-----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, GdbClHCu0qiiXozsb6IXWTjWl9a55mddvG9H/kPrAOywqpL3hLwLxuYOPnLtRIGf Lnn1teyIIBS1stTkDIBLKQ== 0000899243-02-002261.txt : 20020813 0000899243-02-002261.hdr.sgml : 20020813 20020813162622 ACCESSION NUMBER: 0000899243-02-002261 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: US ONCOLOGY INC CENTRAL INDEX KEY: 0000943061 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SPECIALTY OUTPATIENT FACILITIES, NEC [8093] IRS NUMBER: 841213501 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-26190 FILM NUMBER: 02730048 BUSINESS ADDRESS: STREET 1: 16825 NORTHCHASE DR STREET 2: STE 1300 CITY: HOUSTON STATE: TX ZIP: 77060 BUSINESS PHONE: 2818732674 FORMER COMPANY: FORMER CONFORMED NAME: AMERICAN ONCOLOGY RESOURCES INC /DE/ DATE OF NAME CHANGE: 19950327 10-Q 1 d10q.txt FORM 10-Q FOR PERIOD ENDING JUNE 30, 2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 Or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number: 0-26190 US Oncology, Inc. (Exact name of registrant as specified in its charter) Delaware 84-1213501 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 16825 Northchase Drive, Suite 1300 Houston, Texas 77060 (Address of principal executive offices) (Zip Code) (832) 601-8766 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of August 6, 2002, 91,392,420 shares of the Registrant's Common Stock were outstanding. In addition, as of August 6, 2002, the Registrant had agreed to deliver 5,396,584 shares of its Common Stock on certain future dates for no additional consideration. US ONCOLOGY, INC. FORM 10-Q JUNE 30, 2002 TABLE OF CONTENTS Page No. PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements 3 Condensed Consolidated Balance Sheet 3 Condensed Consolidated Statement of Operations and Comprehensive Income 4 Condensed Consolidated Statement of Cash Flows 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 3. Quantitative and Qualitative Disclosures about Market Risks- 30 PART II. OTHER INFORMATION Item 1. Legal Proceedings 30 Item 4. Submission of Matters to a Vote of Security Holders 31 Item 6. Exhibits and Reports on Form 8-K 32 SIGNATURES 33 2 PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS US ONCOLOGY, INC. CONDENSED CONSOLIDATED BALANCE SHEET (in thousands, except par value)
ASSETS June 30, 2002 December 31, 2001 ------------- ----------------- (unaudited) Current assets: Cash and equivalents.................................................... $ 110,323 $ 20,017 Accounts receivable .................................................... 276,161 275,884 Prepaid expenses and other current assets............................... 53,546 35,334 Due from affiliates..................................................... 47,753 57,807 ------------- ------------- Total current assets....................................... 487,783 389,042 Property and equipment, net.................................................. 280,515 286,218 Management service agreements, net........................................... 331,054 379,249 Deferred income taxes........................................................ 15,297 18,085 Other assets................................................................. 26,077 20,368 ------------- ------------- $ 1,140,726 $ 1,092,962 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term indebtedness............................ $ 23,268 $ 44,040 Accounts payable........................................................ 150,918 135,570 Due to affiliates....................................................... 12,348 13,537 Accrued compensation cost............................................... 16,478 15,455 Income taxes payable.................................................... 15,121 22,498 Other accrued liabilities............................................... 45,056 47,201 ------------- ------------- Total current liabilities.................................. 263,189 278,301 Long-term indebtedness....................................................... 212,443 128,826 ------------- ------------- Total liabilities.......................................... 475,632 407,127 Minority interest............................................................ 10,111 9,067 Stockholders' equity: Preferred Stock, $.01 par value, 1,500 shares authorized, none issued and outstanding................................................................ Series A Preferred Stock, $.01 par value, 500 shares authorized and reserved, none issued and outstanding................................................ Common Stock, $.01 par value, 250,000 shares authorized, 95,301 and 94,819 issued, 91,869 and 92,510 outstanding............................... 953 948 Additional paid in capital................................................... 476,179 469,999 Common Stock to be issued, approximately 5,716 and 7,295 shares.............. 47,924 56,955 Treasury Stock, 3,432 and 2,309 shares....................................... (25,882) (11,235) Retained earnings............................................................ 155,809 160,101 ------------- ------------- Total stockholders' equity ................................ 654,983 676,768 ------------- ------------- $ 1,140,726 $ 1,092,962 ============= =============
The accompanying notes are an integral part of this statement. 3 US ONCOLOGY, INC. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (in thousands, except per share data) (unaudited)
Three Months Six Months Ended June 30, Ended June 30, 2002 2001 2002 2001 --------- ---------- ---------- ---------- Revenue....................................................... $ 410,972 $ 383,571 $ 802,324 $ 751,503 Operating expenses: Pharmaceuticals and supplies............................. 214,220 196,759 411,815 384,632 Field compensation and benefits.......................... 86,192 80,659 172,293 158,978 Other field costs........................................ 46,402 47,077 94,261 92,076 General and administrative............................... 15,708 14,521 29,270 28,788 Depreciation and amortization............................ 18,347 17,400 36,218 34,553 Impairment, restructuring and other charges.............. 39,268 - 39,973 5,868 --------- ---------- ---------- ---------- 420,137 356,416 783,830 704,895 --------- ---------- ---------- ---------- Income (loss) from operations................................. (9,165) 27,155 18,494 46,608 Interest expense, net......................................... (6,274) (6,641) (11,783) (13,380) --------- ---------- ---------- ---------- Income (loss) before income taxes and extraordinary loss...... (15,439) 20,514 6,711 33,228 Income tax benefit (provision)................................ 5,867 (7,796) (2,551) (12,627) --------- ---------- ---------- ---------- Net income (loss) before extraordinary loss................... (9,572) 12,718 4,160 20,601 Extraordinary loss on early extinguishment of debt, net of income taxes of $5,181...................................... - - (8,452) - --------- ---------- ---------- ---------- Net income (loss) and comprehensive income.................... $ (9,572) $ 12,718 $ (4,292) $ 20,601 ========= ========== ========== ========== Earnings per share - basic: Net income (loss) before extraordinary loss per share......... $ (0.10) $ 0.13 $ 0.04 $ 0.21 Extraordinary loss, net of income taxes, per share............ - - (0.08) - --------- ---------- ---------- ---------- Net income (loss) per share................................... $ (0.10) $ 0.13 $ (0.04) $ 0.21 ========= ========== ========== ========== Shares used in per share calculations - basic................. 99,539 100,022 99,694 99,804 ========= ========== ========== ========== Earnings per share - diluted: Net income (loss) before extraordinary loss per share......... $ (0.10) $ 0.13 $ 0.04 $ 0.21 Extraordinary loss, net of income taxes, per share............ - - (0.08) - --------- ---------- ---------- ---------- Net income (loss) per share................................... $ (0.10) $ 0.13 $ (0.04) $ 0.21 ========= ========== ========== ========== Shares used in per share calculations - diluted............... 99,539 100,306 99,694 100,177 ========= ========== ========== ==========
The accompanying notes are an integral part of this statement 4 US ONCOLOGY, INC. CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands) (unaudited)
SIX MONTHS ENDED JUNE 30, 2002 2001 --------- --------- Cash flows from operating activities: Net income (loss) ............................................................ $ (4,292) $ 20,601 Non cash adjustments: Depreciation and amortization .......................................... 36,218 34,553 Impairment, restructuring and other charges ............................ 41,584 331 Extraordinary loss on early extinguishment of debt, net of income taxes 8,452 -- Gain on sale of assets ................................................. (3,917) -- Deferred income taxes .................................................. 2,788 8,911 Undistributed earnings in joint ventures ............................... 1,211 -- Changes in operating assets and liabilities: ........................... (2,952) 43,267 --------- --------- Net cash provided by operating activities ......................... 79,092 107,663 --------- --------- Cash flows from investing activities: Acquisition of property and equipment .................................. (27,995) (30,512) Net payments in affiliation transactions ............................... -- (565) --------- --------- Net cash used by investing activities ............................. (27,995) (31,077) --------- --------- Cash flows from financing activities: Proceeds from Credit Facility .......................................... 24,500 20,000 Repayment of Credit Facility ........................................... (24,500) (80,000) Proceeds from Senior Subordinated Notes ................................ 175,000 -- Repayment of Senior Secured Notes ...................................... (100,000) -- Repayment of other indebtedness ........................................ (11,913) (10,926) Deferred financing costs ............................................... (7,449) -- Proceeds from exercise of options ...................................... 2,224 3,059 Purchase of Treasury Stock ............................................. (6,922) -- Payment of premium upon early extinguishment of debt ................... (11,731) -- --------- --------- Net cash provided (used) by financing activities .................. 39,209 (67,867) --------- --------- Increase in cash and equivalents ............................................. 90,306 8,719 Cash and equivalents: Beginning of period .................................................... 20,017 3,389 --------- --------- End of period .......................................................... $ 110,323 $ 12,108 ========= ========= Interest paid ................................................................ $ 6,250 $ 7,887 Taxes paid ................................................................... $ 1,959 $ -- Non cash transactions: Value of Common Stock to be issued in affiliation transactions ......... $ -- $ 337 Delivery of Common Stock in affiliation transactions ................... 8,926 6,148 Debt issued in affiliation transactions ................................ -- 1,145 Value of Common Stock, received in exchange for assets ................ 9,735 -- Value of forfeited Common Stock to be issued from contract separations . 105 326 Debt forfeited from contract separations ............................... 867 --
The accompanying notes are an integral part of this statement 5 US UNCOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial reporting and in accordance with Form 10-Q and Rule 10.01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the unaudited condensed consolidated financial statements contained in this report reflect all adjustments that are normal and recurring in nature and considered necessary for a fair presentation of the financial position and the results of operations for the interim periods presented. The preparation of the Company's financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as disclosures on contingent assets and liabilities. Because of inherent uncertainties in this process, actual future results could differ from those expected at the reporting date. These unaudited condensed consolidated financial statements, footnote disclosures and other information should be read in conjunction with the financial statements and the notes thereto included in US Oncology, Inc.'s Form 10-K filed with the Securities and Exchange Commission on March 29, 2002. NOTE 2 - REVENUE The Company provides the following services to physician practices: oncology pharmaceutical management, outpatient cancer center operations, cancer research and development, and other practice management services. The Company currently earns revenue from physician practices under two models, the physician practice management (PPM) model and the service line model. Under the PPM model, the Company enters into long term agreements with affiliated practices to provide comprehensive services, including all those described above, and the practices pay the Company a service fee and reimburse all expenses. Under the service line model, the first three services described above are offered by the Company under separate agreements for each service line. Net operating revenue includes the two components - net patient revenue and the Company's other revenue. o Net patient revenue. The Company reports net patient revenue for those business lines under which the Company's revenue is derived from payments for medical services to patients and the Company is responsible for billing those patients. Currently, net patient revenue is comprised of patient revenue of affiliated practices under the PPM model. Net patient revenue also will include revenues of practices that enter into agreements under the outpatient cancer center operations service line. o Other revenue. Other revenue is revenue derived from sources other than patient services of affiliated practices. Other revenue includes revenue from pharmaceutical research, informational services and activities as a group purchasing organization. Other revenue also includes revenues from pharmaceutical services rendered by the Company under our oncology pharmaceutical management service line agreement. Net patient revenue is recorded when services are rendered to patients based on established or negotiated charges reduced by contractual adjustments and allowances for doubtful accounts. Differences between estimated contractual adjustments and final settlements are reported in the period when final settlements are determined. Under the Company's PPM service agreements, amounts retained by the affiliated physician groups for physician compensation are primarily derived under two models. Under the first model (the net revenue model), amounts retained by physician groups are based upon a specified amount (typically 23% of net revenue) and, if certain financial criteria are satisfied, an incremental performance-based amount. Under the second model (the earnings model), amounts retained by practices are based upon a percentage (typically 65% - 75%) of the difference between net patient revenues less direct expenses, excluding interest expense and taxes. The Company's revenue is equal to net operating revenue minus amounts retained by the practices under the Company's PPM service agreements. 6 US UNCOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) The following presents the amounts included in the determination of the Company's revenue (in thousands):
THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Net operating revenue ............... $ 531,795 $ 491,869 $ 1,032,744 $ 965,735 Amounts retained by practices ....... (120,823) (108,298) (230,420) (214,232) ----------- ----------- ----------- ----------- Revenue ............................. $ 410,972 $ 383,571 $ 802,324 $ 751,503 =========== =========== =========== ===========
The Company's most significant service agreement, which is the only service agreement that represents more than 10% of revenues to the Company, is with Texas Oncology, P.A. (TOPA), which is managed under the earnings model. TOPA accounted for approximately 23% and 24%, respectively, of the Company's total revenue for the second quarter of 2002 and 2001, and for 23% and 24%, of the Company's total revenue for the six month periods ended June 30, 2002 and 2001, respectively. NOTE 3 - IMPAIRMENT, RESTRUCTURING AND OTHER CHARGES In the fourth quarter of 2000, the Company comprehensively analyzed its operations and cost structure, focusing on non-core assets and activities of the Company to determine whether they were still consistent with the Company's strategic direction. As a result, the Company recorded a restructuring charge in the fourth quarter of 2000. Details of restructuring charge activity relating to that charge for the six months ended June 30, 2002 are as follows (in thousands):
ACCRUAL AT ACCRUAL AT DECEMBER 31, 2001 PAYMENTS JUNE 30, 2002 ----------------- -------- ------------- Severance of employment agreement........ $ 215 $ (18) $ 197 Site closures............................ 1,081 (160) 921 -------- --------- -------- Total.................................... $ 1,296 $ (178) $ 1,118 ======== ========= ========
The Company has recognized a deferred income tax benefit for substantially all of these charges as many of these items will be deductible for income tax purposes in subsequent periods. In the first quarter of 2001, the Company announced plans to further reduce overhead costs and recognized additional pre-tax restructuring charges of $5.9 million, consisting of (i) a $3.1 million charge relating to the elimination of approximately 50 personnel positions, (ii) a $2.5 million charge for remaining lease obligations and related improvements at sites the Company determined to close, and (iii) a $0.3 million charge relating to abandoning certain software applications. All of the charges were recorded in the first quarter of 2001. The Company has recognized and accounted for these costs in accordance with the provisions of Emerging Issues Task Force Consensus No. 94-3 "Accounting for Restructuring Costs". As a result, the Company recorded the following pre-tax charges during the first quarter of 2001, with activity through June 30, 2002 (in thousands):
