ITEM 1. BUSINESS
THE COMPANY
Response Oncology, Inc. ("The Company") is a comprehensive cancer management company. The Company provides advanced cancer treatment services through outpatient facilities known as IMPACT(R) Centers under the direction of practicing oncologists; owns the assets of and manages the nonmedical aspects of oncology practices; and conducts outcomes research on behalf of pharmaceutical manufacturers. Approximately 400 medical oncologists are associated with the Company through these programs.
IMPACT(R) Services The Company presently operates 54 IMPACT(R) Centers in 26 states and the District of Columbia which provide high dose chemotherapy with stem cell support to cancer patients on an outpatient basis. Through its IMPACT(R) Centers, the Company has developed extensive medical information systems and databases containing clinical and patient information, analysis of treatment results and side effects and clinical care pathways. These systems and databases support the Company's clinical trials program, which involves carefully planned, uniform treatment regimens administered to a significant group of patients together with the monitoring of outcomes and side effects of these treatments. The clinical trials program allows the Company to develop a rational means of improving future treatment regimens by predicting which patients are most likely to benefit from different treatments.
Each IMPACT(R) Center is staffed by, and makes extensive use of, experienced oncology nurses, pharmacists, laboratory technologists, and other support personnel to deliver outpatient services under the direction of independent medical oncologists. IMPACT(R) Center services include preparation and collection of stem cells, administration of high dose chemotherapy, reinfusion of stem cells and delivery of broad-based supportive care. IMPACT(R) Center personnel extend the support mechanism into the patient's home, further reducing the dependence on hospitalization. The advantages of this system to the physician and patient include (i) convenience of the local treatment facility; (ii) specialized on-site laboratory and pharmacy services, including home pharmacy support; (iii) access to the Company's clinical trials program to provide ongoing evaluation of current cancer treatment; (iv) specially trained medical and technical staff; (v) patient education and support materials through computer, video and staff consultation; and (vi) reimbursement assistance.
High dose chemotherapy is most appropriate for patients with lymphoma, acute leukemia, multiple myeloma and breast and ovarian cancer. Patients referred to the Company by the treating oncologist are placed on a treatment protocol developed from the cumulative analysis of the Company's approximately 3,000 high-dose cases. Protocols conducted at the IMPACT(R) Center begin with a drug regimen which allows for the collection and cryopreservation of stem cells. A stem cell is a cell which originates in the bone marrow and is a precursor to white blood cells. At the appropriate time, stem cells capable of restoring immune system and bone marrow functions are harvested over a two to three day period. The harvested stem cells are then frozen and stored at the IMPACT(R) Center, and following confirmation of response to treatment and a satisfactory stem cell harvest, patients receive high dose chemotherapy followed by reinfusion of stem cells. Most patients are then admitted to an affiliated hospital for approximately 10-14 days. After discharge, the patient is monitored in the oncologist's office. The Company believes that the proprietary databases and the information gathering techniques developed from the foregoing programs enable practicing oncologists to cost effectively manage cancer cases while ensuring quality. Clinical research conducted by the Company focuses on (i) improving cancer survival rates; (ii) enhancing the cancer patient's quality of life; (iii) reducing the costs of cancer care; and (iv) developing new approaches to cancer diagnosis, treatment and post-treatment monitoring.
Since 1989, the Company has conducted a clinical trials program pursuant to which carefully planned, uniform treatments administered to a substantial number of patients have been monitored and studied, with the results being collected in a database and utilized to predict outcomes and determine utilization of high dose chemotherapy as a treatment. In addition, the Company has recorded outcomes from over 3,000 cases in which high dose chemotherapy was utilized as a treatment and has developed and continues to refine treatment
pathways, which forecast the best outcome with the lowest possible cost. Pursuant to agreements between the Company and the oncologists who supervise their patients' treatment in IMPACT(R) Centers, such oncologists are obligated to record and monitor outcomes, collect information and report such information to the Company.
The Company also provides pharmacy management services for certain medical oncology practices. These services include compounding and dispensing pharmaceuticals for a fee, typically cost plus a percentage.
Oncology Practice Management Services During 1996, the Company adopted a strategy of diversification into physician practice management and since then has consummated affiliations with 12 medical oncology practices, including 43 medical oncologists in Florida and Tennessee. Through these affiliations, the Company believes that it has successfully achieved deep geographic penetration in those markets, believing that significant market share is crucial to achieving efficiencies, revenue enhancements, and marketing of complete cancer services to diverse payors including managed care. Pursuant to management service agreements ("Service Agreements"), the Company provides management services that extend to all nonmedical aspects of the operations of the affiliated practices.
Pursuant to the Service Agreements, the Company is the sole and exclusive manager and administrator of all day-to-day business functions connected with the medical practice of an affiliated physician group. The Company is responsible for providing facilities, equipment, supplies, support personnel, and management and financial advisory services. Under the terms of the Service Agreements, the Company (among other things): (i) prepares annual capital and operating budgets; (ii) prepares financial statements; (iii) orders and purchases medical and office inventory and supplies; (iv) bills patients and third party payors as agent for the affiliated practices; (v) maintains accounting, billing, medical, and collection records; (vi) negotiates and administers managed care contracts as an agent for affiliated physicians; (vii) arranges for legal and accounting services related to practice operations; (viii) recruits, hires and appoints an executive director to manage and administer all of the day-to-day business functions of each practice; and (ix) manages all non-physician professional support and administrative personnel, clerical, secretarial, bookkeeping and collection personnel. The Company seeks to combine the purchasing power of numerous physicians to obtain favorable pricing and terms for equipment, pharmaceuticals and supplies and to obtain favorable contracts with suppliers.
In return for its management services, the Company receives a service fee based on net revenue or net operating income of the practice. Pursuant to each Service Agreement, the physicians and the practice agree not to compete with the Company and the practice. Each Service Agreement has an initial term of 40 years and, after the initial term, will be automatically extended for additional five year terms unless either party delivers written notice to the other party 180 days prior to the expiration of the preceding term. The Service Agreement only provides for terminationmay "for cause". If the Company terminates the Service Agreement for cause, the practice is typically obligated to purchase assets (which typically include intangible assets) and pay liquidated damages, which obligations are guaranteed by individual physician owners of the practice for a period of time. Each Service Agreement provides for the creation of an oversight committee, a majority of the members of which are designated by the practice. The oversight committee is responsible for developing management and administrative policies for the overall operation of each clinic.
In February 1999 the Company announced that it had terminated its Service Agreement with one of the Company's three underperforming net revenue model relationships. Concurrently, the Company established a reserve against the three Service Agreements in accordance with Financial Accounting Standards Board Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of." The structure of these contracts has failed over time to align the physician and Company incentives, producing deteriorating returns and/or negative cash flows to the Company. Since this was not a "for cause" termination initiated by the Company the affiliated practice was not responsible for liquidated damages. A separate negotiated settlement was agreed on by the Company and the affiliated practice and the
Company anticipates that the affiliated practice will continue to participate in the Company's IMPACT Center network.
The Company is currently discussing a termination with the second of the three underperforming relationships. The termination will not be deemed "for cause" and a negotiated settlement is expected to be reached in the second quarter of 1999.
Cancer Research Services The Company also utilizes its outcomes database to provide various types of data to pharmaceutical companies regarding the use of their products. The IMPACT(R) Center network and the Company's medical information systems make the Company ideally suited to this process. The Company is currently participating in several projects with leading pharmaceutical manufacturers to furnish data in connection with FDA applications and post-FDA approval marketing studies. Revenue from these contracts helps to underwrite the Company's clinical trials expenses. Such relationships with pharmaceutical companies allow patients and physicians earlier access to drugs and therapies, which guarantee the Company's role as a leader in oncological developments.
COMPETITION
As a result of growing interest among oncologists and the more widely recognized efficacy of high-dose chemotherapy treatments, the competitive environment in the field is starting to heighten. Most community hospitals with a commitment to cancer treatment are evaluating their need to provide high dose treatments, and other entities are competing with the Company in providing high-dose services similar to those offered by the Company. Such competition has long been contemplated by the Company, and is indicative of the evolution of this field. While the Company believes that the demand for high dose chemotherapy services is sufficiently large to support several significant providers of these services, the Company is subject to increasing competitive risks from these entities.
In addition, the Company is aware of at least three competitors specializing in the management of oncology practices and two other physician management companies that manage at least one oncology practice. Several health care companies with established operating histories and significantly greater resources than the Company are also providing at least some management services to oncologists. There are certain other companies, including hospitals, large group practices, and outpatient care centers, that are expanding their presence in the oncology market and may have access to greater resources than the Company. Furthermore, organizations specializing in home and ambulatory infusion care, radiation therapy, and group practice management compete in the oncology market.
The Company's profitability depends in part on the continued success of its affiliated physician groups. These physician groups face competition from several sources, including sole practitioners, single and multi-specialty groups, hospitals and managed care organizations.
GOVERNMENT REGULATION
The delivery of healthcare items and services has become one of the most highly regulated of professional and business endeavors in the United States. Both the federal government and the individual state governments are responsible for overseeing the activities of individuals and businesses engaged in the delivery of healthcare services. Federal law and regulations are based primarily upon the Medicare program and the Medicaid program, each of which is financed, at least in part, with federal money. State jurisdiction is based upon the state's authority to license certain categories of healthcare professionals and providers, and the state's interest in regulating the quality of healthcare in the state, regardless of the source of payment and the state's relevant participation in and funding of its Medicaid program.
The Company believes it is in material compliance with applicable laws. The Company has engaged health law counsel to evaluate compliance with applicable laws, but has not received the results of such review. However,
the laws applicable to the Company are subject to evolving interpretations and therefore, there can be no assurance that a review of the Company's or the affiliated physicians' practices by a court or law enforcement or regulatory authority will not result in a determination that could adversely affect the operations of the Company or the affiliated physicians. Furthermore, there can be no assurance that the laws applicable to the Company will not be amended in a manner that could adversely affect the Company.
