services provided. Such amounts are recorded net of contractual adjustments and other uncollectible amounts. Contractual adjustments result from the differences between the amounts charged for services performed and the amounts allowed by government programs and other public and private insurers. The Company's revenue from practice management affiliations includes a fee equal to practice operating expenses incurred by the Company (which excludes expenses that are the obligation of the physicians, such as physician salaries and benefits) 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 upon the Company's contracts with certain pharmaceutical manufacturers to manage clinical trials and is generally measured on a per patient basis for monitoring and collection of data. The following table is a summary of net revenue by source for the respective three and six-month periods ended June 30, 2000 and 1999.
Three Months Ended Six Months Ended (In Thousands) June 30, June 30, --------------------- -------------------- 2000 1999 2000 1999 ------- ------- ------- ------- Net patient service revenue $ 3,627 $ 7,778 $ 8,260 $15,927 Practice management service fees 19,210 16,712 39,203 34,301 Pharmaceutical sales to physicians 11,637 9,361 22,418 19,105 Clinical research revenue 165 202 344 1,029 ------- ------- ------- ------- $34,639 $34,053 $70,225 $70,362 ======= ======= ======= =======
Revenue is recognized when earned. Sales and related cost of sales are generally recognized upon delivery of goods or performance of services. - 7 - 8 Net Earnings (Loss) Per Common Share: A reconciliation of the basic earnings (loss) per share and the diluted earnings (loss) per share computation is presented below for the three and six-month periods ended June 30, 2000 and 1999. (Dollar amounts in thousands except per share data)
Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ----------------------------- 2000 1999 2000 1999 ----------- ----------- ---------- ---------- Weighted average shares outstanding 12,290,406 11,931,731 12,286,272 11,990,206 Net effect of dilutive stock options and warrants based on the treasury stock method --(A) 30,255 --(A) 33,681 ---------- ----------- ---------- ----------- Weighted average shares and common stock equivalents 12,290,406 11,961,986 12,286,272 12,023,887 ========== =========== ========== =========== Net earnings (loss) $ (123) $ 457 $ (416) $ 1,612 ========== =========== ========== =========== Diluted per share amount $ (0.01) $ 0.04 $ (0.03) $ 0.13 ========== =========== ========== ===========
(A) Stock options and warrants are excluded from the weighted average number of common shares due to their anti-dilutive effect. NOTE 2 -- NOTES PAYABLE The terms of the Company's original lending agreement provided for 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 June 30, 2000, $35.2 million aggregate principal was outstanding under the Credit Facility with a current interest rate of approximately 9.8%. The Company is subject to certain affirmative and negative covenants which, among other things, require the Company to maintain certain financal ratios, including minimum fixed charge coverage, funded debt to EBITDA and minimum net worth. 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 minumum 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 - 8 - 9 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. Furthermore, in light of the uncertainty surrounding the clinical data relative to the treatment of breast cancer with high dose chemotherapy and the termination of certain pharmaceutical sales contracts, there can be no assurance that the Company will remain in compliance with the terms of the Credit Facility, as amended. In such event, the Company would be required to obtain waivers relative to the covenant violations or renegotiate certain terms of the Credit Facility. 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 hedged $18.0 million under the terms of the Swap Agreement. The Swap Agreement matured on July 1, 2000. In June 2000, the Company entered into a new Swap Agreement effective July 1, 2000 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 7.24% and the ninety-day LIBOR rate and are settled quarterly. The Company has hedged $17.0 million under the terms of the Swap Agreement. The Swap Agreement matures on July 1, 2001. 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 $16.97. NOTE 3 -- INCOME TAXES Upon the consummation of the physician practice management affiliations, the Company recognized deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of purchased assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. NOTE 4 -- COMMITMENTS AND CONTINGENCIES 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, 2001, 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 and as of June 30, 2000, 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 5 -- DUE FROM AFFILIATED PHYSICIANS Due from affiliated physicians consists of management fees earned and due pursuant to the management service agreements ("Service Agreements"). In addition, the Company may also fund certain working capital needs of the affiliated physicians from time to time. - 9 - 10 NOTE 6 -- 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 as well as compounding and dispensing pharmaceuticals to certain medical oncology practices. 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 in the Company's annual audited consolidated financial statements 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. The totals per the schedules below will not and should not agree to the consolidated totals. The differences are due to corporate overhead and other unallocated amounts which are reflected in the reconciliation to consolidated earnings (loss) before income taxes. (In thousands)