RESTRUCTURING ASSET ACCRUAL AT ACCRUAL AT EXPENSES PAYMENTS WRITE-DOWNS DECEMBER 31, 2001 PAYMENTS JUNE 30, 2002 -------- -------- ----------- ----------------- -------- ------------- Costs related to personnel reductions................... $ 3,113 $ (2,900) $ - $ 213 $ (213) $ - Closure of facilities ........ 2,455 (1,323) - 1,132 (131) 1,001 Abandonment of software applications................. 300 - (300) - - - --------- --------- --------- --------- ------- -------- Total......................... $ 5,868 $ (4,223) $ (300) $ 1,345 $ (344) $ 1,001 ========= ========= ========= ========= ======= ========
7 US UNCOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) During the three months and six months ended June 30, 2002, the Company recognized the following impairment, restructuring and other charges (in thousands):
Three Months Ended Six Months Ended June 30, 2002 June 30, 2002 ------------- ------------- Service line conversions ......................... $ 7,545 $ 7,545 Impairment of service agreement .................. 33,821 33,821 Consulting costs for implementing service line ... 1,033 1,397 Personnel reduction costs ........................ 568 909 Gain on sale of practice assets .................. (3,917) (3,917) Impairment of working capital assets, net ........ 218 218 ------------- ------------- $ 39,268 $ 39,973 ============= =============
The service line conversions charge related to transitioning two PPM practices to the service line model during the second quarter, and comprises (i) a $5.9 million write-off of the net intangible value of the PPM service agreements at those practices since those agreements were terminated and new agreements were executed to provide only oncology pharmaceutical management services, and a $2.1 million write-off of working capital at those practices, less (ii) $0.4 million in consideration that would have been paid by the Company that was forfeited by the physicians in those transactions. The impairment of the service agreement was a non-cash, pretax charge of $33.8 million related to a revenue model service agreement that became impaired during the second quarter based upon the Company's analysis of projected cash flows under that agreement, taking into account developments in that market during the quarter. During the second quarter of 2002 the Company recognized $1.0 million in professional fees in connection with the implementation of the service line model and $0.6 million for personnel reductions. During the first quarter of 2002, the Company also recognized charges of $0.7 million consisting of: (i) $0.3 million in costs related to personnel reductions, and (ii) $0.4 million in consulting fees related to the Company's conversion to the service line model. During the second quarter of 2002, the Company terminated a service agreement as it related to certain radiology sites and sold the related assets, including the right to future revenues attributable to radiology technical fee revenue at those sites, in exchange for the delivery to the Company of 1.1 million shares of the Company's Common Stock, which had a fair market value of $9.7 million at the date of the termination based on the then trading price per share of $8.85. In connection with that sale, the Company also recognized a write-off of a receivable of $0.5 million due from the physicians and agreed to make during the third quarter of 2002 a cash payment to the buyer of $0.6 million to reflect purchase price adjustments. The transaction resulted in the Company recognizing a $3.9 million gain. The $0.2 million net impairment of working capital assets comprised (i) an aggregate charge of $3.3 million for the reduction in the estimated recoverable amount of working capital assets of four practices with which the Company believes it will terminate its relationships, reduced by (ii) an increase in the Company's estimates of the recoverable amount of working capital assets of a practice with which the Company separated effective July 1, 2002 on terms that included payment for working capital in excess of anticipated recovery and of another practice which management had previously believed would terminate its relationship with the Company, but no longer expect to do so. NOTE 4 - EXTRAORDINARY LOSS During the first quarter of 2002, the Company recorded an extraordinary loss of $13.6 million, before income taxes of $5.2 million, in connection with the early extinguishment of the $100 million Senior Secured Notes due 2006 and the previously existing credit facility. The loss consists of payment of a prepayment penalty of $11.7 million on the Senior Secured Notes and a write-off of unamortized deferred financing costs of $1.9 million related to the terminated debt agreements. 8 US UNCOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) NOTE 5 - CAPITALIZATION During 2000, the Company acquired 5,057,786 shares of Common Stock at an average price of $4.72 per share, pursuant to a share repurchase authorized by the Board of Directors in March 2000. In March 2002, the Board of Directors of the Company authorized the repurchase of up to $35 million in shares of its Common Stock in public or private transactions and authorized the Company to accept up to $15 million in shares of its Common Stock in connection with terminating service agreements with physician groups. The table below sets forth the Company's Treasury Stock activity for the six months ended June 30, 2002 (shares in thousands):
Average Shares Purchase Price -------- -------------- Treasury Stock shares as of December 31, 2001 .......................... 2,309 $4.72 Treasury Stock purchases ............................................... 1,235 8.70 Treasury Stock received in connection with the sale of certain assets... 1,100 Treasury Stock issued in connection with affiliation transactions ...... (1,212) -------- Treasury Stock shares as of June 30, 2002 .............................. 3,432 ========
NOTE 6 - INDEBTEDNESS As of June 30, 2002 and December 31, 2001, respectively, the Company's long-term indebtedness consisted of the following (in thousands): June 30, December 31, 2002 2001 --------- ----------- 8.42% Senior Secured Notes due 2006 ........... $ -- $ 100,000 9.625% Senior Subordinated Notes due 2012 ..... 175,000 -- Notes Payable ................................. 1,968 2,733 Subordinated Notes ............................ 56,490 67,438 Capital lease obligations and other ........... 2,253 2,695 --------- ---------- 235,711 172,866 Less: current maturities ...................... (23,268) (44,040) --------- ---------- $ 212,443 $ 128,826 ========= ========== Credit Facility In June 1999, the Company amended and restated its existing loan agreement and revolving credit/term facility. Under the terms of that agreement, the amounts available for borrowing were $275 million, including a $100 million facility that expired in June 2000, leaving availability of $175 million expiring in June 2004. On February 1, 2002, the Company terminated its $175 million revolving facility and entered into a new $100 million five-year revolving credit facility (New Credit Facility), which expires in February 2007. Proceeds from loans under the New Credit Facility may be used to finance development of cancer centers and new PET facilities, to provide working capital or for other general business uses. Costs incurred in connection with the extinguishment of the Company's previous credit facility were expensed during the first quarter of 2002 and recorded as an extraordinary loss in the Company's condensed consolidated statement of operations and comprehensive income. Costs incurred in connection with establishing the New Credit Facility are being capitalized and amortized over the term of the New Credit Facility. 9 US UNCOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) Borrowings under the New Credit Facility are secured by substantially all of the Company's assets. At the Company's option, funds may be borrowed at the Base interest rate or the London Interbank Offered Rate (LIBOR), plus an amount determined under a defined formula. The Base rate is selected by First Union National Bank (First Union) and is defined as its prime rate or Federal Funds Rate plus 1/2%. No amounts were borrowed or outstanding under this New Credit Facility during the first six months of 2002. Senior Secured Notes In November 1999, the Company issued $100 million in senior secured notes (Senior Secured Notes) to a group of institutional investors. The notes bore interest at 8.42%, matured in equal annual installments of $20 million from 2002 through 2006 and ranked equally in right of payment with all current and future senior indebtedness of the Company. The Senior Secured Notes contained restrictive financial and operational covenants and were secured by the same collateral as the Company's previous Credit Facility. The Senior Secured Notes were repaid in full on February 1, 2002 with the proceeds of the Company's Senior Subordinated Notes. Senior Subordinated Notes On February 1, 2002, the Company issued $175 million in 9.625% senior subordinated notes (Senior Subordinated Notes) to various institutional investors in a private offering pursuant to Rule 144A. The notes were subsequently exchanged for substantially identical notes in an offering registered under the Securities Act of 1933. The notes are unsecured, bear interest at 9.625% annually and mature in February 2012. Payments under the Senior Subordinated Notes are subordinated, in substantially all respects, to the Company's New Credit Facility and other "Senior Indebtedness," as defined in the indenture governing the Senior Subordinated Notes. Proceeds from the Senior Subordinated Notes were used to pay off the $100 million in borrowings under the existing Senior Secured Notes, an $11.7 million prepayment penalty on the early termination of the Senior Secured Notes and facility fees and related expenses associated with establishing the Senior Subordinated Notes and New Credit Facility of $4.8 million and $2.7 million, respectively. Costs incurred in connection with extinguishment of the Company's previous Senior Secured Notes, including the prepayment penalty were expensed in the first quarter of 2002 and reflected as an extraordinary loss in the Company's condensed consolidated statement of operations and comprehensive income. Costs incurred in connection with establishing the Senior Subordinated Notes, including facility fees are being capitalized and amortized over the term of those notes. Notes payable The notes payable bear interest, which is payable annually, at rates ranging from 5.3% to 10% and mature between 2002 to 2005. The notes are payable to physicians with whom the Company entered into long-term service agreements and relate to affiliation transactions. The notes payable are unsecured. Subordinated notes The subordinated notes are issued in substantially the same form in different series and are payable to the physicians with whom the Company entered into service agreements. Substantially all of the notes outstanding at June 30, 2002 bear interest at 7%, are due in installments through 2007 and are subordinated to senior bank and certain other debt (including the Senior Subordinated Notes). If the Company fails to make payments under any of the notes, the respective practice can terminate the related service agreement. Capital lease obligations and other indebtedness Leases for medical and office equipment are capitalized using effective interest rates between 6.5% and 11.5% with original lease terms between two and seven years. Other indebtedness consists principally of installment notes and bank debt, with varying interest rates, assumed in affiliation transactions. Master Leasing Facility The Company has entered into an operating lease arrangement, known as a "synthetic lease", under which a special purpose entity has acquired title to properties, paid for the construction costs and leased to the Company the real estate and equipment at some of the Company's cancer centers. The synthetic lease facility was funded by a syndicate of financial institutions. 10 US UNCOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) The synthetic lease was entered into in December 1997 and matures in June 2004. As of June 30, 2002, the Company had $72.0 million outstanding under the synthetic lease facility, and no further amounts are available under that facility. The annual lease cost of the synthetic lease is approximately $3.6 million, based on interest rates in effect as of June 30, 2002. At June 30, 2002, the lessor under the synthetic lease held real estate assets (based on original acquisition and construction costs) of approximately $59.2 million and equipment of approximately $12.8 million (based on original acquisition cost) at nineteen locations. On February 1, 2002, the Company amended and restated the synthetic lease agreement primarily to replace certain lenders. The lease is renewable in one-year increments, but only with consent of the financial institutions that are parties thereto. In the event the lease is not renewed at maturity, or is otherwise terminated, the Company must either purchase the properties under the lease for the total amount outstanding or market the properties to third parties. Defaults under the lease, which include cross-defaults to other material debt, could result in such a termination and require the Company to purchase or remarket the properties. If the Company sells the properties to third parties, it has guarantees on the residual value up to 85% of the total amount outstanding for the properties. The guarantee obligations are secured by substantially all of the Company's assets. The primary lease obligations are secured by the lease properties. The synthetic lease includes customary covenants, representations, and events of default, including cross-defaults to material indebtedness, including the New Credit Facility and Senior Subordinated Notes. If the properties were sold to a third party at a price such that the Company would be required to make a residual value guarantee payment, such amount would be recognized as an expense in the Company's statement of operations. The synthetic lease is an operating lease under generally accepted accounting principles "GAAP" and therefore the obligations are not recorded as debt and the underlying properties and equipment are not recorded as assets on the Company's balance sheet. The Company's rental payments (which approximate interest amounts under the synthetic lease financing) are treated as operating rent commitments, and are excluded from the Company's aggregate debt maturities. The FASB determined that synthetic lease properties meeting certain criteria would be required to be recognized as assets with a corresponding liability effective April 1, 2003. The Company's synthetic lease meets these criteria. The determination is not final and is subject to additional rule-making procedures, but assuming the determination becomes a formal accounting pronouncement and assuming the Company does not alter the arrangement to maintain off-balance sheet treatment under the new rules, the Company would expect to recognize $72.0 million in additional property and equipment with a corresponding liability on the Company's balance sheet as of April 1, 2003. NOTE 7 - EARNINGS PER SHARE The Company computes earnings per share and discloses basic and diluted earnings per share (EPS). The computation of basic EPS is based on a weighted average number of outstanding shares of Common Stock and Common Stock to be issued during the periods. The Company includes Common Stock to be issued in both basic and diluted EPS as there are no foreseeable circumstances that would relieve the Company of its obligation to issue these shares. The computation of the diluted EPS is based on a weighted average number of outstanding shares of Common Stock and Common Stock to be issued during the periods as well as all dilutive potential Common Stock calculated under the treasury stock method. 11 US UNCOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) The table below summarizes the determination of shares used in per share calculations (in thousands):
Three Months Six Months Ended June 30, Ended June 30, ------------------- ------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Outstanding at end of period: Common Stock ......................................................... 91,869 90,835 91,869 90,835 Common Stock to be issued ............................................ 5,716 9,440 5,716 9,440 -------- -------- -------- -------- 97,585 100,275 97,585 100,275 Effect of weighting and Treasury Stock ............................... 1,954 (253) 2,109 (471) -------- -------- -------- -------- Shares used in per share calculations-basic .............................. 99,539 100,022 99,694 99,804 Effect of weighting and assumed share equivalents for grants of stock options at less than the weighted average price ............... - 284 - 373 -------- -------- -------- -------- Shares used in per share calculations-diluted ............................ 99,539 100,306 99,694 100,177 ======== ======== ======== ======== Anti-dilutive stock options not included above .......................... 16,005 4,648 16,005 4,648 ======== ======== ======== ========