FEDERAL LAW
The federal healthcare laws apply in any case in which the Company is providing an item or service that is reimbursable under Medicare, Medicaid or other federally-funded programs ("Federal Reimbursement Programs") or is claiming reimbursement from Federal Reimbursement Programs on behalf of physicians with whom the Company has a Service Agreement. The principal federal laws include those that prohibit the filing of false or improper claims with the Federal Reimbursement Programs, those that prohibit unlawful inducements for the referral of business reimbursable under Federal Reimbursement Programs and those that prohibit the provision of certain services by a provider to a patient if the patient was referred by a physician with which the provider has certain types of financial relationships.
False and Other Improper Claims The federal government is authorized to impose criminal, civil and administrative penalties on any person or entity that files a false claim for reimbursement from Federal Reimbursement Programs. Criminal penalties are also available in the case of claims filed with private insurers if the government can show that the claims constitute mail fraud or wire fraud or violate state false claims prohibitions. While the criminal statutes are generally reserved for instances involving fraudulent intent, the civil and administrative penalty statutes are being applied by the government in an increasingly broader range of circumstances. For example, the government takes the position that a pattern of claiming reimbursement for unnecessary services violates these statutes if the claimant should have known that the services were unnecessary. The government also takes the position that claiming reimbursement for services that are substandard is a violation of these statutes if the claimant should have known that the care was substandard. Severe sanctions under these statutes, including exclusion from Federal Reimbursement programs, have been levied even in situations not resulting in criminal convictions. The Company believes that its billing activities on behalf of affiliated practices through Service Agreements are in material compliance with such laws, but there can be no assurance that the Company's activities will not be challenged or scrutinized by governmental authorities. A determination that the Company or any affiliated practice has violated such laws could have a material adverse effect on the Company.
Anti-Kickback Law Federal law commonly known as the "Anti-kickback Amendments" prohibits the knowing or willful offer, solicitation, payment or receipt of anything of value (direct or indirect, overt or covert, in cash or in kind) which is intended to induce the referral of patients covered by Federal Reimbursement Programs, or the ordering of items or services reimbursable under those programs. The law also prohibits remuneration that is intended to induce the recommendation of, or furnishing, or the arranging for, the provision of items or services reimbursable under Federal Reimbursement Programs. The law has been broadly interpreted by a number of courts to prohibit remuneration which is offered or paid for otherwise legitimate purposes if the circumstances show that one purpose of the arrangement is to induce referrals. Even bona fide investment interests in a healthcare provider may be questioned under the Anti-kickback Amendments if the government concludes that the opportunity to invest was offered as an inducement for referrals. The penalties for violations of this law include criminal sanctions and exclusion from the federal healthcare program.
In part to address concerns regarding the implementation of the Anti-kickback Amendments, the federal government in 1991 published regulations that provide exceptions, or "safe harbors," for certain transactions that will not be deemed to violate the Anti-kickback Amendments. Among the safe harbors included in the regulations were provisions relating to the sale of physician practices, management and personal services agreements and employee relationships. Subsequently, regulations were published offering safe harbor protection to additional activities, including referrals within group practices consisting of active investors. Proposed amendments to the Anti-kickback Amendments were published in 1994 which, if ultimately adopted, would result in substantive changes to existing regulations. The failure to qualify under a safe harbor provision, while potentially subjecting the activity to greater regulatory scrutiny, does not render the activity illegal per se.
There are several aspects of the Company's relationships with physicians to which the anti-kickback law may be relevant. In some instances, the Company itself may become a provider of services for which it will claim reimbursement from Federal Reimbursement Programs, and physicians who are investors in the Company may refer patients to the Company for those services. Furthermore, the government may construe some of the marketing and managed care contracting activities of the Company as arranging for the referral of patients to the physicians with whom the Company has a Service Agreement. Finally, at the request of a physician or medical practice with which the Company has a Service Agreement, the Company will manage in the physician's office the provision of ancillary services which the physician desires to make available to his patients. At the present time, the services provided by the Company in its IMPACT(R) Centers are generally not reimbursable by Federal Reimbursement Programs.
Although neither the investments in the Company by physicians nor the Service Agreements between the Company and physicians qualify for protection under the safe harbor regulations, the Company does not believe that these activities fall within the type of activities the Anti-kickback Amendments were intended to prohibit. A determination that the Company had violated the Anti-kickback Amendments would have a material adverse effect on the Company's business.
The Stark Self-Referral Law The Stark Self-Referral Law ("Stark Law") prohibits a physician from referring a patient to a healthcare provider for certain designated health services reimbursable by Medicare or Medicaid if the physician has a financial relationship with that provider, including an investment interest, a loan or debt relationship or a compensation relationship. The designated services covered by the law include radiology services, infusion therapy, radiation therapy, outpatient prescription drugs and hospital services, among others. In addition to the conduct directly prohibited by the law, the statute also prohibits "circumvention schemes," that are designed to obtain referrals indirectly that cannot be made directly. The penalties for violating the law include (i) a refund of any Medicare or Medicaid payments for services that resulted from an unlawful referral; (ii) civil fines; and (iii) exclusion from the Medicare and Medicaid programs. The Stark Law contains a number of exceptions potentially applicable to the Company's operations. These include exceptions for a physician's ownership of certain publicly traded securities for certain in-office ancillary services and for certain personal services arrangements.
On January 9, 1998, the Health Care Financing Administration (the "HCFA") issued proposed rules (the "Proposed Regulations") regarding the Stark Law as it relates to designated health services other than clinical laboratory services. The Proposed Regulations contemplate that designated health services may be provided by a physician's practice or by any other corporation, including an entity that owns the operation. A corporation that merely owns the components of a health services operation, such as the building that houses the facility or the medical equipment used at the facility, would not be deemed to own the operation. It is not clear, however, whether and to what extent the additional provision of services by the Company to affiliated practices and the receipt of a service fee based on net revenue or net operating income would cause the Company to be deemed to own such operation. In addition, the Proposed Regulations would apply to an entity that does not bill under its own Medicare number but receives payment for services from the billing entity as part of a so-called "under arrangements" agreement (the term of art under the Proposed Regulations relating to certain hospital arrangements) or similar agreements. It is not clear whether the term "similar agreements" would apply to the Service Agreements. If the Company is deemed to "own the operation" or to be engaged in an arrangement similar to an "under arrangements" agreement, it would be deemed a provider of the services addressed by the Proposed Regulations.
The Company believes that it is not currently a provider of any designated health service under the Stark Law for which the Company claims reimbursement from Medicare or Medicaid. The Company intends to assure that any designated health services provided by physicians with whom the Company has a Service Agreement will qualify under the applicable exception in the Stark Law for in-office services. However, because the Company will provide management services related to those designated health services, there can be no certainty that the Company will not be considered as the provider for those services. In that event, the referrals from the physicians will be permissible only if (i) the Company qualifies for the exception for publicly-traded corporations and (ii) the Service Agreement meets the exception in the Stark Law for payments by physicians to
a health care entity. To qualify for such exception, such payments must be set at a fair market value. The Company intends to structure its arrangements so as to qualify for applicable exceptions under the Stark Law, however, there can be no assurance that a review by courts or regulatory authorities would not result in a contrary determination.
The Stark Law contains an exception for investment interests by physicians in a health care provider where the health care provider is a company whose securities are traded on a national securities market and which, as of the end of the most recently completed fiscal year, had stockholders' equity exceeding $75 million. The Company's stockholders' equity currently is less than $75 million, thus such exception is not available to physicians who own the Company's securities.
STATE LAW
State Anti-Kickback Laws Many states have laws that prohibit the payment of kickbacks in return for the referral of patients. Some of these laws apply only to services reimbursable under the state Medicaid program. However, a number of these laws apply to all healthcare services in the state, regardless of the source of payment for the service. The Company pays oncologists who supervise their patients' treatment at the IMPACT(R) Centers fees for collecting and monitoring treatment and outcomes data and reporting such data to the Company. The Company believes such fees reflect the fair market value of the services rendered by such physicians to the Company. However, the laws in most states regarding kickbacks have been subjected to limited judicial and regulatory interpretation and, therefore, no assurances can be given that the Company's activities will be found to be in compliance. Noncompliance with such laws could have an adverse effect upon the Company and subject it and such physicians to penalties and sanctions.
State Self-Referral Laws A number of states have enacted self-referral laws that are similar in purpose to the Stark Self-Referral Law. However, each state law is unique. For example, some states only prohibit referrals where the physician's financial relationship with a healthcare provider is based upon an investment interest. Other state laws apply only to a limited number of designated health services. Finally, some states do not prohibit referrals, but merely require that a patient be informed of the financial relationship before the referral is made. The Company believes that it is in compliance with the self-referral law of any state in which the Company has a financial relationship with a physician. The Company has engaged health law counsel to evaluate compliance with applicable laws, but has not received the results of such review.
Fee-Splitting Laws Many states prohibit a physician from splitting with a referral source the fees generated from physician services. Other states have a broader prohibition against any splitting of a physician's fees, regardless of whether the other party is a referral source. In most cases, it is not considered to be fee-splitting when the payment made by the physician is reasonable reimbursement for services rendered on the physician's behalf.
The Company will be reimbursed by physicians on whose behalf the Company provides management services. The Company intends to structure the reimbursement provisions of its management contracts with physicians in order to comply with applicable state laws relating to fee-splitting. However, there can be no certainty that, if challenged, the Company and its affiliated physicians will be found to be in compliance with each state's fee-splitting laws.