Physician IMPACT Practice Cancer Research Services Management Services Total -------- ---------- -------- ----- For the three months ended June 30, 2000: Net revenue $15,264 $19,210 $ 165 $ 34,639 Total operating expenses 14,763 16,524 156 31,443 ------- ------- ------ -------- Segment contribution 501 2,686 9 3,196 Depreciation and amortization 104 987 -- 1,091 ------- ------- ------ -------- Segment profit $ 397 $ 1,699 $ 9 $ 2,105 ======= ======= ====== ======== Segment assets $19,006 $85,210 $1,210 $105,426 ======= ======= ====== ======== Capital expenditures $ 141 $ 98 -- $ 239 ======= ======= ====== ======== Physician IMPACT Practice Cancer Research Services Management Services Total -------- ---------- -------- ----- For the three months ended June 30, 1999: Net revenue $17,139 $16,712 $ 202 $ 34,053 Total operating expenses 14,980 14,282 263 29,525 ------- ------- ------- -------- Segment contribution (loss) 2,159 2,430 (61) 4,528 Depreciation and amortization 135 934 -- 1,069 ------- ------- ------ -------- Segment profit (loss) $ 2,024 $ 1,496 $ (61) $ 3,459 ======= ======= ======= ======== Segment assets $23,281 $88,182 $ 2,521 $113,984 ======= ======= ======= ======== Capital expenditures $ 116 $ 36 -- $ 152 ======= ======= ======= ========
- 10 - 11 Reconciliation of consolidated earnings (loss) before income taxes:
2000 1999 ------- ------- Segment profit $ 2,105 $ 3,459 Unallocated amounts: Corporate salaries, general and administrative 1,411 1,883 Corporate depreciation and amortization 57 51 Corporate interest expense 829 788 ------- ------- Earnings (loss) before income taxes $ (192) $ 737 ======= =======
(In thousands)
Physician IMPACT Practice Cancer Research Services Management Services Total -------- ---------- -------- ----- For the six months ended June 30, 2000: Net revenue $30,678 $39,203 $ 344 $ 70,225 Total operating expenses 29,402 34,038 337 63,777 ------- ------- ------ -------- Segment contribution 1,276 5,165 7 6,448 Depreciation and amortization 197 1,974 -- 2,171 ------- ------- ------ -------- Segment profit $ 1,079 $ 3,191 $ 7 $ 4,277 ======= ======= ====== ======== Segment assets $19,006 $85,210 $1,210 $105,426 ======= ======= ====== ======== Capital expenditures $ 151 $ 270 -- $ 421 ======= ======= ====== ======== Physician IMPACT Practice Cancer Research Services Management Services Total -------- ---------- -------- ----- For the six months ended June 30, 1999: Net revenue $35,032 $34,301 $1,029 $ 70,362 Total operating expenses 30,248 29,190 779 60,217 ------- ------- ------ -------- Segment contribution 4,784 5,111 250 10,145 Depreciation and amortization 281 1,855 -- 2,136 ------- ------- ------ -------- Segment profit $ 4,503 $ 3,256 $ 250 $ 8,009 ======= ======= ====== ======== Segment assets $23,281 $88,182 $2,521 $113,984 ======= ======= ====== ======== Capital expenditures $ 146 $ 53 $ 4 $ 203 ======= ======= ====== ========
Reconciliation of consolidated earnings (loss) before income taxes:
2000 1999 ------- ------ Segment profit $ 4,277 $8,009 Unallocated amounts: Corporate salaries, general and administrative 3,182 3,657 Corporate depreciation and amortization 112 101 Corporate interest expense 1,648 1,651 ------- ------ Earnings (loss) before income taxes $ (665) $2,600 ======= ======
- 11 - 12 Reconciliation of consolidated assets:
As of June 30, -------------------------- 2000 1999 -------- -------- Segment assets $105,426 $113,984 Unallocated amounts: Cash and cash equivalents 6,777 3,948 Prepaid expenses and other assets 3,144 3,905 Property and equipment, net 846 945 -------- -------- Consolidated assets $116,193 $122,782 ======== ========
- 12 - 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW 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; compounds and dispenses pharmaceuticals to certain medical oncology practices for a fee; owns the assets of and manages the nonmedical aspects of oncology practices; and conducts clinical research on behalf of pharmaceutical manufacturers. Approximately 300 medical oncologists are associated with the Company through these programs. As of June 30, 2000, the Company's total network included 38 IMPACT Centers located in 20 states and the District of Columbia. The network consists of 22 wholly owned centers, 13 managed programs, and 3 centers owned and operated in joint venture with a host hospital. In May of 1999, the results of certain breast cancer studies were released at the meeting of the American Society of Clinical Oncology (ASCO). These studies, involving the use of high dose chemotherapy, sparked controversy among oncologists, and, in the aggregate, caused confusion among patients, third-party payers, 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 a 52% decrease in high dose procedures in the first six months of 2000 as compared to the first six months of 1999. The Company closed 12 marginal IMPACT Centers in 1999 due to decreased patient volumes and 4 additional IMPACT Centers in the first six months of 2000. 