NOTE 8 - SEGMENT FINANCIAL INFORMATION The Company has adopted the provisions of FASB Statement of Financial Accounting Standards No. 131 (FAS 131), "Disclosure About Segments of an Enterprise and Related Information". FAS 131 requires the utilization of a "management approach" to define and report the financial results of operating segments. The management approach defines operating segments along the lines used by management to assess performance and make operating and resource allocation decisions. Beginning in the first quarter of 2002, the Company has determined that its reportable segments are those that are based on the Company's method of internal reporting, which disaggregates its business by service line, and that sufficient information is now available to permit such reporting. The Company's reportable segments are oncology pharmaceutical management, other practice management services, outpatient cancer center operations, and cancer research and development. The oncology pharmaceutical management segment purchases and manages specialty oncology pharmaceuticals for our affiliated practices. Management of the administrative aspects of affiliated medical oncology practices is included in the other practice management services segment. The outpatient cancer center operations segment develops and manages comprehensive, community-based cancer centers, which integrate all aspects of outpatient cancer care, from laboratory and radiology diagnostic capabilities to chemotherapy and radiation therapy. The cancer research and development services segment contracts with pharmaceutical and biotechnology firms to provide a comprehensive range of services relating to clinical trials. The operating results of this segment are reflected in the "other" category. The Company's business is conducted entirely in the United States. The financial results of the Company's segments are presented on the accrual basis. For the first six months of 2002, 98.5% of the Company's oncology pharmaceutical management revenue and outpatient cancer center revenue was derived from the PPM model with the remainder derived under service line model agreements to provide oncology pharmaceutical management services. To determine results of the oncology pharmaceutical management segment with respect to practices managed under the Company's PPM model, we have assumed that the pharmaceuticals purchased and pharmacy management services under this segment are provided at rates consistent with the rates at which we are offering those services outside of the PPM model. Therefore, the financial results of that segment include inter-segment revenues with other practice management services reflecting PPM results after the effect of removing the oncology pharmaceutical management results and outpatient cancer center operations results (which are actual results of that service line within the PPM model) disclosed below. As such, the combined operating results of the oncology pharmaceutical management segment and other practice management segments for the six months ended June 30, 2002 represent the operating results under the Company's PPM activities relative to the management of the non-medical aspects of affiliated medical oncology practices plus the results under oncology pharmaceutical management services for practices under service line model agreements. 12 US UNCOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) The Company evaluates the performance of its segments based on, among other things, earnings before interest, taxes, depreciation, amortization, impairment, restructuring and other charges and extraordinary loss (EBITDA). The Company has not disclosed prior year's segment data on a comparative basis because management could not obtain comparative data for prior years due to financial systems limitations. Asset information by reportable segment is not reported since the Company does not produce such information internally. The table below presents information about reported segments for the three and six months ended June 30, 2002 (in thousands): THREE MONTHS SIX MONTHS ENDED ENDED JUNE 30, 2002 JUNE 30, 2002 -------------- ------------- Net operating revenue: Oncology pharmaceutical management ....... $ 224,952 $ 430,584 Other practice management services ....... 213,335 414,636 -------------- ------------ Medical oncology ......................... 438,287 845,220 Outpatient cancer center operations ...... 78,509 156,244 Other .................................... 14,999 31,280 -------------- ------------ $ 531,795 $ 1,032,744 ============== ============ Revenue: Oncology pharmaceutical management ....... $ 225,439 $ 431,692 Other practice management services ....... 117,753 234,751 -------------- ------------ Medical oncology ......................... 343,192 666,443 Outpatient cancer center operations ...... 54,076 107,134 Other .................................... 13,704 28,747 -------------- ------------ $ 410,972 $ 802,324 ============== ============ EBITDA: Oncology pharmaceutical management ....... $ 20,761 $ 39,035 Other practice management services ....... 23,613 47,100 -------------- ------------ Medical oncology ......................... 44,374 86,135 Outpatient cancer center operations ...... 17,938 33,921 Other .................................... 1,846 3,899 -------------- ------------ 64,158 123,955 General and administrative expenses ...... (15,708) (29,270) -------------- ------------ $ 48,450 $ 94,685 ============== ============ The following is a reconciliation of net operating revenue to consolidated revenue (in thousands): THREE MONTHS SIX MONTHS ENDED ENDED JUNE 30, 2002 JUNE 30, 2002 -------------- ------------- Net operating revenue..................... $ 531,795 $ 1,032,744 Less: amounts retained by the practices... (120,823) (230,420) -------------- ------------- Revenue................................... $ 410,972 $ 802,324 ============== ============= 13 US UNCOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) The following is a reconciliation of EBITDA to consolidated income (loss) from operations (in thousands): Three Months Six Months Ended Ended June 30, 2002 June 30, 2002 -------------- ------------- EBITDA........................................ $ 48,450 $ 94,685 Depreciation and amortization................. (18,347) (36,218) Impairment, restructuring and other charges... (39,268) (39,973) -------------- ------------- Income (loss) from operations................. $ (9,165) $ 18,494 ============== ============= NOTE 9 - COMMITMENTS AND CONTINGENCIES As disclosed in Part II, Item 1, under the heading "Legal Proceedings," the Company is aware that it and certain of its subsidiaries and affiliated practices are the subject of allegations that their billing practices may violate the Federal False Claims Act. These allegations are contained in qui tam lawsuits filed under seal. The Department of Justice has informed the Company that it does not intend to pursue these lawsuits, but individual plaintiffs may still do so. Because qui tam actions are filed under seal, there is a possibility that the Company could be the subject of other qui tam actions of which it is unaware. NOTE 10 - RECENT PRONOUNCEMENTS In June 2001, the FASB issued Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" (FAS 143), which addresses accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS 143 is effective for fiscal years beginning after June 15, 2002. The Company is currently assessing the impact of this new standard. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Impairment or Disposal of Long-Lived Assets" (FAS 144), which is effective for fiscal years beginning after December 15, 2001. The provisions of FAS 144 provide a single accounting model for impairment of long-lived assets. The Company's adoption of FAS 144 has not had a material effect on the Company's financial position or operating results. In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No.4, 44, and 62, Amendment of FASB Statement No. 13, and Technical Corrections" (FAS 145). In general, FAS 145 will require gains and losses on extinguishments of debt to be classified as income or loss from continuing operations rather than as extraordinary items as previously required under Statement of Financial Accounting Standards No. 4. Gains or losses from extinguishments of debt for fiscal years beginning after May 15, 2002 shall not be reported as extraordinary items unless the extinguishment qualifies as an extraordinary item under the provisions of APB Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. The Company is currently assessing the impact of this new standard. NOTE 11 - SUBSEQUENT EVENT Effective July 1, 2002, the Company terminated its PPM service agreement with a physician practice, consisting of sixteen physicians, under the net revenue model. This practice represented 2.5% of the Company's revenue for the first six months of 2002. The Company received $3.7 million in cash from the practice as consideration for the termination and for practice assets, including working capital, sold back to the practice and expects to record a $3.4 million gain in the third quarter of 2002. 14 US UNCOLOGY, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION The following discussion should be read in conjunction with the financial statements, related notes, and other financial information appearing elsewhere in this report. In addition, see "Forward-Looking Statements and Risk Factors" included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC). GENERAL We provide comprehensive services to our network of affiliated practices, made up of more than 850 affiliated physicians in over 450 sites, with the mission of expanding access to and improving the quality of cancer care in local communities and advancing the delivery of care. The services we offer include: o Oncology Pharmaceutical Management. We purchase and manage specialty oncology pharmaceuticals for our affiliated practices. Annually, we are responsible for purchasing, delivering and managing more than $700 million of pharmaceuticals through a network of more than 400 admixture sites, 31 licensed pharmacies, 51 pharmacists and 180 pharmacy technicians. o Outpatient Cancer Center Operations. We develop and manage comprehensive, community-based cancer centers which integrate all aspects of outpatient cancer care, from laboratory and radiology diagnostic capabilities to chemotherapy and radiation therapy. We have developed and operate 77 integrated community-based cancer centers and manage over one million square feet of medical office space. We have installed and manage 13 Positron Emission Tomography (PET) units, as well as 59 Computerized Axial Tomography (CT) units. o Cancer Research and Development Services. We facilitate a broad range of cancer research and development activities through our network. We contract with pharmaceutical and biotechnology firms to provide a comprehensive range of services relating to clinical trials. We currently manage 98 clinical trials, supported by our network of over 650 participating physicians in more than 330 research locations. During the first six months of 2002, we enrolled over 1,600 new patients in research studies. o Other Practice Management Services. Under our physician practice management arrangements, we act as the exclusive manager and administrator of all day-to-day non-medical business functions connected with our affiliated practices. As such, we are responsible for billing and collecting for medical oncology services, physician recruiting, data management, accounting, systems, and capital allocation to facilitate growth in practice operations. Historically, we have contracted with physician groups to provide all of the above services under the PPM model. Under the PPM model, we enter into long-term agreements with affiliated practices to provide comprehensive management services, including all of the above service lines, to our affiliated practices, and the practices pay us a service fee and reimburse us for all expenses. Under some agreements, the fees are based on practice earnings before taxes - known as the "earnings model". In others, the fee consists of a fixed fee, a percentage of the practice's revenues (in most states) and, if certain performance criteria are met, a performance fee - known as the "net revenue model". Under the net revenue model, the practice is entitled to retain a fixed portion of its net revenue before any service fee is paid, provided that all operating expenses have been reimbursed. We believe that the earnings model properly aligns practice priorities with respect to appropriate business operations and cost control, with us and the practice sharing proportionately in practice profitability, while the net revenue model results in us disproportionately bearing the impact of increases or declines in operating margins. For this reason, we have, since 2001, been negotiating with practices under the net revenue model to convert to the earnings model. Since the beginning of 2001 and through June 30, 2002, fourteen practices accounting for 22.3% of our net operating revenue in the first six months of 2002 have converted to the earnings model. 62.4% of net operating revenue in the second quarter of 2002 is attributable to practices on the earnings model as of June 30, 2002. Currently, 66% of the net operating revenue is attributable to practices that are either on the earnings model or the service line model. 15 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) In October 2001, we commenced a strategy to focus our operations on three core service lines: oncology pharmaceutical management, outpatient cancer center operations, and cancer research and development services and began marketing these core services through a non-PPM model. Under the new model, which we refer to as the "service line model", each of those core service lines is offered to physician groups under a separate contract, and we do not necessarily provide the other practice management services described above. To implement this service line strategy, we have organized the company in three divisions, and manage and operate our business under distinct service lines. This report includes segment financial information (See Note 8 to Condensed Consolidated Financial Statements), which reflects a division of our existing PPM operations into the various service line offerings in the PPM relationship. As we enter into new service line model agreements, we will report revenue from those agreements in the appropriate segment. Under the service line model, we are offering physician groups three service lines, each with a separate agreement. Those agreements are structured as follows: o Oncology Pharmaceutical Management. We are responsible for providing comprehensive pharmaceutical management and will be paid on a per-dose basis for the pharmaceutical agent and on a per-dose basis for admixture services. Affiliated practices are required to purchase substantially all of their drugs through us. We also act as a group purchasing organization and will receive a fee from pharmaceutical manufacturers for this service, as well as providing data and informational services to pharmaceutical companies. o Outpatient Cancer Center Operations. We agree to develop outpatient cancer centers under development agreements and leases with physician groups. Under the leases, we expect to receive our economic costs of the property plus an amount sufficient to give us a predetermined rate of return on invested capital. In addition, we provide management services and expect to receive an additional fee of 30% of net earnings from radiation operations, subject to adjustments. o Cancer Research and Development. We contract with pharmaceutical companies and others needing research services on a per trial basis. Our contracts with physician groups outline the terms of access to clinical trials and provide for research related services. We will pay physicians for each trial based on economic considerations relating to that trial. All of our PPM practices are being afforded the opportunity to terminate their existing service agreements, repurchase certain of their operating assets, and enter into new service line model agreements. We cannot assure you as to how many practices will take this opportunity or the timing of transition, and we currently expect that a large percentage of existing affiliated practices will remain on the PPM model for the foreseeable future. During the second quarter of 2002, two of our PPM practices, comprised of nine physicians, terminated their PPM agreements and entered into service line model agreements. As practices transition to this service line model, we would expect the financial impact to be receipt of cash payments, recognition of restructuring and reorganization costs (which are mainly non-cash charges), and a reduction in our revenues and earnings related to those practices. We cannot more accurately predict the magnitude or timing of this financial impact until practices agree to change structures. For those practices that remain on the PPM model, we will continue to negotiate with "net revenue model" practices to move to the "earnings model", and otherwise to manage those practices pursuant to existing agreements. In addition to converting two PPM practices to the service line model, we have entered into service line model agreements with two practices in new markets, both of which were effective during the second quarter of 2002. During 2001, we terminated service agreements with four oncology practices. For purposes of the following discussion and analysis, same practice revenues exclude the results of these disaffiliated practices. 16 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) FORWARD-LOOKING STATEMENTS AND RISK FACTORS The following statements are or may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995: (i) certain statements, including possible or assumed future results of operations contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations," (ii) any statements contained herein regarding the prospects for any of our business or services and our development activities relating to the service line model, cancer centers and PET installations; (iii) any statements preceded by, followed by or that include the words "believes", "expects", "anticipates", "intends", "estimates", "plans" or similar expressions; and (iv) other statements contained herein regarding matters that are not historical facts. US Oncology's business and results of operations are subject to risks and uncertainties, many of which are beyond the Company's ability to control or predict. Because of these risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements, and investors are cautioned not to place undue reliance on such statements, which speak only as of the date thereof. Factors that could cause actual results to differ materially include, but are not limited to, the degree to which practices managed by us convert to the earnings model or service line model, our ability to attract and retain additional physicians and practices under the service line model, expansion into new markets, our ability to develop and complete cancer centers and PET installations, our ability to maintain good relationships with our affiliated practices, government regulation and enforcement, proposed changes in accounting rules relating to our leasing facility, reimbursement for healthcare services, particularly including reimbursement for pharmaceuticals, changes in cancer therapy or the manner in which cancer care is delivered, drug utilization, our ability to create and maintain favorable relationships with pharmaceutical companies and other suppliers, and the operations of the Company's affiliated physician groups. Please refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, particularly the section entitled "Risk Factors," for a more detailed discussion of certain of these risks and uncertainties. The cautionary statements contained or referred to herein should be considered in connection with any written or oral forward-looking statements that may be issued by US Oncology or persons acting on its behalf. US Oncology does not undertake any obligation to release any revisions to or to update publicly any forward-looking statements to reflect events or circumstances after the date thereof or to reflect the occurrence of unanticipated events. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate these estimates, including those related to service agreements, accounts receivable, intangible assets, income taxes, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The introduction of a new business model, the service line structure, and the coincident stress it is placing on our network, represent changes in our business and may make our historical experiences less informative in making future estimates. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our consolidated financial statements include the results of US Oncology, Inc. and its wholly-owned subsidiaries. We do not include the results of our affiliated practices (and the amounts they retain for physician compensation), because we have determined that our relationships with the practices under our service agreements do not warrant consolidation under the applicable accounting rules. Management believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated condensed financial statements. These critical accounting policies include our policy of non-consolidation, revenue recognition, general estimates of accruals, intangible asset amortization and impairment, and the treatment of synthetic leases. Please refer to the notes to our condensed consolidated 17 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) financial statements, particularly Note 1, and the "Critical Accounting Policies" section of our Annual Report on Form 10-K for the year ended December 31, 2001 for a more detailed discussion of such policies. Currently, there is a tentative conclusion regarding accounting treatment of off-balance sheet financing vehicles. A change in accounting rules relating to off-balance sheet financing might require us to change our accounting treatment of our synthetic lease financing. On February 27, 2002, the Financial Standards Accounting Board (FASB) determined that synthetic lease properties meeting certain criteria would be required to be recognized as assets with a corresponding liability effective April 1, 2003. Our synthetic lease meets these criteria. The determination is not final and is subject to additional rule-making procedures, but assuming the determination becomes a formal accounting pronouncement and we do not alter the arrangement to maintain off-balance sheet treatment under the new rules, we would expect to recognize $72.0 million in additional property and equipment with a corresponding liability on our balance sheet as of January 1, 2003. The possible impact of such a change is discussed below in "Liquidity and Capital Resources." RESULTS OF OPERATIONS The Company was affiliated with the following number of physicians by specialty as of June 30,: 2002 2001 ------ ------ Medical oncologists ............................ 676 654 Radiation oncologists .......................... 126 122 Diagnostic radiologists / other oncologists .... 69 68 ------ ------ 871 844 ====== ====== The following table sets forth the sources for growth in the number of physicians affiliated with the Company: THREE MONTHS SIX MONTHS ENDED ENDED JUNE 30, JUNE 30, 2002 2001 2002 2001 ------ ------ ------ ------ Affiliated physicians, beginning of period . 867 860 868 869 Physician practice affiliations ............ 11 -- 11 6 Recruited physicians ....................... 12 15 19 22 Physician practice separations ............. -- (18) -- (18) Retiring/Other ............................. (19) (13) (27) (35) ------ ------ ------ ------ Affiliated physicians, end of period ....... 871 844 871 844 ====== ====== ====== ====== The following table sets forth the number of cancer centers and PET units managed by the Company as of June 30,: 2002 2001 ------ ------ Cancer centers........... 77 74 PET units................ 13 7 18 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) The following table sets forth the key operating statistics as a measure of the volume of services provided by the practices:
THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, 2002 2001 2002 2001 --------- --------- --------- --------- Medical oncology visits ................. 617,635 602,315 1,234,848 1,214,441 Radiation treatments .................... 162,259 163,175 325,270 327,025 PET scans ............................... 3,088 1,191 6,012 2,224 New patients enrolled in research studies 766 995 1,614 1,946
The following table sets forth the percentages of revenue represented by certain items reflected in the Company's Statement of Operations and Comprehensive Income. The information that follows should be read in conjunction with the Company's unaudited condensed consolidated financial statements and notes thereto included elsewhere herein.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, 2002 2001 2002 2001 --------- --------- --------- ------- Revenue...................................................... 100.0% 100.0% 100.0% 100.0% Operating expenses: Pharmaceuticals and supplies.............................. 52.1 51.3 51.3 51.2 Field compensation and benefits........................... 21.0 21.0 21.5 21.1 Other field costs......................................... 11.3 12.3 11.8 12.3 General and administrative................................ 3.8 3.8 3.6 3.8 Impairment, restructuring and other charges............... 9.5 -- 5.0 0.8 Depreciation and amortization............................. 4.5 4.5 4.5 4.6 --------- --------- -------- -------- Income (loss) from operations................................ (2.2) 7.1 2.3 6.2 Net interest expense......................................... (1.5) (1.7) (1.5) (1.8) --------- --------- -------- -------- Income (loss) before income taxes, and extraordinary loss.... (3.7) 5.4 0.8 4.4 Income tax benefit (provision)............................... 1.4 (2.1) (0.3) (1.7) --------- --------- -------- -------- Net income (loss) before extraordinary loss.................. (2.3) 3.3 0.5 2.7 Extraordinary loss, net of income taxes...................... -- -- (1.0) -- --------- --------- -------- -------- Net income (loss)............................................ (2.3)% 3.3% (0.5)% 2.7% ========= ========= ======== ========
Revenue. Our revenue is net operating revenue, less the amount of net operating revenue retained by our affiliated physician practices under PPM service agreements. The following presents the amounts included in determination of our revenue (in thousands):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, 2002 2001 2002 2001 -------- -------- ---------- ---------- Net operating revenue...................... $ 531,795 $ 491,869 $1,032,744 $ 965,735 Amounts retained by the practices.......... (120,823) (108,298) (230,420) (214,232) --------- --------- ---------- --------- Revenue.................................... $ 410,972 $ 383,571 $ 802,324 $ 751,503 ========= ========= ========== =========
Net operating revenue includes two components - net patient revenue and our other revenue: o Net patient revenue. We report net patient revenue for those business lines under which our revenue is derived from payments for medical services to patients and we are responsible for billing those patients. Currently, net patient revenue is comprised of patient revenue of affiliated practices under the PPM model. Net patient 19 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) revenue also will include revenues of practices that enter into agreements under the outpatient cancer center operations service line. o Other revenue. Other revenue is revenue derived from sources other than patient services of affiliated practices. Other revenue includes revenue from pharmaceutical research, informational services and activities as a group purchasing organization. Other revenue also includes revenues from pharmaceutical services rendered by us under our Oncology Pharmaceutical Management service line agreement. Net patient revenue for services to patients by the practices are recorded when services are rendered based on established or negotiated charges reduced by contractual adjustments and allowances for doubtful accounts. Difference between estimated contractual adjustments and final settlements are reported in the period when final settlements are determined. Net operating revenue is reduced by amounts retained by the practices under our services agreement to arrive at our revenue. Amounts retained by practices increased from $214.2 million for the first six months of 2001 to $230.4 million for the first six months of 2002, an increase of $16.2 million, or 7.6%. Amounts retained by practices increased from $108.3 million in the second quarter of 2001 to $120.8 million in the second quarter of 2002, an increase of $12.5 million, or 11.6%. Such increase in amounts retained by practices are directly attributable to the growth in net patient revenue combined with the increase in profitability of affiliated practices. Amounts retained by practices as a percentage of net operating revenue increased from 22.2% to 22.3% for the six months ended June 30, 2001 and 2002, respectively, and from 22.0% to 22.7% for the second quarters of 2001 and 2002, respectively, as a result of increased profitability of the practices. Net operating revenue increased from $965.7 million in the first six months of 2001 to $1,032.7 million in the first six months of 2002, an increase of $67.0 million, or 6.9%. Same practice net operating revenue (which excludes the results of practices with which we disaffiliated since June 30, 2001) increased from $933.6 million for the first six months of 2001 to $1,032.7 million for the first six months of 2002, an increase of $99.2 million, or 10.6%. Net operating revenue increased from $491.9 million for the second quarter of 2001 to $531.8 million for the second quarter of 2002, an increase of $39.9 million, or 8.1%. Same practice net operating revenue increased from $476.5 million for the second quarter of 2001 to $531.8 million for the second quarter of 2002, an increase of $55.3 million, or 11.6%. Revenue growth was caused by increases in revenues attributable to pharmaceuticals and to cancer center operations. Revenue growth from cancer center operations is attributable to the increase in diagnostic services, primarily PET. PET scans increased from 2,224 in the first six months of 2001 to 6,012 in the first six months of 2002, an increase of 3,788, or 170.3%. PET scans increased from 1,191 in the second quarter of 2001 to 3,088 for the second quarter of 2002, an increase of 1,897, or 159.3%. The increase in the number of PET scans is attributable to our opening six PET units since June 30, 2001, as well as growth of 38.3% in the number of treatments on the three PET units that were operational during the first six months of 2001. We currently have 15 cancer centers and 12 PET installations in various stages of development. We expect to open three cancer centers and six PET installations during the remainder of 2002. Operating Segments. The following table shows our net operating revenue by segment for the three months ended June 30, 2002 and March 31, 2002 and the six months ended June 30, 2002 (in thousands). Since this is the first year in which we have reportable segments, and for which sufficient information is now available to permit such reporting, no prior year comparable information is available (see Note 8 to Condensed Consolidated Financial Statements):
Three Months Ended Three Months Ended Six Months Ended June 30, 2002 March 31, 2002 June 30, 2002 ------------- -------------- ------------- Oncology pharmaceutical management ...... $ 224,952 $ 205,632 $ 430,584 Other practice management services ...... 213,335 201,301 414,636 ---------- ---------- ---------- Medical oncology ........................ 438,287 406,933 845,220 Outpatient cancer center operations ..... 78,509 77,735 156,244 Other 14,999 16,281 31,280 ---------- ---------- ---------- $ 531,795 $ 500,949 $1,032,744 ========== ========== ==========
20 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) Medical oncology net operating revenue increased from $406.9 million in the first quarter of 2002 to $438.3 million for the second quarter of 2002, an increase of $31.4 million or 7.7%. This increase was due to the increased utilization of certain drugs. Outpatient cancer center operations net operating revenue increased from $77.7 million in the first quarter of 2002 to $78.5 million for the second quarter of 2002, an increase of $0.8 million, or 1.0%. This growth is attributable to the increase in PET scans. Currently 98.5% of our operating revenue is derived under the PPM model. The following table shows the amount of operating revenue we derived under each type of service agreement for the three and six months ended June 30, 2002 (in thousands):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, 2002 2001 2002 2001 ---- ---- ---- ---- Earnings model ............ $ 331,590 62.4% $ 265,463 54.0% $ 643,788 62.3% $522,492 54.1% Net revenue model ......... 192,048 36.1% 216,677 44.0% 370,775 35.9% 428,060 44.3% Service line model ........ 1,556 0.3% 0 0.0% 1,556 0.2% 0 0.0% Other ..................... 6,601 1.2% 9,729 2.0% 16,625 1.6% 15,183 1.6% ---------- ------ ---------- ------ ---------- ------ -------- ----- $ 531,795 100.0% $ 491,869 100.0% $1,032,744 100.0% $965,735 100.0% ========== ====== ========== ====== ========== ====== ======== ======
62.4% of net operating revenue for the second quarter of 2002 was derived from earnings model service agreements, and 36.1% was derived from net revenue model service agreements, as compared to 54.0% and 44.0%, respectively, in 2001. 62.3% of net operating revenue for the first six months of 2002 was derived from earnings model service agreements, and 35.9% was derived from net revenue model service agreements, as compared to 54.1% and 44.3%, respectively, in 2001. During the first six months of 2002, three practices accounting for 3.3% of our net operating revenue for the first six months of 2002 converted to the earnings model. Effective since the beginning of 2001 and through June 30, 2002, fourteen practices accounting for 22.3% of net operating revenue in the first six months of 2002 have converted from the net revenue model to the earnings model. As of June 30, 2002, twenty-three service agreements were on the earnings model and fourteen service agreements were on the net revenue model. In addition during the second quarter of 2002, we transitioned two PPM practices to the service line model and commenced operations at two new practices under the service line model. Effective July 1, 2002, the Company disaffiliated with a physician practice, consisting of sixteen physicians, under the net revenue model. This practice represented 2.5% of the Company's revenue for the first six months of 2002. The following table shows our revenue by segment for the three months ended June 30, 2002 and March 31, 2002 and the six months ended June 30, 2002 (in thousands):
Three Months Ended Three Months Ended Six Months Ended June 30, 2002 March 31, 2002 June 30, 2002 ------------- -------------- ------------- Oncology pharmaceutical management ...... $225,439 $206,253 $431,692 Other practice management services ...... 117,753 116,998 234,751 -------- -------- -------- Medical oncology ........................ 343,192 323,251 666,443 Outpatient cancer center operations ..... 54,076 53,058 107,134 Other ................................... 13,704 15,043 28,747 -------- -------- -------- $410,972 $391,352 $802,324 ======== ======== ========