The Florida Board of Medicine recently ruled in a declaratory statement that payments of 30% of a physician group's net income to a practice management company in return for a number of services, including expansion of the practice by increasing patient referrals through the creation of provider networks, affiliation with other networks, and the negotiation of managed care contracts, constituted fee-splitting arrangements in violation of the Florida law prohibiting fee-splitting and could subject the physicians engaged in such arrangements to disciplinary action. This order only applies to the physician practice management company and the individual physicians whose fact situation was presented to the Florida Board of Medicine for a declaratory statement. The Florida Board of Medicine has agreed to stay implementation of the order pending appeal of the decision to the Florida court by the affected physician practice management company. While the Company believes that its Service Agreements are substantially different from the management services agreement that the Florida Board
of Medicine ruled on, there is a risk that an adverse decision by the Florida courts on the case presented could have an adverse precedential impact on the Company's Service Agreements with Florida affiliated practices. The Company's Service Agreements contain provisions requiring modification of the Service Agreements in such event in a manner that preserves the economic value of the Service Agreement, but there can be no assurance that Florida courts would specifically enforce such contractual provisions. Such adverse determinations could have a material adverse effect on the Company.
Corporate Practice of Medicine Most states prohibit corporations from engaging in the practice of medicine. Many of these state doctrines prohibit a business corporation from employing a physician. However, states differ with respect to the extent to which a licensed physician can affiliate with corporate entities for the delivery of medical services. Some states interpret the "practice of medicine" broadly to include decisions that have an impact on the practice of medicine, even where the physician is not an employee of the corporation and the corporation exercises no discretion with respect to the diagnosis or treatment of a particular patient.
The Company's standard practice under its Service Agreements is to avoid the exercise of any responsibility on behalf of its physicians that could be construed as affecting the practice of medicine. Accordingly, the Company believes that it is not in violation of applicable state laws relating to the corporate practice of medicine. However, because such laws and legal doctrines have been subjected to only limited judicial and regulatory interpretation, there can be no assurance that, if challenged, the Company will be adjudicated to be in compliance with all such laws and doctrines.
Insurance Laws Laws in all states regulate the business of insurance and the operation of HMOs. Many states also regulate the establishment and operation of networks of health care providers. While these laws do not generally apply to companies that provide management services to networks of physicians, there can be no assurance that regulatory authorities of the states in which the Company operates would not apply these laws to require licensure of the Company's operations as an insurer, as an HMO or as a provider network. The Company believes that it is in compliance with these laws in the states in which it does business, but there can be no assurance that future interpretations of insurance and health care network laws by regulatory authorities in these states or in the states into which the Company may expand will not require licensure or a restructuring of some or all of the Company's operations.
State Licensing The Company's laboratories operated in conjunction with certain IMPACT(R) Centers are registered with the U.S. Food & Drug Administration and are certified pursuant to the Clinical Laboratory Improvement Amendments of 1988. In addition, the Company maintains pharmacy licenses for all IMPACT(R) Centers having self-contained pharmacies, and state health care facility licenses, where required.
REIMBURSEMENT AND COST CONTAINMENT
Approximately 40% of the net revenue of the Company's practice management division and less than 5% percent of the revenue of the Company's IMPACT(R) division are derived from payments made by government sponsored health care programs (principally, Medicare and Medicaid). As a result, any change in reimbursement regulations, policies, practices, interpretations or statutes could adversely affect the operations of the Company. In recent years, the federal government has sought to constrain the growth of spending in the Medicare and Medicaid programs. Through the Medicare program, the federal government has implemented a resource-based relative value scale ("RBRVS") payment methodology for physician services. RBRVS is a fee schedule that, except for certain geographical and other adjustments, pays similarly situated physicians the same amount for the same services. The RBRVS is adjusted each year and is subject to increases or decreases at the discretion of Congress. To date, the implementation of RBRVS has reduced payment rates for certain of the procedures historically provided by physicians who have Service Agreements with the Company. RBRVS-type payment systems have also been adopted by certain private third party payors and may become a predominant payment methodology. A broader implementation of such programs would reduce payments by private third party payors and could indirectly reduce the Company's operating margins to the extent that the cost of providing management services related to such procedures could not be proportionately reduced. To the extent the Company's costs increase, the Company may not be able to recover such cost increases from government reimbursement programs. In addition, because of cost containment measures and market changes in non
governmental insurance plans, the Company may not be able to shift cost increases to non governmental payors. The Company expects a reduction from historical levels in per patient Medicare revenue received by certain of the physician groups with which the Company contracts; however, the Company does not believe such reductions would, if implemented, result in a material adverse effect on the Company.
Rates paid by private third party payors, including those that provide Medicare supplemental insurance, are based on established physician, clinic and hospital charges and are generally higher than Medicare payment rates. Changes in the mix of the Company's patients among the non-governmental payors and government sponsored health care programs, and among different types of non-government payor sources, could have a material adverse effect on the Company.
EMPLOYEES
As of March 1, 1998, the Company employed approximately 700 persons, approximately 500 of whom were full-time employees. Under the terms of the Service Agreements with the affiliated physician groups, the Company is responsible for the practice compensation and benefits of the groups' non physician medical personnel. No employee of the Company or of any affiliated physician group is a member of a labor union or subject to a collective bargaining agreement. The Company believes that its labor relations are good.
ITEM 2.
ITEM 2. PROPERTIES
As of March 1, 1999 the Company leased 35,000 square feet of space at 1805 Moriah Woods Boulevard, in Memphis, Tennessee, where the Company's headquarters are located. The lease expires in 2002. The Company also leases all facilities housing the Company's operating facilities. Management believes that the Company's properties are well maintained and suitable for its business operations. The Company may lease additional space in connection with the development of future treatment facilities or practice affiliations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
No material litigation is currently pending against the Company, and the Company is not aware of any outstanding claims against any affiliated physician group that would have a material adverse effect on the Company's financial condition or results of operations. The Company expects its affiliated physician groups to be involved in legal proceedings incident to their business, most of which are expected to involve claims related to the alleged medical malpractice of its affiliated oncologists.
ITEM 4.
ITEM 4. MATTERS SUBMITTED TO STOCKHOLDERS' VOTE
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET INFORMATION AND RELATED STOCKHOLDER MATTERS
The Company's common stock trades on The Nasdaq Stock Market under the symbol "ROIX." As of February 16, 1999 the Company's common stock was held by approximately 1,850 shareholders of record.
The Company has not paid any cash dividends on the common stock since its inception. The Board of Directors does not intend to pay cash dividends on the common stock in the foreseeable future, but intends to retain all earnings, if any, for use in the Company's business.
RECENT SALES OF UNREGISTERED SECURITIES
Securities Issued in Connection with Physician Practice Affiliations
During the Company's 1996 fiscal year, the Company issued shares of its Common Stock, warrants to purchase the Company's Common Stock, and unsecured and subordinated promissory notes ("PIK Notes") payable at the option of holders in shares of Common Stock (collectively, the "Unregistered Securities") in ten separate acquisition transactions pursuant to which the Company acquired the operating assets or stock of ten medical oncology practices from the physician owners ("Physician Owners") thereof or the professional association owned by such Physician Owners ("P.A."). In each case, the Unregistered Securities were issued in exchange for either 100% of the outstanding stock or other equity interests owned by the Physician Owners of the practices or, in one case, certain of the assets of the P.A. The Unregistered Securities were offered and issued to the Physician Owners or, in one instance, the P.A., in reliance upon the exemption from registration under Section 4(2) of the Securities Act of 1933. Each of the Physician Owners was an accredited investor, as that term is defined in Rule 501 under Regulation D, and each of the Physician Owners was represented by competent transactional counsel. The affiliation transactions and Unregistered Securities issued in connection with the affiliations are as follows:
In January 1996, the Company issued to Physician Owners a single 9% PIK Note in the principal amount of $5,959,972 that matures in 2011, with principal and interest payable on an amortized basis. Any payment of principal and interest may be paid, at the option of the holder of the PIK Note, in shares of Common Stock at a conversion price of $14.00 per share.
In April 1996, the Company issued to Physician Owners 80,000 warrants to purchase Common Stock at a price of $11.75. These warrants expired in connection with the termination of this Service Agreement in February 1999. In addition, the Company issued a 5% PIK Note to a Physician Owner in the principal amount of $150,000 maturing in 1997, payment of which may be made, at the option of the holder, in shares of Common Stock at a conversion price of $11.75 per share. This note was repaid in cash by the Company in 1997.
In June 1996, the Company issued to a Physician Owner 196,154 shares of Common Stock. In addition, the Company issued to the Physician Owner a $5.1 million 4% PIK Note maturing in December 1998, payment of which may be made, at the option of the holder, in shares of Common Stock at a conversion price of $15.60 per share.
In July 1996, the Company issued to Physician Owners an aggregate of 117,600 shares of Common Stock.
In August 1996, the Company issued to Physician Owners 5% PIK Notes in the aggregate principal amount of $1,900,000 maturing August 1, 2001, payment of which may be made, at the option of the holders, in shares of Common Stock at a conversion price of $13.75.
In October 1996, the Company issued to Physician Owners an aggregate of 326,170 shares of Common Stock. In addition, the Company issued 4% and 5% PIK Notes in the aggregate principal amount of $5,636,625 maturing through 2001, payment of which may be made, at the option of the holders, in shares of Common Stock at conversion prices ranging from $12.73 to $18.00 (approximately $4 million of which has a conversion price of $12.73).
In November 1996, the Company issued 47,836 shares of Common Stock. In addition, the Company issued to Physician Owners 5.6% PIK Notes in the aggregate principal amount of $772,500, payment of which may be made, at the option of the holders, in shares of Common Stock at a conversion price of $14.20.
Securities Issued to Controlling Shareholder
In April 1996, the Company issued an unsecured, $10 million convertible note to Seafield Capital Corporation ("Seafield"), who at the time was the Company's controlling shareholder, bearing interest at a rate of prime plus 1%, which after August 1, 1996, became convertible at the election of Seafield into shares of the Company's Common Stock. Proceeds of the loan were used to finance a practice management affiliation. The note was exchanged for 909,090 shares of Common Stock during August 1996.