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. At the 2000 ASCO annual meeting, additional data on this topic was presented by affiliates of the Company and other researchers that indicated favorable preliminary results. Despite these results, the Company has not experienced an increase in referrals of breast cancer patients. If additional follow-up data is negative, conflicting, or inconclusive, it could result in a further decrease in high dose referrals and procedures and adversely affect the financial results of this line of business. In response to this uncertainty, the Company is evaluating new diseases that could potentially be managed through the IMPACT Center network. However, there can be no assurance that other such diseases can be identified, related treatment protocols implemented, and effectively managed through the existing network. During the first quarter of 2000, the Company decided to expand into the specialty pharmaceutical business and began to put in place certain of the resources necessary for this expansion. In this move, the Company intends to leverage its expertise and resources in the delivery of complex pharmaceuticals to cancer patients into the delivery of specialty drugs to patients with a wide range of chronic, costly and complex diseases. Specifically, this will include the distribution of new drugs with special handling requirements, and is expected to involve the use of the Company's regional network of specialized pharmaceutical centers. In addition, the Company intends to use its national network of IMPACT Centers and its highly trained healthcare professionals to administer the most fragile compounds to the expanded patient population. The Company has hired an expert consultant to assist in the development of the business plan and is in the process of recruiting a chief medical officer and director of managed care. The Company has also engaged in initial discussions with potential strategic partners. The soft launch of the specialty pharmaceutical business is expected to occur by the end of third quarter 2000. 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 - 13 - 14 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 1998 the Company recorded an impairment charge related to three under performing 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 failed over time to align physician and Company incentives, producing deteriorating returns and negative cash flows to the Company. 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 under performing net revenue model relationships. Since these were not "for cause" terminations initiated by the Company, the affiliated practices were not responsible for liquidated damages. 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 recorded a loss contingency related to the Service Agreements and associated assets in accordance with Financial Accounting Standards Board Statement - 14 - 15 No. 5 "Accounting for Contingencies". The Company terminated the second Service Agreement in April of 2000. During the second quarter of 2000, the Health Care Financing Administration ("HCFA"), which runs the Medicare program, announced its intent to overhaul pharmaceutical reimbursements. HCFA has targeted dozens of drugs, principally those used for the treatment of cancer and AIDS. More specifically, Medicare utilizes the average wholesale price ("AWP") of pharmaceuticals as the benchmark for reimbursement. It is their position that some drug companies are reporting artificially inflated AWPs to industry guides that are used for government-reimbursement purposes resulting in overpayments by Medicare and profits for physicians and other providers. This change is scheduled to take effect on October 1, 2000, but is subject to further analysis and debate. Should this change be adopted, it would have a material adverse effect on reimbursement for certain pharmaceutical products utilized by the Company's affiliated physicians in the practice management division. Consequently, the Company's management fee in its practice management relationships would be materially reduced. RESULTS OF OPERATIONS Net revenue increased 2% to $34.6 million for the quarter ended June 30, 2000, compared to $34.0 million for the quarter ended June 30, 1999. The $4.2 million, or 54%, decrease in IMPACT Center revenue was offset by a $2.3 million, or 24%, increase in pharmaceutical sales to physicians and a $2.5 million, or 15%, increase in practice management service fees. Net revenue was $70.2 million for the six months ended June 30, 2000, compared to $70.4 million for the same period in 1999. IMPACT Center revenue decreased by $7.7 million, or 48%, and clinical research revenue decreased by $.7 million, or 67%. Pharmaceutical sales to physicians increased $3.3 million, or 17%, while practice management service fees increased $4.9 million, or 14%. The decrease in high dose chemotherapy revenues continues to reflect the confusion and related pullback in breast cancer admissions resulting from the high dose chemotherapy/breast cancer study results presented at ASCO in May 1999. The increase in pharmaceutical sales to physicians is due to growth and increased drug utilization by the physicians serviced under these agreements. Clinical research revenue decreased primarily as a result of a decline in the number of research studies being conducted by the Company and a decrease in patient accruals on open studies. The Company is currently evaluating its strategy and business plan relative to standard and high dose chemotherapy clinical trials. Finally, the increase in practice management service fees is due to growth in utilization of both ancillary and non-ancillary services, and occurred despite a 5% and 12% decrease in the number of physicians under management agreements between the quarter and six months ended June 30, 2000, as compared to the same periods in 1999. On a same-physician basis, practice management service fees increased 19% and 