21 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) Revenue increased from $391.4 million for the first quarter of 2002 to $411.0 million for the second quarter of 2002, an increase of $19.6 million, or 5.0%. Revenue growth was caused by increases in revenues attributable to pharmaceuticals and to a lesser extent cancer center operations. Medicare and Medicaid are the practices' largest payors. During the first six months of 2002, approximately 43% of the practices' net patient revenue was derived from Medicare and Medicaid payments and 38% was so derived in the comparable period last year. During the second quarter of 2002, approximately 43% of the practices' net patient revenue was derived from Medicare and Medicaid payments and 39% was so derived in the comparable period last year. This percentage varies among practices. No other single payor accounted for more than 10% of our revenues in the first six months of 2002 and 2001. Pharmaceuticals and Supplies. Pharmaceuticals and supplies expense, which includes drugs, medications and other supplies used by the practices, increased from $384.6 million in the first six months of 2001 to $411.8 million in the same period of 2002, an increase of $27.2 million, or 7.1%. Pharmaceuticals and supplies expense increased from $196.8 million in the second quarter of 2001 to $214.2 million in the second quarter of 2002, an increase of $17.5 million, or 8.9%. As a percentage of revenue, pharmaceuticals and supplies increased from 51.2% in the first six months of 2001 to 51.3% in the same period in 2002 and increased from 51.3% in the second quarter of 2001 to 52.1% in the second quarter of 2002. The increase was attributable to an increase in the percentage of our revenue attributable to pharmaceuticals partially offset by more favorable drug pricing with respect to some drugs. We expect that third-party payors, particularly government payors, will continue to negotiate or mandate the reimbursement rate for pharmaceuticals and supplies, with the goal of lowering reimbursement rates, and that such lower reimbursement rates as well as shifts in revenue mix may continue to adversely impact our margins with respect to such items. Current governmental focus on average wholesale price (AWP) as a basis for reimbursement could also lead to a wide-ranging reduction in the way pharmaceuticals are reimbursed by payors. We also continue to believe that single-source drugs, possibly including oral drugs, will continue to be introduced at a rapid pace, thus further impacting margins. In response to this decline in margin relating to certain pharmaceutical agents, we have adopted several strategies. The successful conversion of net revenue model practices to the earnings model will help reduce the impact of the increasing cost of pharmaceuticals and supplies. Likewise, the implementation of the service line model should have a similar effect, since our revenues and earnings are not directly dependent on pharmaceutical margins under that model. In addition, we have numerous efforts underway to reduce the cost of pharmaceuticals by negotiating discounts for volume purchases and by streamlining processes for efficient ordering and inventory control and are assessing other strategies to address this trend. We also continue to expand our business into areas that are less affected by lower pharmaceutical margins, such as radiation oncology and diagnostic radiology. However, as long as pharmaceuticals continue to become a larger part of our revenue mix as a result of changing usage patterns (rather than growth), we believe that our overall margins will continue to be adversely impacted. Field Compensation and Benefits. Field compensation and benefits, which includes salaries and wages of our field-level employees and the practices' employees (other than physicians), increased from $159.0 million in the first six months of 2001 to $172.3 million in the comparable 2002 period, an increase of $13.3 million or 8.4%. Field compensation and benefits increased from $80.7 million in the second quarter of 2001 to $86.2 million in the second quarter of 2002, an increase of $5.5 million, or 6.9%. As a percentage of revenue, field compensation and benefits increased from 21.1% in the first six months of 2001 to 21.5% in the first six months of 2002 and remained at 21.0% for the second quarters of 2001 and 2002. The increase is attributed to increases in employee compensation rates to address shortages of certain key personnel such as oncology nurses and radiation technicians. We continue to experience a severe shortage of qualified radiation personnel, with a vacancy rate of up to 20%. This scarcity of full-time employees requires us to hire more expensive temporary employees, and to incur significant costs in our recruitment efforts. We believe that this staff shortage will continue to adversely affect our radiation business. The increase is partially offset by economies of scale realized by increased revenues, particularly from pharmaceuticals. Other Field Costs. Other field costs, which consist of rent, utilities, repairs and maintenance, insurance and other direct field costs, increased from $92.1 million in the first six months of 2001 to $94.3 million in the first six months of 2002, an increase of $2.2 million or 2.4%. Other field costs decreased from $47.1 million in the second quarter of 22 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) 2001 to $46.4 million in the second quarter of 2002, a decrease of $0.7 million, or 1.4%. As a percentage of revenue, other field costs decreased from 12.3% in the first six months of 2001 to 11.8% in the first six months of 2002 and from 12.3% in the second quarter to 2001 to 11.3% in the second quarter of 2002. Such decreases are attributable to reduced facilities expense as a result of practice disaffiliations since June 30, 2001 and to a lesser extent the conversion of two practices to the service line model, combined with the economies of scale gained through increased revenue, particularly from pharmaceuticals. General and Administrative. General and administrative expenses increased from $28.8 million for the first six months of 2001 to $29.3 million for the first six months of 2002, an increase of $0.5 million, or 1.7%. General and administrative expenses increased from $14.5 million in the second quarter of 2001 to $15.7 million in the second quarter of 2002, an increase of $1.2 million, or 8.2%. In 2002, several new positions have been created to help manage and support the Company's introduction of the service line model. We anticipate incurring additional general and administrative costs during the remainder of 2002, as we add additional resources in our sales and marketing areas in connection with our introduction of the service line model. As a percentage of revenue, general and administrative costs decreased from 3.8% in the first six months of 2001 to 3.6% for the first six months of 2002 and was at 3.8% for the second quarters of 2001 and 2002. Overall, the Company experienced an increase in operating margins from the first six months of 2001 to the first six months of 2002, with earnings before taxes, interest, depreciation and amortization, impairment, restructuring and other charges and extraordinary loss (EBITDA), as a percentage of revenue, increasing from 11.6% to 11.8%. A number of factors contributed to the increase in operating margins, including a greater percentage of affiliated practices under the earnings model and an increase in medical oncology and outpatient cancer center operations. The increase in operating margin was partially offset by an increase in field personnel costs. The following is the EBITDA of our operations by operating segment for the three months ended June 30, 2002 and March 31, 2002 and the six months ended June 30, 2002 (in thousands). Since this is the first year in which we have reportable segments, and for which sufficient information is now available to permit such reporting, no prior year comparable information is available (See Note 8 to Condensed Consolidated Financial Statements):
THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, 2002 MARCH 31, 2002 JUNE 30, 2002 --------------- -------------- ------------- Oncology pharmaceutical management......... $ 20,761 $ 18,274 $ 39,035 Other practice management services......... 23,613 23,487 47,100 -------------- -------------- ------------ Medical oncology........................... 44,374 41,761 86,135 Outpatient cancer center operations........ 17,938 15,983 33,921 Other...................................... 1,846 2,053 3,899 -------------- -------------- ------------ 64,158 59,797 123,955 General and administrative expenses........ (15,708) (13,562) (29,270) -------------- -------------- ------------ $ 48,450 $ 46,235 $ 94,685 ============== ============== ============
Impairment, restructuring and other charges. In the fourth quarter of 2000, we comprehensively analyzed our operations and cost structure, focusing on our non-core assets and activities to determine whether they were still consistent with our strategic direction. As a result, we recorded a restructuring charge during the fourth quarter of 2000. Details of the restructuring charge activity relating to that charge for the first six months of 2002 are as follows (in thousands):
ACCRUAL AT ACCRUAL AT DECEMBER 31, 2001 PAYMENTS JUNE 30, 2002 ----------------- -------- ------------- Severance of employment agreement......... $ 215 $ (18) $ 197 Site closures............................. 1,081 (160) 921 --------- -------- --------- Total..................................... $ 1,296 $ (178) $ 1,118 ========= ======== =========
23 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) During the first quarter of 2001, we announced plans to further reduce overhead costs and recognized additional pre-tax restructuring charges of $5.9 million, consisting of (i) a $3.1 million charge relating to the elimination of approximately 50 personnel positions, (ii) a $2.5 million charge for remaining lease obligations and related improvements at sites we determined to close and (iii) a $0.3 million charge relating to software applications we decided to abandon. The charges are summarized in the following table (in thousands):
RESTRUCTURING ASSET ACCRUAL AT ACCRUAL AT EXPENSES PAYMENTS WRITE-DOWNS DECEMBER 31, 2001 PAYMENTS JUNE 30, 2002 -------- -------- ----------- ----------------- -------- ------------- Costs related to personnel reductions... $ 3,113 $(2,900) $ - $ 213 $ (213) $ - Closure of facilities................... 2,455 (1,323) - 1,132 (131) 1,001 Abandonment of software applications.... 300 - (300) - - - -------- ------- -------- --------- ------- --------- Total................................... $ 5,868 $(4,223) $ (300) $ 1,345 $ (344) $ 1,001 ======== ======= ======== ========= ======== =========
We recognized the following impairment, restructuring and other charges during the three months and six months ending June 30, 2002 (in thousands): THREE MONTHS SIX MONTHS ENDED ENDED JUNE 30, 2002 JUNE 30, 2002 ------------- ------------- Service line conversions ......................... $ 7,545 $ 7,545 Impairment of service agreement .................. 33,821 33,821 Consulting costs for implementing service line ... 1,033 1,397 Personnel reduction costs ........................ 568 909 Gain on sale of practice assets .................. (3,917) (3,917) Impairment of working capital assets, net ........ 218 218 --------- -------- $ 39,268 $ 39,973 ======== ======== The service line conversions charge related to our transitioning two PPM practices to the service line model during the second quarter, and comprises (i) a $5.9 million write-off net intangible value of the PPM service agreements at those practices since those agreements were terminated and new agreements were executed to provide only oncology pharmaceutical management services, and a $2.1 million write-off of working capital at those practices, less (ii) $0.4 million in consideration that would have been paid by us that was forfeited by the physicians in those transactions. The impairment of service agreement was a non-cash, pretax charge of $33.8 million related to a net revenue model service agreement that became impaired during the second quarter based upon our analysis of projected cash flows under that agreement, taking into account developments in that market during the quarter During the second quarter we recognized $1.0 million professional fees for consultants advising us on the implementation of the service line and $0.6 million for personnel reductions. During the first quarter of 2002, we also recognized charges of $0.7 million consisting of (i) $0.3 million in costs related to personnel reductions, and (ii) $0.4 million in consulting fees related to our introduction of the service line model. During the second quarter, we terminated a service agreement as it related to certain radiology sites and sold the related assets, including the right to future revenues attributable to radiology technical fee revenue at those sites, in exchange for delivery to us of 1.1 million shares of our common stock. In connection with that sale, we also recognized a write-off of a receivable of $0.5 million due from the physicians and agreed to make a cash payment to the buyer of $0.6 million to reflect purchase price adjustments during the third quarter. The transaction resulted in a $3.9 million gain based on the market price as of the date of the termination. 24 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) The $0.2 million net impairment of working capital assets comprised (i) an aggregate charge of $3.3 million for the reduction in the estimated recoverable amount of working capital assets of four practices with which we now believe we will terminate our relationships, reduced by (ii) an increase in our estimates of the recoverable amount of working capital assets of a practice with which we separated effective July 1, 2002 on terms that included payment for working capital in excess of our anticipated recovery and of another practice which we had previously believed would disaffiliate, but no longer expect to do so. We anticipate that a total of up to 10% of our affiliated physicians could depart in connection with our transition process, including the departure of 38 physicians that have already occurred as part of our transition. As discussed above, during the second quarter of 2002, we recorded a pre-tax, non-cash charge of $33.8 million related to the impairment of a certain service agreement. We evaluate our intangible assets for impairment, which involves an analysis comparing the aggregate expected future cash flows under the agreement to its carrying value as an intangible asset on our balance sheet. In estimating future cash flows, we consider past performance as well as known trends that are likely to affect future performance. In some cases we also take into account our current activities with respect to that agreement that may be aimed at altering performance or reversing trends. All of these factors used in our estimates are subject to error and uncertainty. Interest. Net interest expense decreased from $13.4 million in the first six months of 2001 to $11.8 million for the first six months of 2002, a decrease of $1.6 million or 11.9%. Net interest expense decreased from $6.6 million in the second quarter of 2001 to $6.3 million in the second quarter of 2002, a decrease of $0.4 million, or 5.5 %. As a percentage of revenue, net interest expense decreased from 1.8% for the first six months of 2001 to 1.5% for the first six months of 2002 and from 1.7% for the second quarter of 2001 to 1.5% for the second quarter of 2002. Such decreases are due to lower borrowing levels during the first six months of 2002. On February 1, 2002, we refinanced our indebtedness by issuing $175 million in 9.625% Senior Subordinated Notes due 2012 and repaying in full our existing senior secured notes and terminating our existing credit facility. Our previously existing $100 million senior secured notes bore interest at a fixed rate of 8.42% and would have matured as to $20 million in each of 2002-2006. This increased rate of interest was offset by lower levels of debt during the first six months of 2002, as compared to the same period in 2001. Income Taxes. For the first six months of 2002, we recognized tax expense of $2.6 million, after extraordinary loss, resulting in an effective tax rate of 38.0%, which is consistent with the same prior year period. For the second quarter of 2002, we recognized an income tax benefit of $5.9 million as a result of the impairment and restructuring charges discussed above. Extraordinary Loss. During the first quarter of 2002, we recorded an extraordinary loss of $13.6 million, before income taxes of $5.2 million, in connection with the early extinguishment of our $100 million Senior Secured Notes due 2006 and our existing credit facility. The loss consisted of payment of a prepayment penalty of $11.7 million on the Senior Secured Notes and a write-off of unamortized deferred financing costs of $1.9 million related to the terminated debt agreements. In September 2001, in connection with introducing the service line model, we announced in a press release that introduction of, and conversion to, the service line will cause us to record unusual charges of up to approximately $480 million for impairment of service agreements and other assets arising from the transition process and other expenses related to our implementation of the service line model, depending on how many of our practices choose to adopt the service line model or otherwise terminate their relationship with us. Since we do not currently believe that all of our practices will choose to terminate their PPM agreements, we do not anticipate recognizing the full $480 million in charges. The impairment, restructuring and other charges recorded during 2002 are included in this amount. In addition, the extraordinary loss is part of that aggregate amount since the refinancing was necessitated by our introduction of the service line. Other charges are expected to consist primarily of write-offs of assets relating to terminations of existing service agreements for practices converting to the service line, as well as other restructuring and unusual charges relating to the introduction of our service line model. (See Note 3 to Condensed Consolidated Financial Statements). Through June 30, we had recorded $14.0 million in unusual cash charges and $39.6 million in unusual non-cash charges in connection with our transition process. 25 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) Net Income. Net income decreased from $20.6 million, or $0.21 per share, in the first six months of 2001 to a net loss of $(4.3) million, or $(0.4) per share, in the first six months of 2002, a decrease of $24.9 million or 120.8%. Net income as a percentage of revenue changed from 2.7% for the first six months of 2001 to (0.5)% for the first six months of 2002 and from 3.3% in the second quarter of 2001 to (2.3)% in the second quarter of 2002. Included in net income for the first six months of 2002 are impairment, restructuring and other charges of $40.0 million and an extraordinary loss on early extinguishment of debt of $8.5 million, net of income taxes. Excluding the extraordinary loss and impairment, restructuring and other charges, net income for the six months ended June 30, 2002 would have been $28.9 million, which represents earnings per share of $0.29. Included in net income for the six months ended June 30, 2001 were pre-tax restructuring charges of $5.9 million. Excluding the restructuring charges, net income for the first six months of 2001 would have been $24.2 million, which represents earnings per share of $0.24. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2002, we had net working capital of $224.6 million, including cash and cash equivalents of $110.3 million. We had current liabilities of $263.2 million, including $23.3 million in current maturities of long-term debt, and $212.4 million of long-term indebtedness. During the first six months of 2002, we provided $79.1 million in net operating cash flow, invested $28.0 million, and provided cash from financing activities in the amount of $39.2 million. As of August 6, 2002 we had cash and cash equivalents of $110.0 million. Cash Flows From Operating Activities During the first six months of 2002, we generated $79.1 million in cash flows from operating activities as compared to $107.7 million in the comparable prior year period. The decrease in cash flow is attributable to (i) advance purchases of certain pharmaceutical products during the first six months of 2002 in order to obtain favorable pricing and qualify for certain rebates, and (ii) less reduction in number of accounts receivable days outstanding. Our accounts receivable days outstanding as of June 30, 2002 decreased to 48 days from 50 days as of December 31, 2001, as compared to a decrease to 58 days as of June 30, 2001 from 67 days as of December 31, 2000. Cash Flows from Investing Activities During the first six months of 2002 and 2001, we expended $28.0 million and $30.5 million in capital expenditures and financed an additional $3.3 million and $15.5 million through various leasing facilities, respectively. During the first six months of 2002, we expended $15.6 million on the development and construction of cancer centers. In addition, we expended $3.9 million on installation of PET centers, of which $3.3 million was financed through various equipment operating leases. Maintenance capital expenditures were $11.8 million and $18.8 million in the first six months of 2002 and 2001, respectively. For all of 2002, we anticipate expending a total of approximately $30-$35 million on maintenance capital expenditures and approximately $40-$45 million on development of new cancer centers and PET installations. Expected capital expenditures on cancer center and PET development are below prior period amounts due to the Company's focus on transitional activity. Cash Flows from Financing Activities During the first six months of 2002, we provided cash from financing activities of $39.2 million as compared to cash used of $67.9 million in the first six months of 2001. Such increase in cash flow is primarily attributed to the proceeds from the issuance of our Senior Subordinated Notes due 2012, net of the cash payments for the retirement of our previously existing indebtedness, including a prepayment premium paid as a result of early extinguishment of our Senior Secured Notes due 2006. In addition, we expended $10.7 million to repurchase 1.2 million shares of our Common Stock during the second quarter of 2002. Historically, we satisfied our development and transaction needs through debt and equity financings and borrowings under a $175 million syndicated revolving credit facility with First Union National Bank (First Union), as a lender and as an agent for various other lenders. We also used a $75 million synthetic leasing facility in connection with developing integrated cancer centers. Availability of new advances under the leasing facility terminated in June 2001. We discuss this in more detail below. On February 1, 2002, we entered into a five-year $100 million syndicated revolving credit facility and terminated our existing syndicated revolving credit facility. Proceeds under that credit facility may be used to finance the 26 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) development of cancer centers and new PET facilities, to provide working capital or for other general business purposes. No amounts have been borrowed under that facility. Our credit facility bears interest at a variable rate that floats with a referenced interest rate. Therefore, to the extent we have amounts outstanding under the credit facility in the future, we would be exposed to interest rate risk under our credit facility. On February 1, 2002, we issued $175 million in 9.625% Senior Subordinated Notes due 2012 to various institutional investors in a private offering under Rule 144A under the Securities Act of 1933. The notes were subsequently exchanged for substantially identical notes in an offering registered under the Securities Act of 1933. The notes are unsecured, bear interest at 9.625% annually and mature in February 2012. Payments under those notes are subordinated in substantially all respects to payments under our new credit facility and certain other debt. We used the proceeds from the Senior Subordinated Notes to repay in full our existing $100 million in Senior Secured Notes due 2006, including payment of a prepayment penalty of $11.7 million due as a result of our repayment of the notes before their scheduled maturity. We also used proceeds from the Senior Subordinated Notes to pay fees and related expenses of $4.8 million associated with issuing those notes and to pay fees and related expenses of $2.7 million in connection with the new credit facility. During the first quarter of 2002, we recognized the prepayment penalty of $11.7 million and a write-off of unamortized deferred financing costs related to the terminated debt agreements of $1.9 million, which were recorded as an extraordinary item during the first quarter of 2002. Our introduction of the service line structure, in particular our offering existing affiliated practices the opportunity to terminate service agreements, repurchase their assets and enter into service line agreements, required an amendment or refinancing of our existing facilities. The new credit facility and Senior Subordinated Notes give us flexibility in this regard. In addition, we believe that the longer maturity of the Senior Subordinated Notes adds stability to our capital structure. We have entered into an operating lease arrangement known as a "synthetic lease", under which a special purpose entity has acquired title to properties, paid construction costs and leased to us the real estate and equipment at some of our cancer centers. The synthetic lease facility was funded by a syndicate of financial institutions. A synthetic lease is preferable to a conventional real estate lease since the lessee benefits from attractive interest rates, the ability to claim depreciation under tax laws and the ability to participate in the development process. We entered into the synthetic lease in December 1997. It matures in June 2004. As of June 30, 2001, we had $72.0 million outstanding under the synthetic lease facility, and no further amounts are available under that facility. The annual lease cost of the synthetic lease is approximately $3.6 million, based on interest rates in effect as of June 30, 2002. The lessor under the synthetic lease holds real estate assets (based on original acquisition and construction costs) of approximately $59.2 million and equipment of approximately $12.8 million (based on original acquisition cost) at nineteen locations. The lease is renewable in one-year increments, but only with consent of the financial institutions that are parties thereto. If the lease is not renewed at maturity or otherwise terminates, we must either purchase the properties under the lease for the total amount outstanding or market the properties to third parties. Defaults under the lease, which includes cross-defaults to other material debt, could result in such a termination, and require us to purchase or remarket the properties. If we sell the properties to third parties, we have guaranteed a residual value of at least 85% of the total amount outstanding for the properties. The guarantees are secured by substantially all of our assets. If the properties were sold to a third party at a price such that we were required to make a residual value guarantee payment, such amount would be recognized as an expense in our statement of operations. 27 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) A synthetic lease is an operating lease according accounting principles generally accepted in the United States "GAAP". Thus, our obligations under the synthetic lease are not recorded as debt and the underlying properties and equipment are not recorded as assets on our balance sheet. Our rental payments (which approximate interest amounts under the synthetic lease financing) are treated as operating rent commitments, and are excluded from our aggregate debt maturities. On February 27, 2002, the FASB determined that synthetic lease properties meeting certain criteria would be required to be recognized as assets with a corresponding liability effective January 1, 2003. Our synthetic lease meets these criteria. The determination is not final and is subject to additional rule-making procedures, but assuming the determination becomes a formal accounting pronouncement and assuming that we do not alter the arrangement to maintain off-balance sheet treatment under the new rules, we would expect to recognize $72.0 million in additional property and equipment with a corresponding liability on our balance sheet as of January 1, 2003. If we were to purchase all of the properties currently covered by the synthetic lease or if changes in accounting rules or treatment of the lease were to require us to reflect the properties on our balance sheet, the impact to the consolidated financial statements would be as follows: o Property and equipment would increase by $72.0 million (the purchase price for the assets subject to the lease); o Assuming the purchase of the properties were financed through borrowing, or in the event the existing arrangement were required to be characterized as debt, indebtedness would increase by $72.0 million; and o Depreciation would increase by approximately $3.6 million per year as a result of the assets being owned by us. Acquiring the properties may require us to borrow additional funds. We may not be able to do so, particularly if we are required to purchase the properties as the result of an event of default. Any borrowing would also likely reduce the amount we could borrow for other purposes. In addition, changes in future operating decisions or changes in the fair market values of underlying leased properties or the associated rentals could result in significant charges or acceleration of charges in our statement of operations for leasehold abandonments or residual value guarantees. Because the synthetic lease payment floats with a referenced interest rate, we are also exposed to interest rate risk under the synthetic lease. A 1% increase in the referenced rate would result in an increase in lease payments of $0.7 million annually. Borrowings under the revolving credit facility and advances under the synthetic leasing facility bear interest at a rate equal to a rate based on prime rate or the London Interbank Offered Rate, based on a defined formula. The credit facility, synthetic leasing facility and Senior Subordinated Notes contain affirmative and negative covenants, including the maintenance of certain financial ratios, restrictions on sales, leases or other dispositions of property, restrictions on other indebtedness and prohibitions on the payment of dividends. Events of default under our credit facility, synthetic leasing facility and Senior Subordinated Notes include cross-defaults to all material indebtedness, including each of those financings. Substantially all of our assets, including certain real property, are pledged as security under the credit facility and synthetic leasing facility. 28 US UNCOLOGY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued (unaudited) We are currently in compliance with covenants under our synthetic leasing facility, revolving credit facility and Senior Subordinated Notes, with no borrowings currently outstanding under the revolving credit facility. We have relied primarily on cash flows from our operations to fund working capital. We currently expect that our principal use of funds in the near future will be in connection with the purchase of medical equipment, investment in information systems and the acquisition or lease of real estate for the development of integrated cancer centers and PET centers, as well as implementation of the service line structure, with less emphasis than in past years on transactions with medical oncology practices. It is likely that our capital needs in the next several years will exceed the cash generated from operations. Thus, we may incur additional debt or issue additional debt or equity securities from time to time. Capital available for health care companies, whether raised through the issuance of debt or equity securities, is quite limited. As a result, we may be unable to obtain sufficient financing on terms satisfactory to management or at all. 29 US Oncology, Inc. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS In the normal course of business, our financial position is routinely subjected to a variety of risks. Among these risks is the market risk associated with interest rate movements on outstanding debt. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures. Our borrowings under our synthetic leasing facility and revolving credit facility contain an element of market risk from changes in interest rates. We have, in the past managed this risk, in part, through the use of interest rate swaps; however, no such agreements have been entered into in the first six months of 2002, and we were not obligated under any interest rate swap agreements during the first quarter period ended June 30, 2002. We do not enter into interest rate swaps or hold other derivative financial instruments for speculative purposes. No amounts are currently outstanding under the revolving credit facility, nor were any amounts outstanding under the revolving credit facility during the first six months of 2002. $72.0 million is outstanding under the synthetic leasing facility. Our Senior Subordinated Notes due 2012 bear interest at a fixed rate of 9.625%. For purposes of specific risk analysis, we use sensitivity analysis to determine the impact that market risk exposures may have on us. The financial instruments included in the sensitivity analysis consist of all of our cash and equivalents, long-term and short-term debt and all derivative financial instruments. To perform sensitivity analysis, we assess the risk of loss in fair values from the impact of hypothetical changes in interest rates on market sensitive instruments. The market values for interest rate risk are computed based on the present value of future cash flows as impacted by the changes in the rates attributable to the market risk being measured. The discount rates used for the present value computations were selected based on market interest rates in effect at June 30, 2002. The market values that result from these computations are compared with the market values of these financial instruments at June 30, 2002. The differences in this comparison are the hypothetical gains or losses associated with each type of risk. A one percent increase or decrease in the levels of interest rates on variable rate debt with all other variables held constant would not result in a material change to our results of operations or financial position or the fair value of its financial instruments. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The provision of medical services by our affiliated practices entails an inherent risk of professional liability claims. We do not control the practice of medicine by the clinical staff or their compliance with regulatory and other requirements directly applicable to practices. In addition, because the practices purchase and resell pharmaceutical products, they face the risk of product liability claims. Although we maintain insurance coverage, successful malpractice, regulatory or product liability claims asserted against us or one of the practices could have a material adverse effect on us. We have become aware and previously disclosed that we and certain of our subsidiaries and affiliated practices are the subject of qui tam lawsuits commonly referred to as "whistle-blower" lawsuits that remain under seal, meaning that they were filed on a confidential basis with a U.S. federal court and are not publicly available or disclosable. The U.S. Department of Justice has determined that it will not intervene in any of those qui tam suits of which we are aware. In these suits, the individual who filed the complaint may choose to continue to pursue litigation in the absence of government intervention, but has not yet indicated an intent to do so. Because qui tam actions are filed under seal, there is a possibility that we could be the subject of other qui tam actions of which we are unaware. We intend to continue to investigate and vigorously defend ourselves against any and all such claims, and we continue to believe that we conduct our operations in compliance with law. Qui tam suits are brought by private individuals, and there is no minimum evidentiary or legal threshold for bringing such a suit. However, the Department of Justice is legally required to investigate the allegations in these suits. The 30 US Oncology, Inc. Legal Proceedings--continued subject matter of many such claims may relate both to our alleged actions and alleged actions of an affiliated practice. Because the affiliated practices are separate legal entities not controlled by us, such claims necessarily involve a more complicated, higher cost defense, and may adversely impact the relationship between us and the practices. If the individuals who file complaints and/or the United States were to prevail in these claims against us, and the magnitude of the alleged wrongdoing were determined to be significant, the resulting judgment could have a material adverse financial and operational effect on us including potential limitations in future participation in governmental reimbursement programs. In addition, addressing complaints and government investigations requires us to devote significant financial and other resources to the process, regardless of the ultimate outcome of the claims. We and our network physicians are defendants in a number of lawsuits involving employment and other disputes and breach of contract claims. In addition, we are involved from time to time in disputes with, and claims by, our affiliated practices against us. Although we believe the allegations are customary for the size and scope of our operations, adverse judgments, individually or in the aggregate, could have a material adverse effect on us. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The Company held its Annual Meeting of Stockholders on May 9, 2002. (b) No disclosure required. (c) The following matters were voted upon at the Annual Meeting: (i) Election of Class III Directors
Broker Nominee Votes For Votes Against Votes Abstained Non-Votes ------- --------- ------------- --------------- --------- Russell L. Carson 85,674,776 2,016,493 0 0 Richard B. Mayor 85,671,676 2,019,593 0 0 Boone Powell, Jr. 85,675,176 2,016,093 0 0 R. Dale Ross 82,462,978 5,228,291 0 0
(ii) Approval of US Oncology, Inc. 2002 Key Executive Performance Stock Option Plan
Votes For Votes Against Votes Abstained Broker Non-Votes --------- ------------- --------------- ---------------- 40,466,694 26,779,996 191,176 20,253,403
(iii) Ratification of the Appointment of PricewaterhouseCoopers LLP as US Oncology's independent accountants for 2002.