In October 1996, the Company obtained a $23.5 million credit facility from Seafield to be used to finance practice affiliations and for working capital. The facility was evidenced by a convertible note payable upon the earlier of the closing of an equity offering, or August 1, 1998. The note provided for interest at a rate of 8% escalating at certain points during the term of the note, was unsecured, and was convertible at the election of Seafield Capital Corporation into shares of the Company's Common Stock at a conversion price equal to the market price of the Common Stock at the date of conversion; provided, however, that after December 31, 1996, the conversion price would be the lower of market or $11.00 per share. In February 1997, the $23.5 million credit facility and accrued interest thereon was converted into 3,020,536 shares of the Company's Common Stock at a rate of $8 per share.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA (in thousands except per share data)
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a comprehensive cancer management company. The Company provides advanced cancer treatment services through outpatient facilities known as IMPACT(R) Centers under the direction of practicing oncologists; owns the assets of and manages the nonmedical aspects of oncology practices; and conducts outcomes research on behalf of pharmaceutical manufacturers. Approximately 400 medical oncologists are associated with the Company through these programs.
In 1990 the Company began development of a network of specialized IMPACT(R) Centers to provide complex outpatient chemotherapy services under the direction of practicing oncologists. The majority of the therapies provided at the IMPACT(R) Centers entail the administration of high dose chemotherapy coupled with peripheral blood stem cell support of the patient's immune system. At December 31, 1998, the Company's network consisted of 54 IMPACT(R) Centers, including 33 wholly-owned, 15 managed programs, and 6 owned and operated in joint venture with a host hospital. Prior to January 1997, the Company derived substantially all of its revenues from outpatient cancer treatment services through reimbursements from third party payors on a fee-for-service or discounted fee-for-service basis. During 1997, the Company began concentrating its efforts on contracting on a "global case rate" basis where the Company contracts with the appropriate third-party payor to receive a single payment that covers the patient's entire course of treatment at the center and any necessary in-patient care.
The Company also provides pharmacy management services for certain medical oncology practices. These services include compounding and dispensing pharmaceuticals for a fee, typically cost plus a percentage.
During 1996 the Company executed a strategy of diversification into physician practice management and subsequently affiliated with 43 physicians in 12 medical oncology practices in Florida and Tennessee as of December 31, 1998. Through these affiliations, the Company believes that it has successfully achieved deep geographic penetration in those markets, believing that significant market share is crucial to achieving efficiencies, revenue enhancements, and marketing of complete cancer services to diverse payors including managed care. Pursuant to Service Agreements, the Company provides management services that extend to all nonmedical aspects of the operations of the affiliated practices. The Company is responsible for providing facilities, equipment, supplies, support personnel, and management and financial advisory services.
In its practice management relationships, the Company has predominantly used two models of Service Agreements: (i) an "adjusted net revenue" model; and (ii) a "net operating income" model. Service Agreements utilizing the adjusted net revenue model provide for the payment by the physician group out of practice net revenue, in the following order of payment (A) physician retainage (i.e. physician compensation, benefits, and prerequisites, including malpractice insurance) of between 24% and 34.7% of net revenue ("Physician Expense"); (B) a clinic expense portion of the management fee (the "Clinic Expense Portion") equal to the aggregate actual practice operating expenses exclusive of Physician Expense; and (C) a base service fee portion (the "Base Fee") of between 8.7% and 24% of net revenue. In the event that net revenue is insufficient to pay all of the foregoing in full, then the Base Fee is first reduced, followed by the Clinic Expense Portion of the management fee, and finally, physician retainage, therefore effectively shifting all operating risk to the Company. In each Service Agreement utilizing the adjusted net revenue model, the Company is entitled to a Performance Fee generally equal to 50% of Annual Surplus, defined as the excess of practice revenue over the sum of Physician Retainage, the clinic Expense Portion, and the Base Fee.
Service Agreements utilizing the net operating income model provide for a management fee equal to the sum of a Clinic Expense Portion (see preceding paragraph) plus a percentage (the "Percentage Portion"), ranging from 15% to 40%, of the net operating income of the practice (defined as net revenue minus practice operating expenses). Practice operating expenses do not include Physician Expense. In those practice management relationships utilizing the net operating income model Service Agreement, the Company and the physician
group share the risk of expense increases and revenue declines, but likewise share the benefits of expense savings, economies of scale and practice enhancements.
Each Service Agreement contains a liquidated damages provision binding the physician practice and the principals thereof in the event the Service Agreement is terminated "for cause" by the Company. The liquidated damages are a declining amount, equal in the first year to the purchase price paid by the Company for practice assets and declining over a period of between 5 and 17.5 years. Principals are relieved of their individual obligations for liquidated damages only in the event of death, disability, or retirement at a predetermined age. Each Service Agreement provides for the creation of an oversight committee, a majority of whom are designated by the practice. The oversight committee is responsible for developing management and administrative policies for the overall operation of each clinic. However, under each Service Agreement, the affiliated practice remains obligated to repurchase practice assets, including intangible assets, in the event the Company terminates the Service Agreement for cause.
In February 1999 the Company announced that it had terminated its service agreement with one of the Company's three underperforming adjusted net revenue model relationships. Concurrently, the Company established a reserve against the three service agreements in accordance with Financial Accounting Standards Board Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of." The structure of these contracts has failed over time to align the physician and Company incentives, producing deteriorating returns and/or negative cash flows to the Company. Since this was not a "for cause" termination initiated by the Company the affiliated practice was not responsible for liquidated damages. A separate negotiated settlement was agreed on by the Company and the affiliated practice and the Company anticipates that the affiliated practice will continue to participate in the Company's IMPACT Center network.
The Company is currently discussing a termination with the second of the three underperforming relationships. The termination will not be deemed "for cause" and a negotiated settlement is expected to be reached in the second quarter of 1999.
RESULTS OF OPERATIONS
1998 Compared to 1997
Net revenue increased 26% to $128.2 million for the year ended December 31, 1998, compared to $101.9 million for the year ended December 31, 1997. Practice management service fees from affiliations were $59.5 million in 1998 compared to $46.5 million in 1997 for a 28% increase. Additionally, pharmaceutical sales to physicians increased $8.5 million or 46% from $18.3 million in 1997 to $26.8 million in 1998.
EBITDA (earnings before interest, taxes, depreciation and amortization) decreased $28.6 million or 195% to ($14.0) million for the year ended December 31, 1998 in comparison to $14.6 million for the year ended December 31, 1997. The decrease is primarily due to the reserve for impairment of management service agreements and associated assets of $24.9 million recognized in the fourth quarter of 1998.
Salaries and benefits costs increased $4.4 million, or 21%, from $20.8 million in 1997 to $25.2 million in 1998. The increase is primarily due to the addition of employed physicians and their support personnel in the practice management division and general increases in salaries and benefits. Salaries and benefits expense as a percentage of net revenue was 20% in the years 1998 and 1997.
Supplies and pharmaceuticals expense increased $18.2 million, or 37%, from 1997 to 1998. The increase is primarily related to greater utilization of new chemotherapy agents with higher costs in the practice management division and increased volume in pharmaceutical sales to physicians. Supplies and pharmaceuticals expense as a percentage of net revenue was 52% and 48% for the years ended 1998 and 1997, respectively. The
increase as a percentage of net revenue is due to the lower margin associated with the increased pharmaceutical sales to physicians as well as general price increases in pharmaceuticals used in the practice management division.
Other operating expenses increased $2.9 million, or 26%, from $11.0 million in 1997 to $13.9 million in 1998. Other operating expenses consist primarily of medical director fees, purchased services related to global case rate contracts rent expense, and other operational costs. The increase is primarily due to increased volume in the practice management division in 1998.
General and administrative expense increased $3.0 million, or 70%, from $4.3 million in 1997 to $7.3 million in 1998. The increase is primarily due to a consolidation of certain of the Company's business office functions at the Company's headquarters during the year expenses recognized for various aborted mergers and acquisitions during 1998, as well as general corporate expense increases.
Depreciation and amortization increased $.9 million from $4.7 million in 1997 to $5.6 million in 1998. Based on recent guidance from the Securities and Exchange Commission, the Company announced a change in the amortization period of Service Agreements acquired in practice management affiliations to 25 years from 40 years beginning July 1, 1998.
1997 Compared to 1996
Net revenue increased 51% to $101.9 million for the year ended December 31, 1997, compared to $67.4 million for the year ended December 31, 1996. Practice management service fees from affiliations were $46.5 million compared to $19.3 million for a 141% increase. Additionally, pharmaceutical sales to physicians increased $4.8 million or 36% from $13.5 million in 1996 to $18.3 million in 1997.
EBITDA (earnings before interest, taxes, depreciation and amortization) increased $7.6 million or 109% to $14.6 million for the year ended December 31, 1997 in comparison to $7.0 million for the year ended December 31, 1996. The increase is primarily due to the increase in revenues related to the Service Agreements with affiliated physicians. The Company's net earnings, however, reflect significant non-cash expenses related to the amortization of the costs of the Service Agreements.
Salaries and benefits costs increased $4.5 million, or 28%, from $16.3 million in 1996 to $20.8 million in 1997. The increase is primarily due to the addition of operational management personnel for the practice management division and general increases in salaries and benefits. Salaries and benefits expense as a percentage of net revenue were 20% and 24% in 1997 and 1996, respectively. The decrease as a percentage of net revenue is due to the significant increase in the revenue base from practice management service fees.