23% for the quarter and six months ended June 30, 2000, as compared to the same periods in 1999. Salaries and benefits costs decreased $1.1 million, or 17%, from $6.4 million for the second quarter of 1999 to $5.3 million in 2000. For the six months ended June 30, salaries and benefits costs decreased $2.2 million, or 17%, from $13.0 million in 1999 to $10.8 million for the same period in 2000. The decrease is primarily due to the termination of certain Service Agreements, the modification of a Service Agreement which resulted in a change in the manner in which physician compensation is recorded, the closing of various IMPACT Centers and a reduction in corporate staffing. Pharmaceuticals and supplies expense increased $4.1 million, or 21%, and $7.9 million, or 20%, for the quarter and six months ended June 30, 2000 as compared to the same periods in 1999. The increase is primarily related to increased volume in pharmaceutical sales to physicians and greater utilization of new chemotherapy agents with higher costs in the practice management division, thus causing a decrease in the overall operating margin. Pharmaceuticals and supplies as a percent of net revenue was 69% and 58% for the quarters ending June 30, 2000 and 1999, respectively. For the six months ended June 30, 2000 and 1999, supplies and pharmaceuticals - 15 - 16 expense as a percentage of net revenue was 68% and 57%, respectively. General and administrative expenses decreased $.5 million, or 29%, from $1.7 million in the second quarter of 1999 to $1.2 million in the second quarter of 2000. For the six months ended June 30, general and administrative expenses decreased $.7 million, or 21%, from $3.4 million in 1999 to $2.7 million for the same period in 2000. The decrease is primarily due to the closure of various IMPACT Centers and the termination of certain Service Agreements. In addition, the Company terminated its Service Agreement with a single-physician practice during the second quarter of 2000. This termination resulted in the receipt of a $.2 million settlement that reduced general and administrative expenses in the second quarter of 2000. Other operating expenses decreased $.5 million, or 19%, from $2.7 million for the second quarter of 1999 to $2.2 million for the second quarter of 2000. For the six months ended June 30, other operating expenses decreased $1.4 million, or 23%, from $6.1 million in 1999 to $4.7 million for the same period in 2000. Other operating expenses consist primarily of medical director fees, purchased services related to global case rate contracts, rent expense, and other operational costs. The decrease is primarily due to the closure of various IMPACT Centers and lower purchased services and physician fees as a result of lower IMPACT and cancer research volumes as compared to the quarter and six months ended June 30, 1999. EBITDA (earnings before interest, taxes, depreciation and amortization) decreased $.9 million, or 33%, to $1.8 million for the quarter ended June 30, 2000 as compared to $2.7 million for the quarter ended June 30, 1999. For the six months ended June 30, EBITDA decreased $3.2 million, or 49%, to $3.3 million in 2000, as compared to $6.5 million for the same period in 1999. The reduction is principally due to the decrease in IMPACT Center and cancer research volumes as compared to the same periods in 1999. EBITDA from the IMPACT services segment decreased $1.7 million, or 77%, and $3.5 million, or 73%, for the quarter and six months ended June 30, 2000 as compared to the same periods in 1999. The decrease is primarily due to a decrease in breast cancer referral volumes. During the second quarter of 2000, the Company received notices of termination of pharmaceutical sales agreements from two physician practices effective July 1, 2000. The EBITDA contribution from these agreements totalled $.2 million for the six months ended June 30, 2000. While the Company is currently marketing these services to other physician practices, there can be no assurance that new agreements will be executed to replace the EBITDA contributed by the terminated agreements. EBITDA from the physician practice management segment increased 11% for the quarter ended June 30, 2000 and 1% for the six months ended June 30, 2000 as compared to the same periods in 1999. The lower increase in EBITDA for the six months ended June 30, 2000 is principally due to increases in pharmaceutical and supply costs, increases in contractual adjustments, and the termination and modification of certain Service Agreements. The increase in this division EBITDA for the second quarter of 2000 is principally due to the modification and settlement of certain Service Agreements. EBITDA from cancer research services decreased $.2 million for the six months ended June 30, 2000 as compared to the same period in 1999. The decrease is primarily due to a decline in the number of research studies being conducted by the Company and decrease in patient accruals on open studies. LIQUIDITY AND CAPITAL RESOURCES At June 30, 2000, the Company's working capital was ($8.6) million with current assets of $47.6 million and current liabilities of $56.2 million. The Company's Credit Facility matures on June 30, 2001. Consequently, the entire outstanding principal balance on the Company's Credit Facility is classified as a current liability at June 30, 2000. Cash and cash equivalents represented $6.8 million of the Company's current assets. Cash provided by operating activities was $1.7 million in the first six months of 2000 compared to $5.4 million for the same period in 1999. This