Votes For Votes Against Votes Abstained Broker Non-Votes --------- ------------- --------------- ---------------- 85,958,074 1,667,004 66,191 0
(d) No disclosure required. 31 US Oncology, Inc. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit Number Description ------ ----------- 3.1 Amended and Restated Certificate of Incorporation (filed as Exhibit 3.1 to the Company's Form 8-K/A filed June 17, 1999 and incorporated herein by reference) 3.2 Amended and Restated By-Laws (filed as Exhibit 3.2 to the Company's Form 8-K/A filed June 17, 1999 and incorporated herein by reference) 4.1 Rights Agreement between the Company and American Stock Transfer & Trust Company (incorporated by reference from Form 8-A filed June 2, 1997). 4.2 Indenture dated February 1, 2002 among US Oncology, Inc., the Guarantors named therein, and JP Morgan Chase Bank as Trustee (filed as Exhibit 3 to, and incorporated by reference from, the Company's Form 8-K filed February 5, 2002). 4.3 Registration Rights Agreement dated as of February 1, 2002 by and among US Oncology, Inc., the Guarantors named therein and UBS Warburg LLC, Deutsche Banc Alex. Brown Inc. and First Union Securities, Inc. as Initial Purchasers (filed as Exhibit 4 to, and incorporated by reference from, the Form 8-K filed February 5, 2002). 10.1* 2002 Key Executive Performance Stock Option Plan 99.1 Certification of Chief Executive Officer 99.2 Certification of Chief Financial Officer (b) Reports on Form 8-K None. - ------------------------------------------------------------------------------ * Denotes exhibit pertaining to executive compensation 32 US Oncology, Inc. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. US ONCOLOGY, INC. Date: August 13, 2002 By: /s/ R. Dale Ross -------------------------------------------- R. Dale Ross, Chief Executive Officer (duly authorized signatory) Date: August 13, 2002 By: /s/ Bruce D. Broussard -------------------------------------------- Bruce D. Broussard, Chief Financial Officer (principal financial and accounting officer) 33 EX-10.1 3 dex101.txt 2002 KEY EXECUTIVE PERFORMANCE STOCK OPTION PLAN Exhibit 10.1 US ONCOLOGY, INC. 2002 KEY EXECUTIVE PERFORMANCE STOCK OPTION PLAN 1. PURPOSE. The mission of US Oncology, Inc. (the "Company") is to increase access to and advance the delivery of high-quality cancer care in community-based settings throughout the United States. The Company understands that it must have a highly motivated, focused and committed key executive management team to accomplish its mission and objectives. The purpose of the 2002 Key Executive Performance Stock Option Plan (the "Plan") is to provide an additional incentive to a limited number of key executives to enhance the possibilities for long-term success beyond normal expectations and to reward them upon the achievement of that success. 2. DEFINITIONS. As used herein the words and phrases below shall have the following meanings: (a) "Board" shall mean the Board of Directors of the Company. (b) "Code" shall mean the Internal Revenue Code of 1986, as amended. (c) "Committee" shall mean the Compensation Committee of the Board (or, if there is no such committee, the Board committee performing equivalent functions), which shall be comprised of at least three members who are (i) "non-employee directors" as defined under rules and regulations promulgated under Section 16(b) of the Exchange Act and (ii) "outside directors" as defined in Section 162(m) of the Code, and who shall be members of the Board, appointed by the Board to administer the Plan. The Board shall have the power to fill vacancies on the Committee arising by resignation, death, removal or otherwise. (d) "Common Stock" shall mean the common stock of the Company, $.01 par value per share, regardless of the series or class. (e) "Disability" shall mean the person so affected is unable to engage in substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than one hundred eighty (180) days. The Committee's determination as to whether a Participant has incurred a Disability shall be final and conclusive as to all interested parties. (f) "Eligible Employee" shall mean a key executive officer of the Company as determined pursuant to Section 4. (g) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. (h) "Fair Market Value" shall mean, with respect to a share of Common Stock on any date herein specified, the average of the highest and lowest quoted Selling Price per share of Common Stock on the date in question. The term "Selling Price" per share of Common Stock for a day or days shall mean (i) if the shares of Common Stock are listed or admitted for trading on a national securities exchange, the reported sales price regular way, or, in case no such reported sale takes place on such day or days, the average of the reported closing bid and asked prices regular way, in either case on the principal national securities exchange on which the shares of Common Stock are listed or admitted for trading, or (ii) if the shares of Common Stock are not listed or admitted for trading on a national securities exchange, (A) the transaction price of the shares of Common Stock on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") or, in the case no such reported transaction takes place on such day or days, the average of the reported closing bid and asked prices thereof quoted on NASDAQ, or (B) if the shares of Common Stock are not quoted on NASDAQ, the average of the closing bid and asked prices of the shares of Common Stock in the over-the-counter market, as reported by The National Quotation Bureau, Inc., or an equivalent generally accepted reporting service, or (iii) if on any such trading days the shares of Common Stock are not quoted by any such organization, the fair market value per share of Common Stock on such day(s), as determined in good faith by the Committee. If, in the discretion of the Committee, another means of determining Fair Market Value shall be necessary or advisable in order to comply with the requirements of Section 162(m) of the Code or any other applicable law, governmental regulation, or ruling of any governmental entity, then the Committee may provide for another means of such determination. (i) "Participant" shall mean any individual who has received an award of a Stock Option and has not exercised the Stock Option and received the Common Stock subject to the Stock Option. (j) "Retirement" shall mean the termination of employment from the Company constituting retirement as determined by the Committee. (k) "Securities Act" shall mean the Securities Act of 1933, as now in effect or as hereafter amended. (l) "Stock Option" shall mean a stock option pursuant to which a Participant is eligible to acquire Common Stock pursuant to the terms and conditions of the Plan and the Stock Option Agreement. (m) "Stock Option Agreement" shall mean the agreement described in Section 7. (n) "Terminated For Cause" shall mean that a Participant's employment is terminated as a result of a breach of his or her written employment agreement, if the Participant is subject to a written employment agreement, or if the Committee determines that such Participant is being terminated as a result of misconduct, dishonesty, disloyalty, disobedience or action that might reasonably injure the Company or its business interests or reputation. 3. ADMINISTRATION OF THE PLAN. The Plan shall be administered by the Committee. Subject to the provisions of the Plan, the Committee shall have authority to adopt rules and regulations for carrying out the Plan, determine the Eligible Employees, determine the exercise price and term of each Stock Option, determine the vesting period and vesting conditions for Stock Options, determine the series or class of Common Stock to be subject to the Stock Option, determine the Fair Market Value of Common Stock, and interpret, construe, and implement the provisions of the Plan. Decisions of the Committee (including decisions regarding the interpretation and application of the Plan) shall be binding on the Company and on all Participants and other interested parties. The Committee shall hold its meetings at such times and places as it deems advisable. A majority of the Committee shall constitute a quorum for a meeting. All determinations of the Committee shall be made by a majority of its members attending the meeting. Furthermore, any decision or determination reduced to writing and signed by all of the members of the Committee shall be as effective as if it had been made by a majority vote at a meeting properly called and held. 4. ELIGIBLE EMPLOYEES. The individuals who shall be eligible to participate in the Plan shall be such key executive officers (including executive officers who may be members of the Board of Directors) of the Company, or of any subsidiary of the Company, as the Committee shall determine from time to time. 5. SHARES OF COMMON STOCK SUBJECT TO THE PLAN; MAXIMUM GRANTS. The number of shares of Common Stock available for Stock Options shall equal 5,000,000. The shares of Common Stock available under the Plan may consist of shares of any series of Common Stock provided that the rights of such shares to dividends, to liquidation proceeds and to share in the appreciation in the value of the Company shall be not less than the rights of any other series of Common Stock. If any Stock Option shall expire or terminate for any reason without being exercised, shares of Common Stock subject to such Stock Option shall again be available for grant in connection with grants of subsequent Stock Options. The maximum number of shares of Common Stock that may be granted under Stock Options to any single Eligible Employee in any 12-month period shall be 750,000. 6. STOCK OPTION TERMS. (a) Exercise Price. The exercise price per share of Common Stock under each Stock Option shall be determined by the Committee; provided, however, that such exercise price shall not be less than 100% of the Fair Market Value per share of such Common Stock on the date of grant, as determined by the Committee. (b) Term. The Committee shall fix the term of each Stock Option, which shall be not more than ten years from the date of grant. In the event no term is fixed, such term shall be ten years from the date of grant. A-2 (c) Exercise; Transferability. The Committee shall determine the time or times at which a Stock Option may be exercised in whole or in part; provided, however, that other than as provided in Section 10, in no event shall a Stock Option be exercisable before the expiration of six months from the date of its grant or after ten years from the date of its grant. Stock Options shall not be transferable by the Participant otherwise than by will, under the laws of descent and distribution, or pursuant to a qualified domestic relations order (as defined by the Code) and shall be exercisable only by him or by his duly appointed personal representative. (d) Nonqualified Stock Options. Stock Options shall be "nonqualified" in that they shall not be designated by the Committee as intended to be qualified as "incentive" stock options under Section 422 of the Code. (e) Method of Exercise. Stock Options shall be exercised by the delivery of written notice to the Company setting forth the number of shares of Common Stock with respect to which the Stock Option is to be exercised and, subject to the subsequent provisions hereof, the address to which the certificates representing shares of the Common Stock issuable upon the exercise of such Stock Option shall be mailed. In order to be effective, such written notice shall be accompanied at the time of its delivery to the Company by payment of the exercise price of such shares of Common Stock, which payment shall be made in cash or by cashier's check, certified check, or postal or express money order payable to the order of the Company in an amount (in United States dollars) equal to the exercise price of such shares of Common Stock. Such notice shall be delivered in person to the Secretary of the Company, or shall be sent by registered mail, return receipt requested, to the Secretary of the Company, in which case, delivery shall be deemed made on the date such notice is deposited in the mail. (f) Withholding. Whenever shares of Common Stock are to be issued or delivered pursuant to the Plan, the Company shall require the Participant to remit to the Company an amount sufficient to satisfy federal, state, and local withholding tax requirements prior to the delivery of any certificate or certificates for such shares, which payment may be made in the manner set forth in clause (e) above or in the manner permitted by clause (g) below. (g) Alternative Payment for Stock. Alternatively, payment of the exercise price may be made, in whole or in part, by delivery of shares of Common Stock already owned by the Participant. Unless otherwise permitted by the Committee, payment of the exercise price with shares of Common Stock shall be made only with shares owned by the Participant for at least six (6) months. If payment is made in whole or in part in shares of Common Stock owned by the Participant, then the Participant shall deliver to the Company, in payment of the option price of the shares of Common Stock with respect to which such Stock Option is exercised, (i) certificates registered in the name of such Participant representing a number of shares of Common Stock legally and beneficially owned by such Participant, free of all liens, claims and encumbrances of every kind and having a Fair Market Value as of the date of delivery of such notice that is not greater than the exercise price of the shares of Common Stock with respect to which such Stock Option is to be exercised, such certificates to be accompanied by stock powers duly endorsed in blank by the record holder of the shares represented by such certificates; and (ii), if the exercise price of the shares of Common Stock with respect to which such Stock Option is to be exercised exceeds such Fair Market Value, cash or a cashier's check, certified check, or postal or express money order payable to the order of the Company in an amount (in United States dollars) equal to the amount of such excess. The Company may extend and maintain, or arrange for the extension and maintenance of, financing to any Participant to purchase shares pursuant to exercise of a Stock Option and/or to pay withholding taxes on such terms as may be approved by the Committee in its sole discretion. In considering the terms for extension or maintenance of credit by the Company, the Committee shall, among other factors, consider the cost to the Company of any financing extended by the Company. (h) Terms of Initial Grants. Of the shares available under the Plan, at least 3,750,000 shares shall be made as initial grants (the "Initial Grants") following the adoption of the Plan by the Company's stockholders pursuant to Section 22. The Stock Option Agreements for each Stock Option that is one of the Initial Grants to a Participant in connection with the adoption of this Plan shall contain the following provisions, none of which may be modified or revised except in compliance with Section 17 of this Plan: A-3 (i) a requirement that the Participant shall not receive any additional grants of stock options or other equity interests (including, without limitation, restricted stock grants, stock appreciation rights and phantom stock rights) in the Company, whether pursuant to this Plan or any other plan, prior to the second anniversary of the Participant's initial grant under this Plan; (ii) a provision that vesting of the Stock Options granted shall not occur until seven (7) years following the date of such grant, unless such vesting is accelerated pursuant to provision (iii) below; and (iii) a vesting schedule setting forth certain internal return on invested capital ("ROIC") targets for the Company beginning with the fiscal year ending December 31, 2002, which targets, if met, will result in some or all of the Stock Options granted becoming vested and exercisable. (i) No Change in Exercise Price. The exercise price of any Stock Option granted at any time shall not be decreased or otherwise "repriced", whether through amendment, cancellation or replacement grants. This requirement shall not be modified or revised except in compliance with Section 17 of this Plan. 7. STOCK OPTION AGREEMENT. The Stock Options awarded to an Eligible Employee shall be evidenced by a separate written agreement (the "Stock Option Agreement") which shall be subject to the terms and provisions of the Plan, and which shall be signed by the Participant and by the Chief Executive Officer or a Vice President of the Company, other than the Participant, in the name of and on behalf of the Company. The Stock Option Agreement shall contain such provisions the Committee in its discretion deems advisable. In the event of any inconsistency or conflict between the terms of the Plan and a Stock Option Agreement, the terms of the Plan shall govern. 