Supplies and pharmaceuticals expense increased $19.2 million, or 64%, from 1996 to 1997. The increase is primarily related to pharmacy expenses at the affiliated physician practices that were not included in the Company's operating results for the full year of 1996. Supplies and pharmaceuticals expense as a percentage of net revenue was 48% and 44% for the years ended 1997 and 1996, respectively. The increase as a percentage of net revenue is due to the higher pharmaceutical costs associated with the increased practice management service fees and pharmaceutical sales to physicians.
Other operating expenses increased $3.2 million, or 41%, from $7.8 million in 1996 to $11.0 million in 1997. Other operating expenses consist primarily of medical director fees, rent expense, and other operational costs. The increase is primarily due to 1997 being the first full year of operations of the Company's practice management division.
Depreciation and amortization increased $1.2 million from $3.5 million in 1996 to $4.7 million in 1997. The increase is primarily attributable to the first full year of amortization of the Service Agreements purchased in practice management affiliations consummated during 1996.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company's working capital was $16.4 million with current assets of $52.2 million and current liabilities of $35.8 million. Cash and cash equivalents represented $1.1 million of the Company's current assets.
Cash provided by operating activities was $2.8 million in 1998 as compared to cash provided by operating activities of $6.6 million in 1997. The decrease in operating cash flow is primarily the result of a lengthening in IMPACT Center receivables collections process due to the Company's strategic increase in the number of global case rate contracts. The Company believes that the delay in collections is a temporary one and has implemented procedures that are expected to expedite the billing and collections process for global case rate contracting.
Cash used in investing activities was $2.7 million and $1.2 million in 1998 and 1997, respectively. Cash used in financing activities was $1.4 million in 1998 and $3.3 million in 1997.
The Company has a $45.0 million Credit Facility, expiring March 31, 1999, to fund the Company's acquisition and working capital needs. The Credit Facility, comprised of a $35.0 million Acquisition Facility and a $10.0 million Working Capital Facility, is collateralized by the common stock of the Company's subsidiaries. The Credit Facility bears interest at a variable rate equal to LIBOR plus a spread between 1.5% and 2.125%, depending upon borrowing levels. At December 31, 1998, $37.8 million aggregate principal was outstanding under the Credit Facility with a current interest rate of approximately 8.04%. The Credit Facility contains affirmative and negative covenants which, among other things, require the Company to maintain certain financial ratios, including minimum fixed charges coverage, funded debt to EBITDA, net worth and current ratio. The Company was not in compliance with certain of these covenants at December 31, 1998. The Company has received an extension on the maturity of the Credit Facility until June 30, 1999 and has received a waiver of the covenant violations as of December 31, 1998.
In May 1997, the Company entered into a LIBOR based interest rate swap agreement ("Swap Agreement") with an affiliate of the Company's primary lender as required by the terms of the Credit Facility. Amounts hedged under the Swap Agreement accrue interest at the difference between 6.42% and the thirty day LIBOR rate and are settled monthly. As of December 31, 1998, approximately 40% of the Company's outstanding principal balance under the Credit Facility was hedged under the Swap Agreement. The Swap Agreement matures in March 1999 and is cancelable at the lender's option after July 1998.
In March 1999 the Company received a commitment for a $30.0 million Line of Credit which will mature on March 31, 2002 to replace the existing Credit Facility. The Line of Credit will be collateralized by the common stock and assets of the Company and its subsidiaries. The Line of Credit will bear interest at a variable rate equal to LIBOR plus a spread between 1.375% and 2.5%, depending upon borrowing levels. The Company is also obligated to a commitment fee of .25% to .5% of the unused portion of the Line of Credit. The Company will be subject to certain affirmative and negative covenants which, among other things, require the Company to maintain certain financial ratios, including minimum fixed charges coverage, funded debt to EBITDA, net worth and current ratio. The Company is currently in negotiations with respect to the uncommitted portion of the line of credit.
Long-term unsecured amortizing promissory notes bearing interest at rates from 4% to 9% were issued as partial consideration for the practice management affiliations consumated in 1996. Principal and
interest under the long-term notes may, at the election of the holders, be paid in shares of common stock of the Company based upon conversion rates ranging from $13.75 to $17.50. The unpaid principal amount of the long-term notes was $5.5 million at December 31, 1998.
Capital expenditures of $1.7 million for the year ended December 31, 1998 were primarily associated with the expansion of the Company's network of IMPACT(R) Centers and practice management affiliations.
The Company is committed to future minimum lease payments under operating leases of $24.8 million for administrative and operational facilities.
The Company has commitments to lease machinery under 54 month operating leases through 2003. The estimated fair value of the equipment is $1.2 million.
IMPACT OF YEAR 2000
The Year 2000 Issue exists because many computer systems and applications currently use two-digit date fields to designate a year. As the century date occurs, computer programs, computers and embedded microprocessors controlling equipment with date-sensitive systems may recognize Year 2000 as 1900 or not at all. This inability to recognize or properly treat Year 2000 may result in computer system failures or miscalculations of critical financial and operational information as well as failures of equipment controlling date-sensitive microprocessors. In addition, there are two other related issues, which could also lead to miscalculations or failures: (i) some older systems' programming assigns special meaning to certain dates, such as 9/9/99 and (ii) the Year 2000 is a leap year.
The Company started to formulate a plan to address the Year 2000 Issue in the second quarter of 1998. To date the Company's primary focus has been on its own internal information technology systems, including all types of systems in use by the Company in its operations, finance and human resources departments, and to deal with the most critical systems first. The Company has developed a Year 2000 Plan to address all of its Year 2000 issues. The Year 2000 plan involves the following phases: awareness, assessment, renovation, testing and implementation. The Company has completed an assessment of its internal information technology systems and has established a timetable for the renovation phase of the systems. The Company has already completed the renovation of approximately 75% of its information technology systems, including modifying and upgrading software and purchasing new software, and continues to renovate the remaining portions of the systems. The Company's goal is to complete the testing and implementation phases by June 30, 1999, although complications arising from unanticipated acquisitions might cause some delay.
The Company has also begun to assess the potential for Year 2000 problems with the information systems of its payors and vendors. The Company expects to complete the assessment with respect to such parties by April 30, 1999. The Company has been provided an estimated timetable for completion of renovation and testing that such vendors with which the Company has a material relationship will undertake. The Company has estimated the costs that it may incur to remedy the Year 2000 issues relating to such parties at $85,000. The Company's diagnostic imaging equipment used to provide imaging services have computer systems and applications, and in some cases embedded microprocessors, that could be affected by Year 2000 issues. The Company has assessed the impact on its diagnostic imaging equipment by contacting the vendors of such equipment. The vendors with
respect to the majority of the equipment used by the Company have informed the Company that such equipment is Year 2000 compliant.
The Company has made an assessment of the potential for Year 2000 problems with the embedded microprocessors in its other equipment, facilities and corporate and regional offices, including telecommunications systems, utilities and security systems. The Company estimates, on a preliminary basis, that the cost of assessment, renovation, testing and implementation of its internal systems will range from approximately $15,000 to $30,000. The major components of these costs are: consultants, programming new software and hardware, software upgrades and travel expenses. The company expects that such costs will be funded through operating cash flows. This estimate, based on currently available information, will be updated as the Company proceeds with renovation, testing and implementation, and may be adjusted upon receipt of more information from the Company's vendors and other third parties and upon the design and implementation of the Company's contingency plan. In addition, the availability and cost of consultants and other personnel trained in this area and unanticipated acquisitions might materially affect the estimated costs. The effects of the aforementioned costs have had no material impact on the Company's progress as it relates to other information system projects and implementation.
The Company's Year 2000 issue involves significant risks. There can be no assurance that the Company will succeed in implementing the Year 2000 Plan it is developing. The following describes the Company's most reasonably likely worst-case scenario, given current uncertainties. If the Company's renovated or replaced internal information technology systems fail the testing phase, or any software application or embedded microprocessors central to the Company's operations are overlooked in the assessment or implementation phases, significant problems, including delays, may be incurred in billing the Company's major customers (Medicare, HMO's or private insurance carriers) for services performed. If its major customers' systems do not become Year 2000 compliant on a timely basis, the company will have problems and incur delays in receiving and processing correct reimbursements. If the computer systems of third parties (including hospitals) with which the Company's systems exchange data do not become Year 2000 compliant both on a timely basis and in a manner compatible with continued data exchange with the Company's systems, significant problems may be incurred in billing and reimbursement. If the systems on the diagnostic imaging equipment utilized by the Company are not Year 2000 compliant, the Company may not be able to provide imaging services to patients. If the Company's vendors or suppliers of the Company's necessary supplies and power, telecommunications and financial services fail to provide the Company with services, the Company will be unable to provide services to its customers. If any of these uncertainties were to occur, the Company's business, financial condition and results of operations would be adversely affected. The Company is unable to assess the likelihood of such events occurring or the extent of the effect on the Company.
The Company is establishing a contingency plan to address unavoidable Year 2000 risks with internal information technology systems and with customers, vendors and other third parties; and expects to create such a plan by June 30, 1999.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk exposure is to changes in interest rates obtainable on its Credit Facility. The Company's interest rate risk objective is to limit the impact of interest rate fluctuations on earnings and cash flows and to lower its overall borrowing costs. To achieve this objective, the Company manages its exposure to fluctuations in market interest rates for its borrowings by selecting interest periods for traunches of the Credit Facility that are more favorable to the Company based on the current market interest rates. The Company has the option of fixing current interest rates for interest periods of 1, 2, 3, 6 or 12 months.
The Company is also a party to a LIBOR based interest rate swap agreement ("Swap Agreement") with an affiliate of the Company's primary lender as required by the terms of the Credit Facility. Amounts hedged under the Swap Agreement accrue interest at the difference between 6.42% and the thirty day LIBOR rate and are settled monthly. As of December 31, 1998, approximately 40% of the Company's outstanding principal balance under the Credit Facility was hedged under the Swap Agreement. The Swap Agreement matures in March 1999 and is cancelable at the lender's option after July 1998. The Company does not enter into derivative or interest rate transactions for speculative purposes.