decrease is largely attributable to the $.4 million net loss incurred by the Company in the first six months of 2000 as compared to $1.6 million in net earnings for the first six months of 1999. In addition, the Company has experienced a slow down of inflows from accounts receivable in the - 16 - 17 IMPACT division due to a decrease in revenue in 2000 as compared to 1999. This decrease is also due to the timing of inventory purchases and payments of accounts payable. Cash used in investing activities, principally related to the purchase of equipment, was $.5 million for both the six months ended June 30, 2000 and 1999. Cash used in financing activities was $1.7 million for the six months ended June 30, 2000 and $2.1 million for the same period in 1999. This decrease is primarily attributable to distributions to joint venture partners and financing costs incurred during the first six months of 1999, tempered by an increase in principal payments on notes payable during the first six months of 2000. The terms of the Company's original lending agreement provided for 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 June 30, 2000, $35.2 million aggregate principal was outstanding under the Credit Facility with a current interest rate of approximately 9.8%. 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 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 minumum 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. Furthermore, in light of the uncertainty surrounding the clinical data relative to the treatment of breast cancer with high dose chemotherapy and the termination of certain pharmaceutical sales contracts, there can be no assurance that the Company will remain in compliance with the terms of the Credit Facility, as amended. In such event, the Company would be required to obtain waivers relative to the covenant violations or renegotiate certain terms of the Credit Facility. 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 hedged $18.0 million under the terms of the Swap Agreement. The Swap Agreement matured on July 1, 2000. In June 2000, the Company entered into a new Swap Agreement effective July 1, 2000 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 7.24% and the ninety-day LIBOR rate and are settled quarterly. The Company has hedged $17.0 million under the terms of the Swap Agreement. The Swap Agreement matures on July 1, 2001. - 17 - 18 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 $11.50 to $16.97. The unpaid principal amount of the long-term notes was $2.3 million at June 30, 2000. 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 its 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. 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; (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. - 18 - 19 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE 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 borrowings by selecting interest periods for traunches of the Credit Facility that are more favorable to the Company 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"), effective date July 1, 2000, 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 7.24% and the ninety-day LIBOR rate and are settled quarterly. The Swap Agreement matures July 1, 2001. The Company does not enter into derivative or interest rate transactions for speculative purposes. At June 30, 2000, $35.2 million aggregate principal was outstanding under the Credit Facility with a current interest rate of approximately 9.8%. The Company does not have any other material market-sensitive financial instruments. - 19 - 20 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not applicable. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS At the annual meeting of stockholders held on June 13, 2000, the following proposals were adopted by the margins indicated: (1) To elect three directors to hold office for a term of one year until the annual meeting of stockholders in the year 2001 (Class III Directors):
Votes For Votes Withheld Abstain --------- -------------- ------- Anthony M. LaMacchia 9,666,833 74,745 2,405 W. Thomas Grant, II 9,665,789 75,789 2,405 James R. Seward 9,682,034 59,544 2,405
William H. West, M.D., Frank M. Bumstead and Leonard A. Kalman, M.D., continue serving as directors until the annual meeting of stockholders in the year 2001 (Class I Directors). P. Anthony Jacobs and Lawrence N. Kugelman continue serving as directors until the annual meeting of stockholders in the year 2001 (Class II Directors). (2) To amend the 1996 Stock Incentive Plan to authorize the issuance of an additional 500,000 shares of Common Stock.
Votes For Votes Against Abstain --------- ------------- ------- 9,383,462 299,868 60,653
(3) Ratification of selection of KMPG, LLP as the Company's independent auditors for the 2000 fiscal year.
Votes For Votes Against Abstain --------- ------------ ------- 9,652,781 9,992 81,210
- 20 - 21 ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A)EXHIBITS 10(t) Employment Agreement between Registrant and Patrick J. McDonough 10(u) Swap Agreement dated June 29, 2000 between Registrant and Bank of America, N.A. 27 Financial Data Schedule (for SEC use only) - 21 - 22 SIGNATURES Pursuant to the requirements 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/ Peter A. Stark -------------------------------------- Peter A. Stark Vice President, Finance and Principal Accounting Officer Date: August 14, 2000 By: /s/ Anthony M. LaMacchia -------------------------------------- Anthony M. LaMacchia President and Chief Executive Officer Date: August 14, 2000