8. TERMINATION OF EMPLOYMENT, DEATH, DISABILITY AND RETIREMENT. (a) Termination of Employment. If a Participant's employment is terminated for any reason whatsoever other than death, Disability or Retirement, with respect to any Stock Option granted pursuant to the Plan outstanding at the time, unless otherwise established by the Committee, no further vesting shall occur and the Participant shall be entitled to exercise his or her rights with respect to the portion of the Stock Option vested as of the date of termination for a period expiring on the earlier of (i) the expiration date set forth in the Stock Option Agreement or (ii) ninety (90) calendar days after such termination date and, thereafter, the Stock Option and the Participant's rights thereunder shall be completely terminated; provided, however, that if a Participant is Terminated for Cause, such Participant's right to exercise the vested portion of his or her Stock Option shall terminate as of 12:01 a.m. on the date of termination of employment. (b) Retirement. Unless otherwise approved by the Committee, upon the Retirement of a Participant: (i) any nonvested portion of any outstanding Stock Option shall immediately terminate and no further vesting shall occur; and (ii) any vested Stock Option shall expire on the earlier of (A) the expiration date set forth in the Stock Option Agreement with respect to such Stock Option; or (B) the first anniversary of the date of Retirement. (c) Death or Disability. Upon termination of employment as a result of death or Disability: (i) 50% of any nonvested portion of any outstanding Stock Option shall immediately and fully vest notwithstanding the original vesting schedule; and (ii) any vested Stock Option, including those vested pursuant to Section (c)(i), shall expire upon the earlier of (A) the expiration date set forth in the Stock Option Agreement with respect to such Stock Option or (B) the first anniversary of such termination of employment as a result of death or Disability. A-4 9. REQUIREMENTS OF LAW. The Company shall not be required to sell or issue any shares of Common Stock under any Stock Option if the issuance of such shares shall constitute a violation by the Participant or the Company of any provision of any law, statute, or regulation of any governmental authority whether it be Federal or State. Specifically, in connection with the Securities Act, upon exercise of any Stock Option, unless a registration statement under the Securities Act is in effect with respect to the shares of Common Stock covered by such Stock Option, the Company shall not be required to issue such shares unless the Committee has received evidence satisfactory to it to the effect that the holder of such Stock Option is acquiring such shares of Common Stock for investment and not with a view to the distribution thereof, and that such shares of Common Stock may otherwise be issued without registration under the Securities Act or State securities laws. Any determination in this connection by the Committee shall be final, binding and conclusive. The Company may, but shall in no event be obligated to, register any securities covered hereby pursuant to the Securities Act. The Company shall not be obligated to take any affirmative action in order to cause the exercise of a Stock Option, or the issuance of shares pursuant thereto, to comply with any law or regulation of any governmental authority. 10. CHANGE IN STOCK AND ADJUSTMENTS; CHANGE OF CONTROL. (a) The existence of outstanding Stock Options shall not affect in any way the right or power of the Company or its stockholders to make or authorize any or all adjustments, recapitalizations, reorganizations or other changes in the Company's capital structure or its business, or any merger or consolidation of the Company, or any issue of bonds, debentures, preferred or prior preference stock ahead of, or affecting, the Common Stock or the rights thereof, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise. (b) If the Company shall effect a subdivision or consolidation of shares or other capital readjustment, the payment of a stock dividend, or other increase or reduction of the number of shares of Common Stock outstanding, without receiving compensation therefor in money, services or property, then (a) the number, class, and per share price of shares of Common Stock subject to outstanding Stock Options hereunder shall be appropriately adjusted in such a manner as to entitle a Participant to receive upon exercise of a Stock Option, for the same aggregate cash consideration, the same total number and class of shares as he would have received had he exercised his Stock Option in full immediately prior to the event requiring the adjustment; and (b) the number and class of shares then reserved for issuance under the Plan shall be adjusted by substituting for the total number and class of shares of Common Stock then reserved that number and class of shares of Common Stock that would have been received by the owner of an equal number of outstanding shares of each class of Common Stock as the result of the event requiring the adjustment. (c) After a merger of one or more corporations into the Company or after a consolidation of the Company and one or more corporations in which the Company is the surviving corporation, each holder of an outstanding Stock Option, upon exercise of such Stock Option, shall be entitled to receive (at no additional cost but subject to any required action by stockholders) in lieu of the number and class of shares of Common Stock with respect to which such Stock Option is exercisable, the number and class of shares of stock (or other securities or consideration) to which such holder would have been entitled pursuant to the terms of the agreement of merger or consolidation if, immediately prior to such merger or consolidation, such holder had been the holder of record of the same number and class of shares of Common Stock which he would have otherwise received upon exercise of such Stock Option. (d) If the Company is merged into or consolidated with another corporation under circumstances where the Company is not the surviving corporation, or if the Company is liquidated, or sells or otherwise disposes of substantially all its assets to another corporation while unexercised Stock Options remain outstanding under the Plan, (i) subject to the provisions of clause (iii) below, after the effective date of such merger, consolidation, liquidation, or sale, as the case may be, each holder of an outstanding Stock Option shall be entitled, upon exercise of such Stock Option, to receive at no additional cost, in lieu of shares of Common Stock, shares of such stock (or other securities or consideration) as the holders of shares of Common Stock received pursuant to the terms of the merger, consolidation, liquidation, or sale; (ii) unless otherwise provided in the Participant's Stock Option Agreement, any limitations set forth in or imposed pursuant to this Plan shall automatically lapse so that all Stock Options, from and after a thirty (30) day period preceding the effective date of such merger, consolidation, liquidation or sale, as the case may be, shall be exercisable in full; and (iii) all outstanding Stock Options may be canceled by the Board as of the effective date of any such merger, consolidation, liquidation or sale provided that (a) notice of such cancellation shall be given to each holder of a Stock Option, and (b) A-5 unless otherwise provided in the Participant's Stock Option Agreement, each holder of a Stock Option shall have the right to exercise such Stock Option in full (without regard to any limitations set forth in or imposed pursuant to Section 8 hereof) during a thirty (30) day period preceding the effective date of such merger, consolidation, liquidation, or sale. In the event the acceleration of vesting provided by clause (ii) or (iii) above would result in imposition of the excise tax imposed by Section 4999 of the Code, a Participant may elect to waive such acceleration with respect to such number of shares subject to unvested Stock Options as the Participant shall designate, and the Participant shall be entitled to designate from among his unvested Stock Options those Stock Options which shall not be subject to accelerated vesting. (e) Except as expressly provided herein, the issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, for cash, property, labor, or services, either upon direct sale, exercise of rights or warrants to subscribe therefor, or conversion of shares or obligations of the Company convertible into such shares or other securities, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number, class or price of shares of Common Stock then subject to outstanding Stock Options. (f) Upon a Change of Control, any limitations set forth in or imposed pursuant to this Plan shall automatically lapse so all Stock Options shall be exercisable in full. For purposes of this Plan, a "Change of Control" is defined (i) as the transfer of beneficial ownership of a majority of the outstanding shares of US Oncology stock to any person or entity (including a "group" as such term is used in Section 13(d)(3) of the Securities Exchange Act of 1934), except that if beneficial ownership would be deemed to occur merely upon the execution of voting agreements to support a merger, consolidation or other transaction to be consummated in the future, then the Board of Directors may in its sole discretion determine that the date of such Change of Control shall instead be the date of such consummation, (ii) the stockholders of the Company prior to any merger, consolidation or other transaction do not continue to own at least fifty percent (50%) of the surviving entity following such merger, consolidation or other transaction; (iii) the Company sells, leases or exchanges all or substantially all if its assets to any other person or entity (other than a direct or indirect wholly owned subsidiary of the Company); (iv) the Company is materially or completely liquidated; or (v) during any consecutive two-year period, individuals who constituted the Board of Directors of the Company (together with any new directors whose election by the Board of Directors or whose nomination for election by the stockholders of the Company was approved by a vote of at least three quarters of the directors still in office who were either directors at the beginning of such period or whose election or nomination for election was previously so approved) cease for any reason to constitute a majority of the Board of Directors then in office. Notwithstanding anything contained herein to the contrary, a "Change of Control" shall not be deemed to have occurred in the event of a tender offer, leveraged buyout, leveraged recapitalization or similar transaction in which the Company's then Chief Executive Officer participates or has any agreement or arrangement to participate directly or indirectly as an investor or participant (e.g., through receipt of equity, additional stock options or entering into a new employment agreement) in such transaction. 11. NO RIGHTS AS STOCKHOLDER. A holder of a Stock Option shall have no rights as a stockholder with respect to any shares of Common Stock until the issuance of a stock certificate for such shares. Except as otherwise provided in Section 10, no adjustment shall be made for dividends (ordinary or extraordinary, whether in cash, securities, or other property) or distributions or other rights for which the record date is prior to the date such stock certificate is issued. 12. NO EFFECT ON EMPLOYMENT RELATIONSHIP. Participation in the Plan shall not confer upon any employee any right to continue in the employ of the Company or interfere in any way with the right of the Company to terminate any employee's employment at any time. 13. NO FUND ESTABLISHED. It is not intended that awards under this Plan be set aside in a trust which would qualify as an employee's trust within the meaning of sections 401 or 402 of the Internal Revenue Code of 1986, as amended, or in any other type of trust, fund, or separate account. The rights of any Participant and any person claiming under such Participant shall not rise above or exceed those of an unsecured creditor of the Company. 14. NO ASSIGNMENT OR ALIENATION OF BENEFITS. Except as contemplated by Section 6(c), no right or benefit under this Plan shall be subject to anticipation, alienation, sale, assignment, pledge, encumbrance, or charge, and any attempt to anticipate, alienate, sell, assign, pledge, encumber, or charge the same shall be void. No right or benefit hereunder shall in any manner be liable for or subject to any debts, contracts, liabilities, or torts of the person entitled to such benefits. A-6 15. SUBSTITUTION OPTION. Stock Options may be granted under this Plan from time to time in substitution for stock options held by employees (or nonemployee directors) of another corporation who are about to become employees (or nonemployee directors) of the Company as the result of a merger or consolidation with the Company, or the acquisition by the Company of the assets of the other corporation, or the acquisition by the Company of stock of the other corporation as the result of which it becomes a subsidiary of the Company. The terms and conditions of the substitute Stock Options so granted may vary from the terms and conditions set forth in this Plan to such extent as the Board at the time of grant may deem appropriate to conform, in whole or in part, to the provisions of the stock options for which such substitute Stock Options are granted. 16. GENDER, TENSE AND HEADINGS. Whenever the context requires such, words of the masculine gender used herein shall include the feminine and neuter, and words used in the singular shall include the plural. Section headings as used herein are inserted solely for convenience and reference and constitute no part of the construction of this Plan. 17. AMENDMENT AND TERMINATION. The Board may modify, revise or terminate the Plan at any time and from time to time; provided, however, that without the further approval of the holders of at least a majority of the shares of Common Stock that cast votes (in person or by proxy) on the proposal at a duly called meeting, the Board may not (i) change the aggregate number of shares which may be issued under Stock Options pursuant to the provisions of the Plan; (ii) reduce the option price at which Stock Options may be granted to an amount less than 100% of the Fair Market Value per share at the time the Stock Option is granted, or otherwise materially increase the benefits accruing to Participants under the Plan; (iii) change the class of persons eligible to receive Stock Options; (iv) otherwise cause the Plan to not comply with the rules and regulations promulgated under Section 16(b) of the Exchange Act or Section 162(m) of the Code, if applicable; or (v) change any of the terms set forth in Sections 6(h) and 6(i), whether set forth in this Plan or in a Stock Option Agreement. No amendment or termination may adversely affect any vested right of a Participant without the written consent of such Participant. 18. NO GUARANTEE OF TAX CONSEQUENCES. Neither the Company nor the Committee makes any commitment or guarantee that any federal, state or local tax treatment will apply or be available to any person participating or eligible to participate hereunder. 19. SEVERABILITY. In the event that any provision of this Plan shall be held illegal, invalid or unenforceable for any reason, such provision shall be fully severable, but shall not affect the remaining provisions of the Plan, and the Plan shall be construed and enforced as if the illegal, invalid, or unenforceable provision had never been included herein. 20. GOVERNING LAW. The provisions of the Plan shall be construed, administered, and governed by the laws of the State of Texas, without giving effect to principles of conflicts of laws, and, to the extent applicable, the laws of the United States. 21. EFFECTIVE DATE. The Plan shall become effective and shall be deemed to have been adopted on March 21, 2002, if within one year of that date it shall have been approved by the holders of at least a majority of the shares of Common Stock that cast votes (in person or by proxy) on the proposal at a duly called meeting. No Stock Option shall be granted pursuant to the Plan after one day more than ten years after the effective date. 22. STOCKHOLDERS APPROVAL. Notwithstanding any other provisions of the Plan, in order for the Plan to continue as effective, on or before the date which occurs twelve (12) months after the date the Plan is effective, the Plan must be approved by the holders of at least a majority of the outstanding stock of the Company entitled to vote thereon voting in person, or by proxy, at a duly held stockholders' meeting, and no shares of Common Stock shall be issued under the Plan until such approval has been secured. A-7 EX-99.1 4 dex991.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of US Oncology, Inc. (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, R. Dale Ross, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. (S) 1350, as adopted pursuant to (S) 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ R. Dale Ross R. Dale Ross Chief Executive Officer August 13, 2002 EX-99.2 5 dex992.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of US Oncology, Inc. (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Bruce D. Broussard, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. (S)1350, as adopted pursuant to (S)906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Bruce D. Broussard Bruce D. Broussard Chief Financial Officer August 13, 2002 -----END PRIVACY-ENHANCED MESSAGE-----