At December 31, 1998, $37.8 million aggregate principal was outstanding under the Credit Facility with a current interest rate of approximately 8.04%. The Company does not have any other material market-sensitive financial instruments.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This item is submitted in a separate section of this report (see pages 22 through 39).
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information required by this item with respect to the executive officers and directors of the Company is incorporated herein by reference to the sections entitled "Executive Officers" and "Nominees for Election as Directors" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held June 10, 1999.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item with respect to executive compensation is incorporated herein by reference to the section entitled "Executive Compensation" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held June 10, 1999.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item with respect to executive compensation is incorporated herein by reference to the section entitled "Security Ownership of Certain Beneficial Owners, Directors and Management" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held June 10, 1999.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the section entitled "Certain Transactions" in the Company's definitive proxy statement for its Annual Meeting of Shareholders to be held June 10, 1999.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A)(1) and (2) -- The response to this portion of Item 14 is submitted as a separate section of this report
(A)(3) LISTING OF EXHIBITS
2(a) Stock Purchase Agreement between the Registrant and stockholders of Oncology Hematology Group of South Florida (filed as Exhibit 10(m) to Registrant's Form 8-K filed January 17, 1996 (File No. 0-15416) and incorporated herein by reference) 2(b) Purchase and Sale Agreement between the Registrant, Knoxville Hematology Oncology Associates and Partners of Knoxville Hematology Oncology Associates (filed as Exhibit 10(q) to Registrant's Form 8-K filed April 15, 1996 (File No. 0-15416) and incorporated herein by reference) 2(c) Stock Purchase Agreement between the Registrant and stockholders of Jeffrey L. Paonessa, M.D., P.A. (filed as Exhibit 10(s) to Registrant's Form 8-K filed July 5, 1996 (File No. 0-15416) and incorporated herein by reference) 2(d) Stock Purchase Agreement between the Registrant and stockholders of Southeast Florida Hematology Oncology Group, P.A. (filed as Exhibit 2(d) to Registrant's Form 8-K filed July 15, 1996 (File No. 0-15416) and incorporated herein by reference) 2(e) Asset Purchase Agreement by and among the Registrant, stockholders of The Center for Hematology-Oncology, P.A. and the Registrant's Form 8-K filed October 21, 1996 (File No. 1-09922) and incorporated herein by reference
2(f) Stock Purchase Agreement by and among the Registrant, stockholders of Hematology Oncology Associates of the Treasure Coast, P.A., and Hematology Oncology Associates of the Treasure Coast, P.A. (filed as Exhibit 10(z) to the Registrant's Form 8-K filed November 5, 1996 (File No 1-09922) and incorporated herein by reference) 3(a) Charter (1) 3(b) Bylaws (2) 4 Trust Indenture, Deed of Trust and Security Agreement dated April 3, 1990 (3) 10(a) Registrant's 1985 Stock Option Plan, as amended (4) 10(b)* Registrant's 1990 Non-Qualified Stock Option Plan, as amended** (6)(8) 10(c)* Employment agreement between the Registrant and William H. West, M.D. dated January 1, 1995* 10(d)* Employment agreement between the Registrant and Joseph T. Clark dated July 1, 1995**(7) 10(e) Service Agreement between the Registrant and stockholders of Oncology Hematology Group of South Florida (filed as Exhibit 10(n) to Registrant's Form 8-K filed January 17, 1996 (File No. 0-15416) and incorporated herein by reference) 10(f)** Amendment to 1990 Registrant's Non-Qualified Stock Option Plan adopted April 20, 1995 (7) 10(g) Service Agreement between the Registrant and stockholders of Jeffrey L. Paonessa, M.D., P.A. (filed as Exhibit 10(t) to Registrant's Form 8-K filed July 5, 1996 (File No. 0-15416) and incorporated herein by reference) 10(h) Service Agreement between the Registrant and stockholders of Southeast Florida Hematology Oncology Group, P.A. (filed as Exhibit 10(u) to Registrant's Form 8-K filed July 15, 1996 (File No 0-15416) and incorporated herein by reference) 10(i)** Amendment No. 3 to 1990 Registrant's Non-qualified Stock Option Plan adopted December 16, 1995 (8) 10(j) Service Agreement between the Registrant, Rosenberg & Kalman, M.D., P.A., and stockholders of R&K, M.D., P.A. (filed as Exhibit 10(x) to Registrant's Form 8-K filed September 18, 1996 (File No. 1-09922) and incorporated herein by reference) 10(k) Loan Agreement dated April 21, 1997 between Registrant, NationsBank of Tennessee, N.A., AmSouth Bank of Tennessee and Union Planters National Bank (10) 10(l) Registrant's 1996 Stock Incentive Plan(9) 10(m) Second amendment to First Amended and Restated Loan Agreement dated March 31, 1999 between Registrant, NationsBank of Tennessee, N.A., Amsouth Bank of Tennessee and Union Planters National Bank 10(n) First Amendment to Revolving Credit Note dated March 31, 1999 between Registrant, NationsBank of Tennessee, N.A., AmSouth Bank of Tennessee and Union Planters National Bank 11 Statement regarding Computation of Per Share Earnings 13 Annual Report to Shareholders for the year ended December 31, 1997 -- to be filed 23 Consent of Independent Auditors 27 Financial Data Schedule 99(a) Definitive Proxy Statement for Annual Meeting of Shareholders to be held June 11, 1998 -- to be filed
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* These documents may be obtained by stockholders of Registrant upon written request to: Response Oncology, Inc., 1775 Moriah Woods Blvd., Memphis, Tennessee 38117 ** Management Compensatory Plan (1) Incorporated by reference to the Registrant's 1989 10-K, dated July 31, (2) Incorporated by reference to the Registrant's Registration Statement on Form S-1 under the Securities Act of 1933 (File No. 33-5016) effective April 21, 1986
(3) Incorporated by reference in the initial filing of the Registrants' 1990 10-K, dated July 18, 1990, filed July 20, 1990 and amended on September 19, 1990 (4) Incorporated by reference to the Registrant's Registration Statement on Form S-8 under the Securities Act of 1933 (File No. 33-21333) effective April 26, 1988 (5) Incorporated by reference to the Registrant's 1991 10-K, dated July 26, (6) Incorporated by reference to the Registrant's Registration Statement on Form S-8 under the Securities Act of 1933 (File No. 33-45616) effective February 11, 1992 (7) Incorporated by reference to the Registrant's 1995 10-K, dated March 29, 1996 (8) Incorporated by reference to the Registrant's Registration Statement on Form S-8 under the Securities Act of 1933 (File No. 333-14371) effective October 11, 1996 (9) Incorporated by reference to the Registrant's Statement on Form S-8 under the Securities Act of 1933 (File No. 333-28973) effective June 11, 1997 (10) Incorporated by reference to the Registrant's 1997 10-K dated March 31, 1997
(B) Reports on Form 8-K filed in the fourth quarter of 1996 (C) Exhibits - The response to this portion of Item 14 is submitted as a separate section of this report (D) Financial Statement Schedules - The response to this portion of Item 14 is submitted as a separate section of this report
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Response Oncology, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
RESPONSE ONCOLOGY, INC.
By: /s/ Joseph T. Clark --------------------------------- Joseph T. Clark President, Chief Executive Officer, and Director
Date: March 31, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
By: /s/ Frank M. Bumstead By: /s/ Dena L. Mullen -------------------------------- -------------------------------- Frank M. Bumstead Dena L. Mullen Vice-Chairman of the Board Director of Finance
Date: March 31, 1999 Date: March 31, 1999
By: /s/ Joseph T. Clark By: /s/ James R. Seward -------------------------------- -------------------------------- Joseph T. Clark James R. Seward President, Chief Executive Director Officer, and Director
Date: March 31, 1999 Date: March 31, 1999
By: /s/ Mary E. Clements By: /s/ Peter A. Stark -------------------------------- -------------------------------- Mary E. Clements Peter A. Stark Chief Financial Officer Controller
Date: March 31, 1999 Date: March 31, 1999
By: /s/ P. Anthony Jacobs By: /s/ William H. West, M.D. -------------------------------- -------------------------------- P. Anthony Jacobs William H. West, M.D. Director Chairman of the Board
Date: March 31, 1999 Date: March 31, 1999
Independent Auditors' Report The Board of Directors Response Oncology, Inc.:
We have audited the accompanying consolidated balance sheets of Response Oncology, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1998. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index at Item 14(a). These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Response Oncology, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Memphis, Tennessee March 23, 1999
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollar amounts in thousands except for share data)
See accompanying notes to consolidated financial statements.
RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollar amounts in thousands except for share data)
See accompanying notes to consolidated financial statements.
RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollar amounts in thousands except for share data)
See accompanying notes to consolidated financial statements.
RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollar amounts in thousands)
Continued:
See accompanying notes to consolidated financial statements.
RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1998
NOTE A--ORGANIZATION AND DESCRIPTION OF BUSINESS
Response Oncology, Inc. ("the Company") is a comprehensive cancer management company which owns and/or operates a network of outpatient treatment centers ("IMPACT Centers"), which provide stem cell supported high-dose chemotherapy and other advanced cancer treatment services under the direction of practicing oncologists; owns the assets of and manages oncology practices; and conducts clinical cancer research on behalf of pharmaceutical manufacturers.
Prior to July 25, 1997, the Company was a subsidiary of Seafield Capital Corporation ("Seafield"). On July 1, 1997, Seafield's Board of Directors declared a dividend to its shareholders of record on July 11, 1997 of all shares of common stock of the Company owned by Seafield. On July 25, 1997, 1.2447625 shares of the Company's common stock were distributed for each share of Seafield common stock outstanding. The Seafield shareholders paid no consideration for any shares of the Company's stock received in the distribution.
NOTE B--SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and majority-owned or controlled joint ventures. All significant intercompany accounts and transactions have been eliminated in consolidation.
Cash Equivalents: All highly liquid investments with an original maturity of three months or less when purchased are considered to be cash equivalents.
Accounts Receivable: Accounts receivable primarily consists of receivables from patients, insurers, government programs and other third-party payors for medical services provided. Such amounts are reduced by an allowance for contractual adjustments and other uncollectible amounts. Contractual adjustments result from the differences between the amounts charged for services performed and the amounts allowed by the Medicare and Medicaid programs and other public and private insurers.
Due From Affiliated Physicians: Due from affiliated physicians consists of management fees earned and payable pursuant to related service agreements. In addition, the Company may also fund certain working capital needs of affiliated physicians from time to time.
Due to the demographics of oncology patients, a significant portion of the affiliated physicians' medical service revenues are related to third-party reimbursement agreements, primarily Medicare and other governmental programs. Medicare and other governmental programs reimburse physicians based on fee schedules which are determined by the related governmental agency. In the ordinary course of business, affiliated physicians receiving reimbursement from Medicare and other governmental programs are potentially subject to a review by regulatory agencies concerning the accuracy of billings and sufficiency of supporting documentation of procedures performed. Provisions for estimated third-party payor settlements and adjustments are estimated in the period the related services are rendered and adjusted in future periods as final settlements are determined.
Supplies and pharmaceuticals: Supplies and pharmaceuticals are recorded at lower of cost (first-in, first-out) or market.
Property and Equipment: Property and equipment are stated at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives which range from three to ten years.
Equipment under capital lease obligations is amortized using the straight-line method over the shorter of the lease term or the estimated useful life of the equipment. Such amortization is included in depreciation and amortization in the consolidated financial statements.
Management Service Agreements: Costs of obtaining Service Agreements were created by the excess of the purchase price over the fair value of net assets of acquired practices. The Service Agreements are noncancelable except for performance defaults, as defined. In the event a practice breaches the agreement, or if the Company terminates with cause, the practice is required to purchase all tangible assets at fair market value and pay substantial liquidating damages.
At each reporting period, the Company reviews the carrying value of Service Agreements on a practice-by-practice basis to determine if facts and circumstances exist which would suggest that the value of the Service Agreements may be impaired or that the amortization period needs to be modified. Among the factors considered by the Company in making the evaluation are changes in the practices' market position, reputation, profitability and geographical penetration. Using these factors, if circumstances are present which may indicate impairment is probable, the Company will prepare a projection of the undiscounted cash flows before interest charges of the specific practice and determine if the Service Agreements are recoverable based on these undiscounted cash flows. If impairment is indicated, then an adjustment will be made to reduce the carrying value of intangible assets to fair value. Certain Service Agreements were determined to be impaired during 1998, as more fully discussed in note C.
Based on recent guidance from the Securities and Exchange Commission, the Company announced a change in the amortization period of Service Agreements acquired in practice management affiliations to 25 years from 40 years beginning July 1, 1998. The Company estimates that the change in the amortization period will result in additional annual amortization expense of approximately $1,200,000 in subsequent years exclusive of the amortization expense associated with the three impaired Service Agreements discussed in Note C.
Deferred Charges: Deferred charges includes costs capitalized in connection with obtaining long-term financing and are being amortized using the interest method over the terms of the related debt.
Net Revenue: The following table is a summary of net revenue by source for the respective years ended December 31. Net patient service revenue is recorded net of contractual allowances and discounts of $6,043,000, $6,253,000 and $4,898,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Company's revenue from practice management affiliations includes reimbursement of practice operating expenses (other than amounts retained by physicians) and a management fee either fixed in amount or equal to a percentage of each affiliated oncology group's adjusted net revenue or net operating income. In certain affiliations, the Company may also be entitled to a performance fee if certain financial criteria are satisfied.
Pharmaceutical sales to physician revenue is recorded based upon the Company's contract with physician groups to manage the pharmacy component of the groups' practice. Revenue recorded for these contracts represents the cost of pharmaceuticals plus a percentage fee.
Income Taxes: The asset and liability method is used whereby deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
Earnings (Loss) Per Common Share: Earnings (loss) per common share has been computed based upon the weighted average number of shares of common stock outstanding during the period, plus (in periods in which they have a dilutive effect) common stock equivalents, primarily stock options and warrants.
Fair Value of Financial Instruments: The carrying amounts of all asset and liability financial instruments approximate their estimated fair values at December 31, 1998 and 1997. Fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties.
Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
RECLASSIFICATIONS -
Certain Reclassifications have been made in the 1997 and 1996 financial statements to conform with the 1998 presentation.
NOTE C - IMPAIRMENT OF MANAGEMENT SERVICE AGREEMENTS AND ASSOCIATED ASSETS
The Company recognized a pretax impairment charge during the fourth quarter of 1998, based on the criteria described in Note B, totaling $24,877,000. This charge was principally related to the poor performance of three specific Physician Practice Management Service Agreements as further described below. Of the total charge, $22,482,000 related to the impairment of Service Agreement assets and $2,395,000 related to the write-off of certain net tangible assets associated with the individual physician practices.
Certain significant economic issues, especially the introduction of new and more costly cancer drugs and the Company's related inability to convert the subject physician practices to a more equitable revenue sharing model, began to materially and negatively impact these practices during 1998. The subject practices have continued to evidence these adverse operating conditions subsequent to year-end. Practice operating losses and other factors led the Company to evaluate the recoverability of related Service Agreement and other assets. This evaluation and the factors described in the following paragraph led to the recognition of impairment charges in the accompanying 1998 financial statements, which included the complete write-off of the subject Service Agreement assets.
Given the results of the evaluation described above, the Company has been actively negotiating with the subject physician practices, principally regarding potential exit strategies and/or Service Agreement modifications. On February 1, 1999, the Company executed a termination agreement with one of the three physician practices. The terms of the agreement provide for the termination of the Service Agreement and for the Company to return certain net tangible assets to the physician practice. The Company believes that the ultimate terms of any potential termination agreements related to other impaired Service Agreements will parallel, in all material respects, the terms of the executed termination agreement.
NOTE D--PROPERTY AND EQUIPMENT
Balances of major classes of property and equipment at December 31, 1998 and 1997 are as follows: (In thousands)
NOTE E--NOTES PAYABLE
Notes payable at December 31, 1998 and 1997, consist of the following: (In thousands)
The Company has a $45.0 million Credit Facility, expiring March 31, 1999, to fund the Company's acquisition and working capital needs. The Credit Facility, comprised of a $35.0 million Acquisition Facility and a $10.0 million Working Capital Facility, is collateralized by the common stock of the Company's subsidiaries. The Credit Facility bears interest at a variable rate equal to LIBOR plus a spread between 1.5% and 2.125%, depending upon borrowing levels. At December 31, 1998, $37.8 million aggregate principal was outstanding under the Credit Facility with a current interest rate of approximately 8.04%. The Credit Facility contains affirmative and negative covenants which, among other things, require the Company to maintain certain financial ratios, including minimum fixed charges coverage, funded debt to EBITDA, net worth and current ratio. The Company was not in compliance with certain of these covenants at December 31, 1998. The Company has received an extension on the maturity of the Credit Facility until June 30, 1999 and has received a waiver of the covenant violations as of December 31, 1998.
In May 1997, the Company entered into a LIBOR based interest rate swap agreement ("Swap Agreement") with an affiliate of the Company's primary lender as required by the terms of the Credit Facility. Amounts hedged under the Swap Agreement accrue interest at the difference between 6.42% and the thirty day LIBOR rate and are settled monthly. As of December 31, 1998, approximately 40% of the Company's outstanding principal balance under the Credit Facility was hedged under the Swap Agreement. The Swap Agreement matures in March 1999 and is cancelable at the lender's option after July 1998.
In March 1999 the Company received a commitment for a $30.0 million Line of Credit which will mature on March 31, 2002 to replace the existing Credit Facility. The Line of Credit will be collateralized by the common stock and assets of the Company and its subsidiaries. The Line of Credit will bear interest at a variable rate equal to LIBOR plus a spread between 1.375% and 2.5%, depending upon borrowing levels. The Company is also obligated to a commitment fee of .25% to .5% of the unused portion of the Line of Credit. The Company
will be subject to certain affirmative and negative covenants which, among other things, require the Company to maintain certain financial ratios, including minimum fixed charges coverage, funded debt to EBITDA, net worth and current ratio. The Company is currently in negotiations with respect to the uncommitted portion of the line of credit.
The installment notes payable to affiliated physicians and physician practices were issued as partial consideration for the practice management affiliations. Principal and interest under the long-term notes may, at the election of the holders, be paid in shares of common stock of the Company based on conversion prices ranging from $11.50 to $17.00.
The aggregate maturities of long-term debt at December 31, 1998 are as follows: (In thousands)
NOTE F -- LEASES
The Company leases certain office facilities and equipment under lease agreements with original terms ranging from one to forty years that generally provide for one or more renewal options.
Interest has been imputed on capital leases at rates of 6% to 12%. Accumulated amortization of assets recorded under capital leases totaled $1,595,000 and $1,440,000 at December 31, 1998 and 1997, respectively. Amortization of leased assets is included in depreciation and amortization expense.
Total rental expense under operating leases amounted to $3,527,000, $2,619,000 and $2,361,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Company is generally obligated to the lessors for its proportionate share of operating expenses of the leased premises. At December 31, 1998, future minimum lease payments under capital and operating leases with initial terms of one year or more are as follows:
NOTE G --- INCOME TAXES
The actual tax expense for the years ended December 31, 1998, 1997, and 1996, respectively, differs from the expected tax expense or benefit for those years (computed by applying the federal corporate tax rate of 34% to earnings or loss before income taxes as follows (in thousands):
The components of the actual expense for the years ended 1998, 1997 and 1996 are as follows (in thousands):
The approximate tax effects of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax assets and deferred tax liabilities are as follows (in thousands):
The deferred tax liability of ($7,768,000) is calculated by applying the applicable expected tax rate of 38% to the future taxable amounts resulting from the taxable temporary differences between the assigned value of identifiable net assets (Service Agreements) and their tax basis. A portion of the increase in the deferred tax liability ($696,000) is the result of purchase price adjustments in Service Agreements purchased in 1996.
The valuation allowance for the deferred tax assets as of December 31, 1998 is $2,238,000. Management believes that a valuation allowance is necessary with respect to the impairment of physician practices. This is due to the nature (capital) of a loss currently attributed to one of the three practices. There was no valuation
allowance for December 31, 1997 and 1996. Thus, the net change in the total valuation allowance for the year ended December 31, 1998, was an increase of $2,238,000. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, income taxes paid in prior years eligible to be offset by net operating loss carrybacks, and tax planning strategies in making this assessment. Taxable income for the years ended December 31, 1998, 1997, and 1996, was $1,604,000, $3,962,000, and $0, respectively. In order to fully realize the deferred tax asset, the Company will need to generate future ordinary taxable income of $13,118,000 (after considering taxable income in previous years available for carryback) and future capital gain income of $5,889,000. Based upon the level of historical ordinary taxable income, management believes it is more likely than not the Company will realize the benefits of ordinary deductible differences. However, based upon the historical level of capital gain taxable income, management believes that it is not more likely than not the Company will realize the entire deferred tax asset related to the impaired physician practices.
The amount of income that the Company may offset in future years by the net operating loss carryforwards incurred prior to an ownership change in 1990 will be limited, by the application of the Internal Revenue Code Section 382, to $473,000 annually through the year 2005. The unused portion of the net operating losses may be carried forward and realized in future years subject to this limitation.
As of December 31, 1998, the Company had available tax net operating loss carryforwards totaling $3,471,000, all of which is subject to certain annual limitations discussed above. The use of net operating loss carryforwards, for income tax purposes, is also dependent upon future taxable income.
NOTE H -- COMMON STOCK, CONVERTIBLE PREFERRED STOCK, WARRANTS, AND OPTIONS
Common Stock: The $10 million note payable to Seafield was exchanged for 909,090 shares of common stock during August 1996. At December 31, 1996, Seafield's ownership interest in the Company was approximately 56%. On February 26, 1997, the $23.5 million note payable to Seafield and accrued interest thereon was converted into 3,020,536 shares of the Company's common stock at a rate of $8 per share. The conversion increased Seafield's ownership as of February 26, 1997 to 67%.
The Company also has reserved 2,572,400 shares of its common stock for issuance upon the exercise of options (2,235,000), the conversion of Convertible Preferred Stock (4,900), and the exercise of warrants or conversion of debt issued in the practice affiliations consummated during 1996 (332,500).
Convertible Preferred Stock: The shares of Series A Convertible Preferred Stock have the following rights and restrictions: (a) a preference in the event of liquidation equal to $11.00 per share; (b) the right to convert into the number of shares of common stock equal to the stated value of shares surrendered ($11.00) divided by the conversion price of $60.00 -- subject to certain adjustments; (c) the right to receive dividends in the form of common stock at the rate of .011 share of common stock per annum per share payable annually each year commencing January 15, 1988; (d) the shares are redeemable at the Company's option at $11.00 per share; and (e) holders of the preferred stock will not be entitled to vote.
During the years ended December 31, 1998 and 1996, 602 and 600 shares of Series A Convertible Preferred Stock were converted into 110 and 109 shares of common stock, respectively. As of December 31, 1998, 26,631 Convertible Preferred Stock shares remain outstanding.
In December 1998, 1997, and 1996, the Board of Directors approved a common stock dividend of 293, 306 and 306 shares to the holders of the Series A Convertible Preferred Stock of record as of December 15, 1998, 1997, and 1996, respectively, that was paid January 1999, 1998, and 1997, respectively. The market value of the
common stock distributed was $3,000 at each period. The dividends have been reflected in the "Statement of Operations," and the weighted average number of common shares in the determination of net earnings (loss) to common stockholders and the earnings (loss) per common share calculations. The par value of the common stock distributed was charged to paid-in capital.
Options: The 1985 Stock Option Plan (the "1985 Plan"), as amended in fiscal year 1988, allows for granting of incentive stock options, non qualified stock options, and stock appreciation rights for up to 122,000 shares of common stock to eligible officers and key employees of the Company at an exercise price of not less than the fair market value of the common stock on the date of grant for an incentive stock option and not less than 85% of the fair market value of the common stock on the date of grant for a non qualified stock option. The 1985 Plan expired in 1995; no additional shares are available for grant.
The 1990 Non Qualified Stock Option Plan (the "1990 Plan"), as amended in 1995, allows for the granting of non qualified stock options, up to 1,125,000 options to eligible officers, directors, key employees, and consultants of the Company at an exercise price of not less than the market price of the common stock on the date of grant with an option period up to 10 years.
The 1996 Incentive and Non Qualified Stock Option Plan (the "1996 Plan"), as amended in 1997, allows for the granting of up to 1,130,000 options to eligible officers, directors, advisors, medical directors, consultants, and key employees of the Company at an exercise price of not less than the market price of the common stock on the date of grant with an option period up to 10 years.
A summary status of the 1985 Plan as of December 31, 1998, 1997, and 1996 and changes during the years then ended is presented below:
A summary status of the 1990 Plan as of December 31, 1998, 1997, and 1996 and changes during the years then ended is presented below:
A summary status of the 1996 Plan for the years ended December 31, 1998, 1997 and 1996, and changes during the years then ended is presented below:
The following table summarizes information about fixed stock options outstanding at December 31, 1998:
The Company accounts for stock options in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations (APB 25). As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. On December 31, 1995, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (FAS 123), which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternately, FAS 123 allows entities to continue to apply the provisions of APB 25 and provide pro forma net earnings and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in FAS 123 had been applied. The Company has elected to continue to apply the provisions of APB 25 and provide the pro forma disclosures required by FAS 123.
The per share weighted average fair value of stock options granted during 1998, 1997 and 1996 was $4.47, $6.21 and $12.00 on the date of grant. The fair values were calculated by using the "Black Scholes" option-pricing model with the following average assumptions: 1998 - expected dividend yield of 0%, risk-free interest rate of 5.5%, expected volatility factor of 80% and an expected life of five years; 1997 - expected dividend yield of 0%, risk-free interest rate of 5.5%, expected volatility factor of 80% and an expected life of five years; 1996 - - - expected dividend yield of 0%, risk-free interest rate of 6%, expected volatility factor of 77% and an expected life of five years.
Since the Company applies APB 25 in accounting for its plans, no compensation cost has been recognized for its stock options in the financial statements. Had the Company recorded compensation cost based on the fair value at the grant date for its stock options under FAS 123, the Company's net earnings (loss) and earnings (loss) per common share would have been reduced by the proforma amounts indicated below (in thousands except for per share data):
Pro forma net earnings (loss) reflect only options granted in 1998, 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under FAS 123 is not reflected in the pro forma net earnings (loss) amounts presented above because compensation costs are reflected over the option's vesting period of five years for the 1998, 1997 and 1996 options. Compensation cost for options granted prior to January 1, 1995 is not considered.
NOTE I -- BENEFIT PLAN
The Company established a 401(k) Profit Sharing Plan (the "Plan") which allows qualifying employees electing participation to defer a portion of their income on a pretax basis through contributions to the Plan. For each dollar of employee contributions, the Company makes a discretionary percentage matching contribution to the Plan. In addition, eligible employees share in any additional discretionary contributions which are based upon the profitability of the Company. All contributions made by the Company are determined by the Company's Board of Directors. For the Plan year ended December 31, 1998, the approved matching percentage is twenty-five percent (25%) up to a maximum of $1,250 per employee. The expense recognized for the years ended December 31, 1998, 1997, and 1996 for Company contributions to the Plan totaled $130,000, $120,000 and $113,000, respectively.
NOTE J - PROFESSIONAL AND LIABILITY INSURANCE
With respect to professional and general liability risks, the Company currently maintains an insurance policy that provides coverage during the policy period ending August 1, 1998, on a claims-made basis, for $1,000,000 per claim in excess of the Company retaining $25,000 per claim, and $3,000,000 in the aggregate. Costs of defending claims are in addition to the limit of liability. In addition, the Company maintains a $10,000,000 umbrella policy with respect to potential general liability claims. Since inception, the Company has incurred no professional or general liability losses. As of December 31, 1998 the Company was not aware of any pending professional or general liability claims that would have a material adverse effect on the Company's financial condition or results of operations.
NOTE K - SEGMENT INFORMATION
The Company's reportable segments are strategic business units that offer different services. The Company has three reportable segments: IMPACT Services, Physician Practice Management and Cancer Research Services. The IMPACT Services segment provides stem cell supported high-dose chemotherapy and other advanced cancer treatment services under the direction of practicing oncologists. The Physician Practice Management segment owns the assets of and manages oncology practices. The Cancer Research Services segment conducts clinical cancer research on behalf of pharmaceutical manufacturers.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies except that the Company does not allocate interest expense, taxes or corporate overhead to
the individual segments. The Company evaluates performance based on profit or loss from operations before income taxes and unallocated amounts. The totals per the schedules below will not and should not agree to the consolidated totals. The difference should be due to corporate overhead and other unallocated amounts which are reflected in the reconciliation to consolidated earnings (loss) before income taxes.
(In thousands)
Reconciliation of profit (loss):
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS RESPONSE ONCOLOGY, INC. AND SUBSIDIARIES (Dollar amounts in thousands)
(1) Accounts written off, net of recoveries.